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September 23, 2019

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An ordinance tax boost


- Mukesh Butani, Partner [ BMR Legal ]

Mukesh-Butani

Short-term focus shifts to what extent the new measures will impact the fiscal deficit, accelerating non-tax revenue of the government...

Though there have been several precedents for Parliamentary Money Bills, such as income tax amendment, being promulgated by an Ordinance, it’s rare to see such dramatic changes to income tax rates. Just as there is first to everything, last Friday’s development is historical, though rational, given an urgent need for boosting confidence by way of directional tax policy change. There are two ways to view the change. Firstly, should this not have been a logical outcome, given how uncompetitive India as a nation was, getting to with effective tax rates crossing 35 per cent and if one factors the impact of dividend distribution tax (DDT), which was proving to be onerous for foreign investors, who could not claim foreign tax credit in their home country, overhaul was overdue. The DDT regime, introduced in 1997, to levy tax at 7.5 per cent with an objective to simplify collection regime over the years, became burdensome with 21 per cent. This coupled with expansion of buyback levies, including in the July 2019 Budget extended to listed companies, a part of which was rolled back on Friday, has left large corporates struggling to deal with the impact of tax. Given an average of 23 per cent corporate tax rate in the Organisation for Economic Co-operation and Develo­pment (OECD) member countries and a worldwide trend in past few years for reduction in taxes, India was coming under pressure from peer economies. India missed opportunities to moderate its tax rates which it could have done either in 2007, when fiscal deficit and current deficit targets seemed well positioned, and/or when the NDA came to power in 2014. The outcry for reduction in rates grew in situations of economic stress. Though, the government responded with phased reduction for small businesses (turn over less than Rs 400 crore which was raised from Rs 250 crore) over the past two Budgets, including the July 2019, businesses at large and foreign investors view India as amongst high taxed nation.

In the prevailing economic situation, a realisation amongst the mandarins of North and South block that monetary policy and other regulatory changes such as opening of the FDI, bank mergers were having lesser impact, and perhaps, some cha­nges would take their own time to yield results, tax policy emerged as an option of last resort. With a challenge of subdued tax collections on direct and goods and services tax (GST) front, risking further slippage of fiscal deficit is always an option with policy makers, though the debate co­uld be to what extent. Industries ask for a stimulus like 2008 crises or specific industry rate reduction was rightly frowned upon by the government, as is evident from the Friday’s GST Council meeting.

Friday’s rate reduction announcement conveys several messages. That the government is willing to take a bold directional tax policy step for moderating rates, certainly at the cost of fiscal slippage in short term. That it is willing to reconsider its misdirected steps on surcharge levies on FPIs. That it is willing to offer a discriminatory concessional rate to manufacturing entrepreneurs to boost its flagship “Make In India” programme. That its willing to seize a unique opportunity posed due to tariff wars and roll out a red carpet for domestic and foreign multinationals to boost manufacturing.

Sweeping changes, contrary to perception, is a well-crafted strategy. The option to opt for lower rate is subject to giving away tax holidays and incentives, which dragged down India’s effective corporate tax rate to roughly 26 per cent, an argument policy makers used as a defence. Hitherto, the option is with the taxpayer to make a non-reversible election to choose between location/industry-based exemptions such as SEZ, backward area, low cost housing and accelerated depreciation and low tax rate. Last fortnight’s cabinet decision to allow 100 per cent in contract manufacturing coupled with a competitive 17 per cent rate makes India a compelling case and on standalone basis, could turn into a game changer. Though, under the regime, there is a terminal date to commence manufacturing before March 31, 2023, interestingly, there is no sunset clause. This, in my view, signals a permanent move to moderate rates in general, and manufacturing. Of Course, the Parliament is well within its powers to raise taxes, but I wonder why any government would do that! The government preferred to deal with auto industry’s slowdown by offering an accelerated tax depreciation from 15 to 30 per cent for motor cars and 30 to 45 per cent on motor lorries and motor taxi hire for acquisitions made after August 29. The accelerated rates are applicable will apply in the following years, an option better than a onetime reduced GST relief. Not much debated is the expansion of 2 per cent CSR spend to cover spending on incubators for conducting research in science, technology, medicine, and engineering. This opens a fresh credible avenue to direct CSR spends of large taxpayers.

I guess the short-term focus now shifts to what extent these measures will impact the fiscal deficit, accelerating non-tax reve­n­ue of the government which is largely di­vestment targets, and in the medium term tax buoyancy due to upliftment of corporate profits and increased compliance.

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