The PM has started in all earnestness with his set of 10 commandments for his Council of ministers and bureaucrats for fulfilling his election pledge of good and effective governance. I have ventured to suggest 10 commandments on Tax Policy which the FM may consider to usher in the much needed clarity in legislation as also reform of tax administration, when he presents his maiden budget in Parliament in July 2014. These are outlined below.
1. Remove Retrospective amendments brought in Finance Act, 2012
1.1 Indirect Transfer – Capital Gains tax
The needle has literally not moved from the time the retrospective amendment on capital gains tax on indirect transfers was introduced in Finance Act, 2012. Despite the clear recommendations of the Expert Committee headed by Dr Shome to the effect that retrospective amendments should be resorted to in “rarest of rare” cases, there has so far been no attempt made to undo the provisions introduced retrospectively in Finance Act, 2012. Similarly, the vexed issue of “substantial value” derived from a business in India has remained unclarified despite the suggestion that over 50 percent indirect value should be so derived to warrant levy of capital gains tax in India. As a result, the proverbial “sword of Damocles” continues to hang over such past transactions. Moreover, scores of private equity transactions have been adversely impacted with increased costs of insurance and indemnities and even then no real clarity is available for calculation of potential capital gains tax on exits from investments in Indian companies. This uncertainty has also resulted in prospective investments by Private Equity, Institutional and Sovereign Wealth Fund investors being dithered accentuating the negative sentiment for such investments in India. (By all accounts the current surge in investments in capital markets is on account of portfolio investments by institutional investors as opposed to longer term investments). Therefore, the FM has a golden opportunity to remove the retrospective amendment for capital gains tax on indirect transfers and unleash a much needed breath of clarity and certainty on this overhanging issue especially as no appreciable tax revenues have been actually generated by this measure.
1.2 ‘Royalty’ definition
Similarly, the ‘royalty’ definition in domestic law was amended retrospectively to include all kinds of software payments and payments for use of satellites. In the process, in certain cases, Indian companies who were contractually obliged to make payments to non-residents (not covered by ‘royalty’ definition in a tax treaty) ‘net of Indian taxes’ found their commercial costs shoot up as a consequence of this retrospective amendment. Here again, the need of the hour for the FM is to clarify prospective application of the new definition and not respective.
2. Incentivise manufacturing and infrastructure
2.1 Instead of a yearly extension at the munificence of each succeeding FM, there is a need to provide stability of availability of power sector holiday for a period of atleast three years, given the dire need to encourage investments in this crucial sector.
2.2 Considering the thrust on kick-starting growth in manufacturing sector, FM may consider bringing back investment allowance on new plant and machinery during an initial period of, say, three years.
2.3 Removal of Minimum Alternative Tax (MAT) on units in Special Economic Zones (SEZ) as was the case in the original SEZ policy. The subsequent amendment in MAT provisions to make them applicable for units in SEZ resulted in breaking of ‘promissory estoppel’ by Government as scores of units were established on the assumptions of exemption from MAT provisions. This measure created tremendous negative sentiment in domestic industry and needs to be restored to the original position of MAT exemption.
3. Tax Rates and Exemptions
3.1 A plethora of surcharges have become a permanent feature of the tax system insidiously increasing the effective tax rates. It is high time these surcharges are removed once and for all. This will result in a moderate rate of 30 percent tax on corporations which is still higher than most countries in BRIC and other emerging markets.
3.2 The FM should consider enhancing the threshold for income tax exemption on individual incomes in line with inflation as recommended by Standing Committee on Finance. This will enable the Tax Administration to focus its energies on larger tax payers and ensure proper tax assessments and collections at higher income levels.
3.3 To give a boost to construction and housing industry, maximum limits for housing loan deduction should be enhanced keeping in mind the increase in average size of loans in cities across the country.
4. Strengthen Alternative Dispute resolution mechanisms
4.1 The Advance Pricing Agreement (APA) regime has received a thumping response from tax payers with over 400 applications filed in the first two years of its introduction. There is an urgent need to enhance capacity of the APA team to enable them to effectively manage their onerous responsibility. We have seen the first batch of five APAs having been finalised and the pace of disposals needs to be expedited to sustain the excellent momentum built on the initial phase of the APA program.
4.2 Similarly, there is a need to expand the Authority for Advance Ruling (AAR) as we have witnessed an extremely slow pace of admission and disposal of cases at the AAR in the past one year. The AAR is an excellent forum for non-resident tax payers to obtain tax certainty on proposed transactions and it is unfortunately that this forum has virtually been non-functional in recent times.
4.3 Steps should be taken to quicken the pace of conclusion of bilateral dispute resolutions under the Mutual Agreement Procedures (MAP) with various countries, especially USA. This will ensure clearance of accumulated cases and also clarity of tax positions under prevailing facts and circumstances.
