Tipping point for rapid growth

Source: Mint

The upcoming budget certainly has the potential to catapult the economy into a high-growth orbit

There is indeed much ado about finance minister Arun Jaitley’s second full budget, the third in a row, and rightly so. Whether or not “make or break”, this year’s budget is poised to be presented amid immense anticipation, growing turbulence in external macroeconomic circumstances, and India’s yet robust economic fundamentals. The revised gross domestic product (GDP) growth target that still hovers around 7.5% for the current fiscal, with an expectation that it will be a shade higher next year, calls for a transformational budget to set the theme right.

From a big picture standpoint, budget proposals are likely to be oriented towards securing inclusive economic growth by rolling out measures to stimulate private investments; revitalizing the disinvestment programme, possibly with a disinvestment commission; and setting the tone for tax policy and administrative reforms, which could help bridge the gap in tax collections.

Budgeting for two significant outgoes—the Seventh Pay Commission’s recommendations and one-rank one-pension or OROP—with both expected to cost the exchequer nearly Rs.1 trillion, the government hopes to fund them out of disinvestment proceeds. From a fiscal consolidation standpoint, while it is debatable whether skipping the fiscal deficit target (of 3.5% of GDP) for the next fiscal year would be prudent or not, in the larger scheme of things and given the tottering global economic scenario, it wouldn’t after all be such a hard pill to swallow as leading economists have made it out to be.

What is of immediate significance is to contain the current account deficit (estimated at 1.5% of GDP), which is fast emerging as a more contemporary barometer of an economy’s health in the context of the cantering pace of global economic growth, fall in exports and unlikely revival of growth in major world economies.

Talking of tax proposals, one policy statement that should set the overarching theme is the reduction in corporate tax rates to the global OECD (Organization for Economic Cooperation and Development) average of 25%, albeit over four years, while rationalizing or phasing out tax incentives. A case for corporate tax rate reduction is undisputed, considering that the effective tax rate has been short of 25% (between 22% and 23%) over the past years. It is hoped that proposals to scale back or eliminate tax incentives will be implemented judiciously. The withdrawal of existing tax incentives—be it for specified businesses or geographies—unless calibrated after taking into account socioeconomic advantages of the incentive regime, could be counterproductive. Whether or not foreign companies would benefit from the stated policy intent of tax rate rationalization is uncertain yet, although the policy statement doesn’t make an explicit reference to the higher rate of 40% levied on foreign branches in India. Proposals to roll out a three-year income tax holiday (for start-up programmes) should find its way into the legislation; although one would wait to see the fine print.

Several provisions under the extant legislation stand in the way of tax-neutral M&A (merger and acquisition) opportunities, particularly in cases of intra-group restructuring; namely, ineligibility of an Indian company to carry forward tax losses in case of change in beneficial ownership in excess of 49%, etc., and conversion of preference shares into equity not explicitly exempt from tax, unlike in case of conversion of debentures.

The budget is expected to streamline M&A tax rules to facilitate the reorganization of businesses, without compromising their competitiveness from the tax implication standpoint.

More clarity is expected on indirect transfer tax and general anti-avoidance rules (GAAR). While these two legislations have been enacted, administrative aspects of the new legislations continue to be ambiguous. Though foreign investors still hope that retrospective applicability of indirect transfer tax shall be withdrawn, it seems unlikely unless Jaitley springs a pleasant surprise. Given the mixed macroeconomic trends, deferral of GAAR by another year could be a huge positive to investors, especially when India is looking to retrieve its path to sustained 8%-plus GDP growth rate. Although a decision on the deferral of GAAR may appear far-fetched, the outcome of OECD/G-20-led Base Erosion Profit Sharing (BEPS) project shall guide countries to overhaul their domestic legislations and usher in anti-abuse measures. Given that most BEPS action steps commence in 2017, domestic Indian law can wait for another year.

That said, the budget is likely to roll out measures to align India’s tax policy with emerging trends in transfer pricing legislation. Enhanced rigours in disclosure by way of implementing country-by-country reporting standards, overhaul of transfer pricing rules for intangibles and profit attribution for e-commerce business models are a few of the policy changes that could follow suit.

Foreign investors anticipate that the budget shall set out India’s stance on mandatory arbitration in bilateral tax treaties, though India will continue to be sceptical and wait for other emerging economies to take such a stance. It is important that the government reviews the trade-offs, if any exist, between embracing arbitration as a noble forum for dispute resolution in international tax matters and perceived loss of sovereignty. In the same vein, legislating more sophisticated forums of ‘negotiation’ and ‘conciliation’ can improve the efficacy of dispute resolution and send positive vibes to investors.

A lot remains on the plate with respect to tax administrative reforms. It is imperative to sift through recommendations made by think tanks—Tax Administration Reform Commission headed by P. Shome, NITI Aayog and the expert group led by justice (retired) R.V. Easwar—to embrace best practices to reform the architecture of income tax law and overall tax administration. An important aspect shall be to strengthen the functioning of traditional dispute resolution forums such as income tax appellate tribunals and state high courts for capacity expansion in infrastructure.

From the indirect taxes standpoint, a revised road map for the implementation of goods and services tax (GST) is called for, considering that the April timeline is not possible to honour in the wake of the continued political impasse. The budget may come up with an alternative approach, even if that means India must live with an imperfect GST to begin with, so long as the new regime can be fully scaled up to integrate all central and state indirect taxes in the years to come.

Hopes abound. The upcoming budget certainly has the potential to catapult the economy into a high-growth orbit. With strong macroeconomic fundamentals largely unhurt by the volatile global scenario, India finds itself in a sweet spot, and this budget could well be the tipping point for achieving rapid growth.