[Hardeep Singh Chawla is an LL.M. candidate in International Taxation (Class of 2020) at NYU School of Law.
This post seeks to propose various substantive changes that may be introduced into India’s tax regime to provide some succor to individuals and other entities, so as to aid them in navigating through these challenging times and rebuilding the economy]
The Indian government recently announced an economic stimulus package worth 1.7 trillion rupees ($22.5 billion), primarily designed to provide a buffer to low-income households. However, as on date, there has not been any substantial relief granted to companies and businesses. The tax measures announced essentially revolve around deferring deadlines to file various returns and processing low-value refunds quickly. While the All India Association of Industries has termed the fiscal package as ‘a few crumbs
’, they have noted that it may be due to the concerns hovering around the fiscal deficit. The Confederation of Indian Industry (CII), on the other hand, is seeking some relief from the Government especially for medium and small-scale enterprises
(MSMEs). It seems that stimulus 2.0
is in the works and would be unveiled soon.
While considering anticipated stimulus, we need to be mindful that this is about trying to put a floor underneath people and to ensure that companies stay afloat and the layoffs are minimized. The purpose, therefore, is two-fold: first
, about economic relief to the businesses so that the economy does not backslide further and, second
, to provide some fillip for an efficient restart. Therefore, these suggestions are both from a short and a medium term. For the much-anticipated stimulus 2.0 or separate budget
that may be announced, the Government may consider the following substantive tax reliefs:
- Easing business interest expense limitation
Tax laws have an inherent debt bias. Jurisdictions around the world have introduced provisions to limit interest deductibility in case the debt is sourced through an associated enterprise. In times where liquidity is at a premium and economic efficiency demands that the surplus cash in one group company may be utilized more efficiently in another, there is a need to relax the provision governing business expense limitation. These will make debt financing a more attractive option and help the effective utilization of cash resources within the group.
Currently, section 94B of the Income Tax Act, 1961 prescribes 30% threshold of the earnings before interest, taxes, depreciation, and amortization (EBITDA) as the limitation for expensing business interest sourced through a non-resident associated enterprise. This percentage may be increased to a higher threshold. Furthermore, since the projected earnings for the current year may be significantly eroded, the taxpayer may be provided an option to choose the base year (say a choice between the last two years) on which such EBITDA is calculated.
- Realignment of the extant tax losses regime
Tax losses play a pivotal role because they allow the company to be taxed on a net basis in a consistent manner over time. With the abolishment of taxes under the alternate MAT regime (where selected provisions for taxation are adopted by entities), the availability and utilization of tax losses lead to real time cash tax savings. The manner of utilization of tax losses is an integral part of any taxation regime. Offsetting losses of one year with profits of another decreases volatility and equalizes net income subject to tax. Currently, tax losses may be carried forward for a maximum tenure of eight years, subsequent to the year of its generation. Losses are not allowed to be carried forward if the return is not filed within the stipulated time. Unlisted companies (being those in which in which the public are not ‘substantially interested’) lose their tax losses if the beneficial shareholding changes more than 49% with some stipulated exceptions.
The policy regarding tax losses may be modified to a certain extent. Among the options that may be explored to rework the loss regime include introducing loss carryback
provisions (with some exceptions like limiting it to the current tax rate to avoid arbitrage and for specified years) which can provide immediate liquidity through a refund of prior year taxes. On efficient use of tax losses, the Government may mull introducing a consolidation regime whereby losses of one entity may be allowed to be offset by losses of another, if it is within the specified group.
Further, tax losses may be allowed to be carried indefinitely. Some relaxation in the limitation on use of losses in connection with a change in shareholding may also be permitted. This will allow distressed sellers to extract maximum value for their losses.
- Excluding days of travel ban in determining residency
The global lockdown was essentially an abrupt response to the coronavirus pandemic. Taxpayers were left with little or no time to plan their stays or movement. For individuals, residency requirements are in essence bright line tests with number of days spent requirements. Therefore, as a pragmatic policy measure, the lockdown period where these ‘resident’ individuals could not have travelled outside India due to these travel restrictions should be excluded. Unintended consequences may include individuals forming a permanent establishment (PE) for the company in another jurisdiction, place of effective management (POEM) of an entity being arbitrarily shifted owing to temporary situs of key managerial personnel and withholding tax issues with respect to salary payments. These unintended consequence needs to be addressed comprehensively.
- Introducing accelerated depreciation for certain capital investments
Under the Income Tax Act, assessee(s) ordinarily deduct expenses holistically incurred for running the business. However, it is not the case when it concerns capital assets such as plant, machinery and buildings. Typically, capital assets are depreciated over several years, thereby limiting the tax break that may be availed in a particular year. This corporate tax bias against capital investment, to the extent it makes the taxpayer wait for years to claim the cost of the investment, may be reconsidered. Delaying these deductions implies that the tax burden is shifted forward in time since these businesses are unable to deduct the full cost of the investment, and it affects in reducing the after-tax return of these investment in present value. This ultimately results in less capital formation. The Government may consider granting accelerated depreciation for capital investments for some stipulated time as a means to foster future economic growth.
