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February 28th: History Repeats Itself?

Published on Fri, Mar 01,2013 | 09:17, Updated at Sat, Mar 02 at 12:30Source : 

By: Menaka Doshi, CNBC TV18

"I have been at pains to state over and over again that India, at the present juncture, does not have the choice between welcoming and spurning foreign investment. If I may be frank, foreign investment is an imperative."  - P Chidambaram, Finance Minister

That’s how Finance Minister P Chidambaram opened his Budget speech on Thursday, striking the right note in a country starved of investments and faced with declining growth. He must have put a smile on the faces of foreign investors...only to wipe it off an hour later.

"In order to remove the ambiguity that prevails on what is Foreign Direct Investment (FDI) and what is Foreign Institutional Investment (FII), I propose to follow the international practice and lay down a broad principle that, where an investor has a stake of 10 percent or less in a company, it will be treated as FII and, where an investor has a stake of more than 10 percent, it will be treated as FDI. A committee will be constituted to examine the application of the principle and to work out the details expeditiously.” - P Chidambaram, Finance Minister

That was the first surprise. Till here the speech was going fairly well. He announced bits and bobs of infrastructure investments, put in an aggressive 4.8% fiscal deficit target, spoke of capital market reform and then suddenly threw in this half baked idea. Half baked because there are no details forthcoming. Indian budgets are high profile events...this one watched even more closely as it comes in an environment of declining growth and follows an epoch-making budget that include 24 retroactive amendments. High profile events are not the place to showcase meagrely worded ideas, being introduced for the first time. In a country home to complex, sectoral, foreign investment caps and confusing tax treatments for different classes of foreign investors, to suddenly tell a foreign investor his category might change without his will, is not a good idea. I just wish this had been eased in via a separate discussion paper, put through several rounds of debate and then proposed! But if think this is bad...think again.

"Some tax avoidance arrangements have come to notice, and I propose to plug the loopholes. Some unlisted companies have avoided dividend distribution tax by arrangements involving buyback of shares. I propose to levy a final withholding tax at the rate of 20 percent on profits distributed by unlisted companies to shareholders through buyback of shares.” - P Chidambaram, Finance Minister

There's no denying that some MNC structures have used this loophole so the FM's misgivings are justified as is his desire to plug the loophole. I could say the same about his next proposal.

"Another case is the distribution of profits by a subsidiary to a foreign parent company in the form of royalty. Besides, the rate of tax on royalty in the Income-tax Act is lower than the rates provided in a number of Double Tax Avoidance Agreements. This is an anomaly that must be corrected. Hence, I propose to increase the rate of tax on payments by way of royalty and fees for technical services to non-residents from 10 percent to 25 percent. However, the applicable rate will be the rate of tax stipulated in the DTAA.” - P Chidambaram, Finance Minister

Many tax experts I spoke to say both measures are unlikely to yield much revenue and while the former will plug a loophole, the latter will only prove to be confusing as many DTAAs prescribe a 15% tax rate on royalties. That's 2 strikes against MNCs, only partially justified. But the unkindest cut of them all was yet to come. He didn't mention it in his speech but the Finance Bill gave the detail devil up.

'It is proposed to amend sections 90 and 90A in order to provide that submission of a tax residency certificate is a necessary but not a sufficient condition for claiming benefits under the agreements referred to in sections 90 and 90A. This position was earlier mentioned in the memorandum explaining the provisions in Finance Bill, 2012, in the context of insertion of sub-section (4) in sections 90 & 90A. These amendments will take effect retrospectively from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.' – Finance Bill Memorandum

That one clause sent foreign investors scurrying for clarifications and equity markets south. In his press conference the Finance Minister spent several minutes making the distinction between residency and beneficial ownership tests but his explanation did little to calm fears. Several tax experts interpreted this clause as an effort to dilute Circular 789 that allows Mauritius TRC holders to avail of Indo-Mauritius tax treaty benefits. Mauritius is where the bulk of India's foreign investment, FII & FDI, comes from, thanks to its low tax regime. Add to that the one year retroactivity of this proposal and suddenly February 28 became the history that repeats itself. Yes, there is a promise to clarify the situation...but that's not soothing any severely ruffled feathers.

To start on a pro foreign investment note and end on one that is sure to drive investors away – Indian finance ministers seem to be masters at the art of contradiction. Maybe politics is about saying one thing and doing another... but you'd think with GDP growth at 5% they'd stop playing politics with the economy this once?

By the way the contradiction disease doesn't end there...if you took the above mentioned proposal (TRC) out of the Budget I'd characterise it as both ambitious and un-ambitious!

Ambitious in that it projected a reduction in fiscal deficit on a tax revenue target of Rs 88.4 lakh crores – a 19% increase over FY13. I% of that the Finance Minister attributes to the various new surcharges he has imposed. He defends the 18% increase as realistic when compared to the 15% increase in April-December 2012 tax collections. Yet some of the numbers don't look easy...especially the corporate tax target!

Corporation Tax
FY14 Estimate: 16.89% increase over FY13RE

Apr-Dec FY13: 10.6% increase (4.9% lower than Budget Estimates)

Income Tax
FY14 Estimate: 20% increase over FY13RE

Apr-Dec FY13: 22.5% increase (7.6% improvement over Budget Estimates)

Customs Duties
FY14 Estimate: 13.6% increase over FY13RE

Apr-Dec FY13: 6% increase (18.9% lower than Budget Estimates)

Excise Duties
FY14 Estimate: 14.8% increase over FY13RE

Apr-Dec FY13: 17.4% increase (16% lower than Budget Estimates)

Service Tax
FY14 Estimate: 35.7%

Apr-Dec FY13: 33% increase (5.9% improvement over Budget Estimates)

It was an un-ambitious budget in that it had no new ideas to kick-start the investment cycle – except for a 15% deduction on investments in plant and old idea that's come handy this year. Nor were there any out-of-the-box efforts to raise tax revenue – except for a service tax amnesty scheme, that may or may not be a big success.

As one guest left the studio he said ‘atleast this Budget has fewer retroactive amendments than the last one”, I suppose we should be grateful about that!

The author is Corporate Editor CNBC TV18 and the anchor-editor of The Firm. Views are personal.


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