Published Editorial

Budget 2017 - Tax policy for stability and growth

January 2017

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The Financial Express

By

Tejas Desai
Tax Partner, EY India

Tax systems are fundamental to society.  Stability, certainty and consistency in application of tax laws are cornerstones of a sound tax policy. A simpler tax system contributes to economic growth; complexity in tax systems distorts the economy, diverting energies into non-productive administration and litigation.

India’s image as an aggressive tax jurisdiction peaked after the 2012 Budget, when the Government responded with a retrospective change in tax law to undo the Supreme Court ruling in the case of Vodafone. In one stroke, it eroded global confidence in fairness of governance in India.  Investment began to dry up between 2012 and 2014, caused atleast partly by these tax developments. 

The new Government in 2014, promised to end ‘tax terrorism’ and provide certainty in tax policy to boost investment.  Since then, the Government & CBDT have made a sincere attempt in last 2 years to revive India’s image as a tax-certain jurisdiction.  In the context of capital markets, clarity on tax issues of FPIs, PE funds and domestic VC Funds have contributed towards fostering a positive business climate. Renegotiation of some of India’s popular tax treaties as well as grandfathering of existing investments under GAAR demonstrates the Government’s decisiveness and commitment to bring changes in tax policy that help in reducing uncertainty.  

One disruptive event during this period was the controversy relating to MAT on FPIs, which seemed to send a signal to global investors that India had once again moved the goalpost.  The Government however intervened swiftly and contained the damage through administrative/legislative action.

A similar situation has now arisen once again with issuance of Circular No. 41 by CBDT on December 21 on indirect transfer provisions to FPIs and other foreign funds.  Like MAT, this is also a case of conflict between letter of the law and its perceived intent. 

FPIs are liable to tax when they transfer Indian securities and there should not be double taxation when the FPI upstreams cash to investors either directly or via feeder funds through redemptions / buy backs. The Circular provided straight jacketed answers to various questions and confirmed that double or even multiple taxation is a possibility. Ironically the Circular penalised funds that commit a significant portion of their capital to India as compared to those that don’t.  Besides, it put at risk the taxation of historical transactions, where investors may have long exited. 

The Circular threatened to undo the good work done by the CBDT and the Government over the past 2 years.  As expected, the issuance of the Circular evoked strong reactions from the fund industry.  The Government sensing the alarming nature of the situation, issued a Press release keeping the operation of the Circular in abeyance pending the review of representations received from stakeholders.  

While this action of the Government deserves to be appreciated, a key takeaway from this incidence is that investors demand stability in tax policy and such instances tend to create noise in the international arena about India being a hostile tax jurisdiction, which is best avoided.  What is required is a pragmatic approach to the issue if the letter of the law gives rise to such unreasonable consequences.  The Government should now clarify its intention by way of an amendment to Income Tax Act in the Budget, like it did to resolve the MAT controversy, to bring finality to this simmering issue.

Another area of the tax law where the Government needs to take a big-picture and pragmatic approach is the safe harbour regime for domestically managed offshore funds introduced in 2015 vide section 9A of the Income tax Act.  Section 9A provides that an offshore fund will not face any taxation which is worse off than what is provided in the Income-tax Act simply because the fund is managed by an Indian asset manager.  Lack of this simple rule had prevented the domestic fund management industry from managing foreign pools of capital.  SEBI itself has recognised this as a significant opportunity for Indian asset management industry.  While the Government introduced section 9A to enable this, it came with a long list of 17 conditions which the fund/fund manager have to comply to avail of the safe harbour.   Some of the conditions are practically difficult to satisfy for most funds & their managers.  After 2 years of its introduction, this regime has yet to find takers and the opportunity to incentivise the fund management industry, generate employment and garner more taxes remains unexploited.

With GAAR effective from 1 April 2017, the Government still needs to release practical guidance for application of GAAR.  Investors’ expectations on this relate to clarity on application of LOB in treaties and domestic SAAR over GAAR and examples of situations where GAAR would or would not apply. It is important that CBDT issues GAAR Guidelines quickly so as to enable proper planning by those impacted.

There has been speculation that the Government may seek to impose tax on long term capital gains on listed securities, which is currently exempt.  A combination of STT together with exemption/reduced rate on capital gains has served us well for past 12 years.  Any move to modify this regime should weigh the aspect of simplicity that may have to be compromised.

For Budget 2017, while the Government will have in mind some big-bang tax reforms post demonetisation, it should equally focus on providing the desired clarity on issues which continue to be a source of anxiety and impede business decision-making.  From a capital markets perspective, if these issues are resolved, it will have a profound effect on the daily lives of funds, fund managers, investors and the entire ecosystem of financial services market participants, ultimately leading to more participants, increased volumes and buoyancy in tax revenues.  

(Dipen Shah, Tax Director, EY also contributed to this article)

(Views expressed are personal)