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Zero Exemptions = Lower Tax Rate?

Published on Sat, Nov 28,2015 | 11:02, Updated at Mon, Nov 30 at 22:59Source : CNBC-TV18 |   Watch Video :

In 2009 when the draft Direct Tax Code was released – revenue officer Arbind Modi said of the 4.5 lakh companies in the country, only 50,000 paid taxes, even though the remaining 4 lakh companies held a large volume of resources or assets. Fast forward to 2015 – of the 564787 companies that file taxes, 45% don’t make any profits. And though the statutory tax rate is 32-34%, the remaining 55% pay an average effective tax rate of 23%. That’s thanks to a variety of tax deductions and exemptions. Together they cost India Rs 62000 crores, net of MAT. The biggest of which are - accelerated depreciation – it costs the exchequer Rs 37000 crores. Deduction of export profits in SEZs amounts to over Rs 18000 crores. Deductions for the power industry amount to Rs 10000 cr. And deductions for scientific research add up to Rs 8000 crores. Now the government has proposed to do away with all deductions and exemptions, starting FY18. Alongside it will reduce the corporate tax rate to 25% over the next three to four years.

Should India Inc. give up all tax deductions/exemptions in exchange for a 25% corporate tax rate? To answer that question CNBC TV18’s Menaka Doshi is joined by Ramesh Swaminathan, CFO – Lupin and Praveen Sood, Group CFO – HCC. During the show you will also hear from Suresh Senapathy, former CFO, Wipro and VS Parthasarathy, Group CFO, M&M. Also joining the discussion is Pranav Sayta, Partner – Tax, EY.


4.5 lakh companies
50000 paid tax

Total Companies             564787  
Make Profits                   310716                                
Make No Profits              254071  
STATUTORY TAX RATE              32-34%
INDIA INC. PAYS                             23%
Source: Finmin, Projected figures for FY15

Tax Incentives                   Rs 98407 cr
Less MAT                          Rs 36009 cr
Total Tax Incentives         Rs 62398 cr
Source: Finmin, Projected figures for FY15
INCENTIVES                                     REVENUE IMPACT
Accelerated Depreciation                 Rs 37010 cr
SEZ Units                                           Rs 18393 cr
Power Industry                                  Rs 10606 cr
R&D                                                     Rs 8127 cr
Source: Finmin, Projected figures for FY15 


Doshi: I am sure you are all going to say this is directionally a great move, so I will pre-empt the political correctness and come straight to the issue of 25 percent as the flat corporate tax rate that the Finance Minister would like to levy whether next year, two years, three years or in four years as he has laid out. Is that a good enough tax rate because today companies pay on average an effective tax rate of 23 percent.

Swaminathan: Absolutely, that is the question that I have. Why not 23 itself? If the effective tax rate of corporate India is 23 percent, then the headline number should be 23 and not 25. And there again, he has not actually spelled out the pathway really because today, the effective tax rate, the marginal tax rate is actually 34.61 percent. That is 30 percent plus surcharge, plus there is educational cess of about 3 percent. It all accumulates to about 34.61 percent. So, if he is going to bring it down from 34.61 to 25, he has not laid down the pathway. Is this actually reduction from 30 to 25 or is he saying that on top of it, there would be a host of other levies as well. He is silent on that.

Sood: I agree with you, but why are you surprised for this, because you just have seen that same thing happened in case of service tax also. They says I will remove everything from 12 percent service tax, there was some levies and all those things, effective rate was about 13.6 percent. Now they came with 14 percent rate, you paid more and after six months waiting that you are not resisting, they made another Swachh Bharat Abhiyan as tax of 0.5 percent, 14.5 percent. So, this is what I think government is going to do.

Doshi: So, you are saying you do not believe the numbers even if they are saying 25 percent, it is not going to be 25 percent, it is going to be 25 percent with five other things?

Sood: Exactly, 25 percent plus, plus, plus, basically and I think these two taxes what 12 percent surcharge and 3 percent cess, I do not think, I think when Mr Jaitley made his statement, he was meaning that 25 percent in lieu of 30 percent and then on top of it, whatever taxes are there, although we had a promise from Mr Chidambaram that this surcharge will go in two year period, but I do not think it is gone, and I do not think it is going to go away so easily. So, that is my problem is that you promised me a single rate. You cannot keep on adding and loading.

Doshi: Suppose they promise you a single rate, is 25 percent good enough?

Sood: I am very happy with that.

Doshi: Even though effectively, most companies are paying 23 percent today, so for them it would be an increase of 2 percent?

Sood: I would like to give them a benefit of 2 percent as long as they make a promise that they will not be increasing the rate to 25 percent plus in the next two or three years.

Doshi: Where does 25 percent stack up let us say with other countries, whether you look at the developed world, UK, USA, you look at the emerging world, China, Brazil? Is 25 percent a competitive headline rate with no further surcharges? So, we are assuming 25 percent will subsume all these surcharges.

