Budget 2016: Financial services sector needs more focus

BMR AdvisorsFor second year in a row, expectations from the Union Budget remain high. The Government has displayed its commitment to introducing overall tax and policy reforms, projecting India as a viable investment destination with launch of its pet project: ‘Make in India’, accelerating pending infrastructure projects, and building a stable and predictable tax regime. The Finance Minister (‘FM’), with his economic and tax policies, will need to strike a delicate balance between (i) increasing tax collections, (ii) achieving targeted growth rate of 88.5 percent, and (iii) containing the revenue deficit. The Financial Services (‘FS’) sector is likely to be a core focus of the FM for achieving Government’s aspirations. Specifically, from a FS sector perspective, the FM will need to provide an impetus to the banking sector, and introduce policies to rein-in the capital markets. Key expectationsPolicy and reforms• With focus of the Government on increasing long-term growth capital in India, and consistent with past expectations, the Government could consider introducing a separate investment window for pedigree investors such as Foreign Pension Funds (‘FPFs’) and Sovereign Wealth Funds (‘SWFs’). • The Insolvency and Bankruptcy Bill, 2015 (‘Bankruptcy Code’), which was tabled in the Parliament last year, should be passed at the earliest so as to strengthen creditor rights and ensure good corporate governance. The Bankruptcy Code is likely to be the much needed shot-in-the-arm for the banking sector that has been plagued with rising NPAs.• Universal banking licenses should be provided on tap basis to enable financial inclusion, and innovation in the banking sector.• In line with the government’s intent of divesting Government stake in PSUs, the present FDI cap of 20 percent in public sector banks should be increased to 49 percent. This will facilitate much needed capital flow into public sector banks and ensure onward financial support to Indian corporates. • Create a definite roadmap for capitalising PSU banks to ensure efficient functioning and compliance with capital adequacy requirements in line with Basel III norms. • Implement the much awaited Indian Financial Code, which proposes to integrate various securities and FS sector laws in a lucid manner.• Implement recommendations of the Alternative Investment Policy Advisory Committee (‘AIPAC’) for unlocking domestic pools of capital (held by banks, pension funds, provident fund, insurance companies etc) by channeling capital flows to Alternative Investment Funds (‘AIFs’).Direct tax• Unequivocally clarify that the Minimum Alternate Tax (‘MAT’) provisions do not apply to foreign companies (particularly to FIIs) that do not have a place of business or Permanent Establishment (‘PE’) in India. Further, clarify that third-party contracts between FIIs and local custodians, stock brokers and investment advisers do not give rise to a place of business or PE for FIIs.• Prescribe a clear taxability framework for taxation of unsponsored ADR / GDR programmes, as well as DRs that are issued on the back of other Indian securities that are non-equity shares. • Extend the sunset (currently being, June 30, 2017) on concessional tax rate of 5 percent on interest earned by FIIs and other foreign investors on INR denominated bonds, long-term bonds, Government Securities etc, by another 2-3 years. • Amend tax regime for India-based Fund Managers to address concerns of foreign funds, including FPFs and SWFs.• Implement recommendations of AIPAC for revamping the AIF taxation regime; such as: Extend tax pass through status to all Categories of AIFs; Characterize income of AIFs as ‘capital gains’ and ‘income from other sources’ to halt long-drawn litigation; Net losses incurred by AIFs should be passed onto the investors; Remove withholding tax obligations on distribution of exempt income by AIFs to its investors.• Grant full tax deductions to banks on provision created against NPAs, and extend NPA related tax benefits for banks to NBFCs.• Eliminate distribution tax on income distributed by securitization trusts and instead apply tax on investors at applicable tax rates.• Permit carry forward and set-off of unabsorbed tax losses indefinitely to players in the insurance sector, considering the significance of the sector and long gestation period involved.• Exempt general insurance companies from MAT to provide a level playing field to general insurance industry vis-à-vis life insurance industry.Indirect tax• Clarify on non-applicability of service tax on mere apportionment of general administration and other common expenses from head office to branches (which is claimed as a deduction by branch under section 44C of the Income-tax Act, 1961) as there is no provision of service inter se the head office and the branch. • Clarify on non-applicability of service tax on corresponding banking charges, ie charges deducted by foreign banks while remitting funds to Indian banks, by withdrawing trade notice issued by the Mumbai Commissionerate. • Clarify that interchange income earned by Issuing Bank, in respect of credit card transactions, is exempt from service tax since the Acquiring Bank deposits service tax on the entire Merchant Service Fee, which is in turn shared with the Issuing Bank. • Clarify that charges recovered by banks from customers when the minimum average balance falls below the prescribed threshold limit should not be subject to service tax as these charges are merely compensatory and penal in nature.• Set out the definite roadmap for introduction of GST, particularly focussing on the following key aspects while drafting GST provisions: Taxability of non-fee based incomes; Determination of CENVAT credit reversal ratio attributable to input services attributable to passive incomes such as interest, etc; and Clarity on place of supply for undertaking compliances on a pan-India basisTo conclude, the FS sector needs a special thrust in the Union Budget 2016, especially given the Government’s desire to augment the existing infrastructure in the country. The banking and NBFC sectors are likely to be important focus areas for the Government from a tax as well as policy reform standpoint. Specifically, from a tax perspective, the Government will need to gain the confidence of investor community by bringing about changes that reflect Government’s commitment to provide a stable and predictable tax regime. One hopes that growth of the FS sector is paramount in the mind of the FM while drawing up Union Budget 2016.