The current government needs to be applauded for its efforts of the past four years that have made India move from 'fragile 5' to the seventh largest economy in the world. Structural reforms like streamlining the indirect tax system, recapitalising the banks and swifter implementation of the Insolvency & Bankruptcy Code (IBC), have been the biggest drivers of this journey of economic reforms. Having said so, like everything else, some criticism is natural.
This article critically analyses some major hits and misses of budget 2018:
Keeping with the promise, corporate tax rate reduced
Budget 2018 brings cheer to the MSME sector in the form of a reduced corporate tax rate of 25% for companies with turnover of upto INR 250 crore in FY 2016-17. While this is a welcome move, LLPs are not eligible for this reduced rate. Further, by linking the turnover threshold only to a particular year (FY 2016-17), whether companies incorporated thereafter would be able to benefit from this provision is uncertain.
Some relief to distressed companies
Budget 2018 has brought some cheer for rehabilitating companies under IBC by proposing that unlike other companies which can set off only lower of past losses and unabsorbed depreciation for computation of book profits subject to MAT, the companies under IBC can set off both, the unabsorbed depreciation as well as past losses. Further, for such companies, change in shareholding would not result in lapse of past tax losses which is otherwise the case where there is a change in their shareholding beyond 49%.
A blanket exemption from tax of notional income on account of write back of loans under IBC would have been ideal for such companies. Moreover, secondary share transfers pursuant to IBC should also have been exempted from the fair value based taxation for the seller as well as the buyer.
Protecting India's tax base
Budget 2018 has widened the scope of taxable presence of non-residents by moving from a 'physical presence' dominated nexus approach to a 'significant economic presence' nexus approach. Unless the tax treaties are also amended to address this aspect, this domestic law provision may not be effective.
Further, in order to align the domestic tax law with the MLI (Multilateral Instrument), budget 2018 in relation to a non-resident operating through an agent, proposes that an agent who negotiates (and not merely concludes) contracts on behalf of a non-resident will also lead to a taxable presence in India.
Tax holiday for startups made more effective
In relation to the 100% tax holiday which is available to eligible start-ups for three years, the budget proposes to expand the scope of 'eligible business' to include a scalable business model having a high potential of employment generation and wealth creation as against the present restriction in relation to the business being driven by technology or intellectual property.
While this is a welcome move, in view of there being no exemption from MAT, the tax holiday falls short of being completely effective. Further, the requirement of obtaining a certificate from the Inter-Ministerial Board of Certification has not been done away with, which is generally seen as a regulatory hurdle in the success of the 'Start-up India' Initiative.
Parent and subsidiary transfers made tax neutral in entirety
Currently, tax neutrality for such transfers is only available to the transferor and not the transferee which is required to pay tax based on fair value of assets received. This adversely impacts internal group restructurings. In a welcome move, Budget 2018 proposes to exempt the recipient as well from any tax.
Some unfulfilled expectations relating to rationalisation of the fair value based taxation (which deems fair value of assets received as ordinary income) include exemption for transactions like conversion of one security into another, fresh issuance of shares etc.
Jitters to capital markets
One of the biggest talking points in relation to Budget 2018 is the introduction of 10% long term capital gains tax for on-market transfers of listed securities (for gains exceeding INR 1 lakh). Given the buoyant stock markets, this move seems fair from the perspective of the government which will bring significant gains made by investors within the tax net. This proposal essentially brings on-market transfers of listed securities at par with off-market transactions (on-market continues to be subject to securities tax i.e. STT).
Needless to say, this may upset the domestic as well as foreign investors in the short run. Further, retaining the STT even after removal of tax exemption may not be justified.
Dividend taxation regime tinkered
Currently, dividends including distributions which are deemed as dividends, are subject to dividend distribution tax (DDT) payable by the company and are exempt from tax in the hands of the shareholders (except resident non-corporate shareholders). However, distribution by way of loans and advances to substantial shareholders is an exception to this rule. Such loans and advances are not subject to DDT but are taxed at the hands of the shareholders. In order to ensure tax collection at the time of distribution itself, budget 2018 proposes to bring such distributions at par with other dividends except for the tax rate which continues to be 30% (applicable to ordinary income generally) compared to DDT of 20% applicable generally. The only difference in tax rate under the current regime and the proposed regime will be on account of different rates of surcharge applying to corporates and non-corporates.
Instead of the aforesaid minor tinkering, the government should have replaced the DDT regime with a dividend withholding tax regime which, in addition to meeting the objective of tax collection at the time of distribution itself, would have also resulted in a seamless credit of such taxes to the investors. Had this been done, it would have been a master stroke especially to win the confidence of foreign investors.
Ritu Shaktawat is Associate Partner and Raghav Kumar Bajaj is Senior Associate, in the Direct Tax team at Khaitan & Co. (Views are personal)