Tax Incentives - Speed bump or dead end?

28 December 2015
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While presenting the Union Budget 2015, the Finance Minister in his speech had rightly pointed out that India is perceived as a high tax jurisdiction (with a headline tax rate of 30% + +) compared to other competing South East Asian economies which have a sub 30% corporate tax rate. Even among the BRICS nations, India is an outlier with the highest corporate tax rate. Inspite of this relatively high corporate tax rate, the Government’s revenue collection is not buoyant due to a host of industry specific, area-based and activity-based incentives, with effective tax rate being in the mid 23%. This regime of granting tax incentives has also led to discretion to tax administration in granting the tax incentive, litigation and loss of revenue.

To remedy the twin dampener, the Finance Minister had promised to reduce corporate tax rate ‘gradually’ to 25% in a phased manner over a period of four years (Budget 2018 being the last of such exercise during the tenure of the current government).

To compensate the Government finances, various incentives (both profit linked and investment linked) will be phased out for all tax payers – a roadmap of which has been released on November 20 for public comments. As per the roadmap, the following is proposed:

  • Incentive/ exemption provisions where a sunset clause is already provided for will not be extended or preponed.
  • Sunset date of 31 March 2017 will be introduced in respect of incentive/ exemption provisions where a sunset clause does not exist. (Eg: deduction in respect of unit in SEZ and developer of SEZ)
  • Provisions that provide for weighted deduction of expense will be withdrawn from 1 April 2017 and deduction will be restricted to 100% of the capex.
  • Depreciation rates will be rationalized with peak rate of depreciation @ 60% against 100% currently prevailing.

However, there are few more tax incentives enjoyed by taxpayers - the roadmap does not speak about either the need to continue with them or otherwise. These are listed below

Though most of the aforementioned tax incentives provide for a sunset clause, successive governments have had to extend the incentive, for example incentive for power generation considering India’s power deficiency. Therefore, it is hoped that the much needed clarity is provided on the continuity of the aforementioned incentives while issuing the final roadmap.

The Fiscal Math

As per the revised budget estimates for FY15, government’s total revenue from corporations is estimated to be Rs 4.26 lakh crores. Approximately Rs 67,500 crores (net of MAT) is lost due to various tax incentives. The bulk of the revenue forgone is on account of profit-linked incentives – a large number of which have already been pruned (eg: Deduction u/s 10A, deduction to units located in backward regions u/s 80-IB, etc). Though these incentives have been done away with, it may not result in revenue uptick for some time to come for two reasons. Incentives continue for stated holiday period from commercial operation date (eg: 10 years u/s 10A) therefore a new unit will continue to enjoy the incentive for unexpired period. Second, utilization of accumulated MAT credit paid during the tax holiday period. Therefore, the effective cash tax collection by the Government from these units is likely to continue to the applicable MAT rate.

What this means

Let us now look at what this means for the stakeholders - tax payer and the Government.

The roadmap provides for introduction of sunset clause or letting the tax incentive phase out as per the existing sunset clause, where there is one. The incentives can be divided into three types – expenditure- linked, investment-linked and profit-linked. Expenditure-linked incentive will be the hardest hit as there may not be any tax driven incentive to continue to incur those expenses (eg: weighted deduction for skill development, R&D).

Investment-linked and profit-linked (to a greater extent) incentives provides a unique window of opportunity to claim tax incentives. A tax payer who manages to get the proverbial ‘foot in the door’ by setting up the unit before the proposed sunset date can continue to claim tax incentives for the remaining period of tax holiday. For example, a software development company which sets up a SEZ unit in Jan 2017 will be entitled to claim tax holiday for 15 years (ie till 2031 – well beyond the sunset period).

One of the objectives for phasing out tax incentives was also to reduce administrative discretion, tax litigation and plug revenue leakage. Continuation of 100% deduction for capex of specific sectors and R&D is marred with the same discretion and litigation as a weighted deduction (although with lesser motivation for the tax authorities to disallow). Similarly, grant of tax holiday to power unit and those who managed to get their ‘foot in the door’ will ensure that tax litigation will only ebb with time.

With Government keen on reviving private investment and boosting domestic growth, the proposed roadmap gives added impetus to undertake the investment in the next 15 months. Therefore, we may see flurry of investments to claim the tax benefit. But this may not be possible for large projects which take considerable time to build.

MAT Conundrum to continue?

Provisions for levy of tax on ‘book profits’ more popularly referred to as ‘Minimum Alternative Tax (MAT)’ was introduced to shore up revenues from a number of profitable companies which were not liable to corporate tax due to slew of exemptions/ incentives enjoyed by them. Over the years it has been extended to non-corporate tax payers as well under the nomenclature of ‘Alternative Minimum Tax (AMT)’.

As the exemptions/ incentives are being withdrawn, the need to continue with a regime for levy of tax on ‘book profits’ or ‘adjusted book profits’ no longer serves its originally stated purpose.

As discussed earlier, there is no discussion on phasing out of tax incentives to power generation/ distribution business, therefore one is led to believe that the incentive will likely be extended. Add to this that some of the tax payers may likely enjoy the benefit of profit-linked till 2026/ 2031, completely doing away with the MAT/ AMT provisions, though high on industry agenda, seems unlikely. However, continuity of levy of MAT/ AMT at the elevated rate of 18.5%, coupled with reduced corporate tax rate, will only lead to slower rate of MAT credit utilization and/ or ultimately MAT credit remaining unutilized.

Concluding Thoughts

Low and equal tax rate for all tax payers will ensure equity and promote competition. However, in a populous developing economy with wide differentially developed geography, demands for incentivizing specific sectors, activities and geographies are aplenty. At a time when a number of countries are incentivizing research, and development of intellectual property by way of R&D credits and/ or patent box regime, withdrawal of weighted deduction for R&D is a retrograde move. Further, certain companies have heavily invested in projects considering the available tax benefits and phasing out such benefits may entail significant financial burden.

If the past is any indicator of the future, we have not seen the last of the tax incentives being extended by the Indian Government.