Indians are expecting the Finance Minster to bring some crucial changes in the Union Budget 2011. One of the major expectations from the FM is to make the direct tax code (DTC) more efficient. Thus, the FM will have to strike a balance between the inflation and growth and choose not to tinker with taxes.
CNBC-TV18's Menaka Doshi talks to Ajay Lalwani, Co-Chairman of the Direct Taxation Committee of the Bombay Chambers, DM Muthukumaran, Head of Corporate Finance at the Aditya Birla Group and Uday Ved, Head of Taxation at the KPMG to get a clearer perspective on the expectations from the new direct tax code.
Transcript of the interview:
CNBC-TV18: There are several macro drivers that will impact the decision that Pranab Mukherjee takes on headline rates on the big direct tax rates. He has got inflation on one hand which caps his ability to increase rates by fear of passing on enhancing the inflationary pressures but he has also got revenue pressures on the other hand considering that this year we have no 3G sort of big kick in coming in and so where is he going to raise the additional revenue from to meet his fiscal deficit targets that if we progress or continue to progress on the path of fiscal consolidation. So in the context of all of this and the fact that the DTC could become reality April 1 next year, do you believe there will be any changes in the headline rates of direct taxation?
Ajay Lalwani: I don't think one can expect too many changes per se in this coming budget for the simple reason that the rates, which we will have once the DTT kicks off, is something which has already announced which is 30 per cent. We are already very close to 30 per cent right now.
So, therefore the end goal being clear, I don't see any major tinkering that might happen there. You could have some relief in the form of surcharges being done away with etc but that is about it.
DM Muthukumaran: I agree with that analysis. There was mention in the last budget about the tax rate being carefully chosen and there were also rollbacks in the indirect taxes last year and there was a lot of mention about fiscal discipline. More importantly, you can see the undertone in the last budget as well that growth is paramount. So it appears to me that given the disease coming in next year or two, we would expect the tax rate to remain unaffected at this point in time.
CNBC-TV18: No changes in headline rates at that?
Uday Ved: If there is likely to be no change in the headline rates of taxation – direct tax that is – then what growth levers or growth buttons can the finance minister push through tax policy to help industry try and achieve stronger growth this year. There are several issues sector wise if one was to go to, several sectors asking for special sops, incentives, a continuation of the export incentives that the IT industry has been asking for or a change or an extension of the incentives for power projects, what do you expect will likely be the big changes that he can make without disturbing headline rates and help industry which is struggling with higher input cost, inflation and maybe even lower demand this year.
No, I agree with what both Mr Muthukumaran and Mr Lalwani are saying but if you see the history in last few years in terms of the tax rates, it is a history of falling tax rates and doing away with the incentives and that is what is being planned also under the new DTC, which will come in to effect from 2012.
CNBC-TV18: Final draft of DTC is just 30 per cent?
Uday Ved: The final draft is at 30 per cent and in that sense if you look at that, to go from 30 per cent to anything below in this year's budget is very unlikely. I think it is not possible. What I would believe would be that possibly the surcharge and share should be logically removed to do a transition towards 30 per cent rate for DTC.
CNBC-TV18: So get to 30 per cent this year itself so that means no change between this year and next year.
Uday Ved: Absolutely, and that is very competitive globally also.
CNBC-TV18: Is it very competitive globally? I know one of the points you wanted to raise was that considering that profit incentives are going away will the government provide a road map or in fact reducing rates from that 30 per cent level over the course of the next 5-7 years.
Ajay Lalwani: Yes. My personal feeling is that once you take away the incentives today the tax collection which the government really talks about on corporate profits is to order of 21 per cent on an average on corporate profits therefore, it is really the incentives which are bringing down the effect of tax rate. That being the case, it is a stated position that incentives will go. It could taper off so therefore it may not go immediately because there is grandfathering which has been provided for. But eventually, you will have a situation where there will be no incentives. Given that situation I think the tax rates could or should ideally come down and I say this because it is not just 33 per cent of the corporate tax that you are talking of it is the dividend distribution tax added on which is at 16.6 per cent; so the combination of two really works out to 42.7 per cent for an investor. When somebody is looking to invest after a stage when you make profits the amount of taxes that you pay your profit tax as well as the dividend distribution tax is to the order of 42 per cent. Which I think if you compare with tax rates in some of the neighbouring countries is pretty high.
For example, the tax rates in Singapore, Hong Kong or even Taiwan are around 17 per cent. Similarly, China, Indonesia, Malaysia and one or two such countries the tax rate is around 25 per cent. Some of these countries don't have a tax on dividends. So that is the final tax that you pay. Some of them where you do have dividend tax it is to the order of 5 or 10 per cent. So that does not add up to what we are talking of.
