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Making The Right Cut
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The global economic meltdown has affected economies across the world. Due to the crisis, export revenues of Indian companies showed a negative growth of 28 per cent. But robust domestic demand helped them survive. They are getting further fillip from foreign investments as well. Now, the optimistic Indians are cautiously foraying into the international market in order to make the most of the low valuations.
Over the past decade, we have seen Indian businesses connect with the international world, tuning the country’s economy in sync with its global counterparts. This trend has necessitated continuous modernisation and updation of our tax and regulatory framework in order to cater to the growing aspirations of corporate India.
The direct tax collection has for the first time surpassed indirect tax’s contribution to the country’s revenue kitty. There has been a steady increase in the tax-GDP ratio, which is now inching up to 11 per cent. It was in this context that Budget-2009 announced the introduction of a new Direct Tax Code to bring about a structural change in our tax system.
Changes, Back And Forth
So, what changes can one expect from the New Direct Tax Code? Many: simplification, rationalisation, better compliance, to name a few. The foremost in the wish list is consistency in tax policies. Take the example of Employees Stock Option Plan (ESOP) taxation. ESOPs were originally taxed as perquisites in the hands of employees. Subsequent amendments introduced a concept of qualified schemes wherein, on fulfilment of prescribed guidelines, ESOPs were exempt from tax. Then came the Fringe Benefit Tax. The recent budget scrapped FBT and reverted to the initial perquisite regime.
Also, the concept of qualified scheme exemption has not been re-introduced, thereby taxing all benefits granted to employees. One has seen a similar turn of events with the taxation of dividends and Dividend Distribution Tax (DDT) as well. The tax, which was introduced in 1997, was scrapped in 2002, and brought back in 2003.
Somewhat similar is the concern of export oriented units (EOUs or popularly known as 10A/10B companies). The EOUs were initially promised a 10-year tax holiday. The government later restricted the benefit to 90 per cent of the profits.
The Budget 2008 levied a Minimum Alternate Tax (MAT) on these units, forcing them to pay taxes on book profits, initially at the rate of 10 per cent (plus surcharge); which the latest budget increased to 15 per cent (plus surcharge).
These continuous changes have impacted the business plans of several companies. Today, the sunset clause is a matter of debate. Before every budget, there are demands for an extension of these tax holidays. The current budget has once again extended this tax holiday by a year. Still, new units are unsure whether to set up their facilities in a special economic zone (SEZ), which calls for a higher investment, or to set up as an EOU.
But there is a silver lining. If one goes through the budgets of the past few years, there are not too many radical changes. These budgets, though at the cost of being branded as lacklustre or lost opportunities, have subtly heralded an era of a stable tax regime. There may be minor deviations. But on a holistic basis, and directionally, each budget has taught a deep lesson to aggressive tax planners. In each budget, one observes a serious attempt to plug loopholes, curb aggressive tax planning and provide clarifications on contentious issues, though the retrospective effect of these measures is certainly questionable.
As Indian businesses become more global, there arises a definite need for the tax system to get more integrated with global tax systems. The government has taken several steps in this direction, such as the introduction of transfer pricing regulations.
However, there is still an unfinished agenda here. For example, group consolidation and participation exemption regime are two popular tax methodologies followed globally. Essentially, in group consolidation, companies within a group are treated as part of a single tax paying unit. This helps offset the losses in one against the profits of the other. This is especially relevant for diversified groups that operate through different companies due to multiple business compulsions, and pay taxes in some firms while incurring losses in long gestation projects. There is a case here to look at group set offs.
Further, DDT at various levels is also a major tax hurdle in many group structures. Though Budget 2008 introduced a credit mechanism for DDT, it is still limited in its design and scope and can be further liberated.
Controlled Foreign Corporation and Thin Cap Rules are also the new taxing buzz words, and many expect the new tax code to address these constructions with specific provisions.
Having said this, there are some grey areas in the existing tax laws as well, which affect international businesses, and clarifications on the same would be most useful. For example, tax deductions for interest expenses on leveraged buyouts are still a matter of debate. Similarly, no depreciation deduction is available for goodwill arising out of acquisitions.
In an era where Indian businesses are on the prowl acquiring companies many times their size, such provisions turn out to be a significant disadvantage, especially when they are competing with companies from different countries that offer many such concessions.
Last but not the least, the heart of any tax system is all about efficient compliance, moderate tax rates and widening of tax bases. Over the past few years, there has been a serious attempt to smoothen compliances. Streamlining the Advance Rulings Authority, the latest introduction of the dispute resolution mechanism, and other measures were introduced to iron out the compliance issues. Having said this, more initiatives on this front such as speedy dispute resolutions, Advance Pricing Authority for international transactions will be welcome.
The moot point here is the adequacy of these measures in the backdrop of the fast-growing dynamic Indian economy. Speed is of essence here, as the last thing businesses are fond of is uncertainty. For instance, one cannot wait for years to know the direction in which the landmark litigations such as Vodafone or E-Trade Mauritius (on cross-border mergers and acquisitions) would go, because this makes tax planning a tough process. There has also been a serious attempt to widen the tax base by phasing out exemptions, and bringing in more people into the tax net. However, the process needs to be quickened.
In sum, what does each one of us expect from the tax system as our right? It is this: a system that is stable, fair and equitable, has moderate rates, focuses on better compliance, stimulates growth and channellises investments into priority sectors. Are we there yet? Certainly, there are attempts to get there. However, what is questionable is the pace and the adequacy of these measures to aid India’s journey from being an emerging economy to a global powerhouse. What remains to be seen is whether the new Direct Tax Code will serve as a troubleshooter, attempting to meet the evergrowing expectations of India Inc.
Vanvari is Executive Director and Head of M&A Tax, KPMG in India; Khandelwal is Associate Director, KPMG in India
(Businessworld Issue Dated 18-24 Aug 2009)