economy matters
TRANSCRIPT
ECONOMY MATTERS 2
1
FOREWORD
JANUARY 2016
The recent decline in China’s currency, the Yuan, which has fuelled turmoil in Chinese stock markets , highlights a major challenge facing the country: how to balance its domestic and in-ternational economic obligations. The approach the authorities take will have a major impact
on the wellbeing of the global economy. The Yuan, which is set to be included in the IMF’s special drawing rights (SDR) basket, has seen a close to 5 per cent drop in value in 2015. Much of the devalu-ation of the Yuan is aimed at propping exports growth as China’s GDP growth rate slumped below the crucial 7 per cent level in the third quarter of last year, signalling the end of two decades of double-digit growth, which propelled the world’s most populous country to a superpower status in the global economic order. In the aftermath of the financial crisis of 2008-09, China stood tall to carry the world on its shoulders. With the global economic outlook muted this year, China’s slowdown is an extremely worrying sign for the world economy. The Chinese authorities need to be careful of let-ting the Yuan’s value drop significantly as the drop in China’s exports is mainly the result of sluggish global demand, and the collapse of the Yuan would only increase the risk of competitive devaluations in neighboring countries, creating a so-called currency war.
Business sentiment within industry has shown some improvement during the previous quarter of the current fiscal, indicating higher confidence of industry in the economy. The prevailing mood of busi-ness finds a reflection in the CII Business Confidence Index (BCI) for Oct-Dec 2015 (Q3FY16) quarter, which rose marginally to 53.9 as against the level of 53.4 recorded in the quarter ending September, 2015. The BCI recovered this quarter after falling in the previous two quarters.Improvement in the business sentiments, albeit mild, is welcome news at a time when global economic situation contin-ues to remain under stress. In order to sustain the improvement, it would be crucial that we continue to make necessary policy changes to invigorate domestic demand, boost investment and reverse the decline in exports. Even as there is no sustainable sign of betterment in demand conditions, majority of the respondents reported significant improvement in the ease of doing business since the forma-tion of new government at the Centre.
Against a challenging macroeconomic backdrop, the Union Budget is scheduled to be unveiled by finance minister Arun Jaitley on February 29. In the last budget the FM had rightly recognised that investment activity remains sluggish and therefore had focussed on stepping up government capital expenditure. This has yielded positive results. Nevertheless, demand conditions remain subdued and the appetite for investments in the private sector is below par. Given that exports will remain on a declining trend on account of global economic downturn, it is imperative that domestic demand is stimulated. CII would recommend that capital expenditure on key projects in sectors such as roads, railways, irrigation and power be increased substantially. At the same time, the fiscal deficit should not be allowed to increase, as this would put pressure on interest rates, which have just started to soften.
Chandrajit BanerjeeDirector General, CII
3 JANUARY 2016
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EXECUTIVE SUMMARY
JANUARY 2016
Global Trends
The Yuan reached its lowest level against the dollar in five years on January 7, 2016, following repeated devalu-ations by the People’s Bank of China in the first week of the current financial year. Chinese policy makers have pushed the currency lower to try and help boost the competitiveness of the country’s exporters. Addition-ally, a weaker Yuan is feared to drive the global econo-my closer to a recession as the purchasing power of the world’s second largest economy deteriorates every time the currency is devalued. Moving further, Japan narrowly escaped a second recession under the current Abe ad-ministration when the revised July-September GDP data marked annualized 1.0 per cent growth from the previous quarter. But the pickup in consumer spending and capital investments by businesses remains sluggish, and exports are dampened by decelerating growth in emerging eco-nomic led by China. The demand in the economy has to be stimulated by attacking the private sector’s chronic savings surplus. The Japanese government forecasts that GDP growth in the fiscal year beginning in April 2016 will reach 1.7 per cent in real terms — up sharply from around 1 per cent estimated for fiscal 2015 and more optimistic than what many private-sector economists predict.
Domestic Trends
IIP for the month of November 2015 declined sharply to -3.2 per cent, the first contraction in a year. Although a slowdown was expected on account of Diwali and a sharp drop in factors such as auto sales but other factors such as impact from the Chennai floods and steep falls in capi-tal goods and manufacturing may have pushed the print into negative territory. The base effect for the month was also considerably adverse. The data print for this month could be a blip; hence industrial output would recover in the remaining months of this fiscal. In some more bad news for the economy, rising prices for some food prod-ucts and firm demand during the festival season pushed up retail inflation (CPI) to high of 5.6 per cent in Decem-ber 2015. However, the sequential momentum of head-line CPI index edged down. It is however interesting to note that though CPI inflation has shown a spike in the last few months, it still remains more-or-less range bound in RBI’s target range. On the external front, exports have now contracted for the thirteenth consecutive month in December 2015, worse than the steep decline witnessed during the credit crisis of 2008-09, mainly due to tepid
global demand and a volatile global currency market.
Sector in Focus: Tax Reforms - Winds of Change and India’s Response
India’s strong growth potential amid a difficult global en-vironment makes it an attractive investment destination. There are high expectations that the reforms envisioned by the Government will provide new opportunities for growth and investments. The tax reforms agenda is at a prominent position in this context. Around the world, the underlying trend is of countries moving towards a broad-based, low-rate corporate tax environment. At the same time, many countries are also gearing up to introduce BE-PS-related tax reform to protect their tax turf and check profit shifting. The final BEPS reports on all 15 focus areas addressing Base Erosion and Profit Shifting have been made public. These trends and forces are redrawing the architecture of International Taxation. An inevitable cor-ollary to these developments will be a rise in tax disputes. So how is India responding to the changes? The Finance Minister has announced a phased reduction in the corpo-rate tax rate in keeping with the global trend. The corpo-rate sector will also need to forego some of the current incentives in lieu of the rate reduction. This will also be in the interest of simplification of tax laws. On the indirect taxes front, the most awaited tax reform in India is the Goods and Services Tax (GST). While the Constitutional amendment to enable the implementation of GST is still pending, the Industry hopes for an early introduction of a comprehensive and fair GST that will propel economic growth.
Focus of the Month: Budget Expectations
Against a challenging macroeconomic backdrop, the Un-ion Budget is scheduled to be unveiled by finance min-ister Arun Jaitley on February 29. Expectations are high that the government may announce increase in tax ex-emption limit on savings. As private sector investment growth has remained tepid this year, higher savings are expected to make extra resources available to improve investment activity in the economy. Regarding the fiscal deficit target, government is confident of meeting the fis-cal deficit target of 3.9 per cent of GDP for 2015-16, and 3.5 per cent next fiscal, despite pressure of additional outgo on account of the 7th Pay Commission and OROP. In this month’s Focus of the Month, experts provide their views on the expectation from the forthcoming Union Budget.
ECONOMY MATTERS 6
GLOBAL TRENDS
China on Crossroads of Transition as Yuan Depreciates
On January 7, 2016, the People’s Bank of China cut its reference rate for the Yuan by 0.5 per cent, the most since August 2015’s two per
cent devaluation and the eighth straight day that the PBOC guided the Yuan lower. The move sent the Yuan falling to 6.59 to the US dollar, its weakest since Febru-ary 2011. This has resulted in global stocks, currencies and commodities diving and sparking widespread fears of a currency war.
move was believed to be a desperate attempt to boost exports in support of an economy that is growing at its slowest rate in a quarter century, though the PBOC claimed that it was a part of its reforms to move to-wards a more market-oriented economy. Since the rela-tive size of the devaluation appeared to be in line with
In 2015, the People’s Bank of China had surprised mar-kets with three consecutive devaluations of the Yuan, knocking over 3 per cent off its value. Since 2005, Chi-na’s currency had appreciated 33 per cent against the US dollar and the first devaluation on August 11 marked the largest single drop in 20 years. The unexpected
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GLOBAL TRENDS
JANUARY 2016
The Yuan reached its lowest level against the dollar in five years on January 7, 2016, following repeated deval-uations by the People’s Bank of China in the first week of the current financial year. Chinese policy makers have pushed the currency lower to try and help boost the competitiveness of the country’s exporters. But the move unleashed turmoil in both local and international stock markets by raising concerns that China’s economy was weakening too quickly. Additionally, a weaker Yuan is feared to drive the global economy closer to a reces-sion as the purchasing power of the world’s second largest economy deteriorates every time the currency is devalued.
Fears have been elevated about how bad is the slow-down in the world’s second-largest economy. While markets anticipated that Beijing would allow the Yuan to trade more in line with market forces after an entry into the IMF’s reserve currency basket, they now fear that Beijing, to help its exporters, is allowing the Yu-an’s rapid depreciation to accelerate, hinting economy is even weaker than imagined, or that official figures show.Official economic growth in China is still running at just below 7 per cent. But moves to devalue the Yuan suggest attempts to shift the economy from an export-led one to a consumer and services-led one are running
into problems. China is responsible for 17 per cent of all the world’s economic activity, so any downturn in spending there affects the rest of the world. Given the panic in global markets in August 2015, another round of Yuan weakening suggests Beijing thinks the economy is struggling enough to warrant this drastic move. Ex-ports in November dropped 6.8 per cent year-on-year, the fifth straight month of decline, while witnessing a nine-month decline in manufacturing indices,as China struggles with weak global demand, rising labour costs and a strong currency.
A weaker Yuan is also bad news for export-oriented economies like Singapore, Hong Kong, South Korea and Taiwan as their exports will be more expensive to Chi-nese buyers. Their exports to other countries will also have to compete against Chinese rivals who have the ad-vantage of a weaker currency. The resulting capital out-flows has hit Asian currencies and commodities. China is the world’s biggest user of energy, metals and grains and the Yuan’s sharp fall exacerbated the slump in the currencies of big commodity suppliers like Australia, New Zealand and Canada. Fears of a sharper slowdown in China’s economy and market turmoil is also triggering a sell-off in emerging-market assets by risk-averse inves-tors.The currencies of South Korea, Taiwan and Singa-
market fundamentals, the PBOC’s claims could hold water. After a decade of a steady appreciation against the US dollar, investors had become accustomed to the stability and growing strength of the Yuan and a drop of more than 3 per cent had them rattled. China’s Presi-dent Xi Jinping had pledged the government’s commit-ment to reforming economy in a more market-oriented
direction ever since he first took office over two years ago. That and the fact that China was determined to be included in the IMF’s special drawing rights basket of re-serve currencies made the POBC’s claim of devaluation being a measure to allow the market to have a more instrumental role in determining the Yuan’s value more believable.
ECONOMY MATTERS 8
GLOBAL TRENDS
pore are the most vulnerable to a decline in the Yuan as their exporters have the highest exposure to China in Asia. To some extent, weaker currencies might help Asian exporters recoup some of the competitiveness they are losing to China, but at the cost of hurting the buying power of consumers and companies and likely raising the cost of their debt.
The devaluation could also reignite an Asian currency war. It will put pressure on Asian emerging economies like Vietnam, Malaysia and Indonesia to push down their own currencies to help their exporters and to prevent destabilizing capital flows. As it did in the 1997 Asian financial crisis, a competitive spiral of currency de-valuations could result. Such competitive devaluations serve only to crimp trade and economic growth, reduc-ing imports without any benefit to export, according to a research based on more than 100 countries by the Financial Times.
