CBDT roadmap for phasing out tax exemptions - Will Kelkar Committee have the last laugh?

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In line with Finance Minister’s statement in his 2015 Budget Speech to reduce the corporate tax rate from 30% to 25% (over 4 years) and simultaneously gradually withdraw tax exemptions, CBDT has proposed that profit linked, investment linked and area based deductions will be phased out for both corporate and non-corporate tax payers and that sunset dates provided in the Act will not be extended. Further, CBDT has also proposed that there will be no weighted deduction benefit with effect from April 1, 2017.

Is the CBDT proposal fair & balanced enough? Has the time finally come to do away with exemptions, that according to the famous Kelkar Committee report (2004), create "unjustifed distortions"? Does the duet of tax rate reduction & phasing out of exemptions meet the Kelkar committee triple test of " equity, efficiency & effectiveness"? Is there some merit when a well known CEO of a big pharma company, Kiran Mazumdar Shaw, says that doing away with weighted deductions will "kill" innovation and deliver a big blow to the ambitious 'Make in India' campaign?

Renu Narvekar
VP - Global Taxation, Tata Consultancy Services

"While reduction of corporate rate is a step in the right direction, phasing out of deductions pertaining to R&D at a time when "Make in India" is the mantra of the government, is a contradiction that will hamper industrial growth and innovation.

Most of the 34 Organization for Economic Co-Operation and Development (OECD) countries offer preferential tax treatment to R&D expenditure—including current deductions, allowances and credits, and accelerated depreciation of R&D capital expenditure. A number of countries have innovation or patent boxes, under which income attributable to intellectual property (IP) developed through R&D is taxed at favorable rates. In addition, all OECD countries offer R&D grants, loans or other fiscal incentives.

UK, for example has reduced its corporate headline rate to 20% wef 1st April 2015 with a commitment to further reduce the rate to 18% in year 5. This, even while they have expanded their R&D incentives.

Further, with the elimination in deductions and exemptions, the difference between taxable income and book profits is bound to reduce. The difference in the tax rates and the effective rate at which Minimum Alternate Tax (MAT) is levied is set to shrink even further. It is therefore...

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Rajendra Nayak
Partner, International Tax Services, Ernst & Young LLP

"The Government’s proposal for a phased reduction in Indian’s corporate tax rate from 30% to 25% would improve the competitiveness of the Indian economy. The reduction in corporate tax rates would be accompanied by removal of tax incentives and deductions. While the benefits of exemptions are limited to those who can gain access to them, rate cuts apply to corporate entities across-the-board.Tax incentives have been used by countries to achieve a variety of different objectives, not all are equally compelling on conceptual grounds. Stimulating investment, reducing unemployment, promoting specific economic sector and addressing regional development needs are some of the often stated objectives. A crucial consideration that bears on the decision to grant tax incentives should be their cost-effectiveness. Their use should be predicated on the belief that the benefits to the economy that can be expected from an increase (if any) in the incentive-favoured activities would actually outweigh the total costs of the tax incentives granted. Granting tax incentives entails costs in the form of distortions between investments which are granted incentives and those without incentives, forgone revenue (on the assumption that the lost revenue would have to be compensated from alternative distortive taxes), administrative resources required...

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P.V. Srinivasan
Corporate Advisor

Tax incentives are allowed to promote an economic activity. Capital was scarce and high cost of capital inhibited taking of investment risks.  Therefore, for many years, tax incentives were being granted for setting up new industrial undertakings.  This had a positive outcome with regard to manufacturing capacity expansion and employment.    However, there was concentration of industries in and around larger cities like, Mumbai, Calcutta, Chennai etc.  

The tax incentives were later narrowed down to new industrial undertakings set up in notified backward areas.  Thus, labourers, who were earlier migrating to cities, had an opportunity to find local employment opportunities. Tax incentives were intended to offset additional cost of operations and promote employment in under-developed areas.  These incentives helped in creating manufacturing States such as Maharashtra, Gujarat, Tamil Nadu etc, which are dominant contributors to India’s GDP.   

Over years, the inter-State inequity had become apparent.  The tax incentives were later restricted to specified North Eastern States, to channelize manufacturing in these States.   The value addition may not be high but the tax policy certainly helped in attracting fresh investments in these States and promote employment.

Tax incentives have helped in capital formation and generation...

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Krishan Malhotra
Partner, National Practice Head - Tax, Shardul Amarchand Mangaldas

"Keeping in view the prevalent tax rate in other Asian economies, the Finance Minister in his budget speech had raised the issue of India’s perceived high corporate tax and large number of exemptions. He has now announced a road map for implementing dual actions of reducing corporate tax rate from 30% to 25% in gradual manner and removal of corporate tax exemptions. Basic rate of corporate tax is 30% but the effective rate is much lower at 23% because of incentives. Therefore, with tax rates of 25%, 17% and 16.5% in the neighbouring economies of China, Singapore and Hong Kong, a rate reduction in the cards will definitely keep India in the Investor’s portfolio of favourable jurisdictions even if exemptions are phased out gradually. This move would certainly make India’s tax environment more conducive for investment and shows the government’s continued commitment and unrelenting focus on economic growth.

