India Inc: Focus on investment, not consumption

Budget proposals will benefit capex-intensive sectors, but may hit consumer goods by way of lower demand

It's a mixed bag for India Inc. While the Budget had many positives such as greater incentive to capital expenditure (capex); higher duty protection to infant sectors like electronics; lower cost of funds for infrastructure projects; boost to the real estate sector; and extension of the tax holiday for power companies, there were a few negatives, too.

On the positive side, the government is permitting Indian resident taxpayers (beyond a certain threshold) to approach the Authority for Advance Rulings (AAR) for obtaining advance rulings in tax matters. This will reduce litigation and provide certainty to companies.

But the Budget has increased the effective rate of dividend distribution tax by 2.5 per cent leading to lower dividend yield for shareholders and higher dividend outgo for companies. This will have a one-time negative impact on the share price of top dividend-paying companies.

MIXED BAG

Goods news

• 10-year tax holiday for new power projects
• Concession on tax dividend income from abroad extended indefinitely
• Higher FDI limit in defence and insurance
• Lower threshold for FDI in real estate projects
• Increase in tax break on home loans

Bad news

• Dividend distribution tax up by 2.5%
• Retrospective taxation stays
• Slower growth in government expenditure
• Higher carbon cess on coal
• Increase in royalty on minerals  
• Higher tax on cigarettes, aerated drinks & pan masala

"Under the existing law, the dividend distribution tax, or DDT (effective tax rate of 16.995 per cent), was applied to the net amount of dividends actually paid to the shareholders. DDT is now proposed to be applied to the amount of dividend distributed to shareholders by grossing the said amount. This means the amount of dividends actually paid to the shareholder would go down by Rs 2.47 for every Rs 100 to be distributed to the shareholder before calculating DDT," said Sandeep Chaufla, executive director, direct tax, PricewaterhouseCoopers India.

The finance minister also refused to withdraw the retrospective taxation on the indirect transfer of Indian assets as was widely expected, and instead set up a high-level committee of Central Board of Direct Taxes (CBDT) to look into such tax disputes. This will disappoint foreign investors as tax litigation will continue. "The crucial aspect here will be the criteria or parameters that will be applied by this committee in providing its guidance," said Sanjay Sanghvi, partner, Khaitan & Co.

The Budget also makes it tough for companies to grow their top line and bottom line in the near term by slowing government expenditure. The minister plans to increase the government tax revenue by 16.9 per cent in FY15 but expenditure would grow much slower at 12.9 per cent. In other words, government tax collections from companies and individuals would rise faster than what its puts back in the economy by way of salaries, subsidies and other welfare projects. A bulk of the cut will be in the consumption-supporting non-plan expenditure. This will slow the flow of funds to households, hitting demand for consumer goods.

The Budget has tried to balance this by stepping up the allocation to plan or capital expenditure to government-funded projects. The total plan expenditure is set to grow by 20.9 per cent in the current financial year, translating into more business for capital goods and construction firms. The overall impact would, however, be negative. "Demand would remain subdued for the next three-four quarters, given the negative fiscal multiplier of lower government spending and rise in household allocation to financial and physical savings due to higher incentive to savings and home ownership. This will leave corporate earnings unchanged in the near term," said Deep Narayan Mukherjee, senior director ratings, India Ratings & Research.

Things would change for the better if the increase in foreign direct investment limit in defence and insurance sectors and the change in the safe harbor rules for foreign portfolio investors leads to large inflows, adds Mukherjee.

By sticking to the path of fiscal consolidation with the promise to bring down the fiscal deficit to three per cent of the gross domestic product (GDP) in three years, the government has taken off the pressure on the rupee, reducing foreign exchange risks to companies with large dollar debt. This will benefit top companies in capital-intensive sectors such as metals, construction and infrastructure, power and oil and gas.