CNBC-TV18: What do you expect the government will do – you really think they will deal with this with reducing the headline corporate tax rate or might deal with it by tinkering with dividend distribution tax or they might chose to do neither considering that they really do need the revenue this year if they want to meet their deficit targets?
Ajay Lalwani: Sure. One does not really expect them to take up these measures immediately but they could signal a road map as to going forward given that the incentives are going, given that there is already growth in buoyancy in the system tax collections are showing a 40 per cent growth. So with that micro economic enabler to say there is a case for reducing tax rates.
CNBC-TV18: Effective rate today because of the profit linked incentives is at 21 per cent - once that can replace with incentive investment based incentives – how much will the effective rate come back up to 33.
Ajay Lalwani: Certainly not. No.
CNBC-TV18: 24-25 per cent.
Ajay Lalwani: Somewhere there.
CNBC-TV18: Then you add on the dividend distribution tax.
Ajay Lalwani: That is right. You must realize investment based incentives is actually nothing but a deferment of tax – it is accelerated depreciation that are providing so in that sense, yes, it would help in the initial years, in terms of tax saving but over the years you are where you are.
CNBC-TV18: We are constantly looking at this from the point of view of the DTC in fact becoming effective April 1st next year, but it is a legislative process and as we know through experience in this country, free legislative processes are able to stick to time tables.What if the DTC was not likely to become effective next year? The finance minister knows this based on the time that the standing committee is taking to collect inputs and go through the debate once again. He may not chose to publically acknowledge that it is getting delayed but he may say, okay I still have a year or two to play around before the DTC comes into play. Then do you think there might be some big chances in headline rates?
DM Muthukumaran: From my point of view No.
Uday Ved: We still have one year time so today to make that possible statement that there would be a reduction in rate would be inconsistent to what the finance minister is planning. So, today you have to have DTC coming to force on April 1, 2012 when the rate is 30 per cent, reduce from 30 per cent to marginally 27.5 per cent which was being discussed or maybe 25 per cent on extreme basis you can't go back to 30 per cent if DTC was to come into force on 2012.
So, on an immediate basis this year's budget except the surcharge you might reduce 3 per cent from 33.2 to 30 per cent so 3 per cent reduction but the base rate I do not think can change. Yes medium to long term maybe over a period whether DTC comes into picture or not sum- of or large part of this provisions will come into force in the original act itself if DTC was not to come into force. In that situation, yes, you could go from 30 per cent to a little long term basis may be close to 25 per cent assuming the incentive are taken away. Anyway, you have this incentives being carried forward and even further incentives you have the expenditure being based incentives which will take a base rate of 20 per cent from minimum alternate tax. So, there is going to be a minimum 20 per cent tax which Ajay said today's average rate is about 20-21 per cent so at the most it could go to 25 per cent but I would not believe in the near future.
CNBC-TV18: If there is likely to be no change in the headline rates of taxation – direct tax that is – then what growth levers or growth buttons can the finance minister push through tax policy to help industry try and achieve stronger growth this year. There are several issues sector wise if one was to go to, several sectors asking for special sops, incentives, a continuation of the export incentives that the IT industry has been asking for or a change or an extension of the incentives for power projects, what do you expect will likely be the big changes that he can make without disturbing headline rates and help industry which is struggling with higher input cost, inflation and maybe even lower demand this year.
Ajay Lalwani: I think nothing much on the direct tax front for the simple reason that the structure is already in place in terms of direct taxes and the going forward position is also on the table in terms of the DTC.
CNBC-TV18: Let me come to the issue of exemptions, I think there are some expectations or demands atleast for the extension of the export incentives that we have for a year assuming DTC becomes effective next year, I think there are similar expectations with regards to power projects where the exemption expires this year and the people are saying, can you extend it upto April 1, 2012. So do you think those are realistic expectations?
Uday Ved: I absolutely think so. There is a case - the projects executed in this one year will lose out the exemption forever and clearly there is a case as Mr Muthukumaran said, whether it is a profit based incentive or an investment based incentive, certainly for power project, which is ending on March '11. When the DTC was coming into force on March '11, there was a consistence, now there is a one year gap. The other thing that you mentioned about infrastructure, which is the need of the hour and over the next three-five years, there would be huge amount of money close to maybe USD 500 billion or whatever that number could be he is going to be spent and there was this tax exemption for investing in an infrastructure project. So, if you had external commercial borrowings and you paid interest out of that, there was an exemption many years back, which was withdrawn at some point of time. I would believe there is a case for reinstating that, this will also really augment the funding aspect. How do you generate the funds and this could be one way of doing it. So whether a complete exemption or currently the tax on interest is 20 per cent reduce it to 10 per cent and increase the tenure of the bond for maybe more than 10 years or something like that. Certainly, I think some of the short would encourage whether there is a lot of funding is going to come from foreign investors.
