Review of Budget 2010-2011

Introduction

The Union Budget for the year 2010-2011 presented by the Finance Minister, Mr. Pranab Mukherjee targets to augment the pace of growth while improving the fiscal situation. The expectation is that the comprehensive budget will help the economy to rapidly scale to the targeted 9% growth rate as predicted in the Economic Survey of 2009-2010 which also estimated GDP growth for this year at 7.2% as against 6.7% in 2008-09.

This budget review attempts to asses the major proposals made by the Finance Minister and the way they can impact industry, common man and investment scenario in India, if passed without any significant changes.

1.0 Direct Taxes

The Direct Tax Code (“DTC”) which is slated to replace the existing income tax (and wealth tax) law in India would come into effect from April 1, 2011. The DTC proposes radical changes which potentially override the existing principles of tax jurisprudence by proposing to modify the Indian taxation regime and also overhaul the international tax system. Significant impact will be created by the adoption of the “later-in-time doctrine” which will have over-riding effect on the double taxation avoidance agreements. The proposed general anti-avoidance rules are widely worded and are likely to capture most conventional investment structures.

Further, the Income Tax slabs have been relaxed further and exemption of tax saving schemes increased which will encourage consumption and savings. The other major proposals are –

• The conversion of a company into a limited liability partnership is proposed to be exempt from tax, subject to fulfilment of certain conditions.
• The transfer of shares of a closely held company for consideration less than the fair value or for no consideration to a firm or another closely held company is liable to tax if the difference between the fair market value and the consideration exceeds INR 50,000. This change will have wide ramifications. The consideration or fair market value, as the case may be, would be considered as cost of acquisition for computing capital gains. The above amendment will take effect from June 1, 2010.
• Rate of Minimum Alternate Tax has been increased from 15% to 18% on book profits – effective rate will be 19.93% and surcharge on domestic companies reduced from 10% to 7.5%.
• Scope of Explanation under Section 9¹ of the Income Tax Act (“IT Act”) has been substituted to include even the services completely rendered outside India, w.e.f. June 1, 1976. The fees for technical services payable to a non-resident would be taxable in India, whether or not the non-resident has a residence or place of business or business connection in India.
• For a foreign company, the income tax rate and surcharge remains unchanged at 40% and 2.5% respectively. Education cess also remains unchanged.

2.0 Indirect taxes

The central excise rate has been increased to 10%, in a partial rollback of the stimulus package and the peak rate of customs duty has been left unchanged at 10%. Service tax has been retained at 10%, thereby the central excise and service tax rates are now aligned for the first time. The scope of service tax has been extended to 8 new taxable services: (i) promotion, marketing and organizing of games of chance including lottery, (ii) services provided by hospitals, nursing homes and multi-specialty clinics, (iii) storing of medical records service, (iv) promotion or marketing of brand service, (v) services of permitting commercial use of an event relating to art, entertainment, business, sports or marriage, (vi) services provided by electricity exchanges in relation to trading, processing, clearing or settlement of spot contracts, term ahead contracts, seasonal contracts, derivatives or any other electricity related contract, (vii) Any temporary transfer or permitting the use or enjoyment of any copyright defined in the Copyright Act, 1957 (except for original literary, dramatic, musical and artistic works),² and (viii) preferential location service.³

Finally, the Empowered Committee is most likely to finalise the Goods and Services Tax (“GST”) structure and modalities for its implementation, and GST may be implemented from April 1, 2011.

3.0 Sector specific analysis of Budget 2010

The budget has had mixed reactions from across various sectors. It is not possible to examine each and every sector, but the following couple of illustrations will give an indication of the thinking of the government. For example, in the real estate sector, peak excise duty has been increased from 8% to 10% and accordingly peak customs duty has been increased from 24.42% to 26.85%. Renting of immovable property will now attract service tax, contrary to what the Delhi High Court held in its 2009 judgment in Home Solutions Retail India & Others v. Union of India [2009 (237) ELT(Del)]. In the hospitality sector, the budget provides for an extension of benefits in respect of investment linked deduction to new hotels of two-star category and above which will start functioning after April 1, 2010. This will have a direct positive impact on investments made in the tourism sector.

Some key sectoral changes⁴ brought about by the budget have been discussed below:

3.1 Technology, Media, and Telecommunication sector

Customs Duty

The budget has gathered mixed reactions from the media and broadcasting industry. Promotional material like trailers, making of films etc. imported free of cost in the form of electronic promotion kits or beta-cams are being fully exempted from basic customs duty and  counter-veiling  duty.  Custom  duty  exemption  is  also  provided  on  movies/motion pictures recorded on cinematographic films or digital medium and music and gaming software (other than prepackaged form) for retail sale imported on digital media for duplication.

Excise Duty

Digital broadcasting and distribution sector is also pleased with the announcements of the budget. Project imports status has been accorded to “Setting up of Digital Head End,” with 5 per cent concessional customs duty and nil special additional duty of customs. This is expected to bring down the cost of set-top boxes and spur the broadcasting distribution companies, such as cable companies, to shift to digitization, thereby eventually benefiting broadcasting companies.

Service Tax

For the Indian news agencies, service tax exemption has been extended to “online information and database retrieval service” and “business auxiliary service.” Since service tax is billed to the broadcasting industry by news agencies, the exemption will reduce the cost of services for the broadcasting companies.