                                Corporate Tax Rate        DDT
India                     34.61%                                17.3%
Brazil                    34%                                      -
Russia                   0-20%                                  0-15%
China                    25%                                      10%
Indonesia            25%                                      10-20%
Singapore           17%                                      -
                                Corporate Tax Rate        DDT
India                     34.61%                                17.3%
Philippines         30%                                      0-30%
S. Africa               28%                                      15%
S. Korea               24.2%                                   0-20%
UK                          20%                                      -
USA                       15-39%                               -
Source: EY

Sayta: So, let us assume 25 percent is all inclusive. That tax rate is a totality of the tax rate for corporate India. If that is the tax rate, I think we are just about competitive with many countries. If we look at China, we look at Indonesia, we look at Malaysia, we look at UK. UK is in fact, much lower. Some of the countries like Singapore, Hong Kong, Taiwan, UK would be much lower, 20 percent or less. They are all between 16-20 percent. US, of course, is much higher.

Doshi: US is what, above 30?

Sayta: About 35 plus percent, plus they have state tax. So, US is extremely high in terms of tax rate. But other than that, if we look at most of the countries which we compete, which are these ones – even South Africa, I think is around 28 percent – most of the countries, China, Indonesia, Malaysia, Taiwan, South Korea, all of them are – Taiwan aside – all of them are 25. Taiwan, Singapore, Hong Kong around 16-17. UK is 20 but going down to 18. So, most of these countries have a very low tax rate. 25 is just about at the margins of competitiveness but, if it is all inclusive.

And so far as 23 is concerned, I would be okay with 25 for the simple reason that the 23 that we are talking about, I believe is an effective tax rate based on the profits as per the books of companies, but accelerated depreciation is not completely going  away with all of these exemptions and incentives going. Depreciation to a large extent, is still going to be an incentive, so far as the corporate sector is concerned from a tax standpoint and therefore, there will be still some arbitrage between the 25 percent headline corporate tax rate and the effective tax rate when one looks at book profits because the book depreciation might still be below the depreciation allowable for tax purposes – depreciation plus investment allowance and so on. So, I still feel, even if the corporate tax rate was 25, the overall effective tax rate will be below 23 probably, for India Inc. as a whole. So, I would be happy with 25, but an all-inclusive 25.

Doshi: Accelerated depreciation is really the biggest component when you look at what all these incentives and deductions and exemptions cost us. So, the number I put up is it costs us roughly Rs 37,000 crore, but all of it is not going away. Some part of it is still staying. Please explain that to us because the impact of this is across industries, it is not specific to any one industry.

Section 32: Depreciation           

Depreciation Rate On Assets
100% ->
80%  ->
CBDT Discussion Paper

Section 32: Depreciation  

Companies in water supply/treatment system  
Companies manufacturing air/water pollution control equipments
Silk industry
Flour mill industry
Iron & Steel industry
Sugar industry
Clean & Renewable energy equipment
Source: SKP

Sayta: Absolutely, what the paper seems to suggest is that wherever the depreciation rate is above 60 percent, they will probably bring it down to 60 percent.

Doshi: So, either 100 or 80 will come down to 60.

Sayta: Now, those are very few instances. So, pollution control equipment, plus energy saving and renewable energy, these are the 3-4 spaces where the depreciation rate – that is where it is above 60 percent. Those will come down. But otherwise, by and large, the fact that we have a 25 percent depreciation rate generally on plant machinery on intangibles. The fact that we have probably investment allowances on many cases, if those stay, those are big benefits that still stay and therefore, a 25 percent rate is good if it is all-inclusive. I am assuming here that minimum alternate tax (MAT) automatically goes as a natural corollary of all this. And therefore there is no MAT.

Doshi: But, it has to right. I mean it came into being simply to tax those companies that were not showing any taxable profits thanks to incentives, etc. So, if those incentives go away is it not logical that MAT will go away? Is it really a talking point?

Sayta: To your point of has to, I would say, it ought to, but I would rather make it very transparent that it is indeed going.

Doshi: But, logically, it ought to.

Sood: It ought to because if you look at the growth of this tax, from 7.5 percent MAT, suddenly it jumped out to 15 percent and 15 percent straight away to 22 percent today. I mean, 22 percent and 25 percent, it is hardly a difference, so it looks very odd that you are charging a MAT of 22 percent and suddenly, you are charging me a flat tax rate or 25 percent. I mean it has to go.

Doshi: So, accelerated depreciation benefits several industries, some of that benefit will go away as Pranav ha just explained. Besides that, the key other industries that get impacted when incentives are taken away are those industries that invest in research and technology, for instance, the pharmaceutical industry or the automobile industry. Then we have got infrastructure which has several profit linked tax deductions. And then the other biggest other slice of them all is special economic zone (SEZ), again, profit linked incentive. So, we will tackle each one of them on their own. What is your position on the doing away with some part of the weighted deduction on Research and Development (R&D)?

