Published Editorial

Budget 2013: Staying the predictable course

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by

Rajeev Memani
Country Managing Partner
EY

There are very few who can match our finance minister in his clarity of thought and mastery of words. To my mind, his latest budget speech was one of the better articulated budget speeches we have seen in recent years. What made it interesting was the unambiguous thrust on growth, fiscal consolidation and investments, which seeks to address the concerns being faced by the economy.

The manner in which he addressed the opportunities for improvement, his emphasis on India to not take the external environment for granted and to move quickly to restore the domestic balance through fiscal consolidation is undoubtedly the way to go. While the recommendations seek to address these imperatives, there are a few pinpricks which need to be tackled, including some looming issues such as our current account deficit, the effective corporate tax rate, etc.

Fiscal consolidation clearly has been the underlying theme this year. Realizing that the growth rate of the economy is correlated with the investment rate, the focus on increasing capital inflows is desirable, with a view to increasing the investment-GDP ratio. Towards this end, the finance minister has taken measures to target investment of $1 trillion in the infrastructure sector, with emphasis on the issue of infrastructure debt funds, attracting new investments, promoting savings and constitution of a regulatory authority for removing bottlenecks in road construction. Keeping in view the increasing requirements of coal for the power sector and reducing dependence on imported coal, the consideration to devise a public-private partnership policy framework for coal is a welcome move.

Realizing the fact that private sector remains the main contributor to savings, various saving schemes have been put in place, but in my view, the finance minister could have aggressively coaxed the private sector to save more by increasing the investment limits under section 80C. Even, a Rs 50,000 increment in the section, would have played an important role in getting the households to opt for saving schemes rather than invest in gold.

The cabinet committee on investment (CCI) is expected to play a crucial role in revival of investment in the industrial sector, but the emphasis on it did not seem strong enough. The budget proposes some measures to promote investment by providing for a 15% investment allowance for manufacturing companies that invest in plant and machinery in excess of Rs 100 crore and this weighted deduction will reduce the overall effective tax rate, which would be very significant.

The thrust on foreign investment is a key feature of the current budget, given our current account deficit. In that context, the move to remove ambiguity on what constitutes FDI and FII investment is a step in the right direction and a positive endorsement of attracting FDI. I hope this will be followed with opening up of the insurance and other sectors. However, the finance minister has not taken the bull entirely by the horns to address key issues being faced by foreign investors, by coming out with settlement provisions to end long-pending tax disputes and laying down the safe harbour provisions.

The finance minister stated that clarity in tax laws, a stable tax regime, a non-adversarial tax administration, a fair mechanism for dispute resolution and an independent judiciary for greater assurance is the underlying theme of tax proposals. The proposal to set up a Tax Administration Reforms Commission reflects the best global practices. While there is no doubt of India’s attractiveness as a market, tax administration has been a deterrent.

As expected, India Inc. has been leaned upon once again to fund the fiscal deficit by increasing the surcharge rates from 5% to 10%, resulting in an increase in the effective tax rate and dividend distribution tax rate by 1% to 2%. This was unexpected and possibly led to the Sensex nosediving as this left investors disappointed with post-tax returns.

The proposed amendment to Section 90 from 1 April, 2013, to provide that a tax resident certificate (TRC) is necessary but not a sufficient condition to get benefits of a tax treaty has significant ramifications. This would mean that there could be conditions whereby the tax officer could look at whether a company is entitled or not to benefits of the tax treaty. This amendment is contrary to the Central Board of Direct Taxes circular and jurisprudence that production of TRC is sufficient evidence for the purposes of claiming treaty benefits and is bound to hurt international investor sentiments.

On indirect taxes, the finance has proposed no change in the normal rates for excise duty and service tax. The industry was expecting the clarifications on scope of services under the negative list, place of supply rules and eligibility for export benefits to reduce ambiguity. This has not been forthcoming. Instead, a one-time voluntary compliance amnesty scheme has been offered, under which penalty and interest will be waived for returning to the tax fold. This is in line with his intent to widen the tax base. In addition, the fine print now provides for punitive penalties for non-compliance with any of the provisions of the tax legislations.

In conclusion, the budget surprisingly does not contain any provisions to address the contentious issue arising from taxation of indirect transfers to appease the international community. Further, it suggests an inflationary trend and one needs to read between the lines to see how fiscal consolidation can be achieved and the current account deficit can be reined in.