The phasing out deductions and exemptions would reduce the difference between taxable income and book profits. The difference in tax rate and effective rate at which Minimum Alternative Tax (MAT) is levied would even shrink further. Accordingly, the government may also consider removal of MAT over a period of...

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Vipul R Jhaveri
Managing Partner, Tax and Regulatory at Deloitte Haskins & Sells LLP

“A regime of low tax rate with fewer disputes is an attractive proposition for attracting investment. Equally, economic development incentives, which include tax incentives, are a critical component of economic development policy for encouraging investment in underdeveloped areas and priority sectors.While tax disputes and uncertainties have an adverse impact on investments and economic growth, absence of economic development incentives could either divert investments to low priority areas or render investment unattractive.

In an economy as diverse as India, investments get channelized into specific areas e.g. infrastructure etc to serve economic and social needs. Economic incentives therefore play a crucial role for attracting investments and targeting them in priority areas.

Incentives can thus be both a means to attract investments as also a cause for limiting investments due to uncertainties arising on eligibility or quantum. It is therefore desirable to conduct an impact assessment on the efficacy of the incentives and likely impact on attractiveness of new investment post ending of incentive regime while addressing the challenges experienced in the prevailing regime.” 

Girish Vanvari
National Head of Tax, KPMG in India

"The recent circular from CBDT comes as no surprise, since the FM had made the intentions of the government fairly clear in his budget speech earlier this year. The road map provides a three pronged approach. Firstly, that all existing tax holiday sunset provisions will be respected - no roll back and no further extension; Secondly, all other tax holiday provisions where currently there is no sun set clause will have a uniform sunset of March 31 2017; Thirdly, roll back of all weighted deductions from April 2017.The intent of the announcement in the budget was a phased reduction in the corporate tax rates coupled with a phased withdrawal of the exemptions. However, the recent CBDT proposal seems to suggest that the emphasis has shifted from a ‘phased withdrawal’ to ‘withdrawal’ with no clear roadmap for a corresponding corporate tax reduction. The resultant imbalance may create hardship for the corporate tax payers and make the potential investors circumspect.

There is no denying the fact that some of the existing tax incentives have been immensely successful in fostering economic development. If section 10AA of the Income Tax Act, 1961 (‘the Act’) played a big part in the mushrooming...

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Gautam Doshi
Group MD, Reliance Anil Dhirubhai Ambani Group

"The Kelkar Committee Report has three important features, phasing out of exemptions, reduction of the corporate and non-corporate tax rate and bringing an end to Double Taxation by removing the tax on dividends, that is providing that dividends would not be taxed in the hands of shareholders or even in the case of the Company by way of a Dividend Distribution Tax. The Committee also recommended that the package be considered to be a composite package and it be adopted as a whole and not piecemeal.

The current thinking of the Government seems to adopt the recommendation for phasing out of exemptions along with a reduction in the corporate tax rate, though it is not clear whether the reduction would be a one shot reduction or a phased out reduction. But, there is no mention of the abolition of tax on dividends. To this extent, clearly, the Kelkar Committee Report has not found favour with the Government.

The debate between exemptions and deductions on the one hand and lower corporate rates on the other is age old. There are votaries in favour of and against the proposition that lower corporate rates are desirable for the reasons...

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Dinesh Kanabar
CEO, Dhruva Advisors LLP

"There is a near unanimity among economists that tax policy reform in India would be incomplete without a withdrawal of incentives. It has also long been felt in policy circles that many incentives have a distortionary effect on resource allocation and that they unduly affect revenue collections. From a pure economic standpoint therefore, a decision to phase out incentives cannot be seriously faulted.

However, at a practical level, such a withdrawal could have a significant impact on specific sectors, regions and indeed individual taxpayers. Hence, it is necessary that any such exercise be undertaken in a considered and deliberate manner, having regards to potential ground-level implications in addition to the macro-economic factors.

The Government’s proposals reflect an even-handed attempt to balance these potentially conflicting considerations. For instance, its decision to phase out incentives under sections 10AA, 80-IA, 80-IAB and 80-IB by fixing a 2017 sunset date for commencement of activity, rather than fixing a short -term terminal date for the availability of incentives is clearly meant to address taxpayer concerns. As regards other incentives (such as weighted deduction for scientific research, accelerated depreciation etc.), perhaps a slightly longer sunset clause may have been warranted. Since the...

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