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Tax reforms to sustain India's growth
June, 09th 2009

India has shown that it can withstand the worst economic recession to have tested the world since the 1930s. However, the importance of adopting measures that will further strengthen the resilience of the Indian economy cannot be ignored. Corporate India expects the government to implement fiscal measures akin to those instituted by many other countries. Most of the stimulus measures are transitory in nature, but have a lasting impact in boosting overall demand and help restart credit flow to companies.

A recent OECD report found that tax measures represent 56% of the net effect of fiscal stimulus. In its recent study, Worldwide fiscal stimulus tax policy plays a major role, Ernst & Young examined tax-related fiscal stimulus measures in 24 key jurisdictions, including India. The stimulus packages of various countries focused primarily on the following corporate tax measures reductions in corporate income tax rates; encouraging profit repatriation; and accelerated depreciation programmes and stimulus to R&D.

In the three stimulus packages announced starting December 2008, India concentrated on indirect tax cuts, increased government spending and some measure for accelerated depreciation allowance. Expectations are that the government would announce more such measures.

Reductions in corporate income tax rates: With corporate tax rate of 34% for companies with taxable income of more than Rs 1 crore, and other taxes such as dividend distribution tax (DDT) and fringe benefit tax (FBT), the effective tax rate for the industry is well over 40%. The zero tax companies have to pay minimum alternate tax (MAT) at 10% basic rate on adjusted book profits. Corporate India may be justified in its demand for a lower tax rate.

Of the 24 countries covered by the study, nine including Canada, Italy, Japan and Russia reduced their tax rates. Reduced tax rates improve cash flows, stimulate demand and encourage investments, including foreign investments.

Singapore reduced its tax rate to 17%, Chinas corporate tax rate of 25% stands reduced to 15% for high-end technology enterprises. Japan and Netherlands have tax rates of less than 25%. Globally, MAT is not a popular tax measure, it is an artificial tax on a company which has bona fide claimed the tax benefits. There is a need to abolish MAT, which has over the years led to protracted litigation and increased burden of tax collections.

Encouraging profit repatriation: Indian companies are expanding their operations worldwide, either through acquisitions or by setting-up new companies. Many Indian companies use their overseas subsidiaries to hold offshore investments, as repatriating funds to India is extremely tax inefficient foreign dividends are taxed at 34% in India, and credit for foreign taxes paid by the company paying the dividend is not allowed.

Most jurisdictions worldwide avoid this issue by either providing credit for the underlying foreign taxes or by totally exempting the dividend from tax in the recipient jurisdiction. UK and Japan recently announced fiscal measures to exempt from domestic taxation the foreign sourced dividend income received by their domestic corporations. India could consider similar measures to encourage companies to repatriate their profits back home for productive re-investment.

An Indian company distributing dividends to its shareholders is subject to DDT of 17%, even though the dividend is exempt from tax in the hands of the shareholder. While an attempt was made to alleviate the cascading effect in the Finance Act, 2008 by providing for an offset of DDT paid by a lower-tier entity, the provisions are fairly restricted in their scope.

For example, the benefit of set-off is available for distributions within a single-tier holding, the distribution between the companies should take place in the same fiscal year. As an immediate measure, the government could consider extending the relief mechanism for eliminating the cascading impact. This would enable effective circulation of cash within an Indian group.

Accelerated depreciation programmes: Such programmes help improve cash flow for businesses by allowing them to write-off the costs of investments more rapidly. Eleven of the 24 countries in our survey, including Singapore, Netherlands, the US and Germany, introduced accelerated depreciation provisions to typically cover assets created and placed into service through the end of 2009, although some countries have extended the eligible period through 2010 or even 2011.

For instance, in UK, the first year capital allowance stands doubled to 40%. The current depreciation rate in India for plant and machinery is 15%. Reintroducing of investment allowance scheme, which permitted a deduction of up to 25% of the cost of the new asset with a corresponding transfer to a reserve account in the books of accounts, could be considered.

A Ficci study found that investment allowance in the period 1977-78 to 1989-90 boosted investments, gross domestic capital formation rose over six percentage points from 18.4% of the GDP at market prices in 1977-78 to 24.5% of the GDP at market prices in 1989-90. During an economic slowdown, investment allowance could provide the much needed impetus to growth. In addition, providing a stimulus to R&D expenditure would help channelise investments.

As the government prepares a full-fledged budget, it could consider measures adopted in other countries and help corporate India succeed not only domestically but in its worldwide operations.

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