The budget that will be presented on 1st February 2018 will be the last full budget before the 2019 general elections. Equity markets are on a sustained bull run with sensex gained close to 1700 points since the start of this year. One of the key factor driving sensex is the expectations from the union budget. Let us look at some of the key capital market expectations:
Taxation on dividends: According to Angel Broking, tax rate of 10% on dividends in excess of Rs 10 lakhs should be rationalized. Dividends are already subject to DDT and in addition, the companies pay taxes on the profits before declaring any dividends. Therefore, the current system creates multiple layer of taxation on dividends. The rationalization can be made by enhancing the current limit of Rs 10 lakhs or reducing or eliminating DDT
Government spending: Markets welcome government spending as the investments create multiplier effect on the economic growth. Investments in sectors like infrastructure will create job opportunities that will improve the personal disposable income and will aid in consumption driven growth. Government has already hinted massive funding in infrastructure. However, revival of PPP model remains a challenge.
Corporate tax cut: India Inc seek a lower tax rate from the current statutory tax rate of 34.47%. In Budget 2015-16, the Finance Minister had laid out plan to reduce corporate tax to 25% over a period of four years, but the same has not yet been implemented. The current tax rate is making the industry uncompetitive as it is higher than some of the key Asian economies. Any reduction in corporate tax rate will be welcomed by markets as lower rates leads to higher investments and job creation.
Tax benefits to equity investors: According to Angel Broking, a separate sub section under 80C for ELSS funds and Infrastructure stocks with a separable sub limit will provide a big boost for equities in the long run. In addition, government should also consider including mutual funds for Sec 54EC benefits. The benefits of the Section 54EC are available when long term capital gains are reinvested in specific infrastructure bonds with a lock-in period. In the past, mutual funds and infrastructure equities were also included under the definition of eligible investments under Section 54EC of the Income Tax Act. Such measures will provide incentives to the investors to invest in equity markets.
Government finances: Markets will expect moderate fiscal slippage. This is because a higher fiscal deficit will have significant implications like rising prices, possibility of no rate cut and increase in bond yields. Wit international oil prices rising, management of trade deficit and fiscal deficit will be a key factor in determining the future market direction
The growing Indian private equity space and venture capital eco system has come a long way in the last two decades. At the same time tax and regulatory changes along with untapped potential of economy has facilitated significant flow of capital from private equity and venture capital industry (PE and VC).
It is important to note that the fledging startup eco system in India would not have survived had VC and angel funding would not have backed their innovative and part breaking ideas. Government has equally recognised the contribution of PE and VC industry and accordingly has crated enablers in tax and regulatory regime so it can attract large number of investors. However, there are few niggles in the tax regime which can be fixed in Budget 2018
Pass-through tax status to be extended to net losses at Alternative Investment Fund (AIF) level to the Investor
The intention of pass through status was to ensure that there should not be any difference in tax treatment for Investor investing through an AIF or directly in a portfolio company. Currently, Income Tax Act, 1961, (the Act) provides that if losses are incurred by AIF same shall be carried forward by AIF and shall be set off against the income of AIF.
Allowing AIF to set off the losses against income of AIF is not feasible proposition as it does not earn the income in its own account.
In order to make AIF pass through entirely and bring it at par with direct investment by Investors, losses incurred by AIF should be allowed to be set off against the capital gains of the Investors.
Allow management expenses for AIF investments to be capitalized as ‘cost of improvement’
The investment manager of AIFs play active role in supporting the portfolio companies to take them to particular economies of scale, building professional management etc. The management fees are mainly paid to manage the investment in the portfolio companies which in turn results in enhancing the value of investment made by AIF. Therefore, management fees is akin to cost incurred to improve the value of investment. Therefore, law can be amended to provide mechanism to allow allocation of these expenses as cost of improvement against investments.
Tax on primary investment in companies:
Currently excess of premium received by the companies against valuation of the companies which are prepared on the basis of financial performance of the companies is taxed in the hands of recipient companies. One needs to note that startups are funded on the basis of innovative ideas and economic potential.. In the initial years most startups end up incurring losses and therefore valuing them purely on financial performance could be misleading. Therefore in order to reduce protracted litigations, provision needs to be rationalized.
Valuation of unquoted equity shares
As per the current laws, in case of a commercially negotiated transaction involving transfer of unquoted shares, both acquirer and the transferor may suffer tax burden in case the value at which the transaction is being concluded is not in confirmation with the valuation rules which have been prescribed by the regulators. These provisions are intended to be an anti-abuse measure to cover under its ambit the transfer of unlisted shares at prices below their Fair Market Value. There are difficulties faced in case of genuine transfers of unquoted shares having a commercial rationale such as distress sale. A suitable carve out need to be provided for such transactions so it is neither taxed in the hands of seller nor in the hands of buyers.
The purpose of introducing the indirect transfer provisions was to ensure that transaction which are happening outside India but derive their values from India should be taxed in India. However, the present law contains certain gaps which has unintended consequences. In the fund industry, typically multi-layer structure is followed for various commercial and legal reasons. Therefore, testing indirect transfer at each level of remittance would lead to cascading of tax. Further currently carve out is restricted to internal reorganization which happens through mergers/demergers which is not only the mode of reorganisation. The Finance Minister during the last budget indicated that for investment made through FDI route, after its remittance from India, same should not be taxed on subsequent remittance, however appropriate amendment in legislation has not been carried out.
The aforesaid amendments could go a long way in fostering the PE and VC industry and facilitate the larger flow of long term strategic capital to the country supporting the enormous need to capital formation in the country.
Inputs are from some Known Industry Analyst from KPMG AND DELLOITE .