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Indian Budget Increases Investment Taxes

by Lorys Charalambous,, Cyprus

02 March 2007

Indian Finance Minister Palaniappan Chidambaram's 2007 budget received a largely negative response from the corporate and investment sector on Wednesday as he chose to focus his attention on increasing support for agriculture, infrastructure development, education and poverty alleviation, while increasing taxes on investment.

Under Chidambaram's measures, dividend distribution tax has been hiked from 12.5% to 15%, money market mutual funds and liquid mutual funds will attract a 25% dividend distribution tax, and the scope of Fringe Benefit Tax has been expanded to include employees stock option plan. Chidambaram also proposed am additional levy of 1% on all taxes to fund secondary and higher education.

While the Service Tax rate has been left untouched, new services have been brought into the taxable fold. They include services outsourced for mining of minerals, oil or gas, asset management and design services, development and supply of content for use in telecom and advertising purposes and renting of immovable property for commercial purpose. The Finance Minister also raised the exemption limit for small service providers from R400,00 to R800,000. All services provided by technology business incubators and clinical trial of new drugs have been exempted from service tax net.

With regards to the capital market, the Finance Minister said Indian companies will be permitted to issue exchangeable bonds to unlock a part of their holdings in group companies. Mutual funds will also be permitted to launch dedicated infrastructure funds to promote flow of funds into the infrastructure sector.

With the Commonwealth Games due to be held in India in 2010, Chidambaram proposed to give a five-year tax holiday to two, three and four-star hotels in the national capital territory of Delhi. Convention centres with a sitting capacity of not less than 3,000 will also get a tax holiday if they are completed and begin operation between April 2007 and March 2010.

On the direct tax front, there is no change in the tax rate. However, the threshold limit for income tax payers has been increased by R10,000, giving every tax payer a relief of R1,000. Companies with a taxable income of R10 million or less will not have to pay surcharge on income tax. Companies providing cross country natural gas distribution network, including gas pipeline and storage facilities will be entitled to tax concession. Chidambaram also announced that tax-free bonds will be issued through State Pooled Finance Entities to facilitate creation of urban infrastructure.

On excise duty the Finance Minister has brought down the ad valorem component from 8% to 6% on petrol and diesel. Duties on most chemicals and plastics have been reduced from 12.5% to 7.5% and customs duty on polyester fibers and yarn has also been reduced from 10% to 7.5%. The gem and jewellery industry gets relief with duty on cut and polished diamonds reduced from 5% to 3%. Dredgers have been fully exempted from import duty. Duty on drip irrigation systems, agricultural sprinklers and food processing machinery have been reduced by 2.5%. Additional countervailing duty of 4% has been completely lifted from crude and refined edible oils.

To increase the economic viability of the agricultural sector, certain farmers will be brought into the banking system next year. The Finance Minister also promised capital grant or concessional financing to double the production of certified seeds for pulses. He also proposed a financial mechanism for coffee, rubber, spices, cashew and coconut in line with a Special Purpose Tea Fund which has already been launched. The allocation under accelerated irrigation benefit programme has also been increased.

Chidamabaram said the direct tax proposals will yield R30 billion (US$681 million) more while the indirect tax proposals are revenue neutral.

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