In the last couple of years, India’s sound macro-economic fundamentals supported by strong, constructive government policies, benign global commodity prices, RBI’s focus on curbing inflation and a bountiful monsoon have helped India to be the fastest growing major economy in the world. As the Economic Survey for 2015-16 stated, amidst a gloomy economic landscape,India stands out as a haven of stability and an outpost of opportunity. However, as the Finance Minister prepares to present his fourth Budget this term,he would have to contend with some short term turbulence in the comfortable zone that India has been in.
The government’s decision to invalidate old high-value currency notes is guided by the good intent to check the growth of the parallel economy and bring the informal,rural, and cash-based segments of the economy in to the fold of formal economy. Though the move will be beneficial for the Indian economy in the long run, at the current juncture when the private investment is already weak, the demonetisation shock will have a negative short-term impact on GDP growth. The contractionary effect of the cash crunch would significantly affect the growth outcomes of the third and the fourth quarters of this financial year.
To counterbalance these adverse developments, the Finance Minister will need to undertake some regulatory and fiscal stimulus measures that will create a ‘feel good’ effect, spur demand in the economy and incentivise investments, thus reinstating confidence in the economy. The tax buoyancy after the demonetisation and the Income Declaration Scheme should provide the desired fiscal space to reduce the burden on tax payers without compromising on the objective of improving the tax-GDP ratio. The lower tax burden coupled with the implementation of GST backed by robust IT infrastructure would also be instrumental in improving tax compliance in India.
To provide more disposable income in the hands of the individual taxpayers, the basic exemption limit of Rs 2.5lakhs should be revised upwards to Rs 5 lakhs. The tax rate for taxpayers in the income bracket of Rs 5 lakhs to Rs 10 lakhs should be reduced from the current 20 percent to 10 per cent. A reduction in the tax burden will help push consumption and demand by putting more money in the hands of the taxpayers, particularly in the lower and middle income groups.
Currently, the tax burden on the Indian corporate sector is one of the highest in the world, with the applicability of the Minimum Alternative Tax (MAT) at 18.5 percent and the Dividend Distribution Tax (DDT) at 20.36per cent adding to the already high corporate income tax rate of 34.6 per cent. More and more countries are moving to a low tax regime to attract investments. The United Kingdom proposes to reduce its corporate tax rate of 20 per cent to 17 per cent in the next four years.The US President-elect has announced a cut in the corporate tax rate by half to 15 per cent. Even the competing jurisdictions such as Vietnam, Thailand and Philippinesare aiming to reduce the corporate tax rates.India, too, needs a lower, more competitive tax rate otherwise the businesses in India could be lured back to the US or diverted to their jurisdictions. The FM has promised a reduction in the corporate income tax rate to 25 per cent by the year 2019, to be accompanied by the withdrawal of incentives. The Government has already withdrawn some of the incentives and laid down the road map for phasing out the remaining ones. It is now time that a reduction in the corporate tax rate be announced, in line with the global trend.
Over the past months, the Government undertook many positive tax reforms to bring consistency and coherence in tax policy. Significant clarifications were issued to bring clarity and certainty in taxation and steps are being taken to improve ease of compliance and improve dispute resolution.
To bring in greater tax certainty, the Government should issue the guidelines for implementation of GAAR at the earliest. The guidelines should include additional examples to provide clarity on where GAAR should or should not be invoked. The guidelines should also clearly highlight that GAAR is not to be invoked if SAAR applies and that it should not override a treaty. Similarly, the draft guiding principles issued in January 2016 for determination of Place of Effective Management (POEM) should be finalised and made public. Ideally, the POEM provisions should be made effective from the next financial year, after the final guidelines are known and understood by all. In case POEM is applied to consider a foreign company a resident, the same should be referred to as a specialised panel, as in the case of GAAR.
In the interest of improving ease of doing business, the government must consider withdrawing the IncomeComputation and Disclosure Standards (ICDS). Tax payers are already grappling with changes like the CompaniesAct and GST and there is scope for litigation on many aspects of ICDS. It merely results in issues such asmultiplicity of accounting methods, increased compliance burden of multiple records etc., which out weighits benefits. ICDS at best brings timing differences between accounting and taxable income.