Section 35: Expenditure On Scientific Research             
Weighted Deductions
125% - 200%  -> 100%
CBDT Discussion Paper

Swaminathan: If you look at it, at first sight, it says that the tax rate is going to be brought down to 25, but they are also going to in fact, phase out the whole of exemptions. So, potentially, it looks as though it is a fair game, but I would not really agree there. Let me talk about quite a few points. Personally, if your R&D as a percentage of your profit before tax (PBT) is high, in my opinion, if it is higher than 16.5 percent, then you are actually standing to lose out. And this math in respect to our profits for the current year are looking at the profits of the past year as well. So, my in defence point is, actually if my R&D expenditure is in excess of a particular limit, then I am actually going to lose out.

Doshi: Even if the tax rate all-inclusive comes down to 25 percent. And your current effective tax rate that you are paying roughly 24 percent, you pointed out.

Swaminathan: It is about 24 percent, that is correct. So, that is the first thing. Secondly, R&D is its wake, because of its very nature, it actually involves a lot of uncertainty, so we are talking about battling a lot of uncertainties, on the scientific uncertainty, uncertainty on the technical front, because you really do not know whether your technology will get there. On the regulatory front, because you might actually make a submission, but it is quite possible that the regulators do not agree that you have actually got a product. And lastly on the market front itself. So, a lot of uncertainties. So, there is a lot of a risk associated with that.

Doshi: What business does not have risk?

Swaminathan: Sure, but that is R&D by its very nature is very risky.

Doshi: When we get to MR Sood, he will tell you being able to get right of way to build a road, is in itself as risky as being able to create a patent of a product.

Swaminathan: I do not deny that, but that is the risk that you actually have because you have got competition, a host of things. I am speaking about my industry and there is a lot of uncertainty there when it comes to R&D itself, because of the nature of R&D. We might blow a billion dollars, but at the end of it, you might not really have anything in terms of outcomes. Given the fact that there is so much of uncertainty, I would think that there has to be an incentive for actually performing that particular function.

Let us take the example, in fact of other countries. There is incentive for looking at – there is R&D grants being given and for sure, in most countries, there is something that’s known as the patent box regime as well. For example, let us talk about UK. If you have profits coming out of incomes coming out of innovation of patented products, then you are actually talking about a tax rate of not more than 10 percent and this is something which has been done in Netherlands, the UK, the US is looking at it.

Doshi: But, would you not draw a distinction between the profit that you make from a patent or a patented product or a patent embedded in a product and getting the tax break on that? In this case you are getting weighted deduction just for spending money with no outcome mile posts.

Swaminathan: That is exactly the point, because I am bearing that risk and I need to be incentivised for that. Look at the number of patents that have actually come out of India. It is abysmal.

Doshi: Despite the fact that there have been so many…

Swaminathan: I am saying that it is also because of the fact that there has been not too many incentives for people to put more money into research.

Doshi: I have never heard any inventor say I invented this because I got a tax break.

Swaminathan: I am saying that the fact of the matter is that tax breaks are a given in several countries.

Sayta: To be fair, an R&D incentive or credit is available in many countries. If you look at Brazil, Russia, India, China and South Africa (BRICS), all the others, China, South Africa, Russia, Brazil, all of them have R&D benefits. Weighted deductions. I think most of them 150 percent.

Swaminathan: Brazil, Russia, India, China and South Africa: Even Japan has that.

Doshi: But even some part of the weighted deduction is staying right?

Swaminathan: No, it is gone.

Doshi: No, from 200 percent it is going to go to 100 percent, something like that right?

Swaminathan: That is basically, you are saying that the expense is deductible, that is it? You spend a 100, you get a deduction of 100.

Sayta: So, what you are getting is an accelerated depreciation effectively, that is the entire capital expenditure (Capex) is being allowed in year one. It is like that. So, essentially, most of these have 150 percent weighted deduction, the BRICS as I said. Then there are countries which really have profit based incentive for R&D.

Doshi: The patent box regime that Mr Swaminathan spoke about?

Sayta: So, UK has it with levies only 10 percent tax. US is actively considering it, something has been introduced in the house there as well. Netherlands, I think has it. So, there are many countries which have regimes which give a very concessional tax rate to profits from R&D. Now, are these countries already having a very competitive tax rate? We have seen already the tax rate in BRICS. We have seen the tax rate in BRICS, in UK and so on and so forth.

Swaminathan: And a very pertinent point here at this stage, even as you are talking about the new Organisation for Economic Co-operation and Development (OECD) principles that are going to apply, they are not actually talking about actually phasing out of the patent box regime.

Doshi: The Base Erosion and Profit Shifting (BEPS) principles that you are referring to?

Swaminathan: The BEPS principles, absolutely. The BEPS principles actually recognise that. So, it is not as through it is going to be taken out when a new regime comes in at some point of time.

Sayta: So, the point I was making is despite having a competitive tax rate of 25 percent or less, they still have these incentives for R&D. Can India afford it?

