With the economy grappling with diminishing private investment, dwindling exports and a declining savings rate, the Finance Minister was faced with the unenviable task of inspiring investment while keeping an eye on elections due in 2014. Simultaneously, in the backdrop of rising tax controversies, the corporate sector was hopeful of certain positive measures to provide certainty and fairness in the tax system, restore taxpayer confidence and fast-track the dispute resolution process.
The Budget does spell out some positive measures such as formation of Tax Administration Reform Commission, implementation of Rangachary Committee recommendations on Development Centres and Safe Harbour rules, and continued commitment to bring in the Direct Taxes code and the Goods and Service Tax. Incentive for the manufacturing sector in the form of an investment allowance of 15 per cent over and above the depreciation for new plant and machinery exceeding Rs 100 crore is a welcome move. Continuation of concessional tax rate on dividends received by Indian companies from a foreign subsidiary coupled with removal of dividend distribution tax on further declaration of such dividend should promote repatriation of funds to India.
The question remains: Is that enough? Clearly the Budget announcements do not seem to address a lot of expectations from the corporate sector, given the Finance Minister’s statement of a stable and non-adversarial tax regime. Several direct tax proposals seem to be an attempt to increase the tax-GDP ratio by augmenting tax revenues. The imposition of surcharge on the super-rich, increase in surcharge for the corporate sector, imposition of Commodities Transaction Tax on non-agri commodities and unchanged personal income tax slab rates are some such measures. The tax credit relief of Rs 2,000 for income up to Rs 5 lakh may provide little or no relief to the middle class, which constitutes a large segment of the taxpaying population.
A sharp increase, from 10 per cent to 25 per cent, in the tax rates of royalty and fee for technical services (FTS) received by non-residents seems unjustified, given that over a period of time the rate has been gradually reduced from 30 per cent to 10 per cent in the domestic law. In fact, the recently concluded tax treaties (such as Columbia, Uruguay, Ethiopia) contain a 10 per cent tax rate, and most of the other treaties that India has entered into prescribe rates of 10-20 per cent. Moreover, this would adversely impact transactions with non-treaty countries such as like Hong Kong, especially where contractual arrangements are on ‘net of tax’ basis. This rate even exceeds the 20 per cent proposed in DTC.
Share buyback arrangements have been brought under the tax net with the imposition of 20 per cent tax on profits distributed to shareholders. This tax, on similar lines as DDT, is applicable to all unlisted companies. The Memorandum to the Finance Bill seeks to justify this proposal as a measure to curb tax avoidance on the ground that unlisted companies are resorting to share buyback instead of dividend payment to avoid DDT, especially where the capital gains for shareholders are either not chargeable to tax or are taxable at a lower rate.
Interestingly, the Authority for Advance Rulings had, in a recent case, questioned a buyback scheme as a tool of tax avoidance and re-characterised the income arising to the shareholder as dividend income. While that ruling was based on specific facts, the Budget proposals have taken an extreme view by extending the ‘tax avoidant’ inference to all buyback schemes, which are a well-recognised method of returning excess capital to shareholders
Navigating the choppy waters of a strained economy, whose attractiveness was questioned due to tax and regulatory uncertainties, is no easy task. The Budget proposals reflect the Finance Minister’s resolve to bring India back on the path of inclusive and sustainable development.
While the announcements on legislative reforms such as the DTC and GST are steps in the right direction, the loud silence on retrospective amendments leaves the corporate sector asking for more.