Budget 2019: Key tax issues Modi 2.0 must address

As celebrations of the resounding electoral victory of the incumbent government come to an end, it is time now for some action. The first big test for Modi 2.0 is the budget to be tabled next month. One expects this year's budget to set the tone for the government's policy for the next five years.

On the tax front, given that a new direct tax code is possibly on the anvil, it will be interesting to see whether the changes to the current tax regime are minimalistic as a result. The investor/business community would certainly hope that some of their pain points are resolved sooner rather than later.

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The pain points:

Valuation conundrum: Tax issues surrounding valuations, for example, have certainly been a big cause of concern for businesses. A case in point is the serious uptick in litigation involving cases where resident companies have issued shares at a premium.

While the intent to curb black money and tax evasion is laud worthy, experience has shown, that in numerous cases genuine commercial transactions where shares are issued at a premium to identifiable third party investors are caught within the tax net and the resident company has been asked to pay tax on any premium above the deemed fair market value.

Safeguards are, therefore, needed to ensure genuine transactions, executed through regular banking channels with identifiable investors, are not caught in the tax net.

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Tax harmonisation: There is also a need to ensure that the tax laws work in harmony with other legislation such as the Insolvency and Bankruptcy Code, 2016 (IBC). Under the IBC, proceedings may often result in a lender waiving part of the debt due to it. Typically, the borrower would have to have credited the amount so waived in its profit and loss statement.

This, in turn, could trigger a Minimum Alternate Tax (MAT) liability for the borrower since MAT is calculated based on profit-bookings of a taxpayer. Thus a distressed company is potentially saddled with additional tax costs which defeats the purpose of the IBC, to an extent.  Another issue that often crops up is one which surrounds the valuation of such distressed assets.

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These assets may often be transferred at significant discount - at a price which is significantly lower than its fair value for tax purposes. However, under the tax laws, a buyer may have to pay tax on the difference between the fair value and the price at which it buys the asset. Further, the seller may have to pay capital gains tax in certain instances on the difference between fair value and the sale consideration, even though the seller is, in reality, incurring a loss.

The lack of synchronisation between the IBC and tax laws leads to a situation where the potential tax cost of the deal/restructuring is prohibitive. Further, the tax law is out of tune with the commercial reality in such cases, since it fails to recognise the potential risks and pitfalls for any buyer who is acquiring such assets.

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Indirect transfer tax: The indirect transfer tax provisions are another area in need of fine-tuning. For instance, Category I and II Foreign Portfolio Investors (FPIs) have been spared the rigours of the indirect transfer law, whereas Category III FPIs still fall within its ambit.

Further, it is recommended that in case of intra-group transfers, where there is no de facto transfer of control of an underlying asset, indirect transfer tax provisions should not be attracted. Intra-group transfers also tend to hit another snag under the current laws: companies are restricted from carrying forward and setting-off losses, if their shareholding has changed by 49 per cent or more in the year in which the loss has been incurred.

This restriction applies even if there is no ultimate change in shareholding at the parent entity level. Therefore, the restriction on carry-forward and set-off of losses should be done away with when intra-group transfers do not result in a change in the ultimate shareholding within a group.

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High tax cost for businesses: One also hopes that the government takes steps to reduce the tax cost of running a business in India. If the much hyped 'Make in India' programme has to truly take off, one would need to bring down the tax burden for corporates.

Under the current income tax laws, for every rupee of pre-tax profit earned by an Indian company, close to fifty per cent would potentially be payable to the taxman and only the remaining amount would be received by its shareholder.

The high tax burden has discouraged or, at the very least, delayed foreign businesses from setting up manufacturing facilities in India. Alternatively, the government could also consider refreshing the tax incentives enjoyed by manufacturing units in special economic zones as a way of encouraging the manufacturing activity.

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Come July, when the Finance Minister Nirmala Sitharaman presents her maiden budget, much like a selector who picks the cricket team for the world cup, her choices and actions will attract bouquets and brickbats in equal measure. But, if she gets it right, then the cup may just end up coming home.

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(Abhay Sharma is Partner -Tax, Shardul Amarchand Mangaldas & Co and Maulika K Hegde is Associate -Tax, Shardul Amarchand Mangaldas & Co)