Budget 2016: More Work Is Needed

The Union Budget 2016-2017 has been presented in the backdrop of an extremely challenging and volatile global environment and also some significant domestic challenges, including the “twin balance sheets problem” (banks and corporates) and declining exports. It talked about nine pillars on the basis of which the proposals have been drafted and the last of those pertains to tax reforms “to reduce compliance burden with faith in the citizenry”. In the context of tax proposals, the finance minister’s nine pillars include relief to small tax payers, boosting growth, employment generation, promoting affordable housing, reducing litigation and providing certainty.

Corporate Tax Rates
While most exemptions have been capped for March 2017, corporate tax rates have not been reduced, except for some minor changes in relation to small firms and startups; this is certainly a disappointment. Incidentally, the expectation of reduction of tax to 25 per cent is misleading because the current tax rate for companies (incomes in excess to Rs 10 crore) is actually 34.61 per cent (including surcharge and cess), and therefore, the likely scenario is that the rate could go down (in 3-5 years) to 28-29 per cent (and not 25 per cent). Incidentally, weighted deductions on research and development (R&D) are also being phased out; the latter is surprising, since the government’s pre-election manifesto had listed out tax breaks on R&D as one of its key tax initiatives.

Dividend
Dividend is currently subjected to tax in the form of a Dividend Distribution Tax (DDT) on the distributing company, instead of the earlier norm where it was taxed in the hands of the shareholders. In essence, it is anyway economically taxed; as such, the 20 per cent DDT is regressive, in the sense that it applies across the board to all shareholders, small or big, and accordingly, there was an expectation that the withholding tax would be reintroduced. However, that has not happened and instead what has now been done is that if the recipient (other than a company) receives dividend in excess of Rs 1 million per annum, the excess will be taxed at the rate of 11.85 per cent (including surcharge and cess). Two key points here are: This does not apply to dividends received from mutual funds and also does not apply if the company is a recipient (and therefore, will not impact a holding company, but will impact a holding LLP). It is important to note that this is a triple level of tax — corporate tax on the company, DDT on the company and tax on the recipient.

Cross-border Tax Issues
Aligning with global regulations, country-by-country reporting is being put in the statute book, which essentially means that for overseas subsidiaries of Indian companies, crucial information will be available to the tax office at one glance. While conceptually this cannot be faulted, practical experience shows that the Indian tax administration needs to evolve in terms of maturity and business realities, else, (mis)use of this information by the tax office can spiral litigation.

An “equalisation levy” for cross-border online advertising with a deemed income of 6 per cent is sought to be introduced to address some challenges of the digital economy. While conceptually this seems to lead to simplification, the underlying message is that the government believes that this is taxable, and as a concept, the possibility of proliferating to other digital transactions is significant, especially given the rate at which digital transactions are growing, including cross-border ones.

Real Estate Investment Trusts
The realty sector has been really stressed, and even though the legislative framework for REITs was introduced in 2014, it has been a “stillborn” baby, with the primary reason being tax issues. Some of the tax issues such as capital gains on transfer of special purpose vehicles to the REIT not being liable to tax at that stage were addressed in last year’s budget, but some tax issues remained: a key one was DDT on the declaration of dividend by a SPV to a REIT. This has now been removed thereby getting rid of a key bottleneck in the potential launching of REITs.

Tax Collection at Source
There are certain provisions in the Income Tax Act for tax collection at source which are more to rope in the unorganised sector of the economy (forest produce, scrap, etc); the provision basically requires the seller to collect a particular percentage of tax from the buyer and then pay it to the government, and the buyer gets a credit against his tax payable. The Budget provides (presumably to reduce the quantum of cash transactions and to bring high-value transactions within the tax rate) for a 1 per cent collection of tax by the seller from the purchaser in relation to the following items:

* Sale of motor vehicle at value exceeding Rs 10 lakh
* Sale in cash of goods other than gold and jewellery exceeding Rs 2 lakh
* Provision of any services in cash (other than those in which TDS is applicable) exceeding Rs 2 lakh.

While one can understand the second and the third, but it is not clear what purpose would be served with the first one, particularly for a sector which is just beginning to come out of a difficult period, and, in any case, where it is relatively easy to track payments even otherwise.

Startup Tax Initiatives
The Startup India initiative is gathering momentum, and given the number of startups in India (estimated at about 4,200 currently) there is a significant focus on this area. This sector has its own issues with relatively inexperienced promoters, need for funding, quick exits depending on valuations and of course, a lot of cash burn during the initial period. The government has now proposed that it will allow 100 per cent deduction for an eligible startup (set up before 2019) from certain eligible businesses where the deduction is allowed for three consecutive years out of five in which startup is incorporated.

Reducing Tax Interface & Discretion
The Budget seeks to reduce the interface between the taxpayer and the tax department, which should help in reducing tax terrorism, and confrontation. The FM has mentioned that the government is inclined to expand the scope of e-assessment in seven mega cities “in the coming years”. Also, there would be stay of demand on an automatic basis if 15 per cent of the demand is paid, thereby clearly reducing discretion and providing certainty.

Silence Is Not Golden!
GAAR comes into effect from 1 April 2017 and there is a reiteration in the FM’s speech that this will happen; however, there needs to be some detailed guidelines and also clarity on what happens vis-à-vis jurisdictions commonly used by international investors to invest in India, either from a portfolio investment or strategic investment standpoint (and indeed, private equity).

There are several tax proposals in the Budget which will lead to simplification and ease of doing business. However, a lot more needs to be done. Admittedly, some issues are being addressed in a flurry of circulars issued just after the Budget. The encouraging aspect is that there is recognition of the issues and one hopes that, as we move forward, rapid changes would be made with a view to create a far more benign environment as far the tax department and the taxpayers are concerned, while also ensuring accountability of the tax department.