Although it was cold in Davos, which was hosting the Annual World Economic Forum 2018 meet, the Indian Prime Minister warmed up the occasion with his charismatic keynote address in the opening session. “Come to India” was his mantra as he envisions India to become a $5 trillion economy by 2025. This vision may probably have some contextual reference as to what we should expect from the upcoming budget.
The reforms undertaken by the current NDA government have definitely yielded tangible results, enabling India to move 30 places up in the “Ease of Doing Business.” While India is anticipated to be the fastest growing economy in 2018, this is also the NDA Government’s last comprehensive budget to be presented. History tells us that the NDA Government’s budgets are not populist budgets. Thus, the Finance Minister (FM) has a tough job on hand and a delicate rope to walk on, vis-à-vis economic reforms and populist measures.
Corporate tax – The easier ask
The Budget 2015 had announced a phased reduction of corporate tax from 30% to 25% while phasing out all incentives and deductions. While this is a work in progress, recently, in an unprecedented move, the US replaced its 30-year old tax law, and consequently, reduced the corporate tax rate from 35% to 21%.
For investments of the size and nature envisioned at Davos to flow to India, the FM will have to relook at the corporate rate to appear relevant and stay competitive vis-à-vis other jurisdictions. Thus, the FM may consider specific criterion, enabling companies to avail the reduced rate or just provide an option to choose the lower tax rate of 25% while eliminating all deductions vis-à-vis tax holiday benefits.
Second, the Minimum Alternate Tax (MAT) aspect was introduced in India to bring “zero tax companies” within the tax net. As the PM wants India to be “The Investment destination,” the FM could well relook the MAT rate or consider abolishing it altogether. The US too recently abolished similar provisions within its federal tax structure. While abolishing MAT altogether could have revenue loss impact, it would have to be weighed in against potential investment coming in and the resultant benefits, especially the creation of job opportunities, which has been an area of concern for the current government. Third, currently the dividend received into India from its overseas subsidiaries is not exempt from MAT, unlike domestic dividend received, which is exempt. This is a hurdle for funds moving into India. Thus, exemption on foreign-sourced dividend will incentivize funds sitting abroad to move inbound.
Insolvency and Bankruptcy Code (IBC) needs tax clarifications
The introduction of IBC is a welcome move, as it intends to provide for faster and definitive resolution of lender borrower conflict in comparison to the now repealed Sick Industrial Companies Act, 1985 (SICA) and insolvency related provisions of the erstwhile Companies Act, 1956. While some say, it has boosted India’s ranking in the “ease of doing business,” its sheen has been dented slightly due to the absence of or ambiguity in certain tax aspects. Therefore, it would be a pity to have potential tax issues arising because of the resolution plans. Most resolution plans would provide for reduction/ waiver that the lenders would take on their outstanding loans. Such write-back of loans to the profit and loss account would be subject to MAT, in the absence of any current specific exemption. Further, in case of change of shareholding beyond 49% on the acquisition of a distressed company, the business losses of the target company would lapse. Such current provision poses additional hurdles for an optimistic acquirer. The Budget provides for a natural opportunity for the FM to iron out these nuances and clear out ambiguities, which in turn will lend additional layer of support and robustness to the resolution process.
Mergers and acquisitions in focus
The “Start-up India,” and “Digital India” programs were initiated, as the Government wanted to develop and encourage entrepreneurial skills in the country. Thus, investment in start-up companies through preference shares has emerged as preferred instruments for funding by the investors. While traditionally, equity route was preferred, increasingly, the preference shares route is being adopted. This is mainly because this instrument does not require annual interest pay out (as any debt instrument), given the long gestation of the business and can be redeemed in the event of success to extract surplus funds from the company. While, in case of unquoted equity shares, there are specific computational rules, for unquoted preference shares the current rules simply state the value to be the price it would fetch if sold in the open market on the valuation date and that the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. Thus, the current tax laws provide subjectivity in valuing preference shares, it enables the tax authorities to question the valuation methodology adopted by the valuation experts, which could be best avoided. Valuation is a highly subjective matter, especially for start-ups and new age technology industries. Thus, this Budget could lay down specific criterion for valuation of start-ups. While that would be getting into granular details, and thus, tedious, the current law could well be amended to simply provide that where unrelated parties are subscribing to shares at a premium, such premium should be respected rather than rejected.
From a mergers and acquisition’s perspective, the carry forward of losses are permitted only for companies qualifying the “industrial undertaking” criteria (which is mostly satisfied only by manufacturing companies). Today, when the services sector contributes about 60% to India’s GDP, it is ironical that such a restriction on losses is still in place and now literally begging to be replaced. This at the very least will ensure parity for all kinds of undertaking and facilitate necessary reorganization.
Finally, an interestingly timed survey such as the Oxfam survey, which suggests that, “the richest 1% of India cornered 73% of wealth generated last year,” has added to the apprehensions of wealthy people. It would be interesting to see whether the FM would want to toy with any thoughts on the introduction of inheritance tax, especially after two of the biggest initiatives of DeMo and GST.
…. over to 1 February, 2018.
Authors – Rekha Bagry, M&A Tax Partner, PwC India and Vishal Yeole, Associate Director – M&A Tax, PwC India
The views expressed here are personal. Article includes inputs from Saloni Thawani, Associate – M&A Tax, PwC India
(The author can be reached at [email protected])