Expecting a populist Budget 2018? FM's hands could be tied by fiscal constraints

The country is abuzz with discussions around the upcoming National Budget to be presented by the finance minister (FM) on February 1, 2018. Since we Indians are an opinionated lot, all of us have views on what the FM should do or not do. The Finance Minister is in an unenviable position of having to meet multiple expectations ranging from that of corporates or businesses seeking “relief” after GST implementation to individual tax payers hoping for lower income tax rates.  The barrage of articles on Budget expectations, including this one, does seem to suggest that the annual National Budget has become akin to end-of-season sales where everyone expects to pick a real bargain. 

The government’s initiatives to broad base tax compliance and increase tax revenues is yet to yield significant results. According to statistics provided by the Income-tax Authorities (updated in December 2017), only approximately 8 per cent of the total tax filers have reported income over Rs 1 million in financial year 2016-17, while only approximately 0.3 per cent of the total tax filers have reported income over Rs 10 million. 

These statistics tell that many among us have anyway assumed and gifted ourselves a perpetual tax holiday.  It also says that only a very few among us carry the burden of supporting the country’s need for tax revenues. 

The focus of Budget 2018 has to be to revive the sluggish economy, create more jobs, build infrastructure, balance budgetary allocations in view of the lower-than-expected GST collections, and integrate various reforms that have been set in motion. Yet, it is expected that the Budget will bring some joy from a personal tax perspective. Fiscal prudence and populism may have to be balanced though. And while income tax slabs and rates may be favourably rationalised, the Budget may yet call for contribution from the rich and super rich. 

Let’s now turn to the expectations from a personal tax perspective. Individual tax payers want higher threshold income exemptions, lower tax rates, and no surcharge for rich/super-rich. Salary earners want standard deduction and increase in allowance or perquisite exemption limits that were set a long time ago. High income earners, paying tax at the rate of 35.53 per cent, seek tax rates comparable to maximum marginal tax rates in countries like Russia, Hong Kong, Singapore, ranging from 13 to 22 per cent. 

Increase in threshold exemption liable for income-tax: Our fiscal position notwithstanding, it is widely expected that income-tax slabs and rates may be rationalised. It is expected that there will be an increase in maximum amount of income not chargeable to tax from the existing Rs 250,000 to Rs 300,000. There could  also be some changes in income slabs and tax rates. 

This will help the expectations of a populist budget as the government may achieve a two-fold benefit — a happy common man and revived demand in the economy. The increase in personal disposable income will serve the macroeconomic agenda well as it will lead to increased expenditure and increased savings. However, there is a possibility that the FM may again seek to collect additional tax from persons with relatively higher income via  increase in tax or surcharge for those whose incomes exceed Rs 5 million.  Not so good news for the tax-paying high income earners. 

Increase in limit of Section 80C: Section 80C limit is expected to be increased from the current Rs 150,000 to Rs 200,000. While reducing the tax incidence on individuals, it will also get them to invest more.  

Change in long-term capital gain tax regime: Under the current regime, there is 15 per cent tax on sale of listed equity shares in case of short-term capital gain (holding up to 12 months), and zero per cent tax on sale of such shares in case of long-term capital gain (LTCG) (holding period more than 12 months). The favourable tax regime was introduced to encourage people to invest in the equity markets. Now that they are doing so, the economists have been making a case for taxing this income.

With the stock exchange indices touching new highs, the government may agree. There is an ongoing debate on the revenue foregone because of non-taxation of income emanating from sale of listed equity shares held for more than one year. It is said this also creates disparity between debt and equity investors. However, the opposite argument is whether it makes any sense to upset the market momentum and anyway there is Securities Transactions Tax (STT) that continues to be collected on every transaction of purchase or sale. STT and LTCG tax on equity transactions should not co-exist if at all there is introduction of LTCG tax. 

It is expected that the current tax regime of “high risk, high returns and no tax” could change to “high risk, moderate returns and some tax”. Alternatively, the government may continue with the current position of no tax on sale of equity shares, but it may increase the holding period for non-taxation of LTCG from listed equity shares from one year to two.  

Change in dividend taxation regime: It is expected that the government may take away the corporate route to taxing dividend income, that is, dividend distribution tax (DDT), which was introduced in 1997, and return to the classic system of dividend taxation, wherein dividend income is taxed in the hands of the recipient. After the introduction of DDT, until 2016, dividend income was tax free in the hands of the recipients in all cases as the corporates paid tax prior to dividend payout. Finance Act 2016 introduced a provision to tax dividend income in excess of Rs 1 million in the hands of shareholders (individuals, HUFs and firms) at 10 per cent. It is expected that DDT may be scrapped and instead dividend may be taxed in the hands of recipient shareholders. 

Removing DDT will also make profit making and dividend paying companies happy as their effective tax rate, which currently stands at 46 per cent inclusive of DDT, will come down to 34 per cent. 

With DDT regime gone, dividend pay-outs may increase and tax payers will pay tax according to the applicable income tax slab. 

Increase in tax exemption limit on withdrawal from NPS: Even after more than 10 years of its introduction, the National Pension System (NPS) does not seem to have gained popularity relative to other retirement schemes such as the Provident Fund. With the intent to make NPS more popular and tax friendly, the government may increase the current tax exemption on lump-sum withdrawal from the NPS from 40 per cent of total amount payable to 60 per cent of total amount payable. 

Reintroduction of standard deduction: A large section of salary income earners have been pitching for the reintroduction of standard deduction on salary income (which was available until financial year 2004-05). The FM may well choose to bring this deduction back at the cost of removing multiple outdated deductions on salary income to reduce the tax burden of this category of individuals. 

The burden of expectations must weigh very heavily on the FM. As in the past few years, he is likely to manage all such pressures well. While making some concessions on the personal income front, he will, in all likelihood, continue on the journey of fiscal reforms that will strengthen the Indian economy and ultimately benefit us all.

The writer is tax partner and people advisory services leader, EY India