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Budget Overview - Indian Budget


By Tax-News.com Editorial
March 20, 2012


The general consensus among business groups and tax experts is that Finance Minister Pranab Mukherjee has delivered a pragmatic and balanced budget, but perhaps not the bold one that some argue is required to reverse falling rates of economic growth.

Inevitably, there are winners and losers as a result of the Union Budget 2012/13. Individual taxpayers will benefit from a lifting of the threshold at which the lower and top rates of tax kick in; corporate investors have welcomed measures to prevent the 'cascading' of Dividend Distribution Tax, reduce the security transactions tax, lower certain withholding taxes and extend research and development tax deductions; and the energy sector has welcomed tax breaks for thermal energy generation and customs duty relief on the import of coal and gas. On the other hand, the retail and property sector has lamented the 2% rise in Service Tax, as well as the 2% increase in the general excise tax rate; infrastructure investors are disappointed in the lack of new incentives for much-needed investment in capital stock; the shipping industry, while benefiting from a reversal of last year's announcement that customs duty must be paid on ships, is frustrated that no direct incentives materialised in the budget; and the renewable energy sector has complained that production incentives don't go nearly far enough to incentivize clean energy generation.

Gross domestic product growth is expected to slow to 6.9% in 2011/12 - a problem that most governments in the West would be delighted to have! However, in view of the fact that economic growth was running at almost 8.5% per year in the preceding two years, some sections of India's industrial and commercial sector are becoming a little nervous, and wished that the government had been more aggressive at targeting tax measures towards growth.

"There has been no revival of investment allowance, no restoration of tax exemption on dividend income or capital gains for infrastructure capital fund / company and no hike in depreciation rate. These had been expected as fiscal steps for improving investment," the Federation of Indian Chambers of Commerce and Industry (FICCI) noted in its reaction to the Budget. "However, the reduction in withholding tax on interest payable on External Commercial Borrowings (ECBs) in certain sectors and extension of concessional tax treatment on the repatriation of overseas dividends, are indeed welcome features. The raising of the ECB limit for infrastructure sector will also encourage investment in the sector. Growth impulse could be dampened by the 2% hike in excise duty and service tax. These hikes are expected to add to inflationary pressure and would work against budget expectations of lower inflation."

A commitment by the government to examine the possibility of raising the participation threshold for foreign investors in large retail concerns to 51% has been welcomed. However, there was generally disappointment that Mukherjee failed to announce a relaxation of restrictions to foreign investment in certain other key industries, like aviation. The airline industry will, however, be permitted to borrow more from overseas for capital investment.

Nevertheless, like most of the world's developed economies, the Indian government has a wide budget deficit which it is struggling to close, estimated at 5.9% of GDP for 2011/12. Having acknowledged further "slippage" in its finances after a deterioration of direct tax revenue and an increase in subsidies, the government was required to tread a fine line between encouraging growth and generating new revenue. Therefore, on the revenue side of the equation, some important changes are on the way largely as a result of the outcome of the high-profile Vodafone-Essar tax case which was settled in favour of the telecoms giant earlier this year.

The Vodafone case centred on the UK mobile telecoms company's USD11.2bn purchase of a 67% stake in India's Hutchison Essar Ltd in 2007, which was structured as a transaction between Vodafone's Dutch subsidiary and a Cayman Islands-based company that held Hutchison Whampoa's Indian assets. The Indian Tax Office argued that Vodafone was liable to be taxed because the majority of assets were based in India, and that under Indian law, buyers have to withhold capital gains tax. Vodafone, however, contended that as it was the purchaser, not the seller, it made no taxable gain from the transaction.

With USD2.2bn in revenue at stake in the Vodafone case, the Indian government was understandably keen to fight the case all the way to the highest court, and it came as no surprise therefore that the Mukherjee announced the introduction of a general anti-avoidance rule (GAAR) in last week's Budget in order to counter aggressive tax avoidance schemes. Under the GAAR, a 'commercial substance' test will be introduced, and the onus will be on the taxpayer to prove that a transaction's sole purpose is not to obtain a tax benefit. It is thought that with the introduction of the GAAR, structured transactions along the lines of Vodafone/Hutchinson - and there are many similar cases currently being contested in India's courts - could be a thing of the past. Foreign investors and tax advisors will therefore scrutinize how the Indian tax authorities apply the GAAR in practice, for this could have a substantial effect on how investors structure their investments into India.

Further uncertainty continues to cloud the outlook for taxpayers in India with the government refusing to commit to a date for the already delayed introduction of Direct Taxes, Mukerjee informing listeners that it will be implemented "at the earliest" opportunity. The DTC will replace the existing Income Tax Act, 1961 (ITA) and integrate all direct tax laws under a single piece of legislation. However, as is often the case in India, the DTC Bill has been subject to many delays, changes and u-turns. Introduced in parliament in 2010, it was tentatively scheduled to come into force in April 2012, one year later than originally planned. The legislation did not receive the Parliamentary Standing Committee's report into the proposals until March 9 and as a result the government must examine the Committee's recommendations before taking steps to enact the DTC. It is highly unlikely though, that the DTC will become effective this year.