Doshi: So, you are clearly batting in favour of this incentive to stay?

Sayta: Not necessarily. What I am saying is that India has to make an assessment of what is the need of the hour for the country as of now.

Doshi: I am going to hear that about half a dozen times in this discussion, because every industry is saying that.

Sayta: Because, there are five areas. Does India need to incentivise infrastructure creation at this point of time?

Sood: Yes.

Sayta: Does India need to ensure that exports are supported?

Doshi: On behalf of the export industry that I have spent three days talking to, I will say yes!

Sayta: Does India need to ensure we are the design and intellectual capital of the world, not only Make in India, but Design in India and Innovate in India and so on? Does India need to create jobs?

Doshi: Then we should shut this discussion down right now because essentially what you are saying is not a single incentive should go away.

Sayta: What I am trying to say is we have to balance this and say that if corporate tax rate inclusive of surcharge cess is going to come down to 25 percent, are we willing to create a level playing field for all industries and willing to give up most of these incentives.

Doshi: I do want to bring in here VS Parthsarathy, the Group CFO of Mahindra and Mahindra. Now, M&M on a standalone basis, pays an effective tax rate of approximately 24 percent. The group itself stands to lose two critical incentives, tax incentives, the R&D deductions for its automotive business and the SEZ exemptions that apply to its IT business, that is Tech Mahindra. Now, Mr Parthasarathy said, directionally this is a good move, but he had a list of conditions that he had put down to make it a good move. For instance, he said programmes like regional development like the Make in India programme, must continue to get some sort of tax support. He had other conditions as well. Here they are.

Parthasarathy: First is, please be very clear about what is your maximum tax rate. That means, if 25 is all-up all-in, or 25 is going to be 25 plus something, plus something. So, one of the requests I would put it that if you are coming to the new rate of 25, 25 percent should be all-up, all-in tax rate going forward.

The second one is not look at any industry specific but focus on two things. One is what is the inclusive agenda on regional development areas. For example, take some time back, Rudrapur. It gave a tax incentive for people to set up industry there. Everyone knows it is very difficult to set up industry in a new place and not all logistic and ecosystem exists, but by giving this kind of incentive, today Rudrapur may be a thriving hub. So, similarly, if locations need inclusive growth and regional development, that must be supported. And that is not one industry or the other, across industry.

Similarly, Make in India is something that they should say. And when I talk about Make in India, I am only saying look at what emerging countries are doing and therefore we must make to make India a more attractive place than its other competitive markets for manufacturing.

The third one I would say is abolish MAT then, because if you are already bringing down the tax rate to 25 and also reducing most of the deductions, then why have another concept called MAT? And if depreciation is the only difference, tax also can adopt the accounting depreciation. And in which case, there will be no difference and therefore, do not have another concept called MAT.

The fourth one I would say is Dividend Distribution Tax (DDT). The DDT is a double taxation. Please take them away. And the fifth one is in terms of corporate social responsibility (CSR). CSR expenses is as much a business expense today, to take care of the society in which they operate. I mean you could take them as expense equal to an employee expense, employee is for employee and CSR is for the society. Or you can take both as investment. In both cases, there is a case for 100 percent deduction for CSR which should be considered. And if you take all of them together, otherwise what will happen is CSR with 2 percent effective rate is not 25 but, 27. So, if these five things are taken care, I am not very specifically looking at saying auto industry should be given something, but at the same time, I would only mention that R&D is an important element for India to come in as a developer and manufacturer, not just manufacturer, but also having the intellectual property (IP) ecosystem in India.

So, that is what I am asking.

Doshi: I love the answer because it says this is directionally great as long as you do away with DDT. Full deductibility for CSR spends. Keep incentives for regional development. Keep incentives for Make in India, keep incentives for R&D and then I am good with all of this. Essentially, which means, do not change anything in my life, just bring the tax rate down to 25 percent.

Swaminathan: We are living in a utopia.

Doshi: No, even the auto industry is making the same point as you are. Do not take away the R&D incentive whatsoever. Now, one of your compatriots said on CNBC-TV18, Kiran Mazumdar-Shaw, that if this happens that many industries or many companies rather in the space, will have to consider moving their IP activity outside India. Is that really going to effectively happen? What happens if this does go through?

Swaminathan: I hope that was as simple as that. I do not think it is possible. It cannot move it, it is not a shut down, shut-off kind of operation.

Doshi: Is that your fear as well for technology oriented industries?

Sayta: I would feel it is easier said than done. I would feel it is easier said than done. It is not very easy to move an entire head and brain of the R&D department abroad.

Doshi: And it is going to get less and less easy with BEPS coming in, right?

Sayta: Absolutely, and the BEPS principles are very clear. It is substance based. It is going to be extremely difficult. Finally, I think it is going to boil down to where you have the resources and the infrastructure to carry out that research and to succeed. So, I think it will stay. I am not so worried that it will fly away.

Doshi: So, bottomline impact?