Some say that China’s recent actions are indicative of a deeper crisis. One important barometer relates to Chi-nese labour strike data. Newly released figure from the China Labour Bulletin reveal that the number of strikes and workers’ protest dramatically increased at the end of 2015 particularly in manufacturing, construction and mining. As a result the labor costs for big firms tripled - encroaching upon and often flattening profit margins.In the beginning of 2016, manufacturing continued at a nine month low and China’s trade share of GDP was a third of that less than a decade ago. As a result, China is in the throes of a major shift in the balance of power between labour and capital, and is attempting to trans-form its producers into consumers – a grand transition from world’s supply side workshop to its next great marketplace.China’s working population has shrunk by 3.5 million. Many economists in the IMF state that China is reaching a point of labor scarcity, the so-called
“Lewis turning point”, an inevitable developmental phase when wages surge sharply, industrial profits are squeezed, with a steep fall in investment. Indicatively, real wages in China since 2001 have increased at a rate of 12 per cent per annum and observers speculate the recent devaluation of the Yuan reveals complications in China’s attempt to shift from an export-led to a con-sumer and services-led economy.
The current process in China is similar to the crisis in the West in the 1960s and 70s. Changing labour-capital rela-tions coupled with strikes and increased workers’ bar-gaining power lead to higher wages and broader social reforms, resulting in diminished labour output and high-er costs of maintaining workers in production as well as an increased “social wage”, squeezing profits further.In the final phase: capital innovates by automating and/or leaving for a more profitable terrain – however in this case there are few if any options as an alternative to China. Thus, the transition may deepen the crisis of accumulation in the “real economy” for transnational capital.
The devaluation of the Chinese currency is a worrying development for India and will make Indian exports ex-pensive while widening the trade deficit with the neigh-boring nation, even though the depreciation of the Yuan is definitely going to make imported goods from China cheaper. In 2014-15, the bilateral trade between the countries stood at US$72.3 billion with the trade gap at US$49 billion. The government and the Indian industry have time and again raised concerns about the widening deficit. India has been pushing China to give greater market access to Indian products such as agri-cultural products, IT and pharmaceuticals. China wants to push goods into different countries, particularly In-dia, and that would become even cheaper with the cur-rency devaluation.
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GLOBAL TRENDS
JANUARY 2016
The growth in private final consumption expenditure improved to 0.4 per cent in the third quarter of 2015 as compared to a flat growth witnessed in the similar quarter in 2014. Major companies continue to enjoy improved profits, and say they are ready again to offer wage hikes. It remains unclear whether pay raises will be broad enough across the economy to shore up personal consumption, which has remained weak since the first consumption tax hike in 17 years in April 2014. Growth in government final consumption expenditure saw a very slight improvement to 0.3 per cent as compared to 0.2 per cent in the third quarter of 2014. Growth in gross fixed capital formation expanded to 0.3 per cent in the third quarter of 2015 as compared to a contraction of 0.9 per cent in the third quarter of 2014.
Japan narrowly escaped a second recession under the current Abe administration when the revised July-September GDP data marked annualized 1.0 per cent growth from the previous quarter. But the pickup in consumer spending and capital investments by busi-nesses remains sluggish, and exports are dampened by decelerating growth in emerging economic led by China. The combination of fiscal stimulus and mon-etary easing known as Abenomics has spurred corpo-rate profits, increased tax revenue and fueled about 70 per cent gain in the benchmark Topix stock index since Prime Minister Shinzo Abe’s election in December 2012. The Japanese economy has been showing rhythmic
Insufficient private demand remains the core problem. The savings of households in Japan are no longer ex-ceptional. In 2013, Japan’s household savings were 3.8 per cent of Japan’s GDP, against 4.8 per cent in the UK, 5.1 per cent in the US, 6.1 per cent in Italy and 6.3 per cent in Germany. Despite Japan’s corporate savings be-ing exceptional, increasingly, Japan’s corporations do not invest, to match their savings, because of dearth of good investment opportunities in Japan. Consump-tion is a very low share of GDP, because the income of households, that is the workers’ compensation, is a low share of GDP. The demand in the economy has to be stimulated by attacking the private sector’s chronic sav-ings surplus.
fluctuations in the GDP growth for the past nine quar-ters. Growth in GDP in the third quarter of 2015 stood at 0.3 per cent, as compared to a contraction of 0.7 per cent witnessed in the comparable quarter of 2014. This was driven mainly by acceleration in gross fixed capital formation, and also in part by rise in growth in private final consumption expenditure and exports. Over the past nine quarters, the Japanese economy has been coming above and going under the water periodically. Pulsing peaks and troughs, as high as 1.2 per cent in the first quarter of 2014 and as low as -1.9 per cent in the second quarter of 2014 respectively, have marked the growth scenario.
Japanese Economy Narrowly Misses Recession in 3Q15
ECONOMY MATTERS 10
GLOBAL TRENDS
Exports’ growth in the economy has mirrored the fluc-tuations in the GDP growth in Japan. Growth in exports rose to 2.7 per cent in the third quarter of 2015 as com-pared to 1.6 per cent in the third quarter of 2014. Im-
ports, which are a subtraction from the GDP, also saw a minor increase in growth to 1.7 per cent in the third quarter of 2015 as compared to 1.1 per cent in the similar quarter in the previous year.
Prices in the country have been on a downward trend for quite some time now. While inflation in the econo-my stood at mere 0.2 per cent in the third quarter of 2015, steep downfall from 3.4 per cent in the compara-ble quarter in 2014. This was driven by all components – food, energy, services. Food inflation fell to 2.9 per cent in the third quarter of 2015 as compared to 5.5 per cent in the third quarter of 2014. Energy prices continued to contract and witnessed a de-growth of as high as 10.4 per cent in the third quarter of 2015 as compared to an inflation in energy prices to the tune of 6.9 per cent a year ago. Prices of services, except housing, too saw a
fall in growth to 0.9 per cent in the third quarter of 2015 as compared to an inflation in prices of services of 2.9 per cent in the similar quarter in the 2014.
Japan’s declining working population and increasing number of pensioners are keeping demand down and inflation rates low. Abe has been trying to raise wages to also reverse deflation. For the same, corporate income could be redistributed in two ways. One way would be via higher taxes that are then remitted to households, via lower taxation of income and consumption. But in Japan, uniquely, it might be possible to persuade com-panies to act in concert, to raise wages.
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GLOBAL TRENDS
JANUARY 2016
The BOJ scrapped interest rates as its main policy tool in 2013 and instead set a target for the size of the mon-etary base. It has kept its deposit rate at 0.1 per cent. Governor Haruhiko Kuroda has said he is confident that he can attain the 2 percent inflation target around the six months through March 2017, but that timing could change because of the slump in oil prices. Kuroda ini-tially said the bank aimed to reach the goal by March 2015. While the majority view of economists is that the BOJ is far from reaching its inflation target, most say it will stick to its pace of quantitative easing rather than expand or reduce it. The pressure is now on Abe to take up the mantle of stimulus as liquidity in the bond mar-ket evaporates, they argue.
The Japanese government forecasts that GDP growth in the fiscal year beginning in April 2016 will reach 1.7 per cent in real terms — up sharply from around 1 per cent estimated for fiscal 2015 and more optimistic than what many private-sector economists predict. Meanwhile, the consumption tax is scheduled to be raised again in April 2017, from 8 to 10 per cent. It’s expected that the rush to buy before the tax hike will boost consumer spending into the latter half of fiscal 2016 and shore up growth to a certain extent. But it’s widely believed that the impact will not be as strong as before the April 2014 hike, when the GDP grew an annualized 5 per cent in the January-March period — before declining by 7.2 percent in the subsequent quarter.
The policies known as Abenomics, after Shinzo Abe,
Japan’s prime minister since December 2012, were a bold attempt to revitalize the Japanese economy. The quiver of Abenomics contains three “arrows”: fiscal policy, monetary policy and structural reforms. Of the three, monetary policy has been shot most aggres-sively. Under the policy of quantitative and qualitative easing adopted in April 2013, the Bank of Japan has in-creased its balance sheet from 34 per cent of gross do-mestic product at the end of the first quarter of 2013 to 73 per cent two and a half years later. Relative to GDP, the BoJ’s balance sheet dwarfs those of the Federal Re-serve, the European Central Bank and the Bank of Eng-land. The arrow of fiscal policy has, however, not been shot. According to the International Monetary Fund, Ja-pan had a cyclically adjusted fiscal easing of only 0.4 per cent of gross domestic product in 2013. The cyclically adjusted fiscal deficit tightened by 1.3 per cent of GDP in 2014, largely because of a misconceived jump in the rate of consumption tax, from 5 to 8 per cent, in the spring of 2014. A comparable tightening is forecast for 2015. Finally, structural reforms have been quite modest. The government has reformed agricultural co-operatives. It has also agreed to liberalization in the Trans-Pacific Partnership (TPP), the US-led trade pact. It has made modest progress on energy and tax reform. Improve-ment in opportunities for women is moving at a glacial pace. Increasing immigration remains largely taboo. The labour market has entrenched differences between permanent and temporary workers.
ECONOMY MATTERS 12
DOMESTIC TRENDS
Industrial Production Contracts in November 2015
IIP for the month of November 2015 declined sharply to -3.2 per cent, the first contraction in a year. Al-though a slowdown was expected on account of Di-
wali and a sharp drop in factors such as auto sales but other factors such as impact from the Chennai floods and steep falls in capital goods and manufacturing may have pushed the print into negative territory. The base
effect for the month was also considerably adverse. The data print for this month could be a blip; hence indus-trial output would recover in the remaining months of this fiscal. On a cumulative basis, industrial production growth has improved at higher pace of 3.9 per cent in April-November 2015 compared with 2.5 per cent in the corresponding period last year. In FY16, we expect industrial production to grow at a higher rate as com-pared to the previous fiscal on the back of improving global conditions and policy aided domestic upturn.
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DOMESTIC TRENDS
JANUARY 2016
Mirroring the poor performance of the overall indus-trial sector, output of the eight core industries also con-tracted to the tune of 1.3 per cent in November 2015 as compared to 3.2 per cent growth posted in the previous month. The core sector index comprises 38 per cent of the total weightage of items included in the Index of In-dustrial Production (IIP). The index’s cumulative growth
On the sectoral front, growth of manufacturing sector, which constitutes over 75 per cent of the index, declined to 4.4 per cent in November 2015 as compared with healthy 10.6 per cent growth in the previous month. In terms of industries, seventeen (17) out of the twenty two (22) industry groups (as per 2-digit NIC-2004) in the manufacturing sector showed negative growth during the month of November 2015 as compared to the corre-sponding month of the previous year. Electricity output decelerated sharply to 0.7 per cent in November 2015 as compared to 9.0 per cent growth in the previous month. Mining output growth also slowed down to 2.3 per cent from 5.2 per cent in the previous month. The recent auction of coal mines by the government could provide some impetus to coal production in the months to come.
