MARCH 19, 2015

By Harsha Rawal & Richa Savla, Deloitte Haskins & Sells LLP

THE Finance Minister announced in his Budget 2015 speech that the corporate tax rate would be gradually reduced to from 30% to 25% (starting financial year 2016-17). However, the same will be accompanied by phasing out of tax exemptions. He stated that the rationale is to make India a competitive Asian country for attracting foreign investment; increase growth and employment and eliminate tax exemptions which have only led to litigation. Even developed countries are rationalizing their tax regimes in an effort to attract business – for instance, United Kingdom has progressively reduced its corporate tax rate – from 28% in 2010 to 20% in 2015-16. As per the 2013 report of UK's HM Revenue & Customs called ‘Analysis of the dynamic effects of Corporation Tax reductions', theoretically, lower tax rate results in increased investment, jobs / wages and consumption, which in turn leads to higher tax revenues.

As per the World Investment Report 2014 by United Nations Conference on Trade and Development, China, Hong Kong, Singapore, India, Indonesia, Thailand, Malaysia, Korea, Vietnam, Taiwan were top 10 developing Asian recipients (in that order) of foreign investment in 2013. The corporate tax rate for 2014 of China, Indonesia, and Malaysia is 25% while those of the others range from 16.5% to 22%. India's tax rate is the highest amongst all. While foreign investment depends on many factors besides tax; it may be noted that China, Hong Kong and Singapore far surpass India in the race for highest foreign investment and have lower tax rates.

While lowering of the tax rate is beneficial for the taxpayer, the same has been tampered with the withdrawal of tax exemptions. Currently, there are tax holidays / exemptions in context of:

Locational exemptions

++ developing special economic zone (SEZ)

++ setting up unit in SEZ

++ setting up specified businesses in north-eastern states (existing sunset clause till 31 March 2017)

Exemption for specified infrastructure-related activities

++ developing infrastructural facilities

++ power generation (existing sunset clause till 31 March 2017)

Others

++ presumptive lower tax rates in case of certain companies such as retail and cement

++ processing of certain food products and storage / transportation of food grains

++ processing bio-degradable waste

++ investment allowance for plant and machinery in manufacturing sector

++ Offshore Banking Units in SEZ and International Financial Services Centre

++ certain cooperative societies

++ publication of books.

The incentive regime in India is procedure driven and requires significant compliances to be undertaken. Besides, quite a lot of litigation surrounds a taxpayer's claim of such tax holidays, for instance – eligibility for tax holiday where some pre-requisites are not fulfilled, shifting of profits to tax holiday business from other group entities / businesses, set-off of losses of tax holiday business against profits of other businesses, availability of incentives in case of a reorganization / change of ownership of tax holiday unit and so on. For investments already made under the current tax holiday regime, it needs to be seen whether the same is grandfathered. Generally, tax payers claiming tax holidays pay minimum alternate tax (MAT) at 18.5% (exclusive of surcharge and cess) since similar exemptions are not considered while calculating accounting profits. Taxpayers claiming tax exemptions may have to bear the brunt of removal of the same while tax payers, not currently availing exemptions, may have reason to cheer. Going forward, absence of tax exemptions will bring competitors at par as far as tax treatment is concerned and the differential would only be in terms of efficiency and viability of business. Further, it remains to be seen whether weighted deductions for research and development; skill development; training of farmers; capital expenditure incurred in the business of hospital, affordable housing, cold storage / warehousing facility, etc. will also face extinction.

Tax forms an important cost component while evaluating return on investment and hence, tax exemptions influence business decisions to a certain extent. For example, the tax holiday for SEZ units could influence the location of business operations while a company's eligibility to claim tax holiday for power generation could influence its competitive bid for winning the power purchase agreement. Removal of some tax exemptions may adversely affect the Government's ‘Make in India' agenda or its objectives to generate more employment or promote industries in backward areas. The same could be replaced by more effective business-related incentives to encourage such economic activity which require a boost for growth or may otherwise be unviable due to inadequate infrastructure, high costs, etc. However, balancing conflicting interests in a large and a diverse country like India is not going to be an easy task.

While it is not absolutely clear whether the Government will continue the MAT post complete reduction of tax rate, in recent interviews, CBDT chairman was quoted as stating that MAT will be phased out gradually due to decrease in tax rate and removal of exemptions. MAT is calculated on book profit and is compared with tax on profit computed as per the tax law. One of the main differences between the two profits is the tax exemptions granted under the tax law but which are not reduced from the book profits. With the removal of tax exemptions, the difference may become insignificant and may remain only on account of depreciation, creation of reserves, revaluation of assets, etc. However, the rationale for introducing MAT (i.e. ensuring that companies earning book profits enough to declare dividends do not avoid the tax liability through tax planning) could still be a reason for its continuation.

The lower tax rate and withdrawal of tax exemptions should be accompanied by a transparent tax regime, reduced litigation, tax certainty and simpler tax compliance in order to create a significant impact and the Government seems focused on this goal. This coupled with an encouraging environment including quality infrastructure, skilled labour, low inflation will make sure that the interest in India as a destination for growth continues.