4.4 The FM should announce immediate steps to expand the Dispute Resolution Mechanism (DRP) to include full time and independent panel members. The current system of ‘part time’ members with primary responsibilities in the tax administrative field has resulted in the ‘dispute resolution’ part being largely ineffective and the DRP has been reduced to just another intermediary authority before approaching the Tax Tribunal. There is also a need to empower the DRP members to negotiate and settle disputes with the tax payers to ensure greater immediate tax collection as well as reduction in the plethora of cases lined up before the Tax Tribunals throughout the country. This measure will in fact help in quicker finalisation of tax assessments and mobilisation of tax revenues which would be mutually beneficial to tax authorities and tax payers alike.
5. Corporate ‘risk-based’ tax assessments
There is an urgent need for tax administration to evolve from a ‘100% vouchers/bills’ audit mind-set to a ‘systems’ based audit which focuses on few recalcitrant corporate taxpayers and collects more revenues rather than spreading itself too thin over audits of almost all corporate tax payers. This system also encourages taxpayers to take reasonable tax positions with proper disclosures to ensure being regarded as ‘low or moderate’ risk tax payer by the tax authorities. In this method, the tax administration focuses its energies on the ‘high risk’ tax payers who habitually adopt aggressive tax positions or follow opaque tax information disclosure policies. The UK HMRC has successfully implemented this policy and, as its recent report indicates, has actually collected enhanced taxes alongwith greater taxpayers’ satisfaction.
6. Tax Administrative Reforms Committee (TARC)
The above Committee set up under the chairmanship of Dr Shome has already done considerable work in the area of preparing clarifications on operational issues. The FM should allow the TARC to complete its work and logically conclude its finding. The FM should lay down a time bound road map to implement TARC’s recommendations which will go a long way in alleviating many operational issues in tax administration including tax withholding, tax assessments, tax collections and refunds.
7. Dividend Taxation
7.1 The concessional rate of 15 percent tax on dividends received from overseas subsidiaries should be made permanent to encourage Indian MNCs to repatriate overseas earnings back to India.
7.2 There is ambiguity on whether dividend distribution tax (DDT) levied on an Indian company is creditable in the hands of the foreign shareholder as DDT is strictly not a withholding tax. This results in lower after tax earnings for the foreign shareholders with no corresponding gains for Indian Revenue. Therefore, it should be clarified that DDT is a deemed withholding tax to enable its credit in the hands of the foreign shareholder.
8. Goods and Service tax (‘GST’)
8.1 Fast track implementation of GST to achieve increased industrial growth. In a study conducted by National Council of Applied Economic Research (‘NCAER’), it was pointed out that introduction of GST could add between 0.9% – 1.7% to the GDP. Further, exports would increase between 3.2% to 6.3%.
8.3 The GST legislation should be introduced in consultation with the industry.
8.4 There should be a wide tax base to ensure a lower RNR (revenue-neutral rate)
9.1 Recent Supreme Court judgment in the case of Fiat India has interpreted the concept of ‘transaction value’ at variance with the decade long understanding of trade, business and the department.
9.2 Per the new interpretation, any sale price below cost shall not qualify as ‘transaction value’ Excise duty would necessarily be paid on the cost + margin even if no tangible consideration has been received from the buyer.
9.3 The aforesaid interpretation is contrary to the ‘transaction value’ concept which is based on the actual tangible consideration received directly/ indirectly from the buyer.
9.4 Thus, this interpretation has opened a pandora’s box leading to show cause notices being issued to manufacturers located all over India.
9.5 It is desirable that a retrospective amendment is made clearly providing that:
a. Transaction value not to be rejected merely because it is less than cost of production;
b. In absence of a commercial consideration which can be determined in money terms flowing from the buyer to the seller, the sale price shall be treated as the sole consideration
10. Service Tax
10.1 Reduce Service tax rate to 10%
10.2 Treat branch office/ project office (located in India) and the head offices (located outside India) similarly, in case of imports and exports
10.3 Per extant rules, a service provider is liable to pay Service tax on bad debts and the service recipient is barred from availing credit on the same. This is against the principles of value added tax and best practices being followed in other jurisdictions like UK and Australia. Accordingly, Service tax paid on bad debts should be allowed as set off/ refund
10.4 Exempt financial intermediaries from service tax. Currently, a mixed approach is being followed. While deposits, loans are exempt from service tax, other charges like finance charges akin to interest on loan are liable to service tax
10.5 Introduction of the Negative list regime has resulted in taxation of practically all activities done by one person for another for consideration. However, restriction on availing input tax credit on inputs and input services continues leading to an inequitable situation
10.6 Accordingly, it is suggested that the Cenvat credit scheme be amended to allow seamless credits of all inputs and input services related to business, with no restrictions.
These are of course not exhaustive but representative sample of what businesses and individuals alike may be hoping to see in the forthcoming budget next month. It may not be incorrect to state that the expectations of business and the people, at large, from the maiden budget of the FM is running as high as the expectation of the electoral outcome in May in favour of the PM. Will July be as exciting as May? We will have to wait and see.