The details in the use-based segment are fairly encour-aging. Capital goods output is usually a volatile compo-nent but it had shown steady growth for four months before contracting steeply in November 2015. Private capex continues to remain weak in the economy and hence the Government’s role in capital expenditure
from April to November 2015-16 stood at 2.0 per cent, as compared to 6.0 per cent during the corresponding period of 2014-15. Out of the eight core industries only fertilisers and coal reported healthy output numbers. However, production of refinery products, crude oil, natural gas and steel dwindled in the period under re-view.
becomes crucial to support growth recovery. Capital goods output contracted by a hefty 24.4 per cent in the month under review as compared to healthy growth to the tune of 16.3 per cent in the previous month. Con-sumer durables have been on a strong footing for quite a few months now and the November 2015 print stood at 12.5 per cent, albeit lower than the robust 42.3 per cent posted in the previous month. This component has remained positive for six months in a row now and has been aided by continuous improvement in sectors such as passenger cars. The strength in consumer durables helped overall consumer goods to post positive growth to the tune of 1.3 per cent in November 2015. Consumer goods have been positive for a while now but perfor-mance has mostly been tepid on account of weakness in consumer non-durables. For the month of Novem-ber 2015, the non-durables sector registered negative growth to the tune of -4.7 per cent after posting posi-tive growth in the previous month. The weak growth of consumer non-durables is also reflective of the cumula-tive impact of two consecutive years of drought and the growing distress in the rural economy.
ECONOMY MATTERS 14
DOMESTIC TRENDS
Wholesale Price Index (WPI)-based inflation moved up to a 12-month high of -0.7 per cent in December 2015, recording a rise for the fourth straight month from -2.0 per cent in November 2015. As per the revised data, the inflation figure for October 2015 was slightly scaled up to -3.7 per cent from -3.8 per cent reported provision-ally. An increase in WPI inflation in December 2015 was mainly driven by primary articles and fuel products. Fur-ther, the WPI inflation continued to be in the negative zone for the fourteenth straight month in December 2015. WPI has been experiencing deflation on annual basis from November 2014. Sustained decline in WPI is good news for corporate as WPI is input price for manu-facturing process.
Mirroring the rise in WPI based inflation, rising prices for
some food products and firm demand during the fes-tival season pushed up retail inflation (CPI) to high of 5.6 per cent in December 2015. However, the sequential momentum of headline CPI index edged down to -0.4 per cent on a month-on-month basis in December 2015 from 0.4 per cent on month-on-month basis previously. Food inflation came in at multi-month highs of 6.3 per cent as compared to 6.1 per cent in the previous month. Cereals inflation continued to remain muted. Going ahead, this number is likely to see correction as prices cool and the unfavourable base effect wears off. A sig-nificant development seen was an uptick in vegetables CPI as compared to the sharp cooling in on-the-ground prices. Vegetables inflation came in at 14.2 per cent as compared to 3.9 per cent posted in the previous month. Vegetables CPI is likely to correct in the coming months.
OutlookIndustrial production, which has drifted into the negative terrain in November 2015 on account of the steep slide in the growth of manufacturing and electricity sectors, is much below expectations and could be the impact of sub-dued activity experienced in the aftermath of the festive season. However, going forward, we hope that growth would pick up in the coming months as pro-active reform initiatives taken by the government in recent months would make a positive impact on investment decisions and spur a turnaround in demand. In FY16, we expect in-dustrial production to grow at a higher rate as compared to the previous fiscal on the back of improving global conditions and policy aided domestic upturn.
Both Indices of Inflation Rise in December 2015
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DOMESTIC TRENDS
JANUARY 2016
Core inflation showed a marginal uptick to 4.7 per cent in December 2015 as against 4.6 per cent in the previous month. However, the subdued domestic demand cou-
Rising food prices, pushed primary products prices higher to 5.5 per cent in December 2015 as compared to 2.3 per cent in the previous month driven by higher food prices. Inflation in the prices of food articles rose to 8.2 per cent in December 2015 from 5.2 per cent in the preceding month. This was the highest rate of food inflation since July 2014. This was mainly due to rise in prices of condiments & spices (to 21.7 per cent from 18.9 per cent), vegetables (to 20.6 per cent from 14.1 per cent; despite the easing in inflation for onions to +26.0 per cent from 52.7 per cent and tomatoes to 60.2 per cent from 137.6 per cent), eggs, meat & fish (to +5.0 per cent from -2.2 per cent), cereals (to 1.6 per cent from 0.5 per cent) and fruits (to +0.8 per cent from -2.3 per cent). While inflation for pulses eased mildly, it remained at an alarming 55.6 per cent in December 2015 as compared to 58.2 per cent in November 2015. Prices of pulses have risen due to shortage in production. Normally, food prices moderate with the onset of rabi harvesting sea-son. But, due to intermittent unseasonal rainfalls and af-fect of El Nino resulting into drought in some areas and flood in some major agri commodities growing regions,
pled with weak international crude prices are likely to support muted core inflation, which we expect to stay below 5 per cent in the coming months.
the food prices remain elevated. Inflation for primary non-food articles firmed up to 7.7 per cent in December 2015 from 6.3 per cent in November 2015, while inflation for other non-food articles decelerated mildly to 7.9 per cent in December 2015 from 8.0 per cent recorded in the previous month.
Deflation in fuel sector increased to 9.1 per cent in De-cember 2015, as compared to deflation to the tune of 11.1 per cent in the month before, reflecting the hike in prices of petrol and diesel announced on 15 November by 36 paisa per litre and 87 paisa per litre respectively.
Manufacturing products recorded a deflation to the tune of 1.4 per cent in December 2015, remaining flat as compared to last year. The fall was on account of defla-tion in the prices of textiles, chemicals & chemical prod-ucts and basic metals, alloys & metal products. Non-food manufacturing or core inflation, which is widely regarded as the proxy for demand-side pressures in the economy remained flat at -2.0 per cent during the month as compared to -1.9 per cent during the previous month.
ECONOMY MATTERS 16
DOMESTIC TRENDS
India’s merchandise exports contracted for the thir-
teenth consecutive month in December 2015, worse
than the steep decline witnessed during the credit cri-
sis of 2008-09, mainly due to tepid global demand and
a volatile global currency market. Exports contracted
by 14.7 per cent in December 2015, lower than 24.5 per
cent decline witnessed during the previous month. A
stronger rupee compared with its peers has also hurt
exports. The rupee has been the top performing emerg-
ing market currency in 2015, with the real effective ex-
change rate rising 3.7 per cent in the April-December pe-
riod. Further, net earnings from services trade touched
US$6.3 billion in November 2015, up just 0.2 per cent,
while cumulatively in April-November 2015, net earnings
from services fell 3.8 per cent compared with a year
ago, according to data released by the Reserve Bank of
India.
Exports of drugs and pharmaceuticals (8.2 per cent),
chemicals (1.1 per cent), readymade garments (5 per
cent) increased in December 2015, while exports of
gems and jewellery (7.8 per cent), engineering goods
(-15.7 per cent) and petroleum products (-47.7 per cent)
contracted. The eight items of export which turned pos-
itive during the month are coffee, tobacco, spices, ce-
real preparations and miscellaneous processed items,
chemicals, electronic goods, handicrafts (excluding
handmade carpets), plastics and linoleum. Given the
recent trend, exports are likely to fall below US$300 bil-
lion mark, for the first time since FY11. This is certainly
not good news as India aims to take exports of goods
OutlookWPI index has shown deflationary trends since the last fourteenth consecutive month in December 2015 indicat-ing slackness in economic activity across sectors. Retail inflation measured by the consumer price index (CPI) in-creased for the fifth successive month in December 2015, pushed up by a surge in the monthly momentum. Food inflation rose sharply in December 2015, driven especially by pulses and vegetables. It is however interesting to note that though CPI inflation has shown a spike in the last few months, it still remains more-or-less range bound in RBI’s target range. Going forward, we expect subdued demand conditions to keep CPI inflation capped with only transient episodes of rise due to surge in food prices.
EXIM Scenario Continues to Remain Grim
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DOMESTIC TRENDS
JANUARY 2016
and services to US$900 billion by 2020 and raise the
country’s share in world exports to 3.5 per cent from 2
per cent now. Exports in the past four fiscal years have
been hovering at around US$300 billion.
Worried by the continuous decline in exports, the gov-
ernment has raised duty drawback rates for exporters
and implemented the interest stabilization scheme in
November 2015. While the increase in duty drawback
rates will help exporters recover higher input tax outgo
that they pay during the process of making the final
product, the interest stabilization scheme will allow ex-
porters to receive bank loans at a lower rate of interest.
Imports too contracted by 3.7 per cent in December
2015 as against contraction of 30.2 per cent posted in
India’s trade deficit widened to US$11.7 billion in Decem-
ber 2015 as against a deficit of US$9.8 billion in Novem-
ber 2015. On a cumulative basis, trade deficit for April-
December FY2016 was US$99.2 billion, lower than the
deficit of US$111.7 billion during the same period previ-
Rupee has depreciated to its two-year low of 67.6 per
US$, losing close to 9 per cent till January 19th 2016
from the start of FY16. Much of this is based on short-
term trends possibly fuelled by capital exit in the con-
text of the collapse in both oil prices and the Chinese
stock market. FIIs have been in the sell-off mode in eq-
uity segment for last 3 months. From Jan 1 to Jan 20,
November 2015. During April-December 2015, India’s
cumulative imports were US$261 billion. This is a 17 per
cent drop from US$316 billion, the cumulative figure
for the same period last year. Non-oil imports picked
up 7.63 per cent in December 2015, while oil imports
contracted 33.2 per cent due to falling crude oil prices.
Amongst non-oil imports, gold imports remained strong
at US$3.8 billion in December 2015 as against US$3.5 bil-
lion in November. Non gold non crude imports, a broad
gauge of domestic demand and industrial recovery, fell
by 1.9 per cent in December 2015 as against contraction
to the tune of 22 per cent in November 2015. The con-
traction was driven by- coal (-35 per cent), mineral ores
(-22 per cent), fertilizers (-20 per cent), and chemicals
(-5 per cent).
ous year. Though improving domestic competitiveness
through structural reforms is crucial to improve exports
performance, we believe that can only materialize in
the medium-term. In the near-term, a weaker Rupee
can act as a catalyst to revive competitiveness.
2016, foreign institutional investors (FIIs) sold shares
worth Rs 7,146 crore in the domestic equity markets. US
is the biggest importer of crude oil. So when the crude
prices go down, it means US will be saving more dollars
to buy it, as a result dollar as a currency strengthens,
leading to fall of Indian rupee and other currencies at
the forex market.
Rupee Depreciates Sharply
ECONOMY MATTERS 18
DOMESTIC TRENDS
Business sentiment within industry has shown some improvement during the previous quarter of the cur-rent fiscal, indicating higher confidence of industry in the economy. The prevailing mood of business finds a reflection in the CII Business Confidence Index (BCI) for Oct-Dec 2015 (Q3FY16) quarter, which rose margin-ally to 53.9 as against the level of 53.4 recorded in the quarter ending September, 2015. The BCI recovered this quarter after falling in the previous two quarters.