CNBC-TV18: What is the case with MAT, I know that that is one request that is on the table and has been represented to the finance minister, what do you hope will change, do you think it will?
Ajay Lalwani: The chamber has all along been representing and it has worked the other way. Based on inputs from the industry, we have – firstly why did we have MAT, we had MAT to bring to tax certain companies who were not paying tax but look at the way, it has progressed. We started off with a minimum tax of 7.5 per cent that was at a time when the taxes used to be somewhat higher. We are on the profit tax front down to 33 per cent now but the way MAT has progressed, it has moved from 7.5 per cent to close to 20 per cent now.
CNBC-TV18: I think the DTC proposes 20 per cent, current year 18.5 per cent or 19 per cent?
Ajay Lalwani: Yes, currently 18 per cent surcharge takes it upto pretty much close to 20 per cent. With MAT at 20 per cent and normal tax at 30 per cent, can you call it a minimum tax when you are trying to recover 20 per cent of the earnings?
CNBC-TV18: So it is a maximum alternate levy.
Ajay Lalwani: The two reasons why MAT came into play were because of the difference in book profits and the tax profits, which was largely on account of tax incentives and the depreciation differences. Incentives are going away, your depreciation differences have come down largely because the plant and machinery rates, the general rate is down from 33 per cent to 25 per cent to now 15 per cent. So the difference is disappearing and therefore, the whole thing of there being a zero tax company, - you could have initial years losses etc and therefore, you could still have a MAT situation arising but certainly the rate at 20 per cent seems high and our request was that you link it to the corporate tax rates. So if the corporate tax rate is 30 per cent, you could probably be on the higher side, on maximum, have it on 50 per cent of the rate, so it is self-calibrated, the moment the rate changes, your MAT rate also comes down. There is no further interference required.
CNBC-TV18: So is that something you expect he will address this year because I know this has been a pending demand for a while exacerbated by the fact that the DTC proposed 20 per cent.
Ajay Lalwani: Yes, absolutely. Given that only last year, they took it up from 15 per cent to 18 per cent, it would be too much of a flipflop for them.
CNBC-TV18: Bring it back down this year, right?
Ajay Lalwani: Yes.
CNBC-TV18: Is this a big issue there because if incentives are going to fall off when the DTC becomes effective, how many companies continue to be then in the MAT net and for how long and hence, should the FM be spending a large amount of his time thinking about what to do with MAT?
Uday Ved: I don't think – maybe 18 per cent may remain as 18 per cent or it might go to 20 per cent but nothing more than that.
CNBC-TV18: You have a different opinion on this or should I move on to the dividend distribution tax issue?
DM Muthukumaran: No, I don't have a different view. As you rightly said, it is probably not the issue that requires a lot of attention.
CNBC-TV18: Can we come back to then the other often repeated issue of dividend distribution of tax and the constant allegation that this is a double tax on companies, please do something to deal with it.
DM Muthukumaran: I hope he addresses, as I said there is a case as to why you will have chain of companies in India. These are nothing to do with the taxation, these are business exigencies, you may have it for the reasons on financing and you may have it for the reasons of joint venture-ship for projects being in separate companies. So, the chain of companies by itself is a requirement and has been a requirement for a long time. So there is a strong case why we should probably adapt a structure, where sometime ago we used to have this ATM concept, where as long as you pay the dividend in the same year, it keeps getting exempted under the fundamental principle that we don't want to tax the same income more than once. So, I think there is a strong case for that to come back.
Ajay Lalwani: I would say some moderation on the dividend tax rates.
CNBC-TV18: What kind of – how much would you like it lowered by?
Ajay Lalwani: I think it should be taken back in steps to 10 per cent, which is where we started.
CNBC-TV18: It is currently at 16?
Ajay Lalwani: Currently at 16.6 with the surcharge.
CNBC-TV18: So take it back to 10 per cent?
Ajay Lalwani: Yes, when it was introduced, it was supposed to be a simpler method of collecting tax on dividends so instead of taxing numerous shareholders of small amounts, 10 per cent was taken to be a revenue neutral rate where the government thought that it is simpler to pick up that money from the companies and let us not chase the small shareholders. If that indeed was the philosophy and if 10 per cent was supposed to be the revenue neutral rate then there is absolutely no reason why it should have been taken up all the way to 16.6 per cent.
CNBC-TV18: Do you think it will come down to 10 per cent and add to that the other demand that you want, which is to do away with the tax on foreign dividends?
Uday Ved: Reducing from 15 per cent to 10 per cent looks unlikely and this is a South African model that was followed in 1997 when the DTC was changed from a shareholder base to a company base and that has continued over last 13 years. That seems to be the case even going forward. So I don't know whether or I don't think that he can reduce it from 15 per cent back to 10 per cent that would be a massive kind of tax erosion in that sense.
