As the global economy inches towards a state of polycrisis (economics, geopolitics and energy), one wonders who will likely prosper amidst this gloom. India, which is on course to become the world’s most populous country, might just be the answer. Buoyed by growing domestic investments, record foreign direct investment (FDI) inflows and the China plus one strategy increasingly gaining popularity, the country will continue to remain a bright spot in an otherwise uncertain world.
All eyes now on this year’s budget, the last ‘full year one’ before elections. The budget is also significant as it comes on the heels of India’s G20 presidency. Among other things, tax policy will play a pivotal role in all of this.
Driving manufacturing competitiveness
The highly attractive corporate tax rate of 15 percent applies only to new manufacturing companies that commence operations by March 31, 2024. With more supply shifting to India, it is perhaps the right time for the government to consider extending the sunset clause date for new manufacturing commencement by at least three more years. This, when combined with the production-linked incentive schemes, will form a potent force in transforming the country’s manufacturing sector.
Revitalising special economic zones (SEZs)
With the phasing out of the tax holiday for units in SEZs, many are entering the last phase of this tax break. In this phase, the tax holiday is conditional upon creation of a reserve that is to be utilised towards plant and machinery. Since many companies in the services sector do not require heavy investment in plant and machinery, this requirement should either be done away with or expanded to cover buildings, infrastructure, furniture, etc. In addition, with hybrid working becoming the new normal, the government should proactively clarify that SEZ tax holiday benefits will be available in respect of work undertaken by employees working from home in accordance with the updated SEZ rules.
Boosting investor confidence of non-resident (NRs)
First, on equalisation levy, India significantly expanded the scope in 2020, which led to several issues in relation to the applicability across several businesses including payment processing, telecom, financial services, etc., which require urgent clarification. There is also a need to explicitly exclude intragroup transactions that are undertaken through digital means only for increased efficiencies and not for expanded market access.
Second, coming to significant economic presence (SEP) provisions, there is a need to provide rules that address how much of the NR income should be attributed and taxed in India if an SEP is constituted. While such rules can be framed outside of the budget exercise, there is a need to make changes in the law to enable taxpayers to apply such rules to past years as well without interest or penal consequences.
Lastly, ease of compliance. While a tax return filing exemption has been extended to NRs earning certain types of income like royalty, dividend, interest, etc., on which tax has been withheld, there is no exemption from corresponding transfer pricing compliances, which invite heavy penalties. This dilutes the intended benefit and should be addressed by exempting such NRs from transfer pricing compliances. In addition, low monetary thresholds for the SEP provisions trigger return filing obligations for many NRs who have entered into transactions with persons in India. This is an onerous compliance requirement for NRs eligible for treaty benefits and, therefore, a relaxation on this front would be an encouraging move.
In summary, a stable and taxpayer-friendly tax regime will go a long way in improving the country’s investment climate. Reforms in this direction from Budget 2023 will certainly provide the necessary booster shots to propel the next level of growth.
Naveen Aggarwal is partner, tax, KPMG in India