Sayta: Yes, there would be a bottomline impact.

Swaminathan: For sure. And in our case, it is certainly going up. I would say at least a couple of percentage points in.

Doshi: A couple of percentage points?

Swaminathan: Yes.

Doshi: Let us now shift our attention to the infrastructure industry that is also said to lose all its profit linked incentives starting April 1 from what I understand. A wide variety of infrastructure industries get impacted. Power, the sunset date for which is being brought forward to April 1, 2017 also gets impacted in a big way. Can you describe to us what happens to the industry? What are the key exemptions that are going away?

Section 80-IA (4)(i): Deduction For Profits From Infrastructure Facility              
100% deduction for 10 years
Grandfathering of deduction if activity commenced before 1 April, 2017
CBDT Discussion Paper

Section 80-IA: Deduction For Profits From Power Generation/Transmission/Distribution
100% deduction for 10 years
For projects commencing activity before 1 April, 2017
CBDT Discussion Paper

Sood: The biggest exemption available to infrastructure industry is 80 IA. It is a benefit which is being given to develop certain kind of infrastructure enterprises. It talks about build, operate, transfer (BOT) roads, it talks of the roads highways, it talks of townships. It basically, gives you tax hurdle of 10 year period of your choice.

Doshi: Where you do not pay any tax on the profits.

Sood: We do not pay any taxes.

Doshi: Any ten years of the project.

Sood: Any ten years of the project, you can pick up and you will not pay any taxes on that. And again this entire story, because this tax was basically introduced, this exemption was got somewhere in around 1970s – 80 IA. And in 1997, they revised it and then in 2009, from retrospective date, they did amendment and they said the construction companies or the subcontracting companies will not be getting this benefit. This benefit was being taken by the companies who were intermediaries into the development of these businesses like construction companies.

Doshi: So both the developer, the person who owned the road as well as the company that was constructing the road, both of them got a tax holiday of 10 years on all profits. 10 years of their choice during the life of the project.

Sood: As long as, in case of a construction company, it was different, because we were doing the construction for that period. So, whatever work we used to do for that, we can always claim exemption on those income which we earn from doing these projects. So, that was the intention. And that we were claiming. After this circular of 2009, entire thing went for litigations.

Doshi: So, will you weep too much if the incentive goes away?

Sood: We will not weep too much because right now, the entire industry is passing through a phase where it is not making a profitability at any point of time. Every company in the infrastructure sector is carrying forward enough carry forward losses and all those things. And it is not getting on a tax. Most of them are under MAT. We are paying MAT taxation because all our profitability is coming from various account of claims which are not getting basically paid to us and as per the system, what we follow is that on the claims, normally we do not pay taxes because on accrual basis.

Doshi: So, you are saying no impact on let us say Hindustan Construction Companies (HCC), or the other companies that work in the contracting business. As of now, if this incentive were taken away, no collateral impact from the impact on those that are developing infrastructure either?

Sood: No. Let me clarify it very clearly. The companies who are into the development business, even HCC, a part of it is into the development business. Yes, because you do own some roads. HCC infrastructure which do the infrastructure development, there would be impact.

Doshi: Can you quantify it for us from a bottomline impact point of view?

Sood: Very difficult to quantify it because at this point of time, you have again, carry forward losses and everything, but on a going concern, normally, you get tax 10 year holiday, so you pay zero tax, you pay only MAT. And that again on a litigation because there was a concept going on that if everything is exempt for me for 10 year period, how can I supposed to pay MAT. So, again, there is some circular which came subsequently you are supposed to pay MAT on that.

Doshi: So, are you not happy that all of this confusion will go away?

Sood: That is why I am saying. I would be happier, but again, I am not very sure about the companies who are in development business because if you talk about R&D and everybody will make a story that R&D is essential for the development of this new patent and everything and all those things, same argument stands for here also because in this country, infrastructure is deficient. No doubt about it, I am sure that everybody across the table will agree for that. And if you want to build infrastructure currently at this point of time, you have no option, but to incentivise the people normally who are going for the infrastructure development.

As it is we have seen that because of the various environment around us in the sector, most of the companies are unable to carry it out as per the desired speed or the desire time level. So, most of them are incurring losses and getting into all sort of problems. This sector is passing through a crisis period at this point of time.

Doshi: I love the way you answered my question. You said I am all in favour of doing away with all incentives. But this is not the time to do it.

Sood: Yes, I mean you just cannot start with okay, infrastructure sector, whaever we have given I will take away everything. 10 year period has to continue for future.

Doshi: But they are grandfathering this.

Sayta: So long as you complete and commence your project by...

Doshi: Before April 1, 2017.

Sayta: Absolutely.

Doshi: You will still enjoy the 10 year holiday.

Sayta: Absolutely. Even for future projects.

