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A fund of changes for financial services
March, 02nd 2007

There are no major amendments or changes relating to direct or indirect tax affecting the financial services industry. The overall increase in corporate tax rates would apply to this industry too. The changes that have a bearing on this industry are:

Provision of bad and doubtful debt for the banking industry is allowed under Section 36(1)(viia) subject to 7 1/2 per cent of total income and not exceeding 10 per cent of the aggregate advances made by the rural branches.

One of the players left out for the deduction is scheduled co-operative banks that are also not entitled to Section 80P of the Income-Tax Act (the Act) which was withdrawn. By the amendment effective assessment year 2007-2008, they will now be part of the benefit more so since they are not entitled to Section 80P of the Act. Correspondingly, the benefit of Section 43D taxing income on sticky advances on receipt basis will also be available to scheduled cooperative banks.

Long-term finance for industrial and agricultural development and housing finance companies are entitled to deduction under Section 36(1)(viii) of the Act. This deduction is now reduced from 40 per cent to 20 per cent of the profits of the business subject to an overall limit of twice the paid-up capital and reserves.

While the amendment provides for claiming the uncovered balance in the succeeding years, there would be an immediate outflow of tax arising from the lower deduction.

Secondly, the definition of financial entities has been expanded to include co-operative banks providing long-term finance for industrial purposes. Housing finance companies would definitely feel the heat of larger tax outflow on profits.

Medical insurance premium is subject to deduction under Section 80D up to Rs10,000. There are practical problems where payments are made through credit card or any other form.

This hurdle has been overcome and the proposed amendment makes it clear that except for cash payments, all other mode of payments would be entitled for the deduction. The monetary limit for has been raised to Rs 15,000 and in the of a case of senior citizens to Rs 20,000.

The leasing industry had been clamouring for withdrawal of TDS (tax deducted at source) on lease rentals for use of plant and machinery. Section 194I of the Act requires 20 per cent TDS on lease rentals payable by corporates to leasing companies. The margin on a leasing transaction at the maximum is 2 per cent. The only concession shown in the Finance Bill 2007-08 is that the TDS rate has been reduced for leasing of plant and machinery from 15 per cent to 10 per cent.

This is hardly any respite from a hefty TDS rate with companies queuing up before the Assessing officers seeking permission for a lower TDS rate on rentals.

TDS on interest on deposits in governed by Section 194A of the Act and the annual limit for interest without TDS currently is Rs 5000. Effective June 1, 2007, this limit is proposed to be enhanced to Rs 10,000 and will apply for banks, co-operative societies engaged in banking and post-office schemes.

Unfortunately, in the case of deposits placed with NBFCs (non-banking financial companies) the erstwhile limit of Rs 5,000 would continue and with banks hiking the rate of interest on deposits, this differential tax treatment would make bank deposits more attractive.

Hire purchase and leasing transactions got a relief from service tax last year to the extent of 90 per cent of the interest earned on such transactions. By TRU instruction No 334/1/2007 the term financial leases have been defined elaborately to cover various types of contracts and transactions.

The clarification requires all sale and lease-back transactions to be examined carefully at a time when leasing as a product is losing its importance and sale and lease back is virtually non-existent today.

The general insurance industry has got some relief from service tax in respect of availment of input credit. The existing position is that the service provider can only utilise 20 per cent of the amount of CENVAT credit for payment of service tax on the taxable output service. With effect from April 1, 2007, general insurance service providers will be allowed CENVAT credit attributable to inputs and input services used in providing taxable services and setoff the same against taxable output service subject to certain conditions. This has to a large extent alleviated the hardship of the industry on getting only a limited set off of the CENVAT credit.

Mutual funds are convenient parking places for the short-term of money that would otherwise idle in current accounts with banks. Dividends from these money/liquid mutual funds are now exigible to dividend distribution tax at and effective rate of 14.025 per cent if the recipient is an individual or HUF and 22.44 per cent if the recipient is a company. Effective April 1, 2007, the distribution tax is hiked to an effective rate of 28.325 per cent. One is not sure whether this would channel these funds back to the banking sector. In any event this move will be dampener on promoting money/liquid funds.

R. Anand
(The author is Partner, Global Tax Advisory Services, Ernst & Young.)

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