The National Democratic Alliance (NDA) government on Friday laid down a comprehensive road map for phasing out the corporate tax exemptions over the next two years as it looks to reduce the tax rate, simplify the administration and improve India’s competitive edge globally.
At least in the short and medium term, the move will hurt companies that have been benefiting from these exemptions for years.
It may discourage investment in research and development (R&D) and the special economic zones (SEZ) that receive these incentives and have an adverse impact on sectors ranging from infrastructure to information technology (IT) at a time when the government is trying to lift economic growth.
Tax deductions and exceptions have been prone to misuse and consequential litigation, said Riaz Thingna, partner at Walker Chandiok and Co. LLP. But doing away with them would increase the tax burden on some firms and hurt capital investment, he said.
“The pharmaceutical industry benefits from exemptions available for R&D. Information technology companies benefit from the investment depreciation allowance available under Section 10A. Infrastructure companies also get some tax benefits under specific clauses. Sectors like heavy engineering, where large capital investments are made may also get impacted,” he said. “There will be a political fallout also since area-based exemptions given to north-eastern states are now proposed to be done away with.”
Finance minister Arun Jaitley, in this year’s budget speech, said the government will reduce the corporate tax rate to 25% over the next four years from 30% at present. But this would be accompanied by a corresponding phase-out of tax exemptions and deductions, which would bring more clarity to the tax regime, he said.
“Companies will welcome the phasing out of exemptions as long as their corporate tax burden does not increase. The pharma sector will be impacted given that R&D activities will not get a tax advantage,” said Rahul Garg, direct tax leader at PricewaterhouseCoopers India.
In a statement on Friday, the tax department said the exemptions are being phased out on the basis of four major principles. Profit-linked, investment-linked and area-based tax deductions will be phased out for both corporate and non-corporate tax payers.
In addition, the government will not allow the so-called sunset date to be advanced. This means that while existing tax exemptions will run their course, the government will not extend these exemptions further.
“In case of tax incentives with no terminal date, a sunset date of 31 March 2017 will be provided, either for commencement of the activity or for claim of benefit, depending upon the structure of the relevant provisions of the (Income Tax) Act,” the government said.
No weighted deduction will be allowed with effect from 1 April 2017. Weighted deduction allows the tax payer to claim a deduction that is more than the actual expenditure incurred.
Cold chain units, warehousing facilities for storage of agricultural produce, affordable housing projects and production of fertilizers are some of the areas where weighted deduction of 150% of capital expenditure is allowed at present.
The government has sought stakeholder feedback on the road map over the next two weeks. It plans to introduce these changes starting from the next budget in February 2016.
At present, India gives tax holidays to various sectors including power generation, distribution and transmission, special economic zones and telecom.
Tax holidays are also given for setting up manufacturing units in the North-East and some special category states like Jammu and Kashmir and Himachal Pradesh.
All these will be phased out.
According to the revenue foregone statement in the last budget, the impact of major incentives given to the corporate sector, including tax holidays and accelerated depreciation, in the current fiscal is more than Rs.62,000 crore.
The draft road map proposes to reduce the highest rate of depreciation of assets available under the Income-tax Act, 1961, to 60% from 100% available to certain assets at present. This is proposed to be effective from 1 April 2017 and will be applicable to all the old and new assets in that particular asset category.
It also proposes to restrict the tax advantages available to companies involved in development, operation and maintenance of infrastructure; developers of special economic zones as well as companies located in such zones exporting goods or services; and those undertaking commercial production of natural gas to only those units that commence operations by 31 March 2017.
This means that infrastructure projects or any special economic zones or natural gas explorers commencing operations in April 2017 will not get tax advantages otherwise available to these units.
It also proposes to do away with tax benefits provided to donors of non-governmental organizations, or NGOs, as well as all incentives provided to companies undertaking R&D in India. Companies at present get a 200% deduction on the expenditure incurred on R&D. They will now be able to deduct only the actual expenditure incurred with effect from 2017-18 financial year.