The stage has been set for the Union Budget 2016. The expectations of stakeholders are peaking as they await what is in store. Since the commencement of its term, the current government has associated its Make in India campaign with infrastructure development, as it acknowledges this to be one of the pivotal sectors for economic development.
Recognising infrastructure building as a major challenge, the government is committed to transforming it, by joining hands with state governments, increasing public outlays and creating avenues for private participation. It is a well-accepted fact that the infrastructure sector accounts for high inflows of foreign direct investment (FDI) and provides considerable employment opportunities, thus providing an impetus to the business environment.
The year 2015 witnessed a number of policy and tax reforms and initiatives in the infrastructure space, which attracted international investors and raised the bar for future expectations from the government. Some of these initiatives were the liberalisation of FDI in sectors such as construction, defence, airport and railway infrastructure; the creation of real estate investment trusts (REITs) and infrastructure investment trusts (InvITs); the liberalisation of external commercial borrowing (ECB) guidelines; and proposals for the provision of a single-window approval process for ease of doing business in India.
On the tax front, measures such as the introduction of a transparent tax regime for REITs/ InvITs, along with clarity on some tax issues (to ensure that such structures take off), additions to the list of businesses entitled to investment-linked incentives, a proposal to reduce the
corporate tax rate to 25 per cent in a phased manner are noteworthy. There has never been a better time to invest in India, what with various initiatives lined up by the current government (Make in India, Digital India, Skill India, and Start up India, Stand up India) that are designed to facilitate investment, foster innovation and enhance skill development.
There is also a renewed interest in the public-private partnership (PPP) model of infrastructure development. As an outcome of a proposal in the Union Budget 2014-15, the Kelkar Committee was set up to review the PPP model. The committee’s report, which was submitted to the finance minister in 2015, called for a number of measures to revitalise PPPs, including the setting up of an independent regulator and establishing a level playing field between public and private players. The indications are that the PPP business model, which has been losing its sheen, is set to receive some clarity in the upcoming budget.
Though there is high momentum and positive thinking, to actually make India into a world-class infrastructure hub it will be imperative to address issues which hamper the ease of doing business. Whether the issues are policy or tax related, they create an uncertain, unstable and unpredictable environment in the country and impede overall growth. Looking at the existing scenario of tax instability, high litigation and other concerns, a healthy and robust tax regime with minimal litigation is hoped for. It is expected that the government will set up a stable tax regime in this year’s budget.
Tax incentives for the infrastructure sector
At present, Indian tax laws provide a range of incentives to the infrastructure sector in the form of profit-linked incentives for power generation, distribution and transmission, infrastructure facilities, industrial parks, special economic zones; and investment-linked incentives to businesses such as cold-chain facilities and affordable housing projects.
Before every budget announcement, it has been customary for industry to express manifold and well- defined expectations, and broadly to seek greater clarity and more benefits such as:
- Abolishment of the minimum alternate tax (MAT) for companies entitled to tax holidays (since the requirement to pay MAT severely dilutes the tax holiday incentive).
- Clarifying whether modernisation or expansion of an infrastructure project would qualify as a “new” infrastructure facility for availing of tax holidays.
- Defining the airport and port sectors to include ancillary and support services.
- Converting the tax holiday provision to an exemption section to obviate the need for adjustment of profits/losses inter se other undertakings of same taxpayer.
- Increasing the list of specified businesses for investment-linked incentives.
- However, in this fiscal year, the government’s plan to phase out incentives has impacted industry expectations. Though the manner of implementation of the phase-out remains unknown, the negative impact on the infrastructure sector on this account seems inevitable. From a recent press release issued by the Central Board of Direct Taxes, the following would be relevant for the infrastructure sector:
- Tax holiday provisions, where no defined sunset date exists, to have a uniform sunset date of March 31, 2017. For instance, the tax holiday for an infrastructure facility at present does not have a sunset date and, therefore, would get impacted by this. For eligible businesses that begin their tax holiday by the sunset date, the effective period of the tax holiday would extend till 2025-30. No roll-back and/or extensions to be proposed for other tax holiday provisions that already have a sunset date.
The sunset date could be either for the commencement of the activity or for claim of benefit, depending upon the structure of the relevant provision.