The DTC is designed to streamline the income tax system and lighten the tax burden on individuals and companies. Corporate income tax is proposed at the rate of 30%, with the existing 5% surcharge, and 3% educational 'cess' or surcharge to be abolished. This rate would also apply to non-resident businesses which currently pay corporate income tax at 42%, although it is expected that they will also have to pay branch profits tax at 15%.

Also alluded to by Mukherjee was the government's timetable for the introduction of the GST. He reminded listeners that the Constitution Amendment Bill, legislation he says is a preparatory step in the implementation of the GST, was introduced this month, and currently sits before the same Committee. The government is therefore awaiting the Committee's recommendations, and is in the meantime drafting model legislation for the GST in conjunction with the State governments.

To date, the structure of the GST Network (GSTN) has been approved by the Empowered Committee of State Finance Ministers. The Network will be set up as a National Information Utility and will become operational by August, 2012, Mukherjee said. As he explained, the GSTN will implement common permanent account number (PAN)-based registration, returns filing and payments processing for all States on a shared platform. According to Mukherjee, "the use of PAN as a common identifier in both direct and indirect taxes, will enhance transparency and check tax evasion".

Under the GST reforms, the indirect tax regime will be replaced by a comprehensive dual GST with Central GST and State GST to be levied concurrently by the Centre (federal government) and the States. It would replace existing levies such as central sales tax, state sales tax, entertainment tax, lottery tax, electricity duty, stamp duty and value-added tax. The tax will be collected on goods and services at each stage of sale or purchase in the supply chain, and there will be a tax credit mechanism set in place. The end consumer, as the last person in the supply chain, will bear the final tax. The rate of GST is expected to be around 14-16%. Currently, services are taxed at 10% (notched up to 12% in the 2012/13 Budget) and the combined charge of indirect tax on most goods has traditionally been around 20%.

Stiff opposition from a core group of state governments, who fear that they will lose out in revenue terms under the centralised GST system, has meant that this important reform has also been subject to delay. Mukherjee informed parliament that GSTN will be set up as a National Information Utility and will become operational by August 2012, although it is not clear when the tax itself will become effective.

Concluding his Budget speech, Mukherjee said: "For the Indian economy, this was a challenging year. A number of global and domestic factors militated against the growth that had revived in the last two years. But India has thrived under challenges and India will do so now. In the middle of every crisis, there is also an opportunity. It is an opportunity to rethink, re-assess and make way for new ideas and policies. It is in this spirit that I approached the Budget of this year."

Some of the major Budget highlights are as follows:

  • No changes will be introduced to corporate tax rates.
  • The exemption limit for the general category of individual taxpayers will rise from INR180,000 (USD3,600) to INR2m. Upper limit of the 20% tax 'slab' increased from INR800,000 to INR1m.
  • Withholding tax on interest payments on external commercial borrowings reduced from 20% to 5% for three years. The cut will apply to the power, airlines, roads and bridges, ports and shipyards, affordable housing, fertilizer and dams sectors.
  • Restrictions on Venture Capital Funds in nine specific areas removed.
  • Dividend Distribution Tax payable by a holding company to be reduced by DDT paid by subsidiary to reduce the cascading effect of the tax in a multi-tier corporate structure;
  • The repatriation of dividends from foreign subsidiaries will continue to be taxed at a lower rate of 15% for an additional year, to March 31, 2013;
  • An enhanced rate of 150% will be applied to the investment-linked deduction of capital expenditure incurred in certain businesses. The businesses affected will be cold chain facilities, warehouses for the storage of food grains, hospitals, fertilisers, and affordable housing. A series of new eligible sectors will also be introduced.
  • The weighted deduction of 200% for research and development (R&D) expenditure in an in-house facility will be extended beyond March 31, 2012, for a further five years.
  • Small and medium-sized enterprises (SMEs) will benefit from a higher turnover limit for compulsory tax audits and presumptive taxation.
  • Capital gains tax will be lifted on the sale of residential properties, where the sale is used for the subscription of equity in a manufacturing SME for the purpose of purchasing new plant and machinery.;
  • The Securities Transactions Tax (STT) will be reduced by 20%, from 0.125% to 0.1% on cash delivery transactions.
  • The Alternate Minimum Tax (AMT) will be extended to all persons claiming profit-linked deductions. At present, it is applied only to companies.
  • A General Anti Avoidance Rule (GAAR) will be introduced, with the aim of countering aggressive tax avoidance schemes. A GAAR panel will be set up, to ensure that the rule is used only in "appropriate cases". A series of measures will also be introduced to deter the generation and use of 'unaccounted money'. These will include the introduction of compulsory reporting in the case of assets held abroad, and the reopening of certain assessment cases.
  • Tax collection at source will be imposed in various cases, including the purchase in cash of bullion or jewellery in excess of INR200,000, and the transfer of immovable property (other than agricultural land) above a specified threshold. Tax collection at source will also take place in the trading of coal, lignite and iron ore.
  • "Unexplained" money, credits, investments, expenditures, etc., will be taxed at the highest rate of 30%, irrespective of income level.
  • All services, barring those in the "negative list", will be taxed. The list comprises most services provided by the government or local authorities, along with aspects of the education and public transportation systems. A further list of exemptions has also been created, which includes health care, charitable services, religious and sportspersons, performing artists, and independent journalists. Certain construction services will also be exempted.


 

Tags: commerce | tax | economics | budget | business

 

 

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