CNBC-TV18: So he has already negated two demands both on MAT and on DTT.
Uday Ved: Looks unlikely. Certainly, on the foreign dividends is an example, there is a case to make and this has been said in the past also. So, for Indian companies going global, if you have foreign subsidiary, which declares dividends and pays back to the Indian parent whereas, in the Indian case, the tax would have been 15 per cent or 16 per cent including surcharge. In case of foreign dividend, you pay a normal tax because then the taxation is still on the shareholder, you pay a full rate of 30-33 per cent including that. There very clearly a case to equalize with the DTT rate whether it is 15 per cent or 10 per cent. I would say it would be 15 per cent.
CNBC-TV18: When we talk about trying to tax policy that helps stimulate growth, the only thing we have come down to which you believe is realistically possible is a one year extension of the profit linked incentives and one year extension maybe of the investment linked incentives for the power sector and whilst we want MAT and DTT to change, Mr Ved tells us it is unrealistic to expect that to happen, so nothing else will happen when it comes to stimulating growth, is that right?
DM Muthukumaran: From the point of view of stimulating growth probably, you are right but the purpose of budget and taxation focus is also on administrative issues in the budget. So a lot could be done with respect to the same.
CNBC-TV18: For instance?
DM Muthukumaran: There is this withholding tax issue. Until about 2002 if I remember right, there was an exemption on withholding tax with respect to interest paid on foreign borrowings or external commercial borrowings. Today realistically, we, as borrowers in the corporates, are never able to get the ultimate credit for this withholding tax and it ends up being grossed up and we end up paying interest as well as withholding tax on those interests. For some reasons, practical administrative, we are not able to get the credit for it. So, it will be useful if government for example addresses this issue.
CNBC-TV18: Several years ago it was at a fall of a word VDIS and it is back to haunt us last year as well as this year. What is the likelihood or the chances?
Ajay Lalwani: Frankly, I hope something like this does not happen because it is absolutely unfair.
Uday Ved: Last time when the scheme came to us VDIS- Voluntary Disclosure Scheme which was in 1987, I think government had given some kind of commitment at that point of time. It would be absolutely unfair so it could be a moral answer if that is the way it is.
CNBC-TV18: That is the ideological opposition I am asking you practically do you believe that it is a solution that the FM will consider?
Uday Ved: I do not think it will happen.
CNBC-TV18: Let me come to what Uday (Ved) had suggested as maybe the possibility of introducing one time settlement scheme that helps settle the several thousand litigations which have several thousand crore rupees stuck in them by offering a one time plea bargain or one time let us buy some piece opportunity and thereby recovering lots of the locked money in those disputes. How much money do you think something like that can release in terms of revenue and will that be key driver for why they consider this settlement scheme?
Uday Ved: I would think that one thing is generating revenue. Second is just killing the litigation which is clearly one of the key objectives of the government in the act as well as going forward in the DTC. So you have indirect taxes more than 100,000 crore something like that taxes being locked at various levels – be it at a PE (personal equity) level or tribunal or a High Court or a Supreme Court. There are a lot of issues which are recurring issues. It is just continuous. There could be a one time kind of investment in that sense. The corporates just want to buy PEs. This does not mean that they have accepted it. Come and say pay the headline out of 30 per cent - no interest, no penalty. I think that could be one way of addressing a part of the fiscal deficit. I do not know how much amount it will get generated but certainly it would reduce litigation to a large extent.
CNBC-TV18: This is one of those great ideas that we talk about every year and there is no real need for it to be introduced in any one specific year?
Ajay Lalwani: No. Even at the state level when you transition from one set of law to another, it is good to have some measure to clean up the old litigation that you have collected. So introduction of DTC could be a good time to then offer a scheme where you just close all your cases and then you hold the income tax act in the bargain if you can release or if you can collect the taxes which are locked. I think it is a win-win.
CNBC-TV18: This is the tax department version of consent orders and compounding?
DM Muthukumaran: That is correct. I wouldn't think this if it comes will come because you want to collect money. I think it will come because if you want to get ride of the cases.
CNBC-TV18: What do you expect the FM will say with regards to direct taxes on 28th of this month?
Uday Ved: I think it has been made public that there is not going to be major tax reforms otherwise the entire DTC losses the steam. If you see those changes in this budget if at all, one should assume that the DTC is doing to die, which I do not think government wants to do at this point of time. Considering all these aspects, it will be more of a balancing act carrying on for one more year. Hopefully, when the DTC comes into the force with a 30 per cent tax rate or going forward with little reduction, I think the budget from a taxation perspective possible will become a non event.
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