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Mukesh Butani: A more certain tax regime

The Budget sticks to the 3Cs of tax policy - certainty, clarity and consistency

Mukesh Butani 

Mukesh Butani
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    A preparatory exercise

Amidst unprecedented expectations, Finance Minister had a wonderful opportunity as he presented the first full-year Budget of the National Democratic Alliance government. The 14th Finance Commission's report underlining cooperative federalism, a visionary and an encouraging Economic Survey set the perfect stage on Budget-eve; and I must say, the finance minister did his best to please all stakeholders!

High on policy announcements, the Budget sets out a comprehensive vision for all-round economic overhaul, largely focused on revitalising public expenditures without unduly burdening public finances, encouraging wider private participation through a renewed public-private-partnership philosophy, and undertaking structural regulatory and fiscal reforms. The revised estimate of 7.4 per cent for 2014-15 is encouraging; the target for next fiscal year, eight to 8.5 per cent, signals that double-digit economic growth is well within reach.
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A structural reduction in the current account deficit (less than one per cent for 2014-15), the likely monetary policy easing, thanks to declining inflation, and favourable external circumstances thanks to cheaper oil allowed the finance minister leeway of one more year in achieving deficit target of three per cent. That's a bold and ambitious announcement. The government said the need for accelerated fiscal consolidation has sharply reduced since deficit management targets are not worrisome. I hope that the reconstituted will pave the way for an accelerated disinvestment plan and subsidy rationalisation.

From a tax policy standpoint, the Budget scores even better by sticking to the 3Cs of tax policy - "certainty, clarity and consistency". The unequivocal resolve to implement goods and services tax (GST) from next fiscal year and a clear articulation as to the withdrawal of the code (DTC) Bill are the most significant announcements towards providing a more certain tax regime.

implementation could perhaps have an easy path, especially in view of the enhanced devolution of revenue to states. The deferral of the (GAAR) by a couple of years, although anticipated, should woo back investors with frayed nerves.

Reaffirming the government's intent to curb the black money menace, two independent laws are proposed to deal with offshore accounted money and dubious domestic transactions, prescribing prosecution and prohibitive penalties for delinquent taxpayers. Amendments to the Prevention of Money Laundering Act and the Foreign Exchange Management Act shall facilitate effective implementation of the new legislation, though it is unclear if it would be accompanied by amnesty for past defaults.

Taking cognisance of the effective tax rate (23 per cent), it is proposed that corporate tax will be rationalised to 25 per cent in a phased manner, beginning from next fiscal year. This is another significant policy announcement; if achieved, subject to fiscal consolidation targets, it will lead to a long overdue convergence of headline and effective tax rates.

In the interim, the proposal to replace wealth tax by way of additional "super-rich" surcharge of two per cent may pinch domestic companies, too, as the headline tax rate will increase by few basis points. The message is clear: the convergence of tax rates requires the withdrawal of majority tax holiday/concessions in phased manner.

The financial sector comes out as a clear winner, with multiple regulatory and tax proposals to straighten out major distortions; proposals allowing foreign investment in (AIFs) and extending tax pass-through status to Category-II facilitate the unlocking of investment potentials in venture capital. The proposal to rationalise the rules for deeming a taxable presence for foreign funds in India, especially in cases where presence is limited to having a fund manager in India, is a major boost to the sector, and shall reduce tax disputes in genuine cases. Still, the fund industry would have liked to see a more unfettered safe harbour rule for fund managers.

Rationalisation of partial tax pass-through status accorded to real estate investment trusts and infrastructure investment trusts in the last Budget - to provide capital gains tax breaks to sponsors in case of exit at the time of listing of units - will provide a fillip to the business trust structure for funding large infra projects. Tax-free infrastructure bonds, meanwhile, will help garner additional investments for projects in rail, road and irrigation sectors.

From the transfer pricing reforms standpoint, the proposal to enhance threshold for compliance with specified domestic transfer pricing rules will simplify compliances for small and medium businesses, and curb avoidable transfer pricing disputes. I would have been pleased to see more administrative clarity on the advance pricing agreement regime.

Given the Centre's unstinted commitment towards providing a stable and non-adversarial tax regime, implementing the expert committee proposals for indirect transfer taxation is huge step forward. The fine print provides a definition for the "substantial value" test, as Indian assets worth more than Rs 10 crore and representing 50 per cent of total assets of the foreign company whose shares are transferred. Clarity on the "principle of proportionality" for taxing income arising on indirect transfers is in line with international practices. The exemption for business re-organisation and small shareholders or a minority holding of less than five per cent in terms of voting rights is a welcome outcome, and should keep group restructuring and marginal financial investors out of the tax net, though a more liberal limit would have been welcome. In tandem, the proposal to introduce "place of effective management" test for determining the tax residence of a foreign company signals strict source-based taxation, and aligns with bilateral tax treaties and international practices.

I am particularly pleased with the statement in the Budget speech indicating recommendations of the Tax Administrative Reforms Commission are in fairly advanced stage of consideration; I hope the next financial year shall see a dash of reformative supplementary legislations to usher in best administrative practices towards developing a world-class tax administration infrastructure. The key shall be to effective implementation and I would suggest that mandate of the National Institution for Transforming India Aayog be extended to oversee the implementation of such deep administrative reforms.

From a revenue-neutrality standpoint, the widening of the service tax net ahead of implementation ought to make up for revenue foregone on account of direct tax proposals. The increase in service tax and excise duty rates by a couple of percentage points is largely in line with anticipated pre-alignment of tax rates. The reduction in basic and countervailing customs duties to rectify inverted duty structures is one significant for the Indian IT industry.

Overall, it's difficult to find faults in Arun Jaitley's Budget. As a matter of fact, drafting and structuring of the Budget speech deserve an accolade. The well-researched approach of Mr Jaitley's team stands out. I hail this year's Budget as a big milestone towards ushering in the most vital reforms to catapult the Indian economy into a double-digit growth trajectory. Kudos!

Assisted by Sumit Singhania, the writer is managing partner, BMR Legal

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