One concern raised by the budget is with regard to inclusion of copyright as a taxable intellectual property. Copyrights on cinematographic films and sound recording are now being brought under the ambit of service tax, which is expected to increase the cost of these services for the broadcasting industry. The industry has always voiced its concern on the levying of service tax on broadcasting services, especially since print media is exempted from it.

For the information technology (“IT”) sector, the budget proves to be a mixed bag. The setting up of a “Technology Advisory Group” to look into various technological issues for effective tax administration and financial governance has been welcomed by the industry. The absence of another tax holiday extension for Software Technology Parks/Export Oriented Units may be slightly disappointing, but the move is in sync with the structural reforms agenda of the government of gradually taking away the benefit of tax holidays and moving towards the DTC.

Custom Duty

Certain specified capital goods and raw materials used in the manufacture of electronic hardware are also exempted from payment of custom duty. Previously, exemption from countervailing duty for packaged software was available if the software was exploited for commercial use. However, the budget has done away with this restriction and now exemption will be available on all imported packaged software. For the gaming industry, the budget provides an exemption from the entire customs duty on gaming software used in consoles, which are not meant for retail sale.

Excise Duty

Microprocessors for computers (other than motherboard), floppy disk drives, hard disk drives, flash drives, CD/DVDs and combo drives meant for external use will now attract excise duty @ 4%. This is expected to significantly increase the cost of computers and laptops.

Service Tax

Pre-packaged information technology software, with the license for right to its use, is proposed to be exempted from service tax. Presently, the levy of service tax in “information technology software service” is limited to cases where software used is used for furtherance of business or commerce which is now proposed to be expanded to cover all cases irrespective of its use.

The deduction allowed under section 35(2AB)⁵ of the IT Act, in respect of expenditure incurred on approved in-house research and development (“R&D”) is proposed to be increased from 150% to 200%. Needless to say, this will provide additional incentives for companies to maintain and increase investments in innovation and add impetus to further R&D activity. The drugs and pharmaceutical sector will especially benefit from this increase in exemption.

3.2 Banking

In view of the turbulence experienced by the banking and financial market in the last financial year, the budget proposes to set up a Financial Stability and Development Council (“FSDC”), an inter-regulatory agency under the direct supervision of the Finance Minister, with the aim to secure financial stability and liquidity at all times, provide financial literacy, etc. The FSDC will also monitor and closely watch all large industries and financial institutions, address inter-regulatory concerns and coordination issues. Time will tell whether the FSDC will have legal sanctity or will remain a mere agency of the government that will act like a government watchdog.

The government also proposes to set up a Financial Sector Legislative Reforms Commission, which will redraft the financial sector laws and bring them in conformity with industry requirements and eliminate any ambiguities that exist. The Reserve Bank of India also plans to issue further banking licenses to private banks and Non-Banking Financial Companies in order to improve access to banking systems.

3.3 Infrastructure

Infrastructure development is vital to the long term sustainable growth of India’s GDP. Recognizing the need to spur growth of the infrastructure, budget proposes to provide INR 1,735,520 for infrastructure development in urban, semi-urban, and rural areas. This figure accounts for almost 46% of the total allocation for the FY 2010-11. Slum rehabilitation programs will provide a positive boost for the sector and an additional tax rebate of INR 20,000 for investments in infrastructure bonds under section 80 CCF of the IT Act will ensure more funding to the sector. The budget also proposes to allow pending projects to be completed within a period of 5 years instead of 4 years for claiming a deduction of their profits, as a one time interim relief to the housing and real estate sector under Section 80IB(10) of the IT Act. Further, 3% or 5,000 sq. ft, whichever is higher, of the aggregate built up area of housing projects is now allowed to be used for commercial activity, as compared to the earlier threshold of 2% and 2,000 sq. ft. However, an increase in excise duty on cement and cements clinkers will increase the cost of construction. The budget also proposes to grant project import status to “Monorail projects for urban transport,” allowing such projects to enjoy concessional rates of duty.

Substantial impetus has been provided for infrastructure development of the food processing sector. The budget proposes to set up five more food parks towards this objective. It also proposes to allow Extra-Commercial Borrowings in the food processing sector and encourage venture capitalists to invest in this virgin sector. A National Clean Energy Fund is also proposed to set up which will provide funding for research and innovation projects in clean energy technologies. This will provide a great thrust to the development and promotion of the use of clean energy.

Conclusion

The performance of the Indian economy during the last year combined with an analysis of the economic trends over the last couple of years confirms its strong fundamentals. One of the major highlights has been the role of the industry and significant growth in automobile and consumer durables segment. The budget proposals are both proactive and ambitious, without sacrificing the necessary controls, which have steered India relatively comfortably through recent international financial crisis.

Authored by: Neeraj Dubey Dhruv Suri

1 Section 9 specifically deals with the question whether a non-resident has a ‘business connection’ in India from or through which income, profits or gains can be said to accrue or arise to him.
2 Section 13(a) of the Copyright Act, 1957.
3 The term ‘preferential location’ defined to mean any location having extra advantage which attracts extra payment over and above the basic sale price.
4 For Budget proposals for Food and Pharma sector, please see http://www.psalegal.com/alerts.aspx.
5 This provision provides for deduction of expenses incurred by certain companies on scientific research and development.