India Growth Story and the ritual of Annual Union Budget

A twist in the tale yet a powerful economic booster

Atul Dua and Vikas Aggarwal decode the annual Union Budget 2009-10 and provide an insight into the fine print of the legislative changes proposed in the Finance Bill

The Government of India (GOI) presents its budget of revenues and expenses for approval of the Parliament of India annually. However, instead of merely being a statement of account, the annual budget practice of the GOI is always considered as the yearly policy making exercise. This budget, however, seems different. There appears to be a lack of major policy announcements and changes in the tax legislation. The economic survey of the GOI was more forthcoming with respect to the wish-list of the government, but it seems its implementation was not considered prudent for the present year.

The proposals of the Budget 2009-10 and Finance Bill, 2009 have been aptly summarised by the Hon’ble Finance Minister by quoting Mahatma Gandhi.

“Democracy is the art and science of mobilising the entire physical, economic and spiritual resources of various sections of the people in the service of the common good of all.”

There were several challenges before the GOI this year. It is paramount to lead the economy to a high GDP growth rate of 9 per cent per annum at the earliest. Then, in continuation of its earlier practice, the GOI desires to express its sincerity to deepen and broaden the agenda for inclusive development. With respect to its earlier policy initiatives, the GOI intends to improve its delivery mechanism.

The growth rate of GDP has dipped from an average of over 9 per cent in the previous three fiscal years to 6.7 per cent during 2008-09. Whole sale price index rose to nearly 13 per cent in August, 2008 and had an equally sharp fall to zero per cent in March, 2009. The stock markets touched the highest and lowest points in a short span of time.

The revenue deficit and fiscal deficit have been projected at a very high rate. This level of deficit is a matter of concern and the GOI has vowed to address this issue in right earnest to come back to the path of fiscal consolidation at the earliest. However, given the grim global economic outlook, government spending on large scale is necessary to keep the economy afloat. But, with fall in revenues due to the recession, the GOI has to walk a tightrope. Regarding the budgetary spending, there has been a substantial increase in the expenditure of the GOI, which for the first time in the history of India touched more than INR 10,000,000 million, however, there is a fall in estimated tax revenues. There is a proposal to increase spending on infrastructure, ‘common man’ schemes proposed in the earlier years of the present Congress led Government and on Defence.

Structural changes in direct taxes would be pursued by releasing the new Direct Taxes Code soon and in indirect taxes by accelerating the process for the smooth introduction of the GST with effect from 1st April, 2010. The broad contour of the GST Model envisages dual GST comprising of a Central GST and a State GST. The Centre and the States will each legislate, levy and administer the Central GST and State GST, respectively.

Proposals on taxes seek to achieve a stable framework by maintaining the overall rate structure. There is no change in peak customs duty rates and corporate tax rates. While there is talk of distortions caused by several exemptions and deductions, there still is no clear word on withdrawal of exemptions or deductions.

In this Annual Budget, there seems to be a lack of major policy initiatives, but there is a clear intent to revive rural economy with giving few things to cheer about to urban India. The emphasis is to boost the demand side to achieve the desired growth, while maintaining stability on the supply side. However, non-adherence to fiscal responsibility and management is a cause of concern.

Be that as it may, it’s not the proposals, but the integrity and commitment in their implementation, that’s important. We hope that this time around the GOI is serious about its social upliftment agenda which would be positive step in the long term.

Fringe Benefit Tax (FBT) and Commodities Transaction Tax (CTT) Abolished
In a major relief to corporate India and the commodities market, it is proposed to abolish FBT and CTT. FBT has been a major source of revenue to the government since its introduction, but there has been a lot of hue and cry about its appropriateness and legitimacy. However, when revenues are dwindling, this measure, though due, may have been proposed to be implemented from next year.