Section 80-IA(4)(i): Deduction For Profits From Infrastructure Facility
Infrastructure companies involved in…
Road, toll road, bridge or rail system
Highway project
Water supply/treatment, irrigation, sanitation/sewerage/solid waste management  
Port, airport, inland waterway, inland port…
Source: SKP

Doshi: But all the projects thereafter whether it is a port order or an airport order, road....

Sood: And are you sure they will not bring out some retrospective change in the law?

Sayta: Well, I hope not.

Doshi: So, previous projects also do not get the point.

Sood: Because this is the problem.

Doshi: Okay, why be suspicious, they are trying to clean up things, so why be suspicious?

Sayta: I think they have made the intention very clear that grandfather all prior projects. Continue with the exemptions for the remaining part of the 10 year period.

Sood: As long as it is a level playing field with clear knowledge in the beginning.

Doshi: But that is what they are attempting to do. So, let us give them brownie points for that.

Swaminathan: The fact of the matter is the Finance Minister is going to find it very difficult to balance the books. So for all of these wishes are going to turn true, the fact is we are not going to be able to afford it.

Doshi: I like that you are saying that because that is exactly the point here. You are saying that R&D must stay, he is saying that infrastructure must stay.

Swaminathan: The answer really is in actually making sure that there is better compliance, perhaps in broadening the tax base and measures of that kind.

Doshi: That too must be done, but that cannot be the only area of thrust. Let me tell you what the power industry guys told me and I was taking to a few companies through the course of this week. And they said, okay, you take away our incentives, it will be detrimental, we do not understand what this government is up to. On the one hand, it says it wants to revive power, which is in deep trouble right now and then on the other hand, it says it wants to bring the sunset date forward to April 1, 2017. It is fine with us. If we take the hit, we will pass it on in power tariffs and if we pass it one in power tariffs, the cost of consumption of infrastructure such as power, goes up for consumers. Now, that is your problem, not my problem.

How do you respond to this from industry? Is this knee-jerk do not twist my arm, because then I will twist yours, or is that the reality we are all going to have to face if the tax holiday is taken away, the cost of infrastructure becomes more expensive for all of us.

Sayta: That is the fact which we will have to face. The fact of the matter is clearly that there are some sectors within the economy that are probably going to have to lose and there is no doubt about that. At the end of the day, what we are trying to say is, overall, there are certain sectors.

Doshi: But, who is losing here? If the sector is losing and the consumer is paying for higher power tariffs, the consumer is losing at the end of the day. The power company is going to do whatever it can to protect its profitability.

Sayta: So, to some extent, it depends upon of course the ability to pass on those extra costs. But the point is that, someone in the economy is paying the cost. But overall, if as an economy, we are going to have a simpler tax regime, if we are going to have a less litigious tax regime, something that is more level playing field and if we are going to have a very reasonable competitive tax rate that creates a perception of growth, somewhere we have to give it to the Finance Minister, that he needs to balance his books. And there is some pain in certain sectors that will be there.

Sood: If you make a case for the infrastructure, if you make a case for the R&D and all those things, in spite of having all these exemptions, even right now, are you happy with the way they have been progressing? Are you happy with the infrastructure that is happening in India? So in spite of giving so much of incentive, tax incentive and then backward area incentive and all those things.

Doshi: Then you are proving the Finance Minister’s point. It is not tax incentives that make you a healthier industry, it is a variety of other things that the government would like to tackle.

Sood: Precisely. If any business which is based more on to the tax incentive, of some kind of a support from outside, some subsidies and all those things. In the long run, the moment you withdraw them, you will find them limping to become profitable. So, I always believe that if you want to run a model in the country, from day one if you tell me very clearly, no support, no tax benefit, everything will be, as long as you can...

Doshi: You just made the argument that the infrastructure industry would be crippled if you take away these incentives.

Sood: I am simply saying if you take from a retrospective date, what I am trying to say is that as long as you are telling me that you can pass on all these extra costs which you are incurring or extra profit which you are giving up, you can pass on to the ultimate consumer, I am happy with that.

Swaminathan: Honestly, you might not be left with the consumer.

Sood: Why not? Let me talk of the infrastructure basically. Roads, now you are making sure that you cannot levy a stall charge of more than this amount. You cannot do this, you have to leave account government vehicles, you have to do that. The moment you put too much of conditions on me.

Swaminatan: At some point of time, an indifference point does click in.

Doshi: If power costs go up, can you afford not use power? Can you afford not use roads? Can you afford not to use airports in this day and age? Or ports? I mean what infrastructure is not critical?

Swaminathan: The fact is you cannot afford to actually get your way when it comes to, because there has to be a curtailment.

Sood: Airlines keep on charging you from Rs 5,000 to Rs 15,000 to Rs 25,000 for the same to and fro Delhi and you still pay Rs 15,000, you pay Rs 25,000 when you are supposed to go. So, everybody pays where the need be there and as long as you are providing a good services.

Doshi: So, you are principally not objecting to the fact that if there is a date from which no new infrastructure projects get any incentives, you are fine with that as long as it does not apply to those projects that were designed keeping the tax benefit in mind and for whom the internal rate of return (IRR) will now go a little wonky.

