The Hindu Business Line : Budget: Of straight bats and googlies

THE Finance Minister, Mr P. Chidambaram, has a reputation of being a man with the Midas touch. And this time it was a formidable team, one that included a Prime Minister whose reputation as Finance Minister is legendary. But they had the unenviable task of drafting a Budget that would deliver for the common man, the economy and, most important, the Left front.

The Centre's commitment to liberalisation has made India an attractive destination for foreign investors. As a curtain raiser to the Budget came the liberalisation of Foreign Direct Investment in the construction sector. This is an important move considering the trickle-down effect it can have on the economy. Allowing investment will not only open up the sector but also boost construction activity of all types.

While Mr Chidambaram has addressed the burning issue of tax reforms, mere tinkering of tax rates for individuals and corporates will not suffice. The effective corporate tax rate has been lowered by about 3 per cent but the 10 per cent surcharge will push up Dividend Distribution Tax by about 1 per cent. The effective tax cost may rise for capital-intensive domestic companies due to the reduction in the normal depreciation rates on plant and machinery, furniture, vehicles, etc.

The lowered depreciation rates will further strain corporate profits. In fact, the chunk of tax collection is expected to come from higher corporate tax payments as a combination of reduced depreciation rates and imposition of the Fringe Benefit Tax (FBT). This is indicative of the Centre's habit of giving with one hand and taking away with the other.

The reduction in the rate of tax has been offset by the introduction of such retrograde measures as the FBT and the banking cash transaction tax (BCTT). While the intent is justified, the means will not achieve the desired end but only increase paper work. Besides, the assumption that most of the black-money ends up in a bank account is itself questionable.

It is generally accepted that the best way to increase revenue collection is to reduce tax rates and have a transparent and simple administration. While the Finance Minister got the first part of the equation right, he has taken two giant leaps backward on the second.

FBT will only further dilute the benefit of reduced corporate tax rates. The imposition of FBT, a volte face by the Finance Minister, is old wine in new bottle. In his 1997 Budget, he had done away with artificial disallowances such as entertainment, travel, advertising, etc, to simplify tax laws. The same disallowances have been brought back in the guise of FBT. Tax on account of FBT is disallowed under the normal as well as Minimum Alternate Tax (MAT) computation. What may also happen is that certain expenses will be disallowed by tax authorities as not relatable to the business and may be taxed as FBT. This would amount to the same expenses being taxed twice.

It is also not very clear whether foreign companies will be allowed credit in respect ofthe tax paid on account of FBT as the home country may not regard it as doubly taxed income, and furthermore may not regard it as a tax on income, which is what is allowed as credit.

What is most unfair is inclusion of contribution in fringe benefit to superannuation fund. Instead of encouraging post-retirement savings, considering that the social security in India is abysmal, the Centre has taken a share of this pie.

This is against the Exempt Exempt Tax (EET) concept that was introduced with respect to savings. Though the Finance Minister has indicated that legitimate business expenditure will not be covered by FBT, this only leads to litigation.

While the tax rate on royalty/Fees for Technical Services (FTS) earned by non-residents has been reduced to 10 per cent, it remains doubtful whether the royalty/FTS paid under an agreement approved by the Reserve Bank of India (under the liberalised FEMA regime) will qualify for this reduced rate.

With investments allowed under the automatic approval route, the condition for Centre's approval is out of place and should perhaps be deleted. While income from derivatives has been held to be non-speculative in nature, it should have been clarified whether the said income should be taxed as "business income" or "capital gains".

Another measure which is being tom-tomed as a relief measure is the allowability of payments made subsequent to voluntary retirement. This may actually be aimed at denying 100 per cent deduction in the year of payment.

The provision of treating income from zero coupon bonds of specified entities as capital gains and allowing amortised deduction in respect of the discount incurred by the issuing entities is welcome. However, it throws open a question on the deductibility of such discounts in the hands of issuing entities not specified.

The retrospective insertion for carrying forward losses of a bank merging with another will be confined to mergers instituted by the Centre under the Banking Regulation Act, like the take-over of Global Trust Bank by Oriental Bank of Commerce.

Therefore, while the Finance Minister has shown the straight bat on many fronts the googlies in the Budget have left most of us clean bowled.

(The authors are partners, KPMG)

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