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Tax policy plays a vital role in economic stimulus activities
May, 11th 2009

As the world economy seeks firm footing amid the first true global recession since World War II, more and more countries are turning to discretionary fiscal stimulus to boost overall demand and restart the flow of credit to companies. And, while spending measures have received more mainstream attention over the last few months, tax measures actually represent 56% of the net effect of fiscal stimulus, according to a recent OECD report. In its recent study - Worldwide fiscal stimulus tax policy plays a major role, , Ernst & Young examines these tax-related fiscal stimulus measures in 24 key jurisdictions (Countries covered by this study are: Argentina, Australia, Belgium, Brazil, Canada, China, The Czech Republic, European Union, France, Germany, Hong Kong, Hungary, India, Ireland, Italy, Japan, Netherlands, Russia, Singapore, South Korea, Switzerland, Taiwan, Turkey, United Kingdom and United States), including India, and identifies themes that are emerging as governments increasingly rely on their tax systems to administer fiscal stimulus.

"In an increasingly global and interconnected business arena, stimulus-driven tax measures are being adopted in at least one and likely many of the jurisdictions in which a multinational corporation operates. Companies have to be aware of these developments and understand their implications to prepare properly for their impact," says Mark Weinberger, Global Tax Leader at Ernst & Young.

Though the approach has varied from country to country, Ernst & Youngs study illustrates that many countries have focused their tax-based fiscal stimulus efforts on similar types of activities.

Types of tax based fiscal stimulus efforts:

Accelerated depreciation programs to improve cash flow for businesses by allowing them to write off the costs of investments more rapidly (adopted by countries such as India, Australia, Canada, The Czech Republic, France, Germany, Ireland, Netherlands, Russia, Singapore and United States). to improve cash flow for businesses by allowing them to write off the costs of investments more rapidly (adopted by countries such as India, Australia, Canada, The Czech Republic, France, Germany, Ireland, Netherlands, Russia, Singapore and United States).

Carryforward and carryback provisions to provide cash flow assistance by giving traditionally profitable companies more latitude in using net operating loss credits they are accumulating in the current difficult environment (adopted by countries such as Australia (proposed), France, Japan, Singapore, S Korea, Taiwan, United Kingdom and United States). to provide cash flow assistance by giving traditionally profitable companies more latitude in using net operating loss credits they are accumulating in the current difficult environment (adopted by countries such as Australia (proposed), France, Japan, Singapore, S Korea, Taiwan, United Kingdom and United States).

Reductions in corporate income tax rates to improve cash flow, stimulate overall demand and encourage investment, as well as to be more attractive in the international competition for jobs and investment (adopted by countries such as Canada, The Czech Republic, Italy, Japan, Netherlands, Russia, Singapore, S Korea and Taiwan). to improve cash flow, stimulate overall demand and encourage investment, as well as to be more attractive in the international competition for jobs and investment (adopted by countries such as Canada, The Czech Republic, Italy, Japan, Netherlands, Russia, Singapore, S Korea and Taiwan).

Enhancements to the research and development tax credit to provide added incentive for companies to maintain their investment in innovation, and to attract new R&D activity, despite current economic challenges (adopted by countries such as Australia (proposed), Belgium, Canada, France, Ireland, Italy, Russia, Singapore and S Korea). to provide added incentive for companies to maintain their investment in innovation, and to attract new R&D activity, despite current economic challenges (adopted by countries such as Australia (proposed), Belgium, Canada, France, Ireland, Italy, Russia, Singapore and S Korea).
Indirect tax changes to maintain demand by reducing the costs of goods and services (adopted by countries such as India, Australia, Belgium, Brazil, Canada, China, The Czech Republic, France, Hong Kong, Hungary, Ireland, Netherlands, Russia, Switzerland and United Kingdom). to maintain demand by reducing the costs of goods and services (adopted by countries such as India, Australia, Belgium, Brazil, Canada, China, The Czech Republic, France, Hong Kong, Hungary, Ireland, Netherlands, Russia, Switzerland and United Kingdom).

Personal income tax measures to increase overall demand by increasing after-tax pay, particularly for lower and middle income taxpayers (adopted by countries such as Argentina, Australia, Brazil, The Czech Republic, Hungary, Russia, S Korea, Switzerland, Taiwan and United States).
Among the significant emerging trends, the study points out that some of the recently instituted tax-based fiscal stimulus measures are permanent, but many are temporary. Also, in many cases, the new measures favor certain types of activity, with manufacturing, technology, energy efficiency and transportation among commonly targeted categories. In some cases, more generous support is offered for small- and medium-sized enterprises, which generally have been hit hardest by current economic challenges. Along the same lines, the majority of personal income tax measures have focused on lower- and middle-income earners.

