Budget 2011 seems to be the testing time for the Finance Minister. He has a mammoth task of sustaining the growth momentum and garnering more revenue for fiscal consolidation within the constraint of escalating inflation.
Given the current political landscape and with elections due in some States, carrying forward the fiscal reforms would be a tough call.
Minimum alternate tax (MAT)
MAT is an alternate tax levied on companies if they are otherwise not liable to pay regular tax or their regular tax liability is significantly lowered on account of exemptions and deductions available to them under the tax law. The rate of MAT has been consistently increasing, with the present rate at 18%, up from 7.5% in the year 2000-01.
Inclusive of surcharge and cess, the effective rate of MAT is 19.93% which is around two-third of the regular rate of tax of 30%. Consistent increase in the rate of MAT is alleged to distort tax planning and cash flow position of companies, especially those availing tax holiday benefits as also being in conflict with the objective of the Government to provide tax incentives to certain sectors on economic and social considerations.
Besides, the present time limit for carry forward of MAT credit, though recently increased from 7 to 10 years, may still be insufficient for certain taxpayers who may not be fully able to utilise the tax credit.
Rate of MAT may be brought down
The rate of MAT may be brought down to not more than one third of the regular rate tax, or at least, kept stable at the present levels. Any further increase in MAT could create hardships for businesses given the present recessionary conditions. Frequent tinkering with the rates of MAT may be avoided in the interest of stability.
Exemption from MAT may be allowed to companies in the initial years of business, especially to those entitled to tax holiday under the Act. The Government may also consider allowing reduction of book profits by the amounts redeployed in the business for specified purposes.
There is also a case to increase the carry-forward time limit of MAT credit from 10 years to 15 years to prevent any lapse of unutilised credit. It is noteworthy that the DTC proposes a 15 year time limit.
Tax benefit to export sector
Presently, 100% export oriented units and exporters located in Software Technology Parks are allowed tax holiday in respect of profits from export of goods or computer software. The tax holiday is allowed under section 10A and section 10B of the Income-tax Act. However, the benefit will lapse with the end of the current financial year. As a result, such units will have to provide for tax outgo from the next year onwards.
The upcoming DTC does not propose to continue with these tax incentives. The tax holiday was earlier extended on two occasions by one year each. A further extension of the tax holiday may be justified since expiry of tax benefit can affect competitiveness of India as a global outsourcing destination given the impact of possible anti-outsourcing sentiment in some major countries as also the economic objective of earning foreign exchange.
Also, the export sector, badly hit due to economic slowdown, needs fiscal support to tide over the crisis. Since the DTC, proposed to be effective from the financial year 2012-13, would anyway do away with the tax holiday, the benefit may be extended by one year.
Further, the tax holiday benefit is diluted since the export units are liable to pay MAT. Till the financial year 2006-07, they were granted MAT holiday. Along with extension of tax holiday period, MAT holiday may be restored to allow such units to avail complete tax holiday in respect of export profits.
Alternate Dispute Redressal (ADR) mechanism
To arrest increase in tax litigation is perhaps the single most significant challenge before the Government which it presently faces. Besides locking up huge funds, tax litigation is a drain on the resources of the Government and the taxpayer, both in terms of time and money.
The Government has recently taken some initiatives in this regard such as constitution of standing committees in the Department for litigation management, setting up of panel for suggesting measures to tax litigation and formulation of National Litigation Policy. Measures need to be announced in the coming Budget to take these initiatives forward.
Speedy and fair ADR mechanism
A robust, speedy and fair ADR mechanism can go a long way in reducing litigation and preventing blockage of tax revenue. There is a case for making the existing mechanism more effective. The eligibility criteria for approaching dispute resolution bodies may be widened and more powers given to them to allow effective resolution. For instance, the Authority for Advance Rulings route may be opened up for domestic transactions as well.
