As the Union Budget 2018 is the last full budget before the 2019 general elections, expectations about significant reforms on the economic and tax policy front are abound. With several actions and announcements, the government has made it clear that it is on a mission to transform its litigious image into ushering in a non-adversarial tax regime that offers certainty and consistency to the stakeholders. This article discusses some of the important expectations to achieve these objectives.
Measures to boost investment
Currently, there are several profit-linked deductions to incentivise participation in certain businesses. However, availing such deductions invariably leads to long-drawn litigations. These can be more effectively replaced by 'investment-linked' deductions. This would serve the dual purpose: firstly, to boost capital formation and employment generation, and secondly, to give an impetus to the government's Make in India initiative.
Given India's massive need for infrastructure development and the consequent humungous appetite for capital to meet the funding needs of this sector, the infrastructure sector should be excluded from 'thin capitalisation rules'. These rules limit the deduction for interest expense on borrowed capital in certain circumstances.
Rationalisation of income tax law
The law provides tax neutral conversion of a company into an LLP provided the converting company's turnover is less than Rs 60 lakh or assets do not exceed Rs 5 crore in any of the three years preceding such conversion. Given the scale of operations at which Indian businesses now operate, these limits are too small, even for small and medium sized companies. Such conditions are also discriminatory. The LLP form of doing business was simply not available and hence businesses had no option but to set up as companies. Putting a limit of this nature discriminates them against new businesses which can be set up as LLPs and can have large asset base and/or turnover, without being penalised. LLP is a simpler business form which accords the benefit of limiting the liabilities for business risks. Post-conversion, the LLP continues in business in India and any disposal of its assets would necessarily be subject to Indian taxes. Thus, this conversion would not be prejudicial to the Indian revenue. It may simply have a condition that the same people who are beneficial shareholders in the company should continue to be members in the LLP. The monetary limit for tax neutral conversion seems dated and less business-friendly provision.
An urgent need is to overhaul dividend distribution tax (DDT) payable by a company at the rate of 20.36 per cent while distributing dividends, in addition to the corporate tax payable by the company on its income. One of the objectives of DDT was to plug the loophole of tax being escaped in the hands of shareholders. While the objective is totally justified, DDT may not be the answer. DDT being payable by the company leads to a significant tax burden on those shareholders whose income falls below the taxable limits - senior citizens, retired people, pooling vehicles etc. would be the worst affected by this tax. DDT on dividend distributed to foreign investor results in the foreign investor suffering higher tax incidence in India since such investor is unlikely to get credit for DDT paid by the Indian company. This leads to lower returns on their investment as DDT becomes a sunk cost. This reduces the attractiveness of foreign equity investments in India and leads to resorting to artificial structuring and avoidable litigation. Another fall out of DDT is the denial of tax deduction for interest to parent company on borrowings to invest in their ventures in separate entities, since the dividend income is exempt in their hands. It would be far more efficient to replace DDT with Dividend Withholding Tax across the board so that the recipient shareholders are able to claim credit for such a tax based on their income levels. Such a measure will go a long way in encouraging the much-needed long term foreign direct investment in India.
Budget 2018 is expected to bring some clarity on pertaining to distress asset resolution: (i) exempt the levy of Minimum Alternate Tax on notional income due to write off of debt, pursuant to approved resolution plan under the Insolvency and Bankruptcy Code (IBC); (ii) some relaxation from 'fair market value' based taxation for distress sale in secondary share transfers, and (iii) availability of set off of brought forward losses to the company despite change in more than 51% shareholding. This will ensure the success of IBC which is the need of the day in view of the huge NPAs and mobilise the flow of funds back into the economy.
The current government must be lauded for adopting the stakeholder consultation approach in almost every aspect of policy formulation. It is equally important that the policy actions percolate down at grassroot levels and tax administration becomes more tax payer friendly. Rationalisation of tax laws as discussed here will not only help the government achieve this, but will also have two more benefits: increasing tax compliance and bringing down the corporate tax rates to match international standards.
(Daksha Baxi is Executive Director and Raghav Kumar Bajaj is Senior Associate, Direct Tax team, Khaitan & Co)
Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.