"Every countrys actions are dictated by their own specific needs, budgetary reality and political climate, so while they generally share the same goal boosting demand and improving cash flow their approaches can vary significantly, even on similar issues. So, before making any investments or other business decisions based on opportunities stemming from fiscal stimulus efforts, companies really have to be aware of all the variables," says Mark Weinberger.

Another key factor to consider, Weinberger says, is that many governments are already contending with ballooning deficits and sharply falling tax revenues, even as they launch aggressive spending and tax-based fiscal stimulus programs. "Government activities to date have necessarily focused on addressing urgent economic needs, but companies must recognize that these same governments will soon have to find a way to pay for the tax relief and other stimulus they are providing."

For example, in its recent budget announcement, the United Kingdom presented a series of significant income tax increases geared toward high earners, signaling an increased focus on reducing their budget deficit. Hungary, which has generally taken a more conservative approach to fiscal stimulus due to budget challenges, is preparing to increase its value-added tax from 20% to 25%, while also introducing a series of personal income tax rate reductions as it shifts its focus toward taxing consumption more heavily than income.

"In the fiscal stimulus packages announced in phases from December 2008 to March 2009, by the Indian government, India seems to have concentrated on indirect tax cuts, accompanied by increased government spending and some measure of accelerated depreciation provision policies" says Satya Poddar, Partner, Tax policy services, Ernst & Young, India.

He further added, "The depreciation rates in India are very restrictive. Government could have used this opportunity to loosen or increase the depreciation rate, which could have provided needed stimulus to the economy."

"In several countries, a lot emphasis was laid on infrastructure tax system and promoting green energy. Government could have provided additional tax incentive to equipment and technology used in promoting green energy. Energy investments could have lead to not only new jobs and growth, but also spur technological innovation and energy independence for India," emphasized Mr. Poddar

"The new government would do well to introduce measures such as providing for carry back of losses, possible reduction in corporate and personal tax rates perhaps by doing away with surcharge, accelerated bonus depreciation for new plant and machinery, among others. Such measures, will accelerate investments and boost productivity and employment," opines Satya Poddar.

While, we have in the past seen tax policy measures such as streamlining of tax rates, increase tax depreciation, tax holidays for backward areas or sun-rise sectors, progressive measures must also be introduced. One such measure could be providing for carry back of losses, adds Satya Poddar.

Currently in India, unutilized business losses can be carried forward for a period of eight years to be set-off against future business income. There is no provision for carry back of such business losses to be set-off against the profits of the earlier years.

In this environment, many companies including many that traditionally have been very profitable are posting much lower profits or even losses. To provide cash flow assistance to companies in a tax loss position, many countries have instituted or enhanced, provisions relating to the treatment of business losses.

In some countries, the eligible carry forward period has been enhanced (eg: S. Korea from five to ten years). Other countries have introduced new carry back provisions or raised the cap on existing ones, albeit with certain conditions attached (eg: UK has increased the carry back period from one year to three years, but it is subject to a cap of GBP 50,000 on the total amount that can be set off against profits of the earlier two years).

"Permitting Indian companies to carry back business losses will help them to optimize their cash flows," explains Satya Poddar.

"Many opportunities arise from the rate reductions, appealing incentive programs and other stimulus measures that are being liberally offered in many countries around the world. However, these benefits also are contributing significantly to the challenges that governments will face in the future and will likely result in less favorable developments down the road," says Chris Sanger, Ernst & Youngs Global Head of Tax Policy. Ernst & Youngs study highlights several things that companies can focus on to improve their ability to benefit from opportunities, while managing the difficulties associated with challenges to come, including: managing their cash effectively, participating only in incentive programs that support overall business goals, improving communications and overall relationships with authorities and actively monitoring and participating in the tax policy development process. "Successful tax directors will look ahead rather than just file returns for the past," Chris states.

Similarly, Mark Weinberger stresses that tax policy developments will not end with the actions detailed in this study. "These are not likely to be the last stimulus efforts we will see before the global economy fully recovers. And, as governments prepare for their next round of actions, they will look to the experiences of their neighbors, both the positive and the negative, in determining their approach. These future policy choices in the tax arena will have a major impact on companies activities and the returns they can expect on investments across the globe," he concludes.

 
 
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