All dispute resolution processes may be made time bound. The constitution of Dispute Resolution Panel may be reworked to resolve independence issues. It is learnt that a rejig of the Settlement Commission may happen in the coming Budget. A single body for dispute resolution across different taxpayers may be mulled. Safe Harbour Rules for transfer pricing issues were envisaged in the tax law in the year 2009.
These may be notified at the earliest. Provisions for Advance Pricing Arrangements may be introduced to provide certainty in transfer pricing and minimise disputes. This is envisaged under the Direct Taxes Code.
Dividend Distribution Tax (DDT)
Presently, the cascading impact of DDT does not stand mitigated in the case of multi-tier holding structure or even in case of foreign companies having a single tier holding-subsidiary structure in India. This may impact tax efficient repatriation of profits as well as inflow of foreign direct investment. Relief from the cascading impact of DDT was provided in the Budget of 2008 but was restricted to single-tier structure.
The condition that the cascading effect of DDT shall be mitigated only when the taxpayer company is not a subsidiary of any other company should be deleted. In other words, the provision should allow mitigation of cascading effect across multiple tiers. The draft DTC has effectively provided for mitigation of such cascading effect.
Power sector is one of the key sectors of the economy and requires huge investments in the near future. This demands provision of appropriate tax incentives to push the growth in this sector. Presently, units in the power industry are entitled to a tax holiday under section 80-IA if they commence operations before 1 April 2011. The sunset date for power units may be extended by one year.
Upto the financial year 2005-06, the tax laws provided exemption in respect of interest income or long-term capital gains of an infrastructure capital fund or an infrastructure capital company or a co-operative bank from investments made in infrastructure business. This exemption was intended to ensure low cost of raising capital for thrust area projects. However, it was withdrawn in the 2006 Budget citing lowering of tax rates and interest rates on borrowings resulting in reduction of overall cost of infrastructure projects.
Infrastructure development in the country is still in a nascent stage
In view of the fact that infrastructure development in the country is still in a nascent stage and interest rates are on the rising, the exemption may be restored.
Presently, infrastructure businesses are liable to pay MAT. With a view to give a further fillip to the infrastructure sector, profits from such business may be exempt from MAT. It may be noted that the erstwhile MAT provisions exempted power and infrastructure undertakings from the purview of MAT.
Presently, an individual and HUF taxpayers are allowed a deduction of upto Rs. 20,000 towards investment in long-term notified infrastructure bonds. This provision was made last year in tune with the policy thrust of promoting investment in the infrastructure sector. In order to give a further fillip to this objective, the present limit may be raised to Rs. 1 lakh.
Enactment of the Point of Taxation (for Services Provided or Received in India) Rules, 2010 (POT Rules)
Normally, Service tax is payable upon receipt/ payment of consideration of taxable service. This is at odds with the existing "accrual based" system, which is applicable to other indirect taxes and also is proposed to be implemented in the GST regime.
There is also a lack of clarity about the date of levy and collection of Service tax in the existing regime, especially in the case of change of rate, introduction of new taxable service, continuous supply of service, royalty, deposit etc. The draft POT Rules proposed by Central Board of Excise & Customs, propose to link the payment of Service tax to the provision of service, raising of the invoice or receipt of payment for service provided or to be provided, whichever is the earliest.
Key challenge to the successful implementation of the POT Rules
A key challenge to the successful implementation of the POT Rules is to ensure that the provisions and options given are clear and simple. For instance, notifying all the services which would be covered under the "continuous supply of service" clause would be a critical task. The treatment of debit and credit notes, write-offs etc. is another area which is important but not covered in the draft POT Rules.
Moreover, it is a realistic expectation that the availment of Cenvat credit would also be aligned with the POT. The successful implementation of POT Rules is possible only if the provisions are unambiguous and the tax payer is quick enough to align its accounting model. Else, these rules would become a source of litigation. If the POT Rules are introduced in this year's Budget, it would be a re-defining moment of the Service tax law and a step forward to the GST regime.
Future of tax exemption schemes
Presently, there are numerous exemptions under the Central Excise, VAT and Service tax law. The existing exemption schemes are based on the type of goods/ services, location, sector, value etc. It is a reality that out of the existing exemptions many are essential and have a purpose.