Even more significantly, the improvement has been led by the rise in the Current Situation Index rather than the Expectation Index, implying that the rigorous policy efforts being undertaken by the government in recent months have positively influenced the business senti-ments. CII-BCI is calculated as a weighted average of the Current Situation Index (CSI) and the Expectation
The fall of Rupee has been also led by a strengthening
dollar as positive US economic data have raised expec-
tations over further hike in interest rates by the US
Federal Reserve. The rupee is also pressured by worries
over yuan devaluation by the Chinese authorities. De-
There are positive impacts of Rupee depreciation like
boosting export of industries like IT, handicrafts, and
pharmaceuticals textiles. However, there are negative
impacts like increase in import bill, inflation, burden for
Index (EI), with greater weight given to EI as compared to CSI. These indices are based on questions pertain-ing to performance of the economy and respondent’s firm. Respondents are asked to rate the current and expected performance on a scale of 0 to 100. A score above 50 indicates positive confidence while a score above 75 would indicate strong positive confidence. On the contrary, a score of less than 50 indicates a weak confidence index.
The CII 93rd edition of quarterly Business Outlook Sur-vey is based on over 200 responses from large, medium, small and micro firms, covering all broad sectors and re-gions of the country. The survey was conducted from October-December 2015, covering more than 100 firms of varying sizes.
preciation in the Chinese yuan earlier this month had led
to sharp sell-off in the Indian stock markets, affecting
the rupee movement. Chinese yuan has dropped nearly
1.5 per cent against the dollar since the beginning of
2016.
government and industrial foreign borrowings hurting
import based industries. Going forward, we expect Ru-
pee to remain range-bound against the US dollar.
CII Business Confidence Index Improves, Marginally
19
DOMESTIC TRENDS
JANUARY 2016
(i). Credit Growth
A major proportion of the respondents (34 per cent) seemed unsure about the adequacy of the 125 basis points cut in policy rates, by the RBI, in driving the re-
(ii). Ease of Doing Business
The government has spear-headed several initiatives to improve ease of doing business (EODB) over the last year ranging from the Make in India initiative to eas-ing the FDI limits across various sectors, single window clearances, E-biz portal etc. All these initiatives have re-sulted in the improvement in India’s EODB ranking by the World Bank as India jumped up 4 places to stand at
GENERAL ECONOMIC PROSPECTS
covery in credit growth. Closely enough, an equal pro-portion of respondents (33 per cent each) felt that the RBI’s policy actions may or may not support the recov-ery in credit growth.
130 in 2016 from 134 in 2015. On the ground as well, the governments initiatives seem to have had an impact on the business environment as close to two thirds of the respondents (64 per cent) felt that there has been a 10-30 per cent improvement in ease of doing business, of which 35 per cent felt there has been a 10-20 per cent improvement while 29 per cent felt that there has been a 20-30 per cent improvement.
ECONOMY MATTERS 20
DOMESTIC TRENDS
GENERAL BUSINESS PROSPECTS
(iii). Exchange Rate
A major share of the respondents (55 per cent) expect the exchange rate to range between Rs 63 and Rs 67
(i). Capacity Utilisation
Close to half of the respondents (48 per cent) anticipate capacity utilization to lie between 50-75 per cent in the Oct-Dec quarter, marginally up from 47 per cent who witnessed the same in Jul-Sep quarter. Additionally, greater proportion of respondents (35 per cent) expect
per US dollar in 2015-16. This is mainly attributable to the recent strengthening of the US dollar against all major currencies of the world and the persistent weakness in emerging market economies.
capacity utilization to lie above the 75 per cent level in Oct-Dec 2015, up from 25 per cent who witnessed the same in Jul-Sep 2015. Though the capacity utilization has improved over the years, it still stands far below the pre-crisis peak. To bridge this gap, the government has undertaken reforms and initiatives that would help im-prove business environment and overall demand condi-tions in the economy.
21
DOMESTIC TRENDS
JANUARY 2016
(ii). Investment PlansMajor share of the respondents (59.8 per cent) felt that their plans about investing in the domestic economy are likely to remain unchanged in Oct-Dec 2015. Similarly, on an international front, firms do not anticipate a change in their international investment plans, with a majority
(iii). Overall Sales and New OrdersFirms continue to anticipate further improvement in demand conditions, as 44 per cent of the respondents expect new orders to improve in the Oct-Dec 2015, up from 31 per cent who witnessed the same in Jul-Sep 2015 quarter. Further, sales are also expected to
of respondents (70.5 per cent) of the expecting status-quo in Oct-Dec quarter. The prevailing excess capac-ity in the economy is holding back firms from making new investments even though these firms anticipate improvement in sales and new order in the said period.
improve as 44 per cent of respondents anticipate an increase in sales as compared to 32 per cent who wit-nessed the same in the Jul-Sep quarter. It is important to note that firms are upbeat about the demand con-ditions in the coming months even though half of the firms registered no change in sales and new orders in the Jul-Sep 2015 quarter.
ECONOMY MATTERS 22
DOMESTIC TRENDS
(v). Export and Import TrendsMore than half the respondents expect no change in the trade situation in the Oct-Dec 2015 quarter. On the exports front, though a majority of the respondents (54.8 per cent) expect status-quo on their export or-ders, there has been an increase in the percentage of respondents expecting their export orders to improve
Asked to rank the topmost concerns facing industry, 87 per cent respondents to the survey cited low domestic demand, lack of consensus on economic reforms and
(20.5 per cent), as against 17.3 per cent who witnessed the same in the previous quarter. On the other hand, more than two thirds of the respondents (71.6 per cent) anticipate import orders to remain unchanged in the Oct-Dec quarter, as compared to 64.5 per cent of respondents who witnessed the same in the previous quarter.
fragile global economic recovery as among the top-3 constraints impacting investment.
(iv). Profits after TaxProfit expectation has largely remained unchanged from the previous quarter with majority of the respond-ents (44.8 per cent) anticipating status-quo in after tax profits as compared to 45.2 per cent of the respondents
who witnessed the same in the Jul-Sep 2015 quarter. Further it is important to highlight that there has been an increase in the proportion of respondents expecting a decline in after tax profits in Oct-Dec 2015 quarter and a corresponding decline in the share of respondents an-ticipating an increase in after tax profits.
23
SECTOR IN FOCUS
Tax Reforms: Winds of Change and India’s Response
JANUARY 2016
India’s strong growth potential amid a difficult global environment makes it an attractive investment des-tination. There are high expectations that the re-
forms envisioned by the Government will provide new opportunities for growth and investments. The tax re-forms agenda is at a prominent position in this context. Around the world, the underlying trend is of countries moving toward a broad-based, low-rate corporate tax environment. At the same time, many countries are also gearing up to introduce BEPS-related tax reform to protect their tax turf and check profit shifting. The final BEPS reports on all 15 focus areas addressing Base Ero-sion and Profit Shifting have been made public.
These trends and forces are redrawing the architecture of international taxation. The years to come will see a greater focus on multilateralism, more transparency and reporting requirements, stricter tax enforcement, and a new set of rules defining the way domestic/over-seas profits are taxed. An inevitable corollary to these developments will be a rise in tax disputes.
So how is India responding to the changes? The Finance Minister has announced a phased reduction in the cor-porate tax rate in keeping with the global trend. The corporate sector will also need to forego some of the
current incentives in lieu of the rate reduction. This will also be in the interest of simplification of tax laws.
On the indirect taxes front, the most awaited tax re-form in India is the Goods and Services Tax (GST). While the Constitutional amendment to enable the implemen-tation of GST is still pending, the industry hopes for an early introduction of a comprehensive and fair GST that will propel economic growth. Indeed, India is taking the right steps toward tax reforms. What is needed now is a focus on effective and time-bound implementation of the positive reforms already announced. To minimize uncertainty, the industry looks to a structured consulta-tive process as the Indian Government amends tax laws in response to global developments. Equally important will be the tax administrative reform. The alternate dis-pute resolution mechanisms, in particular, need to be improved to take on the challenge of newer controver-sies that the transition will bring.
In this month’s Sector in Focus, we present excerpts from a white paper on “Tax Reforms – Winds of change and India’s response” which was released in the CII 3rd Global Tax Summit held on 8th October 2015 in Delhi. The paper explores the changing tax landscape across the globe. It also discusses the policy and administrative re-forms needed in India for a facilitative tax environment that will provide stability, and encourage investments and growth.
ECONOMY MATTERS 24
SECTOR IN FOCUS
In the current global environment, the advanced econo-mies are experiencing slow growth and many emerging economies are facing difficulties in maintaining decent growth. In this uncertain scenario, India stands out for its resilience, growth potential and attractiveness as an investment destination. As quoted by Reserve Bank of India Governor, “India is an island of relative calm in an ocean of turmoil.” The country has been able to withstand the external shocks and can boast of robust economic growth at 7.0-7.5 per cent. Other macroindi-cators support the sound economic picture. However, India needs the right reforms to sustain this growth. Tax policy and administration is one of the key areas that industry looks to as an enabler for growth and invest-ment.
In the last two years, the thrust of the tax policy has been on promoting investments in the manufacturing sector, bringing certainty in taxation for foreign inves-tors, and providing a stable and non-adversarial tax environment. Several forward-looking and positive measures have been taken by the Government in this direction. These include:
• The Constitutional (Amendment) Bill for the intro-duction of GST was tabled in the Parliament and passed by the Lok Sabha.
• The Government announced the lowering of the corporate tax rate from the current 30 per cent to 25 per cent in the next four years, accompanied by a gradual phase-out of incentives.
• The Government accepted the recommendations of the AP Shah Committee to the effect that Mini-mum Alternate Tax (MAT) provisions will not be applicable to Foreign Portfolio Investors (FPIs) not having a place of business/permanent establish-ment in India, for the period prior to 1 April 2015.
• The Finance Ministry decided not to file an appeal against the Bombay High Court’s ruling in favor of Vodafone in the transfer pricing dispute.
• A High Level Committee has been constituted to regularly interact with industry and help provide clarity and certainty in taxation.
• Greater clarity has been brought in on issues such as taxation of indirect transfer of Indian assets and Place of Effective Management (POEM).
• More enabling tax provisions have been introduced for Real Estate Investment Trusts and offshore funds with fund managers based in India.
• Positive steps have been taken toward tax admin-istration and improving dispute resolution mecha-nisms, e.g., notification of Advance Pricing Agree-ment (APA) rollback rules for four prior years, expansion of scope of the Authority for Advance Rulings (AAR) to resident taxpayers and announce-ment of additional AAR benches, and restructuring the composition, jurisdiction and control of Dispute Resolution Panels (DRPs) across the country.
• A High Level Committee has been constituted to scrutinize fresh cases of indirect transfers arising from retrospective amendments of 2012. The Gov-ernment also announced that there will be no ret-rospective changes that lead to fresh tax liability.
• Internal circulars have been issued by the Central Board of Direct Taxes (CBDT) to its field officers to follow a non-adversarial tax regime.
