The GDP growth rate for India in FY13 is likely to be around 5.5% and there are telltale signs of a slowdown. To counter this, we expect Shri P Chidambaram to present a Union Budget that can stimulate domestic demand.
Srei Infrastructure Finance
The GDP growth rate for India in FY13 is likely to be around 5.5% and there are telltale signs of a slowdown. To counter this, we expect Shri P Chidambaram to present a Union Budget that can stimulate domestic demand. And to make that happen, the Finance Minister must focus on infrastructure creation. India’s infrastructure is bursting at the seams, its carrying capacity is almost saturated and this deficient infrastructure is one of the reasons why inflation, especially food inflation, has remained high. The various advantages of infrastructure creation are creation of new employment opportunities, readying the economy for higher rates of growth, fuelling entrepreneurship and setting in motion a virtuous cycle. Most importantly, infrastructure connects the hinterlands with the mainstream economy and makes growth more inclusive.
There is no dearth of entrepreneurial talent in India. Entrepreneurs in the form of Micro, Small and Medium Enterprises (MSMEs) are scattered all over the country. They constitute the backbone of the India Growth Story. Even in infrastructure creation, numerous MSMEs undertake activities like construction, transportation, etc. However the principal challenge to their growth is financing as many of them reside in remote locations which are outside the reach of banking network. For their credit needs, they essentially rely on NBFCs. The reason why I have outlined this is because the Finance Minister must understand that in order to set in motion infrastructure creation, the machinery that needs to be oiled is the financing vehicle of the infrastructure MSMEs – namely the NBFCs, especially NBFC-AFCs (those which finance infrastructure assets) and NBFC-IFCs (those which finance infrastructure projects). Ideally the Finance Minister should provide a Big Push to NBFC-AFCs and NBFC-IFCs in the forthcoming budget.
It is not the case that the government is not aware of the significance of NBFC-AFCs and NBFC-IFCs. I am just reiterating the point that they need to be treated differently from other NBFCs. Keeping in mind the national need to create new infrastructure, NBFC-AFCs and NBFC-IFCs must be provided special privileges so that they can perform their functions better.
Presently a large portion of infrastructure financing in India is done by commercial banks. But that is not adequate. Thus NBFC-AFCs and NBFC-IFCs must supplement and complement the banks. However, these NBFCs do not enjoy a level playing field vis-a-vis banks. I, hereby, present a few proposals which I would definitely like to see featuring in the Finance Minister’s budget speech in February :
(I) Coverage under SARFAESI Act
Banks and FIs have been notified under the Act, giving them the ability to move against defaulting borrowers and secure their assets. Subsequently, specified housing finance companies (HFCs) have also been notified under the Act. NBFCs have not been notified under the Act. In order to protect the interest of investors, NBFCs should be brought within the purview of the SARFAESI Act. As per the Act, RBI can do this by way of a notification.
(II) Nil TDS
Section 194A of the Income Tax Act provides for TDS at the rate of 10% on payment of interest (excluding interest on securities) to a resident. Sub-section 3 of Sec. 194A provides for non-applicability of Sec. 194A in some cases which includes banking companies to which Banking Regulation Act applies. However, such exemption has not been extended to NBFCs. Resultantly, in contrast to the nil TDS rate enjoyed by banks on their interest receipts, NBFCs’ interest receipts are subject to a TDS rate of 10%. Though NBFCs have the option to apply for a lower withholding certificate under Sec. 197 of the Income Tax Act, practically it becomes difficult to obtain this certificate given the huge number of customers (in many cases in thousands).
The EMI on monthly loan installments receivable to NBFCs has an interest component which is also subject to TDS. In addition, in an ever-dynamic growing business scenario, it is practically impossible to predict the volume and number of new customers and collect details regarding name, addresses, exposure, TAN, etc. of the customers. Therefore, extensive paper work and administration coupled with huge collection costs involved in the issue of large number of certificates, filing quarterly returns, etc. make the entire TDS collection quite costly. Also many a times, the TDS estimated for advance tax computations actually turns out to be much lower than what is actually deducted by the customers, resulting in refund claims. Getting refund can often become a time-consuming affair.