Consequently, it is also proposed to restore the taxation of fringe benefits, as perquisites, in the hands of the employees. Accordingly, perquisite shall include:

The value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer or former employer, free of cost or at concessional rate to the employee. The perquisite value taxable in the hands of the employee will be the difference between the fair market value of the specified security or sweat equity shares on the date on which the option is exercised and the amount actually paid by/recovered from the employee. The “fair market value” will mean the value determined in accordance with the method, as may be prescribed by the Central Board of Direct Taxes (CBDT). The cost of acquisition of such security or shares shall be the fair market value which has been taken into account for the purposes of the determination of perquisite.
The amount of any contribution to an approved superannuation fund by the employer in respect of the employee, to the extent it exceeds INR 0.1 million.
The value of any other fringe benefit or amenity as may be prescribed.

Limited Liability Partnership (LLP)
Limited Liability Partnership Act, 2008, is effective from April 1, 2009. But not many LLPs have been formed since then, due to the lack of clarity of tax treatment of LLPs. It is proposed that the taxation scheme in case of LLPs be similar to that of a general partnership. Income Tax shall be charged at the rate of 30.9 per cent upon the income of the LLP.

Remuneration and interest paid to partners would be allowed as deduction from profits of the LLP and would be taxed in the hands of the partners. There is no amendment in Section 184 of the Income Tax Act, 1961 (IT Act), accordingly, in order for an allowed deduction of remuneration and interest paid to partners, the LLP would be required to comply with the provisions of the said Section.

Apportionment of profit to Partners shall be exempt from tax in the hands of Partners. Any apportionment of profits would not be subject to withholding taxes. Conversion of general partnership to LLP would be tax neutral, if rights and liabilities of partners remain same.

It is proposed to provide that in case of liquidation of an LLP, every partner will be jointly liable for payment of tax, unless he proves that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part. For this purpose, an LLP is being treated differently from a general partnership.

Investment-linked tax incentive for specified business
With a view to create a sound rural infrastructure and an environment friendly alternate means of transportation for bulk goods, it is proposed to provide investment-linked tax incentives by inserting a new Section 35AD in the IT Act for the following businesses:

setting up and operating cold chain facilities for specified products;
setting up and operating warehousing facilities for storage of agricultural produce;
laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network.
The salient features of the new regime of investment-linked tax incentives are the following:
100 per cent deduction would be allowed in respect of the expenditure of capital nature incurred, wholly and exclusively, for the purposes of the specified business, during the previous year in which such expenditure is incurred. The expenditure of capital nature shall not include any expenditure incurred on acquisition of any land or goodwill or financial instrument.
Any loss computed in respect of the specified business shall not be set off, except against profits and gains, if any, of any other specified business. To the extent the loss is unabsorbed, the same will be carried forward for set off against profits and gains from any specified business in the following assessment year and so on (without any limitation).

Consequently, profit-linked deduction provided under Section 80-IA of the IT Act to the business of laying and operating a cross country natural gas distribution network will be discontinued.

Dispute resolution mechanism for cross-border tax disputes
As a relief to foreign investors, alternative dispute resolution mechanism is proposed to be created within the Income Tax Department, as a high level collegium for the resolution of cross border tax disputes, including transfer pricing issues. Any person, whether resident or non-resident, in whose case the variation for any type of matter arises, as consequence of order of transfer pricing officer or any foreign company (for any kind of matter), can avail the benefit of this mechanism. It is provided that a dispute resolution panel would be formed by appointing a body of Commissioners of Income Tax constituted by the CBDT.

Matters would be referred to the panel by the tax payer, where he differs from the variation in income or loss proposed by the tax officer in the draft order forwarded by the tax officer to the tax payer. Based on the order of the panel, the tax officer is required to pass the assessment order. Assessment order so passed would be appealable directly before Income Tax Appellate Tribunal. Accordingly, one stage of appeal before the Commissioner of Income Tax (Appeals) would get eliminated.