All these developments are indicative of the Govern-ment’s firm commitment to provide a more enabling tax environment. However, the industry feels that while many welcome announcements have been made by the Government for a stable and taxpayer-friendly tax environment, the on-the-ground experience does not match up to the good intent. The passage of the Constitutional amendment for GST is still pending due to a disrupted Parliament session. There are still many instances of inconsistencies between intent and inter-pretation of the law: field officials not following the de-partment circulars in spirit; high pitched assessments that do not stand the test of judicial scrutiny in appeals; and the levy of unjustified penalties and holding back of refunds. Clearly, more needs to be done to give shape to the intent and take it to the implementation level.
Tax administration and ease of doing business
Recognizing the need to overhaul the tax administra-tion, the Government has announced a number of posi-tive steps toward a non-adversarial tax regime. How-ever, despite the good intent, the measures have not translated into a visible difference in the on the-ground experience or ease of doing business for taxpayers.
The Tax Administration Reforms Commission (TARC) had made some path breaking recommendations to
I.Tax Reforms for Stability, Growth and Investments
25
SECTOR IN FOCUS
JANUARY 2016
reengineer the current tax administration. The Gov-ernment must revisit these suggestions and prepare a strategy for their implementation. In particular, the following recommendations should be implemented at the earliest:
Structure and governance
• A common Tax Policy and Analysis (TPA) unit — separate from the directorates responsible for operations in the field — should be established to focus on policy development, technical analysis and statutory drafting.
• An Independent Evaluation Office should be set up to monitor the performance of tax administration, promote accountability, evaluate the impact of tax policies and assess all factors that affect tax admin-istration.
• There should be selective convergence of the two boards to achieve better tax governance.
Key internal processes
• PAN should be developed as Common Business Identification Number, which can be used by other government departments.
• There should be a common return for excise and service tax.
• Refunds sanctioned should be paid on time along with the applicable interest automatically and not on demand by taxpayers.
• The rate of interest on refunds should be the same as the interest charged by the tax department.
• Single detailed documentation requirements should be framed for transfer pricing as well as cus-tom valuation by both the boards.
• Tax avoidance instruments should not be used for revenue generation.
Customer focus
• For each of the boards, a dedicated organization should be constituted for delivery of taxpayer ser-vices with customer focus.
• Taxpayer service delivery should be located under one umbrella for large taxpayers.
• Officers and staff at all levels of tax administration should be trained for customer orientation.
• There should be regular stakeholder consultations on issues of tax disagreements and tax law chang-es.
Dispute resolution
• A dedicated task force should be constituted for re-view and liquidation of cases currently clogging the system.
• Clear interpretative statements should be formu-lated on contentious issues that are binding on the tax department.
• The practice of pre-dispute consultation before is-suing a tax demand notice should be established.
• The consequences of not adhering to timelines in resolving disputes should be prescribed.
• Introduce statutory Alternate Dispute Resolution (ADR) process, arbitration and conciliation.
• Settlement Commission should act as part of tax-payer services, and be made available to the tax-payer to settle disputes at any stage.
• Appeals to high courts and the Supreme Court should only be on a substantial question of law.
• On disposal of cases by the Supreme Court/High Court, and if the judgment is accepted by the de-partment, an instruction should be issued to all au-thorities to withdraw appeal in any pending case involving the same issue.
ConclusionThe Finance Minister has stated that India is on the cusp of modernizing and rationalizing its tax policies, and that while fashioning the tax policies for the 21st cen-tury, the tax administration cannot afford to lag behind. The new era of reforms has already begun. It is time to focus on the delivery of the vision. A thorough impact analysis of the proposed reforms, a transparent and consultative approach, backed by a fair administration is the need of the hour. The pace of implementation of reforms will be equally important to make the reforms process perceptible.
ECONOMY MATTERS 26
SECTOR IN FOCUS
The implementation of the Goods and Services Tax (GST) is the top priority from an indirect tax reforms agenda perspective. If implemented in the right man-ner, GST can improve India’s competitiveness, be a cata-lyst to the “Make in India” initiative of the Government and spur investments. While the GST’s proposed design is far from ideal, with its flaws of sector exclusions and the proposed 1 per cent origin tax, there is scope to cor-rect some of these anomalies.
While the Government’s intent and associated actions to implement GST are evident, a political impasse con-tinues to cloud the implementation date, with the delay in the passage of the Constitutional Amendment Bill. However, the Government has been working on vari-ous aspects of GST, namely laws, rules, business pro-cesses, etc. The recent award of a contract to build the GST Network (GSTN) affirms the Government’s commit-ment to implement GST. The Constitution Amendment Bill is anticipated to be passed by the Parliament in the winter session, so that the process of GST implemen-tation gains pace. The implementation date of April 2016 looks challenging and even the Finance Minister’s recent comments — that GST, being a transaction tax, can be implemented in any month of the fiscal — allude to this. It appears that implementation could occur any-time in 2016, possibly around September/October 2016, if not earlier.
The main cause of concern for the industry is the almost complete lack of visibility on what is being drafted by policy-makers with respect to the GST law and rules. It is, therefore, important that the Government bring out these documents in the public domain at the earliest and seek feedback from the industry. It is also impor-tant for the Government to create a proper, structured forum for industry consultations to ensure effective representation and a collaborative approach to the en-tire process. Internationally, such as in the recent Ma-laysian GST implementation, laws and rules were made public more than a year in advance, though changes did happen along the way.
Clarity on rates is another area of concern for the indus-try. Though the mandate for GST design, structure and rates is with the GST Council, the Chief Economic Advi-
sor (CEA) to the Government of India is mandated to present a report on GST rates. This report is likely to be submitted in October 2016 and is expected to provide some insights into the rate structure. The National Insti-tute of Public Finance and Policy is also reexamining the rates in continuation to its previous study. A single rate, though ideal, may not fructify and we are likely to arrive at a multiple rate structure considering the ground real-ity. The industry’s hope is that the rates are moderate and the standard rate is well below 20 per cent for ef-fective compliance.
The recent awarding of the contract for the design, de-velopment and implementation of GSTN is another im-portant milestone. It is critical that the industry is made aware of the compliance requirement under GST, con-sidering that India is looking at transaction-level report-ing with electronic credit matching. While this would lead to automation and a fair degree of transformation — which would be welcome — the industry needs to understand what they need to provide as inputs for compliance so that IT systems are suitably modified.
GST readiness: implications for the industry
GST is much more than a tax reform and will have a wide impact on industry operations, including govern-ment tax administrations. GST readiness will require significant time and proactive planning to leverage its benefits. All aspects of business, namely ERP systems, financial accounting/reporting, controls and processes, tax compliance, supply chain models and operating structure, will undergo changes. GST will impact mar-gins, pricing, working capital and cash flows, which fun-damentally means an opportunity to re-engineer and transform business to leverage this tax reform. Every company would need to commit significant resources to focus and manage this change as a program, while continuing to run existing businesses. This process will be disruptive in the interim, and will require careful and intelligent planning of resource allocation.
Advance and timely knowledge of business process changes, laws and rules, therefore, becomes critical for the industry. Companies also need to understand the importance of advocacy, which could straddle across
II. Indirect Tax Reforms Agenda: Goods and Services Tax
27
SECTOR IN FOCUS
JANUARY 2016
areas of law, place of supply rules, compliance and reg-istration requirements, treatment of existing Central and State incentives, and the rate structure. While there is a lack of an identified forum — especially at the State level — for such interactions/advocacy, identifying po-tential issues and possible solutions could be a good starting point to commence engagement with law mak-ers.
Depending on the complexity and the sector, compa-nies will need a minimum of 8-12 months to manage this change. The lack of clarity on the implementation date poses a challenge for companies to commit to this criti-cal change. While many companies have recognized this and started the process in a phased manner, several are still on the fence and could be caught off guard in case implementation happens in 2016. Our Malaysia experi-ence showed us that, even with the construct of laws being known more than a year in advance, companies struggled to be ready and comply on the implementa-tion date. It is pertinent to mention that the Malaysian GST was fairly simple with a single rate, whereas the Indian GST appears complex to begin with. It involves a dual GST (Center and State), integrated GST for inter-state transactions, and a potential non-creditable origin tax.
GST readiness: recommendations for the industry
In our view, it is already time for companies to start the change process, though in a phased manner with an indirect tax impact analysis at the outset. This can be done by mapping existing transactional tax costs and examining how they pan out in potential GST scenarios, based on the known GST structure and possible rates. Such an analysis would provide insights on how pricing, margins, working capital and cash flows can be poten-tially affected, and the areas that require attention in the operating structure and supply chain. This would also help identify potential areas of advocacy.
Another important area is ERP system reconfiguration requirements. In our understanding, several ERP tax modules will require fundamental changes depending on their versions, which will require time-consuming up-gradation of these ERP versions. The time for these upgrades is over and above the time that would be re-
quired for GST impact changes and customization. Thus, early proactive planning in these areas would allow suf-ficient time for change and testing. Further phases of GST readiness, such as changes in operating structure, supply chain changes (if any), changes in processes and controls, tax accounting changes, training, etc. can then be more effectively rolled out at a later stage as more clarity on the law, rules, compliance and rates emerges. Since the impact of GST would be across business, com-panies would require a cross-functional steering team to address and manage this change at the senior leader-ship level.
Other interim changes in indirect taxes
While the Government continues its efforts to imple-ment GST in 2016, there are some critical actions that it can take in the interim as part of the Union Budget exercise or otherwise.
(i). Dispute resolution efficacy
It is critical to strengthen the dispute resolution mecha-nism, as indirect tax litigation continues to be concern for the industry. The long pendency of disputes and the several stages of appellate proceedings at the levels of departments, tribunals and courts are significantly time-consuming for the industry and the revenue authorities.
The Tax and Administrative Reform Commission (TARC) report’s recommendations have examined these in granular detail and merit immediate implementation. While actions such as appointment of members and establishment of Authority for Advance Rulings have been taken, the pendency and efficacy of disposal of cases requires a sense of urgency with early creation of additional benches as announced.
(ii). Service tax refunds
Service tax refunds in the service exports industry continue to be a huge pain point. While there are juris-dictions that function fairly well, the quantum of pen-dency and rejections leading to litigation are still very high. This affects the fundamental tenet of “ease and cost of doing business.” An efficient, transparent, auto-mated, consistent and time-bound refund mechanism is required for the immediate release of such service tax refunds, with a post-audit mechanism. In order to en-
ECONOMY MATTERS 28
SECTOR IN FOCUS
sure equity and accountability, interest rate on refunds should be the same as the rate applicable for delayed payment of taxes and duties.
(iii). Customs valuation – SVB process
The process of customs valuation scrutiny by the ports and Special Valuation Branch (SVB) needs immediate at-tention. The pendency levels of such assessments and attendant 1-5 per cent extra duty deposits/provisional bonds are a cause of concern for the industry. The TARC report alludes to this glaring fact and recommends elim-inating the SVB process, replacing it with post-clearance customs audit.
(iv). Cenvat Credit Rules liberalization
As a pre-requisite for a good GST, it is important to re-visit the Cenvat Credit Rules restrictions to avail input
credit. The rules should allow credit of all taxes across inputs, capital goods and input services incurred by businesses, without any restriction, to ensure no cas-cading of input taxes and a clean Cenvat.