The additional limitations of the existing system are the following:
a) Follow up with every customer for TDS certificates every quarter (details of which are mandatory for claiming the same in the I. T. return) becomes almost impossible. NBFCs have clients who number in thousands and it is extremely difficult to collect details from everyone.
b) Even if the TDS certificate is issued by the customer, if TDS return has not been filed or not filed properly, the credit for such TDS would not be granted to the NBFC as the details of such TDS would not appear in the NSDL system.
c) Once the TDS credit is disallowed, the NBFCs have a hard time following up with the customers and the exchequer has a hard time clearing outstanding demands against NBFCs which, in reality, do not exist.
In this backdrop, it is only logical to extend the benefit of nil TDS to NBFC-AFCs and NBFC-IFCs under Sec. 194A, especially when these entities are supplementing banks’ efforts in financing infrastructure.
(III) Tax provisions pertaining to NPA deduction
Although NBFCs are also regulated by the RBI just like banks and other FIs, the Income Tax laws treat NBFCs differently, insofar as provisioning for NPAs, bad and doubtful debts are concerned. This discrimination severely impedes functioning of NBFCs, which in turn, thwarts the credit delivery mechanism to the MSMEs.
(a) Under section 36(1)(viia) of Income Tax Act, only the banks and FIs enjoy deduction on provisions for bad and doubtful debt. A deduction of 7.5% of gross total income is allowed as expenses for banks, if provision for bad and doubtful debts is made as per RBI directions, and for FIs the figure is 5%.
It is pertinent to note that even the foreign banks are allowed the benefits under this section of I. T. Act, but the NBFCs are excluded, and this despite the fact that both NBFCs and banks are regulated by similar guidelines and there is in fact no material difference between the businesses carried out by NBFCs and banks.
In absence of specific inclusion of NBFCs in Sec. 36(1)(viia) of I. T. Act, “provision for NPA” made in terms of RBI prudential norms does not constitute an expense for purposes of I. T. Act. So entire provisioning as per RBI prudential norms is disallowed for purposes of computing taxable income of NBFCs. Thus, NBFCs are subjected to higher taxation, and hence are at a disadvantageous position vis-à-vis banks and other FIs.
As the Government itself considers NBFCs to be a vital channel for credit delivery especially to the under-privileged segments of the society, it is essential that such discriminations between NBFCs and banks be eliminated. This inconsistency may be resolved by including NBFCs also in Sec. 36(1)(viia) of I. T. Act so that the benefits are also extended to infrastructure financing NBFCs. The same is already in the proposed Direct Tax Code (DTC) 2010.
(b) Banks, PFIs and publicly listed companies are allowed deductions in income tax up to a certain percentage of their reserves. Since entities like NBFC-IFCs and NBFC-AFCs are contributing to the process of infrastructure creation like the banks, they should also be allowed this benefit even if they are unlisted.
(c) Provisions under sections 115JA and 115JB of the Income Tax Act were amended with retrospective effect starting from AY 1998-99 and 2001-02 respectively. With the amendments, any diminution in value of an asset should be added to the ‘Book Profit’ for calculation of MAT.
The impact of this change is particularly severe on NBFCs as provisions made for bad-debts/ non-performing assets (NPAs) are added to the ‘Book Profit’, that too from the AY 1998-99. Not only does this mean re-opening of assessment of the previous years, but also a possible Income Tax demand on account of the loans which NBFCs might not recover. Simply put, this implies further income tax liabilities on lost assets. This has put the fiscal health of NBFCs under pressure, and may lead to extinction of some NBFCs.
Certainly this would not have been the intent of Finance Ministry as :
§ The budget memorandum intended to impose MAT only on the items ‘below the profit line’ like deferred tax provisions, dividend distribution tax, etc.
§ Further, for the NBFCs, the provision for NPAs is not merely a provision for unascertained liability, but is an administrative expense, which is a charge on the Profit & Loss.
This may be resolved by suitably amending the explanations to sections 115JA and 115JB of the I. T. Act, to exclude “all provisions made on account of NPAs / bad and doubtful debts”. This will also be in consonance with the intent of legislature.
(IV) Access to ECB
Another point worth noting is that the NBFC-AFCs and NBFC-IFCs rely heavily on ECB as a source of long-term funds. In the Union Budget 2012-13, while a number of steps aimed at increasing the scope for ECB in a number of infrastructure sectors were taken, nothing was done to channelize more ECB into NBFC-AFCs and NBFC-IFCs. Presently, the uitlisation of ECB by NBFCs is also subject to some restrictive clauses.
