Union Budget 2018: Time for Bold Changes After Trump’s Tax Reform

Crafting a balanced Budget is an imposing order in itself, and an onerous one a year before an election. The economy faces challenges on multiple fronts: distress in agriculture, the risk of inflation, impact of crude prices on the current account deficit, smoothening the implementation of the goods and services tax (GST) and the Insolvency and Bankruptcy Code, and low credit offtake. Conversely, several factors seem to augur well for the economy: a trend reversal in GDP growth, robust direct tax collections, recovery in GST collections, an expansion of the taxpayer base, receeding fears of the fiscal deficit target being breached, improvement in the outlook of rating agencies, an upward trend in FDI inflows, and a jump in business confidence.

This seems to suggest an upward movement in growth from the third quarter of the financial year. The question now is, how bold will be the Budget proposals be, and to what extent will the government appease businesses.

Corporate Tax Rate

With an effective corporate tax rate near 35 percent, India is among the highest-taxed nations. Trends in OECD member nations, emerging economies, and the landmark US tax reforms suggest a rangebound trend between 17 percent and 24 percent. Although the government has tweaked rates selectively in the past two Budgets, when will India signal an 'across the board' downward trend?

While fiscal considerations and a piecemeal phase-out of exemptions might make policymakers shy away from deep cuts in the tax rate, it is equally important to weigh the external environment and competitiveness.

Budget 2018 is an opportunity to look at cutting the corporate tax rate, despite concerns on fiscal deficit. The direct tax collection figures released in January suggest healthy 18 percent-plus growth, as against the budgeted increase of 15.6 percent. My hunch is that the government may end the year with a 20 percent-plus jump over FY-17, which would be the highest increase over the past decade. Historically, over 30 percent tax collections happen in the last quarter.

Last year, the month of March saw 27 percent of the annual collection, which could perhaps be attributed to the impact of demonetisation and instalment collections from the Income Declaration Scheme, which ended in September 2016.

This enhances my confidence on a direct tax collection bonanza.

The GST collections are stabilising, as is evident from the December 2017 numbers. Although the net collections for the Centre (after taking out 50 percent of Integrated GST, and GST compensation cess) may miss the annual target, the overall collections will stabilise as GST glitches are removed.

The rollout of the e-way bill system will further boost compliance and collection. 

The taxpayer base has clearly expanded with new and more compliant taxpayers, which may prompt the government to set out an ambitious target for FY19. Hence, I see an opportunity to reduce the peak corporate rate as one worth the risk, given the impact it can have on business sentiment.

Dividend Distribution Tax

Another area worth reviewing is the impact the Dividend Distribution Tax (DDT) has had. Over the years, the concept of DDT has perhaps lost its relevance. It was introduced in the 1997 Budget, prior to which shareholders were taxed. Barring the isolated year of 2002-03, dividend continues to be taxed in the hand of the issuing companies, since it was an unwieldy exercise to collect tax from small shareholders, who invariably didn’t file tax returns or claimed a refund from withholding tax. This was in an era where the tax deduction certificates were not available online. The burden, therefore, was shifted to companies who declared dividends and the shareholders were exempt from tax.

What was introduced as a moderate rate of 10 percent in 1997, with ease of collection, has steadily climbed up and is presently at over 20 percent, making it very expensive for declarants of the dividend.

In Budget 2016, an amendment was moved to tax all shareholders at 10 percent (12 percent for high net worth) receiving dividends above Rs 10 lakh. This was over and above the DDT levy. For foreign investors, the DDT is a dead cost as it disentitles them from claiming a foreign tax credit, and results in double taxation of income in their home jurisdiction. The DDT has made the dividend withholding tax redundant under tax treaties, which provide for a concessional rate of 10-15 percent withholding with an ability to claim a foreign tax credit.

Amendments in Budget 2013 introduced a ‘buyback tax’ of 20 percent, bringing buybacks at par with dividends, taking away the exemption otherwise available under the law in pursuance of the Companies Act.

In summary, repatriation of profits has become a challenge for foreign investors, due to an ineffective DDT (from a tax credit standpoint) and the introduction of a tax on buybacks.

With the US offering competitive rates and easier repatriation of subsidiary profits, and other changes in the international tax landscape, there is a need for India to relook at the trade-off between tax rates and the need for more FDI.

Capital Gains On Securities

The capital gains regime, particularly on securities transactions, necessitates a change due to the complexity of rates applicable for various class of investors, varying periods of the threshold for computing the long-term capital gain on assets, and changes to tax treaties with Mauritius, Singapore, and Cyprus.

We need a simple and stable regime for the growth of capital markets and the time for change is now. The growth in the value of assets under management of mutual funds in the past 18 months presents a clear trend in retail investors channelling their savings into capital markets. This is further supported by the increase in foreign portfolio investor investments figures. Both signify confidence in the capital markets.

All taxes levied on fund houses and fund managers are pass-through costs and, hence, certainty of tax liability is of paramount importance.

The securities transaction tax regime introduced in 2004 in lieu of exemption for long-term investment in listed securities shows stable collections over the years, with minimal cost to the government for administering the levy. Budget 2018 should signal simplicity in the rate structure with a moderate rate of tax for short-term gain, stabilise the threshold period to 24 months to avoid short-term players, and continue with the Securities Transaction Tax levy in lieu of long-term capital gains on listed securities.

(Mukesh Butani is Founder, BMR Legal and was assisted by Parul Mittal)

(This article was first published on BloombergQuint. This is an opinion piece and the views expressed above are the author’s own. The Quint and BloombergQuint neither endorses nor is responsible for the same)