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| A mixed bag for financial services, capital markets |
| Tushar Sachade / New Delhi Aug 21, 2009, 00:56 IST |
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In the past few years, Indian financial services industry has grown by leaps and bounds. It was expected from the draft Direct Taxes Code that tax laws would be simplified and tax rates rationalised. Anomalies and differentiation in tax laws would be removed and at the same time, investment in capital markets would continue to be encouraged.
To a large extent, the Code does meet these expectations. Corporate tax rates and individual tax rates have been reduced. This would lead to increased disposable income which could be channelised for investment in capital markets. Taxation of capital gains has been simplified by removing differential tax rates and differentiation between long-term and short-term. Removal of the Securities Transaction Tax (STT) would benefit brokers and day-traders for whom cost of transactions had increased considerably and lead to increased trading volumes.
On the financial services side, there was a long-standing demand from domestic venture capital firms to bring clarity in tax provisions and give them a level-playing field with foreign funds. This has been addressed by treating venture capital funds as tax pass through, irrespective of the sectors in which it invests. A much-needed clarity has been brought on taxation of life insurance companies by exempting profit on a policy holder’s account. Allowing carry forward of business losses in business re-organisations would facilitate consolidation in the banking and financial services sector. Carry forward of losses indefinitely would also help reduce overall tax burden.
However, on the flip side, removal of certain concessions and unclarity on taxation of offshore funds could prove a bit of a damper.
The removal of concessional rates for long-term capital gains reduces the incentive for long-term investors to stay invested. Removal of deduction for investment in ELSS (equity-linked savings scheme) tax schemes would reduce one of the sources for attracting investments in capital markets.
Certain financial services like banks, NBFC and insurance companies suffer losses in the initial years. Also, most of the financial services groups have multiple layer structure due to various regulatory reasons and generally accept deposits from the public. Imposition of tax on gross assets could lead to a significant overall tax burden.
Provisions relating to offshore funds are a bit concerning. Under the present law, the tax treaty overrides Income Tax Act, if more beneficial. Now it is proposed that changes in the Code can override the treaty. Further, while a general rule has been introduced to avoid tax abuse, discretionary powers has been given to tax authorities, which can even override the Treaty. These provisions could make the Indian tax regime unpredictable for offshore fund managers. Also, the provisions extending Indian taxation to offshore transactions (like gains on indirect transfers of Indian assets, interest on offshore leverage for investment in India, offshore fees utilised for investments in India) could lead to serious compliance issues for offshore fund managers.
As the Finance Minister himself has stated, tax reform is a process and not an event. The Code is the first step in this process and hopefully would see further rationalisation in time to come.
(Assisted by Samip Barlota, manager, PricewaterhouseCoopers)
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