- Abolishing capital gains tax concerning shares and mutual funds
Since the overall objective of this stimulus is to provide more liquidity in the hands of the individuals and entities, it may be relevant to keep in abeyance taxes imposed on capital gains arising on account of divestment of specified securities. A capital gains levy distorts the market, whereby realization of gain on transfer of an asset is deferred to avoid taxability, thereby impeding efficient allocation of resources in the economy. While this may be significant in normal circumstances, it is even more acute when there is a liquidity crunch. Therefore, stipulating that capital gains tax may be kept in abeyance for instruments such as shares and mutual funds will seek to grant incentive to realize gains on these instruments allowing liquidity in the hands of the investors.
- Introducing weighted deductions for payroll expense
To incentivize certain behavior, the Income Tax Act stipulates for weighted deductions, which provides for deductions over and above the actual amount of tax-deductible expense incurred from an activity. In April 2010, the Government had introduced 200% weighted deduction for in-house research and development expenses, and India became one of 16 countries in the world to offer this ‘super-deduction’. Over the years, it has been reduced substantially. The Government may mull introducing weighted deductions for payroll expenses thereby incentivizing the employers to retain their existing workforce.
- Increasing slab rates, standard deduction and personal exemption limits
The slabs fix the final tax liability for individuals. While Budget 2020 introduced a new tax regime with higher slabs, the taxpayers opting for such regime were to forgo the exemptions and deductions. A simple calculation would reveal that the taxpayers who took the advantage of these deductions and exemptions were not in a position to gain from such enhanced slab rates. To provide liquidity from a medium-term horizon and in an effort to jumpstart the economy it is paramount that the slabs may be relaxed. With the same reasoning, standard deduction may also be increased.
Further, to incentivize savings, exemption limits for sections 80C and 80D may also be enhanced. With tax revenues projected to dip for the current year, understandably so, the Government will also suffer a cash crunch. Hence, it may offer a sovereign bond for subscription, with built-in tax exemptions (preferably, EEE exemption
), to incentivize such subscription.
- Deeming/ valuation provisions – Restructuring, Distressed sale
The Income Tax Act stipulates various deeming and normative fair value provisions, which creates a legal fiction for tax law purposes. There may be instances where utilization of surplus cash from one sister concern to another may have invoke deemed dividend implications. As in the case for increasing business expense limitation, this may be kept in abeyance as it impedes the ability of the taxpayer to utilize cash from one cash rich concern to another in the same group without suffering tax leakage. Another provision that may hurt individuals is the deemed ‘let-out’ provisions for calculating income under the head ‘income from house property’. These provisions may be relaxed in an economic downturn to further ease cash flow.
Normative fair valuation provisions create a fiction for the fair market value (‘FMV’) at which the property is transacted (both for the seller and the buyer). To put it in context, where the seller of an unlisted share sells that share at 80 rupees, while the FMV is 100 rupees, the capital gains so charged shall be on 100. Similarly, for the person receiving that share, 20 rupees (which is the difference between the FMV and consideration discharged) shall be taxable as their income from other sources. While this seems good policy, the devil lies in the calculation of such FMV. Under the present rules, in certain cases, bankers are allowed to carry the valuation wherein the FMV derived will be discounted by the current market forces. However, in certain other cases, the FMV is computed based on a formula as provided under the rules. The formula is based on the financial statements of the company. In these times, the FMV derived from the formula may not reflect the actual price at which a buyer is willing to buy those shares. It may be a distressed sale. Extended safe-harbors should be provided in this case along with the ability of the taxpayer to demonstrate that the calculated FMV is actually lower than the one derived from computation and/or allow the merchant banker to carry the valuation exercise. These provisions need to be streamlined in the medium term from the perspective of structuring stressed asset transactions.
Budget 2020 introduced a provision which was aimed at overriding the judicial discretion of awarding interim relief on the order of the lower authority by imposing a pre-condition of depositing twenty percent of the disputed amount as mandatory prescription for award of such relief. While there was backlash from the taxpayers (since there are cases where the same issue in the previous year(s) have been decided in favour of the taxpayer or there is ample judicial guidance in other precedents and thus depositing twenty percent of the tax amount is a rather odious requirement), the law stands. For the time being, this amendment may be kept in abeyance, since it will lead to significant cash flow problems for the taxpayers.
This post is primarily aimed at rolling the ball to initiate a thoughtful discussion around India’s tax policy and how the current tax policy needs to be suitably amended to support taxpayers both at an individual and at a corporate level in this crisis situation. This is also an opportunity for India to create a conducive tax and regulatory environment to attract foreign capital and restrict the policy of taxation that kills growth. As Mr. Arvind Datar, Sr. Advocate, eloquently puts it
– we need to realize that taxes are a byproduct of growth. Taxing every activity at the highest possible rate is always counterproductive, especially when the economic engine has come to a grinding halt.
While each proposal will need to be evaluated on the cost-benefit analysis criteria and the expected benefits flowing from each proposal will merit macroeconomic considerations, there is nonetheless an urgent need to amend the current tax regime to help the taxpayers through these trying times.
– Hardeep Singh Chawla