Transfer Pricing
It is proposed to empower the CBDT to make ‘safe harbour rules’. Under this proposal, if transaction complies with safe harbour rules, the income tax authority shall have to accept transaction price. This would reduce the impact of judgmental errors in determining transfer price in international transactions.

Arm’s length price is the arithmetical mean of more than one prices determined as per most appropriate method. It is proposed to clarify that where variation between price so determined and price at which transaction has been undertaken does not exceed 5 per cent of transaction price, the transaction will be deemed to be at the arm’s length price. Therefore, if the transfer price is not within five per cent of the arm’s length price, then transfer price is to be adjusted to the mean price and no benefit of 5 per cent margin is to be given.

Taxation of certain transactions without consideration or for an inadequate consideration as income from other sources
Any ‘sum of money’ (in excess of the prescribed limit of INR 50,000) received without consideration by an individual or HUF is chargeable to income tax in the hands of the recipient under the head ‘income from other sources’. However, anything which is received in kind having ‘money’s worth’ i.e. property is outside the purview of the existing provisions.

It is, therefore, proposed to provide that the value of any property received without consideration or for inadequate consideration will also be included in the computation of total income of the recipient. Such properties mean immovable property, being land or building or both, shares and securities, jewellery, archaeological collections, drawings, paintings, sculptures or any work of art.

The value of moveable property shall be the fair market value, as on the date of receipt in accordance with the method prescribed and in the case of immovable property, the value of the property shall be the ‘stamp duty value’ of the property.

Electoral Trusts
Sections 80GGB and 80GGC of the IT Act provide for deduction in respect of contributions given to political parties by companies and any person respectively.

With a view to reforming the system of funding of political parties, it is proposed to provide that donations to electoral trusts shall be allowed as a 100 per cent deduction in the computation of the income of the donor. “Electoral trust” has been defined as a trust so approved by the CBDT in accordance with the scheme made in this regard by the Central Government. Donations to such electoral trusts shall be treated as income of the trusts, but will be specifically exempt as per the new Section 13B in the IT Act and not included in the total income of the previous year if:

the electoral trust distributes to any political party during previous year’s 95 per cent of the aggregate donations received by it during the said previous year along with the surplus, if any, brought forward from any earlier previous years;
the electoral trust functions in accordance with the rules made in this regard by the Central Government.

Providing time limits for passing of orders u/s 201(1) holding a person to be an assessee in default for withholding tax / TDS violations
Currently, the IT Act does not provide for any limitation of time for passing an order u/s 201(1), holding a person to be an assessee in default. In order to bring certainty on this issue, it is proposed to provide for express time limits in the Act, within which specified order u/s 201(1) of the IT Act will be passed.

It is proposed that an order u/s 201(1) for failure to deduct the whole or any part of the tax, as required under this Act, if the deductee is a resident taxpayer, shall be passed within two years from the end of the financial year in which the statement of tax deduction at source is filed by the deductor. Where no such statement is filed, such order can be passed up till four years from the end of the financial year in which the payment is made or credit is given.

However, no time-limits have been prescribed for an order under sub-section(1) of section 201, where the deductee is a non-resident, as it may not be administratively possible to recover tax from a non-resident and in case where tax has been deducted but not deposited with the GOI.

The scope of service tax is proposed to be extended to include the following additional services:

Service provided in relation to transport of goods by rail;
Service provided in relation to transport of (i) coastal goods, and (ii) goods through Inland Water including National Waterways
Cosmetic and plastic surgery service;
Legal Consultancy service.

AtulDua is a Senior Partner and co-founder of Seth Dua & Associates, India. He is qualified as a lawyer as well as a Chartered Accountant and specialises in cross-border transactions and international trade and taxes and telecom, media and technology. He can be reached at: atul.dua@sethdua.com.

Vikas Aggarwal is a Senior Associate with Seth Dua & Associates in
its tax and international trade practice. He can be reached at vikas.aggarwal@sethdua.com..