Another provision that is prone to many disputes and needs a review is dis allowance under Section 14A. Incomewhich is subject to distribution tax, for instance dividends, and subsequently exempted in hands of therecipient should be excluded from the scope of section14A of the Act. Similarly, amendment to Section 72A ofthe Act to allow benefits of carry forward of losses, pursuant to amalgamation, to all companies irrespective oftheir line of business, especially service businesses will provide much relief.
Many competing jurisdictions including Malaysia, China,Indonesia, Brazil, Vietnam and Singapore provide incentives to MNCs to set-up global research and development(R&D) hubs in their territories. The position of the Indian administration, unfortunately, is not very clear. By dissuading companies from moving high value a dded work to India, Circular 6 acts as a barrier to India developing as an innovation hub. The allegation of PE in case of secondment of expatriates by MNE groups to their Indian subsidiaries dissuades the relocation oftheir key decision makers to India. To encourage investment in R&D space, Circular 6 should be modified to qualify a R&D center as a Contract R&D center and permit it to earn a return on a cost plus basis even if the Centre undertakes an economically significant function(such as conceptualization and design of the product),gets involved in strategic control and direction of the development or undertakes ‘end-to-end’ R&D. Secondment cases should be looked at liberally to not allege PE merely because of the presence of expatriates in India,if such expatriates work under the supervision and control of India business.
Another significant dimension that needs attention is the improvement in the current dispute resolution mechanisms. The government has taken many positive steps in this direction, but further measures are needed to bring about a perceptive change. For instance, 108Advance Pricing Agreements (APAs) have been signed since 2013-14. However, on the bilateral APA front, the absence of Article 9(2) in the tax treaties of some ofthe countries causes artificial barriers as India does not permit transfer pricing dispute resolution through MutualAgreement Procedures (MAP) and bilateral APAs,which otherwise is a global practice. These artificialbarriers should be done away with to make it easier for companies resident in countries like Germany, France,Singapore, Italy and South Korea to access the bilateral APA forum.
Safe Harbour has also not been able to pick up as expected because of the high margins prescribed. The Government should keep more realistic margins in line with the margins agreed under the APA programme.Moreover, the dichotomy created by prescribing two safe harbour margins for software development and IT enabled service i.e., 20 per cent where transaction value does not exceed Rs. 500 crores and 22 per cent where transaction value exceeds Rs. 500 crores, must be removed.The mechanisms of the Authority for Advance Ruling and Dispute Resolution Panels need to be made more effective by increasing the number of benches and providing strict timelines for disposal of cases.
No other reform has been as awaited by the industry as the Goods and Services Tax (GST). At the time of writing this article, there was still a stalemate between the Centre and the States over dual control under GST. The industry hopes that these issues will be resolved at the earliest for timely implementation of GST. In the meanwhile,certain provisions of the Model GST Law must be reviewed. Service sectors such as banking, insurance,telecom, consulting, airlines etc., which have PAN India operations, and e-commerce companies having avirtual presence in every State without being physically present will be seriously affected by the requirement ofState wise multiple registrations. A single centralised registration should therefore replace the requirement of multiple registrations for such service providers.
Refunds under the Model GST Law are provided only in the case of exports and inverted duty structure. Delay in refunds seriously impacts the working capital flow and the cost of doing business. In line with international best practices, any form of excess credit should be promptly refunded. The draft GST law is absolutely silent on manner of grandfathering the existing area based exemptions granted to the units under the Excise laws. A clear provision needs to be laid down so that the interest of the existing manufacturers is not prejudicially affected. The transitory provisions should also clarify how the input credit of the central excise duty(CGST) shall be taken by the trader in the absence of documents evidencing the payment of respective tax.
The Government is taking the right steps to make the economy more transparent, simplify the tax structure and to make India globally competitive. The upcoming Budget should be focused on steadying the ship and restoring confidence in the economy. It’s time to persistently work towards translating the announced reforms into effective implementation and reducing the lag between the policy and on-the-ground action.