Reduction of the accelerated depreciation benefit restriction to 60 per cent for existing and new assets from April 1, 2017.
Thus, the need of the hour is to relook at the plan to phase out incentives and if the phasing out is to be done, it must be implemented in a selective manner and in order of decreasing dispensability of incentives. Undoubtedly, when the requirement is for ”big bang” tax reforms in the infrastructure sector, the above plan may be counter-productive. However, considering that in spirit the ultimate aim of this move is to provide certainty to the taxpayer, minimise tax disputes and bridge the tax rate disparity, the move cannot be discounted completely. Some of the features that can help make it a success are:
- As substantial capital investment is required in the infrastructure sector and the grant of depreciation is only an issue of timing , the accelerated depreciation incentive may be continued, to augment capital formation in the economy.
- Review the provisions of levying MAT as it needs to move in tandem with the corporate tax rate.
- Industries/Sectors vital for providing a stimulus to the Make in India initiative should be relooked at and segregated from the phase- out plan for some years.
- Projects, particularly in the infrastructure space including special economic zones, which are on the drawing board and have a long gestation period should be viewed independently, due to their inability to meet the March 31, 2017 deadline.
- As the Indian economy is heavily reliant on the agricultural sector, incentives for nurturing investments in agricultural and rural infrastructure should be introduced irrespective of the phase-out plan. Such a gigantic developmental effort would require significant private sector investment which can be ensured only through proper tax incentives.
- Relaxation of or exemption from the applicability of dividend distribution tax (DDT) to infrastructure companies on withdrawal of tax incentives.
Regardless of the above, one long-awaited requirement that emerges is for a framework that permits fiscal consolidation of entities, specifically infrastructure companies (on the lines that exist in developed economies). This would lead to better treasury management and improve the viability of projects by allowing developers to offset losses inter se the entities without any tax cost.
Channelisation of funds for investment in the infrastructure sector
There is a visible need for accelerating growth in the infrastructure sector, for which funds need to be arranged. Currently, capital gains investments in bonds issued by the National Highways Authority of India, National Bank for Agriculture and Rural Development, etc. enjoy tax exemption subject to certain conditions. Therefore, in order to encourage the channelising of part of the gains from the sale of immovable property into capital markets, it may be expedient to broaden the list of specified long-term assets under Section 54EC of the Income Tax Act by including mutual funds, whether equity oriented or debt oriented (based on investor choice and risk appetite), with a three-year lock-in period. Similarly, for directing the flow of savings towards railway, power, housing and highways development, the deduction under Section 80CCF of the Income Tax Act available for investment in tax-free bonds should be reintroduced.
Expectations for REITs/InvITs
A major expectation is a full pass-through status being accorded to REITs/InvITs by exempting special purpose vehicles (SPVs) from paying DDT on amounts distributed to the setrusts.
Stable and predictable tax regime
The engineering, procurement and construction industry thrives on the infrastructure sector. One of the areas in which the utmost certainty is required is consortium taxation, keeping in mind that consortium contracts continue to face scrutiny and allegations of association of persons (AOP) status. Clarifications or guidelines laying down the essential aspects for constituting an AOP may help reduce litigation for consortiums formed by non-residents to execute contracts in India.
On the indirect tax front, while exemption from service tax is available on specified infrastructure projects such as airports and railways, similar benefits have not been extended to other equally critical sectors such as power and public transport. Similarly, while the ”works contract service” provided by a subcontractor to the main contractor for specified projects is exempt from service tax, other equally key services rendered to the main contractor (such as consulting engineer services) are not exempt. This leads to higher tax costs for such infrastructure projects.
The infrastructure sector also awaits the introduction of the goods and services tax regime, which, in turn, is likely to eliminate the problems of double taxation under the current indirect tax regime.
Overall, the Union Budget 2016-17 is expected to be a Pandora’s box – full of surprises and strategic proposals. It would be interesting to see the government’s approach and the measures taken to achieve its objective of sustainable growth in the infrastructure sector along with the phasing out of tax incentives. It would be worth watching the way this is to be done and the balancing act required! w
Shweta Aggarwal, Director, Tax Practice, EY, also contributed to the article. The views expressed here are personal.
Ajit Krishnan, Partner and Leader, Infrastructure Practice, EY