ConclusionIt is our considered view that the fuzziness surrounding the implementation date of GST should not, in any way, result in complacency. As discussed earlier, the fact that the Government is moving ahead with the drafting of the law and implementing GSTN indicate that GST may be implemented at short notice. Managing compliance itself may be a difficult task, let alone optimization of the supply chain. The industry will benefit from pro-ceeding with impact analysis and getting compliance systems ready. Given the constraints, this would be the most optimal way of keeping the date with GST.
29
FOCUS OF THE MONTH
Budget Expectations
JANUARY 2016
Domestic GDP data grew at higher rate of 7.4 per cent in the second quarter of FY2016, indi-cating that the recovery has gained strength,
as we had anticipated. GDP growth is likely to exceed 7.5 per cent for the full year. In a year when external demand remains a drag on the economy, this would be considered a strong performance. The acceleration in the manufacturing sector shows that the government’s policy direction is bearing fruit. The Make in India cam-paign with its objective of raising the growth rate in the manufacturing sector has begun to make an impact. Policy measures need to focus on a revival in project execution in manufacturing, real estate and infrastruc-ture.
Though WPI inflation has continued to remain sub-dued, CPI inflation has posted mild spikes in the last few months on the back of rising food prices. However, go-ing forward, CPI inflation is expected to rein in around RBI’s target of 6 per cent for January 2016. On the ex-ternal front, while, US economy is slowly but steadily
inching towards a recovery, growth in emerging market economies (EMEs) continues to remain tepid, thus put-ting our exports in shaky territory. Evidently, exports have now contracted for twelve consecutive months. In November 2015, the contraction was to the tune of 24.5 per cent. Imports too fell for the twelfth consecutive month, declining by a sharp 30 per cent in November 2015. The consistent fall in exports has been exerting upward pressure on the trade deficit.
Against a challenging macroeconomic backdrop, the Union Budget is scheduled to be unveiled by finance minister ArunJaitley on February 29. Expectations are high that the government may announce increase in tax exemption limit on savings. As private sector in-vestment growth has remained tepid this year, higher savings are expected to make extra resources available to improve investment activity in the economy. Regard-ing the fiscal deficit target, government is confident of meeting the fiscal deficit target of 3.9 per cent of GDP for 2015-16, and 3.5 per cent next fiscal, despite pres-sure of additional outgo on account of the 7th Pay Com-mission and OROP. In this month’s Focus of the Month, experts provide their views on the expectation from the forthcoming Union Budget.
ECONOMY MATTERS 30
FOCUS OF THE MONTHCII VIEWPOINT
Select CII’s Budget Expectations
In the last budget the FM had rightly recognised that investment activity remains sluggish and therefore had focussed on stepping up government capital ex-
penditure. This has yielded positive results. Neverthe-less, demand conditions remain subdued and the appe-tite for investments in the private sector is below par. Given that exports will remain on a declining trend on account of global economic downturn, it is imperative that domestic demand is stimulated.
CII would recommend that capital expenditure on key projects in sectors such as roads, railways, irrigation and power be increased substantially. Particular attention should be paid to rural demand, which can be support-ed through spending on rural roads and irrigation. At the same time, the fiscal deficit should not be allowed to increase, as this would put pressure on interest rates, which have just started to soften. The following meas-ures can be taken to ensure this:
(i). Step up PSU disinvestment – This will reduce the borrowing need of the government. With better planning, funds can be raised through the year.
(ii). Reduce subsidy outgo – With greater implementa-tion of direct benefits transfer, the fuel subsidy bill can be steadily reduced. Fertiliser subsidy should be paid directly to farmers as cash transfers.
(iii). Stagger Pay commission pay outs – (entire pay-ment in one year will put pressure on states to also implement higher pay scales. The stimulus from such an increase will be temporary and limited to consumer goods. )
(iv). Raise tax revenue through expansion of base – (both direct and indirect tax revenue have been strong this year and helped in meeting the revenue targets. Efforts to increase the tax base should be ramped up.)
Reduction in Corporate Tax Rate and Ration-alisation of IncentivesCII welcomes the Minister’s proposal to lower the tax rate from the current 30 per cent. CII has been asking for the lowering of the corporate tax burden. A lower tax rate will enable more development and growth of the corporate sector. The phase out of incentives is im-
portant for broadening the tax base and for simplifica-tion of tax law.
Incentives have played an important role in attracting investments for manufacturing as well as infrastructure sectors. Keeping this in mind, CII suggests the follow-ing:
i. The corporate tax rate to be reduced to 22 per cent (and it should be inclusive of surcharge and no other additional levies should be imposed over and above this rate).
ii. The government should announce a year-wise road-map for reduction of corporate tax rate from 30 per cent to 22 per cent.
iii. The withdrawal of incentives should be done in a calibrated manner, in line with the reduction in tax rate and keeping in mind the competitiveness of the sector.
iv. The minimum alternate tax (MAT) should also be withdrawn in a calibrated manner. (While removing MAT, it should be clarified that MAT credit can be carried forward and set-off against their normal tax liability in future).
v. It should be clarified that the sunset date of 01.04.2017 for phase out of incentives means finan-cial year commencing on 01.04.2017.
vi. Phase out of incentives should be prospective. (Any current incentives applicable to qualifying invest-ments made /activities before financial year com-mencing on 01.04.2017 should be grandfathered. It would be a wrong signal to the industry if the cur-rent entitlements are compromised and thus have ‘retroactive taxation effect’).
vii. It may be appreciated that the current effective tax rate (after incentives) as estimated by the govern-ment is 23 per cent. However, this is only an aver-age of the tax burden on various industry sectors. Many industries enjoy an effective tax rate of much less than 23 per cent. The Government should be sensitive to this aspect and the withdrawal of incen-tives should be done in a way that the tax burden on these industries increases in a gradual manner.
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A Tax Blueprint for Growth and Investments
Among the World Bank predictions that the year 2016 could be a year of “perfect storm” for the world economy and a simultaneous slowdown
in the BRICS countries, hope floats that India will contin-ue to expand at a robust pace and boast of an economic growth of more than 7 per cent.
The global economic conditions remain vulnerable, giv-en the prospects of rising interest rates in the US and a slowdown in China. India too is facing the challenge of falling exports, a clear indication that it will have to rely on stimulating domestic demand for pushing up the economic growth to its potential level. The government has stepped up its capital spending to stimulate do-mestic economic activity, but the private sector invest-ments have remained subdued. Given these conditions, adhering to the fiscal consolidation path announced in the last budget would be a serious policy challenge. Therefore, India would need the right reforms to sus-tain its current growth.
The government has taken positive steps to remove some of the bottlenecks that have slowed the econom-ic activity. For instance, allowing greater participation of private companies in coal mining for commercial sale will help increase coal production to meet domestic demand and reduce imports. Similarly, the proposal to legalize land leasing should help liberalise the use of ag-ricultural land for non-agricultural / industrial purposes. The initiative to set up new factories for increasing the freight pulling locomotives, the package to the propos-al for highway expansion in the coming fiscal year with construction of highways accelerated to 30 km per day from the current pace of around 13 km are all positive measures that will help rejuvenate the economy.
Tax policy and administration is one of the key areas that industry looks to as an enabler for growth and invest-
ment. Recognising this, the thrust of India’s tax policy in the last two years has been on promoting invest-ments in the manufacturing sector, bringing certainty in taxation and providing a stable and non-adversarial tax environment. Several forward-looking and positive measures have been taken by the Government in this direction. It is now time to give shape to the good intent and take it to the implementation level.
A significant reform eagerly awaited by the industry is the Goods and Services Tax. With a good design, the GST will remove the current fiscal barriers to manufacturing in India and help create a single market. Industry hopes that the days to come will see the political consensus needed to push this reform through. It is also hoped that the proposals such as additional 1 per cent tax on inter-State supplies and exclusion of significant sectors from the GST base will be done away with. These pro-posals are contrary to the spirit of ‘Make in India’.The industry also looks forward to a moderate revenue neu-tral rate (RNR) that will not create undue burden on the manufacturing and services sectors.
Pending the implementation of GST, the government must address the persistent issues plaguing the indus-try. Correction of the inverted duty structure, ration-alisation of the Cenvat credit scheme to enable avail-ability of credit for all inputs and input services with no restrictions and undue delays in refunds that block the working capital of the companies are some significant concerns that need urgent attention.
An important policy announcement made by the Fi-nance Minister in last year’s Budget was the corporate tax rate reduction from 30 per cent to 25 per cent over the next four years. This is indeed a transformative measure that will spur investments and growth and make the Indian corporate sector more competitive.
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With the current tax rate of 34.61 per cent (inclusive of surcharge and cesses), the applicability of MAT and divi-dend distribution tax (17.3 per cent) makes the overall tax burden on the corporate sector very high. Around the world, the corporate tax trend is to move towards a broad-based, low-rate corporate tax environment, with countries such as the UK announcing a roadmap to lower the tax rate to 18 per cent by 2020.
The corporate tax rate of 25 per cent announced by the government should be inclusive of surcharge and no other additional levies should be imposed over and above this rate. The government should announce a year-wise roadmap for reduction of the tax rate from 30 per cent to 25 per cent. The withdrawal of incentives as announced by the government should be done in a cali-brated manner, in line with the reduction in tax rate. To reduce the tax burden in the real sense, the minimum alternate tax (MAT) should also be withdrawn in a cali-brated manner.
In the context of lowering the overall tax burden on the corporate sector, the taxation of dividends also merits a review. Currently, no other BRICS country imposes a tax on distribution of dividends. Further, there is ambiguity on whether dividend distribution tax (DDT) levied on an Indian company is creditable in the hands of the foreign shareholder as DDT is not a withholding tax. It should be clarified that DDT is a deemed withholding tax to en-able its credit in the hands of the foreign shareholder.
The government has taken many positive steps towards improving tax administration. However, the adminis-trative framework needs a complete overhaul and calls for bold and swift measures. The Tax Administration Re-forms Commission (TARC) had made path-breaking rec-ommendations to re-engineer the current tax adminis-tration. The government must revisit these suggestions and prepare a strategy for their implementation. Con-stitution of a separate Common Tax Policy and Analysis (TPA) unit to focus on policy development, technical analysis and statutory drafting; the need for revenue forecasting based on tax gap analysis; and performing impact assessment analysis for major policy proposals are some of the excellent proposals that merit immedi-ate attention by the government.
There are still many instances of inconsistencies be-tween intent and interpretation of the law; the de-partment circulars not followed in spirit; high-pitched
assessments that do not stand the test of judicial scru-tiny in appeals; and the levy of unjustified penalties and holding back of refunds. Such instances are an outcome of setting unreasonable revenue targets and poor rev-enue management and can be minimised by use of rev-enue analytics and forecasting techniques.
Improving the dispute minimisation and resolution mechanisms is another front that needs urgent atten-tion. It is evident from the global tax developments that many countries are gearing up to introduce BEPS-related tax reform to protect their tax turf and check profit shifting. The next few months will see a greater focus on multilateralism, more transparency and re-porting requirements, stricter tax enforcement and a new set of rules defining the way the domestic / over-seas profits are taxed. An inevitable corollary to these developments will be rise in the tax disputes.