Sood: Precisely, as long as you are allowing me to pass on the basically, the entire cost.

Doshi: Okay, that is the second condition? Allow to me to pass this on.

Sood: Allow me to pass this on. Yes.

INCENTIVES                                     REVENUE IMPACT
Accelerated Depreciation                 Rs 37010 cr
SEZ Units                                               Rs 18393 cr
Power Industry                                   Rs 10606 cr
R&D                                                        Rs 8127 cr
Source: Finmin, Projected figures for FY15

Section 10AA: Deduction For Profits Of SEZ Units’ Exports

100% for first 5 yrs
50% for next 10 yrs
Grandfathering of deduction  if activity commenced before 1 April, 2017
CBDT Discussion Paper

Doshi: Let us now come to SEZs. I think about Rs 18,000 crore is what the ex-chequer gives away to profits made by developing special economic zones and by units located in special economic zones. A variety of industries will get impacted by the doing away of this incentive. IT, big one, pharmaceuticals another one, gems and jewellery, a third one. So, many of those industries that work out of SEZs, export oriented industries will get impacted by this. Exports too are the crying need of the nation at this point in time. So, how would you react to the doing away of the SEZ benefit? You do not seem to be as pained about that as you are about the R&D benefit.

Swaminathan: It is more because of the fact that we are actually our effective tax rate is slightly higher than 20 percent. So, to that extent, I would say that the pain would perhaps be lower when it comes to that. And there is of course going to be the SEZ benefits are there to stay for a period of time.

Doshi: Anyway, SEZ, we knew that there was only going to be a 15 year benefit.

Swaminathan: Absolutely, so to that extent, we are aware of the fact that there is going to be a sunset at some point of time.

Doshi: Would you agree with that that in fact, the death knells for SEZ had been rung a long time ago. This is in some sense is just the final nail in the coffin for SEZs. So, doing away with the incentives for new SEZs again a grandfathering approach has been maintained here. For new SEZs, is not a really bad thing.

Sayta: I would not think so. So, long as people have had enough time and there was a smooth planned transition, I think it should be fine. Of course, the headline tax rate is 25 percent. And you must remember that SEZs we are trying to create pockets of excellence. Several countries have had it. If we have a country where industry is not globally competitive, what we are trying to do is create those pockets, parts of excellence where they can be globally competitive. But there are lots of other incentives which still probably stay. So, there are indirect tax benefits, service tax, customs, duties, stamp -duty, electricity duty, some kind of duty drawback, as we call it Services Exports from India Scheme (SEIS). So, all of those still continues, so I am not too sure it will be completely off the whack, but taking away the tax holiday, I am not sure is going to be a big thing so long as the corporate tax rate headline is brought down to 25 percent.

Doshi: I spoke to Suresh Senapathy, the former CFO of Wipro because IT will be one of the key industries that will get impacted by this and I want to tell you what Mr Senapathy said to me. He first pointed out that there are several foreign taxes and costs that they pay that they do not get credit for in India ans therefore, if exemptions are taken away, it is not a single whammy for them, it is a double whammy for them. Listen in to what Mr Senapathy had to say.

Senapathy: Let us say US for example. US taxes at the state level tax on income. And that is not available under the current double taxation treaty. US tax rates are higher. When you do a double income off-set, it is only restricted to the tax rate that you pay in India and not the tax that you pay in the US. Having said that, let us say the tax rate that you are paying in UK is perhaps at a rate lower than what you are paying India. The off-set is only the actual. So, if you pool the tax that you pay in UK, the tax that you pay in US, etc, etc. then on a pooling basis, which means on an income stream as opposed to a country stream, you will find there is much more efficiency. So, part of that can get addressed by making necessary amendments income tax law. Part of that will get addressed by signing double taxation treaties. Similarly, when you talk about social security, I talked about saying when today; India is doing about USD 100 billion, about USD 4 billion of social security taxes which is wastefully being incurred.

Now, a totalisation agreement can save that kind of an amount so far as Indian companies are concerned and therefore paying a little more tax matters the least. So, I am saying there are therefore elements and I can’t in two minute tell you all the items but there are such multiple items which has to be identified and articulated so that the government and industry work together to be able to mitigate them.

Doshi: So that is one mitigating factor, Mr Senapathy also brought up some issues with regards to the incentives for SEZs going away even though there is grandfathering clause that has been proposed by the government. Here is what he had to say?

Section 80–IAB: Deduction For Profits From SEZ Development

100% deduction for 10 years
Grandfathering of deduction  if activity commenced before 1 April, 2017
CBDT Discussion Paper

Senapathy: Two things, let me clarify on this once for example by 2017 if a developer has already put in a facility and the incentives are withdrawn nobody is going to start a facility there because the tax incentives are no more there and hence we will have a white elephant sitting there  not being put to use – one.