Keeping in mind the sharp depreciation that the Indian Rupee has experienced in the recent past, this is perhaps the right time to liberalise the ECB window for NBFCs.
With rising investments in infrastructure, the infrastructure & construction equipment (ICE) industry is also growing in India. The number of domestic ICE players has increased over the years and many foreign ICE players are also setting up manufacturing bases in India. However, as per present conditions NBFC-AFCs are allowed to utilize ECB funds only on imported ICE. This makes little sense in the current circumstances. There is a strong case for allowing NBFC-AFCs to utilize ECB for financing of domestically manufactured equipment as this would provide a strong fillip to this industry.
Recently, the RBI has relaxed ECB norms for NBFC-IFCs by allowing them to avail ECB up to 75% of their owned funds without approval (earlier limit was 50%). For availing ECBs beyond 75% of their owned funds, NBFC-IFCs would require the approval of the RBI and will, therefore, be considered under the approval route. Also the hedging requirement for currency risk for NBFC-IFC has been reduced to 75% of their exposure from the erstwhile 100% exposure. However, the ECB access conditions for NBFC-AFCs remain unchanged. Since NBFC-AFCs also play a crucial role in financing of infrastructure assets, the revised ECB criteria for NBFC-IFCs should also be made applicable for NBFC-AFCs too.
Another point I would like to add here keeping in mind its significance in the present context. This is not an NBFC-specific issue, but since the focus is on infrastructure creation, I am adding it here. The infrastructure projects in India are presently suffering from an acute lack of equity capital. To counter this, the government has wisely encouraged Venture Capital Companies (VCCs) / Venture Capital Funds (VCFs) to grow, enabling investment through equity into infrastructure and other projects. Unfortunately, there has been some inadvertent error whereby in the Finance Bill 2012 when the Sec. 115U of the Income Tax Act was changed leading to an anomaly whereby investors in the VCF will have to pay tax on accrual basis and not on the basis of receipt.
In the Union Budget 2012-13, an amendment was made by inserting subsection 5 to section 115 U of Income Tax Act 1961, effective from year 2012 -13. It states that:
“the income accruing or arising to or received by the Venture Capital Company or Venture Capital Fund, during a previous year, from investments made in a Venture Capital Undertaking if not paid or credited to the person referred to in Sub Section (1), shall be deemed to have been credited to the account of the said person on the last day of the previous year in the same proportion in which such person would have been entitled to receive the income had it been paid in the previous year.”
This would tantamount to investors paying tax on notional income which they may or may not receive. This has discouraged investors to invest in VCC / VCF thereby creating a new roadblock for infrastructure projects to raise equity. In this scenario, when the income is not distributed or reinvested by the VCC / VCF, then the contributors have to bear the burden of paying 20% / 30% tax (as the case maybe) on the deemed / notional income without actually receiving any such income, making this section impractical and un-implementable. Tax is always on the real income and not on notional income, save and except perks in case of salary and house property income. In one of the rulings the Supreme Court had stated that the concept of deeming provisions should not be stretched beyond a limit. In this case the Act is on taxing a non-receipt as a receipt, which is unconstitutional, and taxability of undistributed profit could be challenged by way of a writ by contributories. The entire tax payout by the contributories is from their pocket, without actually receiving any such income would act as a major deterrent to the future investments by the contributors in VCC / VCF. Even the methodology for arriving at the quantum of the notional income which is to be taxed has not been clearly defined leaving it susceptible to different interpretations by different parties.
In this backdrop, we would therefore request for Sec. 115U of the I. T. Act to be restored in the form as was before Finance Bill 2012. At this critical juncture for the Indian economy, our suggested step is an absolutely imperative and this can indeed act as a trigger for bringing in new equity into infrastructure investments which, in turn, can provide the much needed push for higher economic growth.
We sincerely believe that the suggested above-mentioned steps would go a long way in addressing the functional constraints of NBFC-AFCs and NBFC-IFCs and this, in turn, will facilitate them in enhancing their efficiency levels. If these proposals figure in the Finance Minister’s budget speech in February, I am sure these steps would provide a fillip to infrastructure creation and would set the stage for India to return to the high growth trajectory in near future.