The alternative dispute resolution mechanisms must be improved at the earliest to be equipped to deal with the potential disputes. For instance, Advance Pricing Agree-ments (APAs) have received an enthusiastic response from the taxpayers, with more than 580 APA applica-tions received by the Department. 31 APAs have been signed so far. While this progress is commendable to expedite the signing of APAs, the APA team should be suitably expanded on an urgent basis. Similarly, More than 400 matters are pending before the Authority for Advance Rulings (AAR). Additional benches at Delhi and Mumbai should start functioning as soon as possible.
In line with the TARC’s recommendations, the govern-ment should formulate clear interpretative statements on contentious issues. Appeals to high courts and the Supreme Court should only be on a substantial question of law. On disposal of cases by the Supreme Court/High Court, and if the judgment is accepted by the depart-ment, an instruction should be issued to all authorities to withdraw appeal in any pending case involving the same issue.
The Prime Minister’s vision of ‘Make in India’ provides a tremendous opportunity to the Indian manufacturing to grow and become competitive in the medium to long term. The need of the hour is to provide the right physi-cal and fiscal eco-system to help transform the vision to reality. The government must resolutely keep pushing the ground level reforms, including tax reforms, to build a pro-investments and pro-growth India.
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Expectations from Union Budget, 2016-17
The Union Budget, 2016-17 would be a mid-term budget of the Government since the tenure of the present Parliament would expire only in
2019. Since the year 2019 would be the election year, the budget for the year 2018-19 cannot be expected to be bold and there is likelihood of many pre-election sops to the voters. That leaves one with the remaining two years i.e. 2016-17 and 2017-18 as the years when one can expect Budget proposals in accordance with the demands of the economy. That’s how the Budget 2016-17 becomes significant for the National Democrat-ic Alliance (NDA) Government to be used as a major in-strument for steering the economy through higher and higher growth.
The major challenge before the Union Finance Minister would be to reach the target of maintaining the fiscal deficit of 3.9 percent of the Gross Domestic Product (GDP), while simultaneously increasing public invest-ment to maintain a steady growth. One view is that for maintaining growth, there is no harm in having a small break in the fiscal consolidation by way of public invest-ment through planned capital expenditure, particularly in infrastructure like road, highways, buildings and in power sector. Expenditure in these sectors will boost demand of goods like cement, steel etc. and thus in-crease the manufacturing activity resulting in growth. Even with increased public expenditure, the target of fiscal consolidation can be reached or nearly reached if the current revenue buoyancy in Indirect Taxes is fur-ther enhanced through strategic increase in rates of tax and better tax compliance. There does not seem to be anymore scope to increase the Direct Taxes. That makes the strategic handling of Indirect Taxes more critical.
Another way of continuing with the fiscal consolidation for the Government would be to find ‘expenditure sav-
ings’ and minimize additional expenditure demands. Yet another way would be to undertake bold subsidy reforms by way of minimizing and streamlining the food and fertilizer subsidies. Indeed, 2016 is the year when the Finance Minister can take unpopular steps as the economy demands; the election is still around three years away. Reduction of subsidy would be one. Post-ponement of implementation of the Recommendations of the Seventh Central Pay Commission by one year can be the other one. This will give Government a cushion of over Rupees one lakh crore for the Budget year. With this expenditure savings for one year- a critical and cru-cial year, the Government can afford to continue its public expenditure that would boost growth.
With this background, let us have a look at the Budget Expectations in the universe of Indirect Taxation. First, the Central Excise and Service Tax. The Goods and Ser-vices Tax (GST) Constitution Amendment Bill having missed the bus in the winter session of 2014, it is now certain that GST cannot be implemented from April, 2016. Therefore, the Budget 2016-17 will have to have taxation proposals on Central Excise and Service Tax, the two central taxes that were to be subsumed in GST. That said, it is also true that the GST is unputdownable and its introduction is just a matter of time. Therefore, the Budget 2016-17 would provide an opportunity to prepare the taxmen and taxpayers to be ready for GST by aligning the tax structures of Central Excise and Ser-vice Tax, to start with. Given the need for a smooth tran-sition to the GST regime, one can expect the following from the budget proposals of 2016-17.
The Expert Panel led by MrArvind Subramanian, the Chief Economic Advisor has suggested four GST rates – a standard rate of 18 per cent for most of the goods, a merit rate of 12 per cent for goods of consumption
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by common man, a demerit rate of 40 per cent for To-bacco & Cigarette, luxury cars and some other luxury items and a special rate of 2 per cent for precious met-als. With these recommendations in mind, the Budget may provide for four rates of duty- of course not with the rates recommended for GST.
At present the Central Excise exemptions are more than 300 in number, whereas the state VAT has only around 100 exemptions. Since in the GST regime there will be same set of exemptions for Central GST and State GST, the Budget 2016 may propose for a drastic reduction in the number of Central Excise exemptions. In choosing the exemptions that would continue, it is expected that the need for retaining those relating to Power and In-frastructure sectors would be kept in mind. In the GST regime, the tax rate would be same for goods and ser-vices. Given that the standard rate of goods is expected to be 18 per cent minimum, the Service Tax rate may be increased to 16 per cent incrementally in the Budget 2016.
The threshold limit would remain the same for both Centre and State GST in the GST regime. Currently, the thresholds for Central Excise, Service Tax and State VAT are Rs 1.50 crores, Rs 10 lakhs and Rs 3 to 5 lakhs re-spectively. The Central and States are negotiating for a threshold between Rs 10 lakhs and Rs 25 lakhs. Mean-while, the CEA led panel has recommended for a higher threshold of Rs 40 lakhs. The Budget 2016 will provide an opportunity to bring down the threshold for Central Excise Duty to Rs 75 lakhs and raise that for Service Tax to Rs 20 lakhs.
Now the duty rates on goods that are not related to GST. Considering that there is a public outcry against pollution in metros and big cities and the Judiciary is also intervening by way of discouraging the use of heavy duty diesel vehicles, the Budget may propose further increase in the Excise Duty on Diesel SUVs and other Diesel vehicles and reduction in duty on small ve-hicles that run on CNG or petrol.
The continuous fall in oil prices in the international mar-ket may not continue given the volatile international
situation particularly in Middle East. The Finance Min-ister is expected to use the low oil price to tighten up subsidies and cut the fiscal deficit by increasing excise duty rate of oil and oil products.
As a measure of revenue mobilization to offset the in-creased public expenditure, the Finance Minister may also take cue from the CEA panel’s report and identify a few luxury items and increase Central Excise duty on them, as a prelude to GST.
As for the Customs Duty, the scope for mobilsation of revenue would be less. India has signed a number of Free Trade Agreements, committing herself to either full exemption or preferential rate for Customs Duty. Then, there are certain items with WTO bound rates, be-yond which Customs Duty cannot be enhanced. There-fore, notwithstanding the demand for increased Cus-toms Duty on imported goods so as to give a fillip to the ‘Make in India’ programme, the scope for doing that is limited. Nevertheless, the Finance Minister is expected to increase Customs Duty on goods on which there is no such aforesaid limitations. The finished consumer prod-ucts – particularly the luxury ones may be targeted in this regard.
On the export front, there has been the beginning of a crisis in the ‘emerging markets’ due to prevailing low oil prices – thus resulting in reduced demand in those mar-kets for Indian exporters to explore. In order to help the Indian exporters in making their goods and services competitive, it is expected that the Finance Minister would extend some major tax benefits to the exporters.
Thus, we can expect the Finance Minister to moderately increase the public investment in identified sectors, find some expenditure savings and streamline and minimize food and fertilizer subsidies. He will also have to mobi-lize the extra revenue needed for maintaining the fiscal deficit target of 3.9 per cent of GDP through moderate increase in Indirect Taxes in certain identified items. We can also expect him to give a clear signal about his resolve to introduce the GST by proposing certain pre-paratory measures explained above.
[Mr. Sumit Dutt Majumdar is also the author of a book titled “Customs Valuation – Law and Practice” and “GST in India-its travails, tribulations and challenges ahead”]
(The views are personal and not necessarily of CII)
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Expectations from Budget 2016
It is no secret that India witnessed rapid slowdown in investments made in the past few years. One of the key reasons attributed to such a slowdown was the
investor’s perception that India had an aggressive tax regime. The fact that the Government had resorted to “retrospective tax amendments” to overturn some of the Supreme Court judgments is an illustrative example. This lent to lack of certainty and predictability of the tax system—something that is a very significant pre-requi-site for potential investor confidence.
With its emphasis on improving sentiments, bringing back investor confidence and creating a stable and transparent tax regime, the new Government took cer-tain unprecedented steps such as the decision on not to go in for appeal against an adverse transfer pricing ruling pronounced by the H’ble Bombay High Court in the case of Vodafone (decision in relation to which was taken at the highest echelon, the Union Cabinet), ac-cepting the A. P. Shah Committee report on non-appli-cability of MAT on FIIs / FPIs, and also coming up with a clarification on the position with regard to applicability of MAT on foreign companies.
There was no better way to welcome 2016, but with quite a few tax-payer friendly announcements by the Central Board of Direct Taxes (CBDT), indicating a new approach to tax litigation, i.e.
- Raising the monetary limits or thresholds for filing appeals. With the most interesting aspect of this announcement being—such an increase in thresh-old limit is with a ‘retrospective effect’ albeit in a positive way.
- Extending the mandate of collegiums of Chief Com-missioners of Income Tax (CCIT), which was formed
last year to approve the filing of appeals before High Courts, to even consider withdrawal of ap-peals that are no longer prosecutable.
It is worth mentioning here that never in the past, the Government had done anything similar to reduce the pending tax litigation in India.
In order to further demonstrate its commitment and to provide a simplified and non-adversarial tax regime, the Government had set up a 10-member Income Tax Simplification Committee headed by Retd. Justice R.V. Easwar, with the following broad objectives:
- To check curb litigation and facilitate speedier dis-pute resolution;
- To facilitate the ease of doing business in India;
- To simplify the existing tax laws;
- To suggest any modifications required to ensure certainty and predictability in tax laws without sub-stantially impacting the tax base
The Committee has recently released its draft report, with the first batch of recommendations focusing on bringing simplicity and clarity in tax laws. Many of those recommendations may find their way in the Union Budget 2016-17.
Now, with the Union Budget 2016-17 scheduled to be unveiled by the Finance Minister on 29 February 2016, expectations of the tax payers and the industry run high, that the Government may come out with some major reforms. This second full-year Budget of the cur-rent Government should focus on steps to accelerate economic growth that seems to have stagnated in the
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7.0–7.5 per cent range amid global slowdown.
An interesting fact—India, a country with more than 125 crore people, has only 3.3 per cent tax paying population as compared to 39 per cent in Singapore, 46 per cent in the US, and 7 per cent in New Zealand! Accordingly, in-stead of tinkering with the income tax exemption limit every year, it’s the right time for the Government to go ahead with an aggressive long-term approach which ex-pands its income tax payer base. The same would also provide headroom to focus on economic reforms to achieve higher growth.