Two- if you think that the SEZ benefits are taken away as of today then theoretically the hidden cost continuing to be what it is you will find that the tax rate which the IT companies will be subjected to will be far higher than the marginal tax rate or the tax rate that is applicable to any company who is operating only in the domestic market. Let us assume it is 25 percent from 2017 and from 2017 all these SEZ tax benefits are gone and there is nothing else that has happened in terms of superior double taxation treaties, totalisation agreement has been signed by xyz…. You will find that while most companies operating in Indian domestic economy will be required to pay 25 percent tax. The IT companies were operating on a global basis or any other companies which are in global businesses and therefore are generating profits outside of India. You will have a tax rate which is at least 10 percent more then what a marginal rate of tax in India would be. Which in other words would mean not only that you are in some form discouraging export from India, you are putting them at a disadvantage and you are making it globally non competitive as compared to countries like China, as compared to countries like Vietnam, countries like Philippines and so on.

Doshi: How would you react to what the IT industry seems to be quantifying as the impact on itself?

Sayta: The way I look at it is that the IT industry today probably in any case pays tax around 22-23 percent. I am not too sure that it is significantly different from the 25 percent that the finance minister is talking about. The points Mr Senapathy made are absolutely valid so for example state taxes in US are not creditable against Indian taxes and in any case the US tax rate is higher than the Indian tax rate. So, there is a leakage of the US tax which is not creditable in India. Also there is an absolute truth in what he says as regards to social security payments which probably are leakage again.

Now these are points which separately needs to be negotiated with those concerned countries and probably if those leakage is stop then it will benefit the Indian companies as a whole.

Doshi: That is a fairly long-term thins. It is not going to happen in one or two years. Let us be honest about that?

Sayta: Absolutely true.

Doshi: So if that doesn’t happen for next three – four years but in the interim the exemptions available to SEZs and earlier there was the STPI exemption since that has gone and now this will go, will it amount to a double whammy to the IT industry because he seems to be given the impression that we were till now balancing the additional amounts we were paying overseas with the fact that we were getting some sorts of exemptions here in India?

Sayta: I am not too sure. I am not an expert in his industry as much as he is but the way I look at it is today most of the IT sector companies, most of the units are not enjoying tax holidays. It is a few units which are enjoying tax holidays because we are in the SEZ zone. We are also probably in that period of 5 years or 15 years that enjoy the tax holiday but the rest of the units are still efficient, are still operating and are still probably making profits.

Doshi: So not as much as of whammy is it?

Sayta:  The way I am looking at it is it will hurt and we have to accept that it will hurt but at the end of the day one will have to give up some of these incentives if we want a reduced tax.

Till we do not accept that reality I am not too sure of this entire effort is going to progress at all.

Doshi: In 2009 we for the first time in this country may be 2005 as you pointed out the Kelkar Committee report but 2009 first draft of Direct Taxes Code (DTC) started a debate in this country saying let us do away with all these profit linked incentives. At that time the thinking was let us shift to investment linked incentives.

The DTC is being junked, it is history. But the issue of incentive is still alive and the ghost is come back to haunt all of you saying let us do away with all incentives. You say my industry is critical he says his industry is critical so Suresh Senapathy saya his industry is critical. VS Parthasarathy says his industry is critical. Now what does the government do?

Sood: I am saying take away incentives

Doshi: So you are in favour. At the end of this discussion you are saying take away all of them including the infrastructure incentives?

Sood: I am pretty sure about it.

Swaminathan: I would rather go by at least incentivising the right sectors.

Doshi: Who decides the right sectors? Infrastructure is right, exports is right.

Swaminathan: Potentially, I am saying that the nature of the spend. Essentially, if you are going to look at innovation which is critical for any economy, you will certainly have to look at incentivising that. I would rather say the way at best is to look at better compliance and expand the overall tax base of this country.

Doshi: This is just direct tax we have been talking about. Indirect tax exemptions amount to Rs five lakh crore, Rs 4,86,452 crore to be precise. So, we are already talking about taking away direct tax incentives. The last time we tried doing that in 2009, it failed. That conversation went nowhere. Are we going to go somewhere this time?

Sayta: I think so. I think the Finance Minister is serious this time. I think we will have to be a little more pragmatic to be able to achieve this. I would feel if we are talking of creating an environment where we enhance productivity, focus on doing business rather than litigating or trying to complicate, to look at complicated tax exemptions, if we want to enhance ease of doing business, probably somewhere we will have to make a beginning.

Swaminathan: And the fact of the matter is when it comes to indirect taxes, we are anyway going to address it through the GST mechanism and that is in the offing. So, I am not too sure a lot of these exemptions would stay. And once you actually have GST in its full form.

Doshi: But that is exactly the reason why I brought it up because the moment industry sees those going away because of GST and these going away because of this effort by the government, all the lobby groups within industry are going to be yelling even louder saying how could you do this to us at a time when the economy is not picking up.

Sood: As long as you are making a level playing field for everybody across the sector, it should be fine with us.


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