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Budget Analysis 2012 - Be Cruel to be Kind


Budget 2012 was expected to put a bruised and hurting economy back on the path of growth. This requires that the Government contain a runaway fiscal deficit (estimated at 5.9 percent for FY 2012), address supply side constraints to help check inflation which has persisted at uncomfortably high levels for much of the year and kick start an investment cycle which has been particularly subdued; given an environment characterised by high interest rates, elevated commodity prices, and weak investor sentiment. Taxand India examines the five objectives that underpin Budget 2012 and how they appear to respond, among others, to these imperatives.

1. The Budget projects a nominal GDP growth of approximately 14 percent. With real GDP growth targeted at around 7 percent, inflation for the year has been projected at 7 percent, a number that will be watched closely. The fiscal deficit for the year has been projected at an uncomfortable 5.1 percent, potentially constraining a correction in interest rates. This is predicated on a tax revenue growth of 15.6 percent, lower than the 18.4 percent growth predicted in Budget 2011. Expenditure is expected to grow at 18 percent; subsidies are to be contained at 2 percent of GDP, to be achieved in part through better targeted subsidies delivered through cash transfers.

2. Thematically, a number of tax and policy initiatives have been proposed to facilitate and foster infrastructure growth and development. In a departure from the policy on external commercial borrowings, the beleaguered power and airline industries have been permitted to raise foreign currency borrowings to finance working capital requirements, including, in the case of the power industry, to refinance rupee borrowings. Tax holiday for generation or generation and distribution of power has been extended by a year until 31 March 2013.

3. Tax withholding on interest payments on such financing has been reduced from 20 percent to 5 percent. Basic customs duty on imported coal has been zero rated. Airlines have been permitted duty free imports of aircrafts parts and testing equipments, to provide boost for India's potential as hub for maintenance, repair and overhaul of civil aircrafts; the policy to permit foreign airlines to acquire up to 49 percent stake in Indian airline operators is under active consideration. The limit for issue of tax free bonds to fund infrastructure development has been doubled to Rs 60,000 crores. Overall funding for the infrastructure sector has been set at Rs 50 lakh crore, with an expectation that half of targeted investment would come from the private sector.

4.In line with expectations, the Direct Taxes Code will not be introduced on April 1, 2012. However, and again in line with expectations, a number of provisions contained in the DTC have been incorporated in Budget 2012. Indirect transfers of assets located in India have been made taxable retroactively from April 1, 1961. This proposition is designed to tax Vodafone-like transactions and its constitutional validity is likely to be challenged. General anti-avoidance provisions have been enacted, in a form more onerous than that proposed in the DTC and in disregard of a number of the Parliamentary Standing Committee's recommendations. Gratifyingly, advance pricing agreements have been introduced, but have been accompanied by an extension of the transfer pricing provisions to domestic transactions and by a retrospective amendment of several transfer pricing provisions designed to negate their interpretation in court rulings. A number of measures have been proposed to detect and tax undisclosed income and assets and a white paper discussing further actions in this regard is to be placed before Parliament shortly. The scope of tax withholding provisions has been expanded, and observations contained in this regard in the Supreme Court's ruling on Vodafone have been overridden. Minimum Alternate Tax continues to permeate insidiously and now applies to all categories of tax payers. Some relief has been provided to companies to avoid the cascading effect of DDT in multi-tier structures.

5. A clear time table for GST continues to elude, although a number of steps have been taken to align existing taxes and processes in preparation for its introduction. All services, barring a limited list, will be liable to service tax. Service tax and excise duty rates have been raised by 2 percent and aligned at 12 percent. Place of Supply Rules, for which a discussion paper has been released as part of budget documents, will likely be aligned with those that will exist under a GST regime. Service tax and excise filings are proposed to be unified, again in preparation for GST. The Constitutional Amendment Bill, required to introduce GST, is being reviewed by a Parliamentary Standing Committee. Meanwhile, the framework for the GST law has been substantially drawn up and work on developing the back end infrastructure for administering GST is expected to ready for testing towards the middle of the year.

Taxand's Take

While introducing the taxation proposals, the Finance Minister drew from Shakespeare's Hamlet and noted that he "must be cruel only to be kind". Given that the Budget proposals have been presented a day after 15 March we must hope that Shakespeare's admonition to "Beware the Ides of March" remains within the confines of classical literature. Taxpayers in India should pay close attention to the budget to discover how the announcements will affect their tax position.

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