Budget 2011: Focus on anti-avoidance measures

The finance minister had to clearly walk a tight rope, buffeted by the constraints of a coalition government and a volatile global political and economic environment.

The pegging of the fiscal deficit for the current fiscal to 5.1%, and projecting an even lower fiscal deficit of 4.6% for the next year are quite impressive achievements.

There are a number of policy announcements such as a hint of FDI in retail, liberalisation of FDI in insurance, and several financial sector reforms.

Tax administration
There are a number of references in the finance minister’s speech to the use of technology in tax administration and this was also reflected in the CBDT vision document.

While this is welcome, the accountability of the tax administration is badly needed. Unfortunately, the focus still seems to be on higher revenues and anti-avoidance measures. The good part is that now there would be threshold limits on the tax disputes being initiated by tax administrators.

On corporate tax front, India Inc does not seem to be quite happy with a 2.5% reduction in the surcharge. The effective corporate tax rate will now be 32.45% (as against 33.22%), while the DTC prescribes a rate of 30%. The effective tax rate on Minimum Alternate Tax (MAT) remains almost same with a marginal increase to 20.01% from 19.93%. Special Economic Zones and Limited Liability Partnerships (LLPs) are now covered under the purview of MAT. The extension of MAT on LLPs seems to be a clear indication that the use of LLP as opposed to companies will now be much less tax advantageous.

Tax rate of 15% on foreign subsidiary dividends received by Indian companies is definitely a welcome move.

Anti-avoidance measures
India has entered into Information Exchange Treaties with some tax haven countries. Wide provisions have been sought to be introduced for transactions being entered into with persons located in some nations which India would deem as ‘non-cooperative’ nations.

These provisions are extremely harsh and wide and would apply even if a private equity fund were to invest in India through a jurisdiction which is considered to be non co-operative. How would the investee company be expected to deal with such a situation?

Another aspect of anti-avoidance has been in relation to transfer pricing. Two amendments are important. First is extension of the powers of survey to transfer pricing officers and second is that a 5% variation as a safe harbour has now been sought to be replaced by guidelines to be notified for different sectors. On the face of it, this seems a positive move, but it has one serious drawback, which is the ability to put substantive powers in the hands of the executive as opposed to the judiciary.

Some sector related changes
There are several sectoral changes which have been brought in on the direct tax front, including a very important one in relation to a 5% withholding tax on interest for cross border investments in infrastructure funds.

Low-cost housing needs a boost and an incentive has been provided in relation to an investment-based deduction for this sector.  On the other hand, in relation to corporates investing in debt-oriented mutual funds, the DDT rate has been increased to 30% as opposed to 25% for money markets/liquid funds and 25% for other debt funds. This will certainly impact the flow of funds from corporates into debt funds.

The year ahead does appear to be a difficult one from a variety of perspectives, both domestic and international. In this context, the budget with its greater emphasis on rural development, education, agriculture and infrastructure has been a fine balancing act.  While the expectations were low, India Inc did expect a directional policy on the way towards the transition to DTC, which could have served as bridge between the current laws and the DTC.

Ketan Dalal is joint tax leader, PwC India