The Tax Administration Reform Commission (TARC) has also echoed the said concern in its report and calculated that the number of people paying taxes should be at least 6 crores. The Parliamentary Standing Committee on Finance in its report has also said that, “time has come to reinvent the tax collection approach, i.e., to move towards the untapped or lesser tapped brackets of income which mostly comprise the un-organized sec-tor and the cash economy.”
Second, with a view to increase export competitive-ness and promote the ‘Make in India’ initiative, it’s the right time that developers of Special Economic Zones (SEZs) and units in these enclaves be given exemption from Minimum Alternate Tax (MAT) and Dividend Dis-tribution Tax (DDT). Here, it would be worthwhile to note that before MAT and DDT were imposed on SEZ in 2011-12, growth in exports from SEZs was far exceed-ing the increase in the country’s overall goods exports, and such high growth rates dropped consistently since these taxes were imposed.
Third, in his budget speech of 2015-16, the Finance Min-ister promised a 5 per cent cut in corporate taxes over
four years. He categorically said, “I, therefore, propose to reduce the rate of corporate tax from 30 percent to 25 percent over the next four years. This will lead to higher level of investment, higher growth and more jobs. This process of reduction has to be necessarily ac-companied by rationalization and removal of various kinds of tax exemptions and incentives for corporate taxpayers, which incidentally account for a large num-ber of tax disputes.”
Following this, in November 2015, CBDT released a road-map to introduce sunset clause for open-ended corpo-rate tax exemptions and concurrently pruning the list of sectors that are entitled to such benefits on research and development, and capital expenditure. The exemp-tions have been categorized as the ones having a sunset clause, those that are open-ended, and the ones that have outlived their utility but still continue to be a part of the Income-tax Act, 1961.
The difficulty with the above Finance Ministers’ state-ment of reducing corporate tax from 30 per cent to 25 per cent is that the current Government has only three regular budgets to go (i.e., 2016-17, 2017-18 and 2018-19). The 2019 budget to be presented by this Government will be an interim one. Therefore, the 5 per cent reduc-tion in corporate tax rates should be fast-forwarded to the next three budgets (including 2016-17 budget).
Consequent to above measures, the Government may be able to accumulate substantial funds to give a re-ally hard push to investment under its flagship ‘Make in India’ program and various other social/economic re-forms. It’s the right time for the Government to move forward and enable the Indian economy to leapfrog and bring the acche din for aamadmi.
(The views are personal and not necessarily of CII)
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Rationalization /Removal of Tax Incentives with Reduction of Corporate Tax Rates
1. The Hon’ble Union Finance Minister in his Budget Speech for the year 2015-16 stated as under:
“ We need to match this transformative piece of legisla-tion in indirect taxation with transformative measures in direct taxation. The basic rate of Corporate Tax in India at 30 per cent is higher than the rates prevalent in the other major Asian economies, making our domestic industry uncompetitive. Moreover, the effective collec-tion of Corporate Tax is about 23 per cent. We lose out on both counts, i.e. we are considered as having a high Corporate Tax regime but we do not get that tax due to excessive exemptions. A regime of exemptions has led to pressure groups, litigation and loss of revenue. It also gives room for avoidable discretion. I, therefore, propose to reduce the rate of Corporate Tax from 30 per cent to 25 per cent over the next 4 years. This will lead to higher level of investment, higher growth and more jobs. This process of reduction has to be neces-sarily accompanied by rationalization and removal of various kinds of tax exemptions, which incidentally ac-count for a large number of tax disputes.”
2. The proposed removal / rationalization the tax in-centives along with a reduction in the Corporate In-come Tax (“CIT”) Rate is a welcome measure. It will go well with the over-arching vision of Ease of Do-ing Business in India. Smaller companies, which do not typically avail incentive deductions, would ben-efit by way of lower outgo on account of reduction in CIT, which resource could be deployed for other business purposes. However, for larger companies which have been claiming large tax incentives, the effective tax rate would not alter materially. Lower incentive claims and lower rate of CIT would bal-
ance out each other. The proposal is also unlikely to result in enhanced CIT collections in the near fu-ture as large companies will be using the unutilized MAT credit accumulated over the years.
3. However, for exporters, rationalization / removal of export related tax incentives would result in anad-ditional tax outgoing for exporters.This would ad-versely impact export competitiveness. Ironically, exporters would suffer an effective tax rate higher than companies engaged in domestic business.
4. Hence, a two-tier corporate tax rate structure may be adopted, viz.:
(i) A normal corporate tax rate for companies en-gaged in any business other than in exports and de-riving substantial profits1 from export of goods and services;
(ii) A reduced corporate tax rate (say, 50 per cent of normal rate) for companies engaged in exports and deriving substantial profits from export of goods and services.
The rationale for a two-tier tax rate structure is ex-plained in Para 5 hereunder.
5. Exporters, particularly in the IT Sector, suffer a higher CIT on their profits and also other taxes on account of the following factors:
a) On-site development of software (including rendering of services for development of software) outside India is a business requirement for compa-nies engaged in providing IT services to overseas
1 Threshold may be 50 per cent of the income under the head profits and gains of business or profession
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clients. Currently, the profits derived from such on-site activity are effectively subject to a much higher
The impact is partially mitigated by the tax incentive in India by way of deduction allowed under Section 10AA of the Income-tax Act for export profits. Thus, export-ers of IT services are in a position to report in the finan-
tax rate than the domestic rate of taxation. Much of the exports are to the US, which levies the fol-lowing taxes:
cial statements an effective tax rate in the range of 23 per cent, which has been the effective collection of corporate tax in India. This is illustrated in Table 1 given hereunder:
Once the exemption under Section 10AA is withdrawn, exporters will suffer an effective tax rate, which is much
higher than domestic companies.This is illustrated in Table 2 hereunder:
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If the CIT Rate in India is reduced to 25 per cent, the dis-parity in the effective tax rate for a company engaged in exports anda company deriving its profits only from
b) Exporters often incorporate subsidiary companies in foreign countriesto gain global foot print. The profits earned by such subsidiaries suffer full tax in the countries where they are incorporated, which in the aggregate is higher than the tax at the domestic corporate tax rate in India. There is no mechanism to grant underlying tax credit for the taxes paid in the countries outside India. Further, when the prof-its of such subsidiaries are repatriated to India, the dividend received in India is liable to tax at the rate of 15 per cent without allowing any expenditure or allowance as per the provisions of Section 115BBD of the Act. Thus, the effective tax rate on such prof-its of overseas subsidiaries is much higher than the tax rate on domestic companies.
c) Exporters of IT services have to depute a significant part of their personnel to overseas jurisdictions to meet contractual obligations to overseas clients. This entails incurring social security taxes. India has entered into only a few Social Security Agreements (SSA). There is no SSA with the US, which is a lead-ing destination for IT services exported by India. Ex-porters incur substantial amounts of social security taxes without getting any economic benefit for its
domestic operations will widen. This is illustrated in Ta-ble 3 below:
employees deployed for rendering services to over-seas clients, which is resulting in double taxation. The impact of these taxes is partially mitigated by allowing a deduction in computing the corporate tax on export profits. If the deduction is withdrawn, the social security taxes will have to be borne in full by the exporters without getting an abatement or set-off against the domestic corporate tax rate.
d) Exporters of IT services, developing software and rendering IT services from India to their overseas clients, have to create or use infrastructure of in-ternational standards. The developers of SEZs are eligible for tax deduction of profits for any 10 out of the first 15 years. This tax incentive partially offsets the higher cost of the infrastructure. Withdrawal of incentives would enhance the cost.
6. If the export profits are subject to a tax rate of 7 per cent, the effective tax rate for exporters will be more or less on par with the effective tax rate for companies deriving profits from domestic opera-tions, as explained in Table 4 below:
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Considering that tax on on-site profits in countries oth-er than the US are lower, a tax rate equal to 50 per cent of the normal tax rate may be prescribed for companies deriving substantial profits from exports of goods and services. Applying a lower rate would also eliminate the large number of disputes associated with granting of tax incentives,
7. Alternative suggestion: If the corporate rate of taxation have to be uniform for all corporate asses-sees, the following concerns of exporters may be addressed as a part of rationalization of incentives:
a) Granting of Foreign Tax Credit (“FTC”) has not evolved yetas the method followed is archaic. As mentioned earlier, a part of the export profits suf-fer tax in foreign jurisdictions. The policy for grant-ing of FTC must be robust.An income approach rather a country-by-country approach may be used for granting FTC. Under the income approach, all foreign sourced incomes and foreign taxes will be aggregated and FTC will be allowed by reducing such aggregate of foreign taxes from the tax liabil-ity in India. This mechanism will facilitate tax rate equalization between domestic profits and export profits. Otherwise, rationalization of tax incentives following reduction in CIT rate, would create huge disparity in the tax cost of companies deriving prof-its from domestic operations and companies deriv-ing export profits. Further, it will adversely impact
export competitiveness, which is opposed to the objective stated in the Union Budget Speech of 2015-16.
b) A weighted deduction may be given for social se-curity costs incurred in countries with which India does not have a Social Security Agreement. Thus, a lower tax on account of the weighted deduction will partly set-off the unrelieved costs on social se-curity.
8. Grandfathering provisions: Long-term fiscal incen-tives have been promised under the current Spe-cial Economic Zones(“SEZ”) regime introduced in the year 2005. MAT is being imposed on SEZs with effect from Assessment Year 2012-13, which has al-ready vitiated the economic returns based on which investments were made. Removal or rationalization of tax benefits within a decade and before the end of the promised incentive period would render the tax policy unstable. Investment in SEZs has been committed based on the promise of granting long-term fiscal incentives. Business evaluations like M&A, FDI, Portfolio investments etc., have been embarked upon on the strength of tax incentives envisaged in law. Tax rate reduction to 25 per cent and removal of incentives would hurt the business case and it would have the effect of a retrospective amendment. Hence, the following are the sugges-tions in this regard:
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(i) The deduction for Developers under Section 80-IAB for SEZs already notified and SEZs to be notified in the next two years may be continued;
(ii) The deduction under Section 10AA may be granted for Units which commence operations within 3 years of sunset clause for deduction for developers of SEZs.
The above measures would ensure viability of SEZs which are already notified and also where substantial in-vestments for acquiring land for being notified as SEZs.
The above tax incentives have the following benefits:
a) Allowing the export oriented businesses to com-pete in the global market.
b) Positioning India on par with other countries, which extend incentives for exports.
c) Generating employment and position India as a reli-able resource for intellectual capital.
d) Improving FDI inflows.
In summary, the recommendations are as under:
a) A corporate income tax rate equal to 50 per cent of the normal corporate tax rate may be notified for companies engaged in exports and deriving sub-stantial profits from exports of goods and services;
b) Alternatively, if the normal corporate income tax rate is to be applied uniformly to all companies, then:
i. Foreign Tax Credit may be allowed under the Do-mestic Tax Law by following an income approach i.e. aggregating all foreign source income and for-eign taxes and allowing a credit against the tax li-ability in India; and
ii. Grandfathering the existing deductions under Sec-tion 80-IAB and Section 10AA in respect of Special Economic Zones with time lag so that current in-vestments are not rendered less viable
(The views are personal and not necessarily of CII)
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