However, there are quite a few exemptions which have achieved their purpose and are no longer considered to be relevant in the existing economic scenario. The process of identifying the exemptions which need to be phased out is in progress and this year's Budget is seen as a starting point.
Another reason for phasing out the exemptions is to ensure a smooth transition to the GST regime, the roll-out date of which would be announced in this year's Budget. The existing exemption schemes hamper the free flow of credits down the supply chain and increases the cascading effect.
The challenge would be to identify the first lot of exemptions which are to be phased out this year. Considering the existing scenario, a complete switch over to the refund model as a mode of exemption is not what the Government is considering. To ensure a smooth transition to the GST regime, a clear road map about the mode and future of exemptions is expected from this Budget.
Areas of concern on the Service tax exemption available to the SEZ developers and units
The provisions in respect of Service tax exemption to SEZ developers/ units underwent a drastic change in 2009. Whereas the earlier provisions provided for upfront and unconditional exemption from payment of Service tax on all input services used in authorized operations of SEZ, the amended law provides such exemption only to those input services that are wholly consumed within the SEZ.
For the input services consumed partially or wholly outside the SEZ, the exemption is available only by way of refund. However, to claim the said exemption, the amending notification mandates prior approval from the Unit Approval Committee (UAC).
With no clarity to decipher the word "consumed", the basis that the UAC should adopt to approve the list of input services remains in mist. It is also unclear whether such approval is binding on the Service tax authorities. The above procedural difficulties come with many legal issues.
Supply of services to a SEZ unit is treated as "exempted"
Contrary to the position in Excise Law, where SEZ is treated as "foreign territory" and goods supplied to SEZ are considered as deemed export, the supply of services to a SEZ unit is treated as "exempted" leading to disentitlement of input tax credit.
Also, with the services being exempted, the applicability of provisions in respect of restrictions on availment of input tax credit is unclear. The situation worsens when, in order to avoid any possible litigation, the vendors charge Service tax on all the services provided to SEZ, whether consumed inside or outside the SEZ.
The Budget is expected to address these ambiguities to ensure a hassle free exemption mechanism, so that no tax gets exported as a part of the cost of goods and services supplied from a SEZ.
Taxability of software/ software services
The recent notifications under the Customs, Excise and Service tax law have tried to resolve the prevailing ambiguities on whether transfer of "information technology software" would attract Excise/ Customs or Service tax. The crux of these notifications is that if the Customs/ Excise duty has been discharged on the basis of Maximum Retail Price (MRP) affixed on the packaged/ canned software, the provision of right to use such software would be exempt from the payment of Service tax.
These notifications provide clarity on the Service tax exemption available in relation to a pre packaged/ canned software intended for retail sale. However, there is still an ambiguity under the "volume licensing model". For instance, the welcome kit imported under the "volume licensing model" is not intended for re-sale and therefore would not be subjected to MRP based valuation.
For levying Customs duty, it would be valued as per the Customs Valuation Rules. The Customs official in most cases would not accept that the duty is to be levied only on the CD value and would proceed to include.
Broadening of the Service tax base
The last two decades have witnessed massive growth in the Service tax law. With just three services at the time of its inception, the Service tax law today encompasses more than hundred services within its purview, with every Budget either adding new services or enlarging the scope of existing services.
It is believed that Budget 2011 would be no exception to this trend. Further, with Goods and Service tax (GST) regime on its way, a broader tax base is expected. On one hand, it is expected that the definition of services such as "works contract service" as given under Service tax law would be expanded to bring it in parity with VAT laws, resulting in inclusion of almost all types of works contract arrangements under the purview of Service tax.
On the other hand, it is expected that certain welfare services such as health and education services would also be brought under the Service tax net. In this endeavor, Budget 2010 has already covered B2B transactions in respect of health services under Service tax and as a step forward, Budget 2011 is expected to encompass other health services such as pathology and diagnostic services within the purview of Service tax.