THE YEAR OF LIVING DANGEROUSLY

There is very little to distinguish India in 2011 from India in 1991 as far as
three important indicators of economic health go: the fiscal deficit, current
account deficit and inflation.

Twenty years ago, India was hurtling towards an unprecedented economic crisis
that took it close to an international default. The famous budget presented by
Manmohan Singh in July 1991 was a turning point in economic management, but
the first clear warnings on the coming crisis and the need for radical reform were
sounded by Yashwant Sinha, in the course of the interim budget he presented in
March 1991 as finance minister in the short-lived Chandra Shekhar government.
Pointing to the noxious combination of elevated fiscal deficits, a high current
account deficit and double-digit inflation, Sinha had said: “I need hardly stress that
neither the government nor the economy can live beyond its means for long. The
room for manoeuvre, to live on borrowed money or time, has been used up
completely. The soft options have been exhausted.”

Cut to early 2011, weeks before finance minister Pranab Mukherjee presents the
new Union budget on 28 February. Much has changed since 1991, mostly for the
better. Yet, there is very little to distinguish India in 2011 from India in 1991 as far
as three important indicators of economic health go: the fiscal deficit, current
account deficit and inflation (see chart). Old economic fissures remain unattended
and domestic demand has once again run ahead of available capacity.

There is no need to hit the panic button. This is not 1991. But the new Union
budget is being framed against the backdrop of a stuttering world economy, and
signs of domestic pressures. There are ample indicators of the key risks in the year
ahead. The fiscal deficit is being funded by domestic savings and there are signs
that it is crowding out private investment; the current account deficit is funded
with foreign capital, but the worrisome drop in foreign direct investment in recent
quarters means that India is increasingly dependent on volatile portfolio and short-
term debt flows; and high inflation is a clear sign that the lack of meaningful
reforms since 2004 has made the economy structurally constrained to increase
aggregate supply, with the output gap shrinking too early in the business cycle. If
India continues on its current policy path, 2011 could be the year of living
dangerously.
Budget Financials

The annual financial statements of the Government for 2010-11 are set to reflect a
fiscal deficit of 5.1% of GDP, lower than the budget estimate of 5.5% for 2010-11.
The target fiscal deficit for 2011-12 is 4.6%.

According to the medium term fiscal policy statement, the target fiscal deficit is to
be progressively reduced to 3.5% by 2013-14. For 2011-12, revenue deficit is
estimated to be 3.4% of GDP, which is the same (in percentage terms) as the
revised estimate for 2010-11.

In his speech before the Parliament, the Finance Minister stated that control over
the fiscal situation was further improved by higher than anticipated non-tax
revenues from 3G spectrum auctions.

Market borrowings are expected to finance 83.09% of the Government’s fiscal

deficit in 2011-12. According to the revised estimates, the interest outgo as a
percentage of the revenue receipts is set to decrease considerably to 30.72% in
2010-11 from 37.20% in 2009-10 and is estimated to be 33.93% in 2011-12.

The Union Budget 2011-12 has estimated the following:

 Gross tax revenues at INR 9,324.40 billion, representing an increase of

approximately 18.50% over the revised estimates of INR 7,868.88 billion for
2010-11.
 Plan expenditure at INR 4,415.47 billion, representing an increase of
approximately 11.78% over the revised estimates of INR 3,950.24 billion for
2010-11.
 As a proportion of the total expenditure (excluding expenditure matched by
receipts), plan expenditure is estimated at 35.11% against the revised
estimate of 32.47% for 2010-11.
 Non-plan expenditure is estimated at INR 8,161.82 billion representing a
decrease of 0.65% over the revised estimates of INR 8,215.52 billion for
2010-11.
BUDGET TO PROMOTE GROWTH

“Our ‘demographic dividend’ of a relatively younger population compared to

developed countries is as much of an opportunity as it is a challenge. Over 70% of
Indians will be of working age in 2025.” this statement reflects the thought behind
and the announcements in Budget 2011 relating to employment and skills:

1. Two areas received significant focus during the budget speech—

infrastructure and agriculture, in particular, food processing. Both these
areas are labour intensive and significant employment generators.

2. A series of measures to promote the setting up of new industrial clusters for

textiles, leather and food processing, besides food parks, capacity addition to
the cold chain and grain storage during the current year has been taken.

3. There is increased funding to promote entrepreneurship.

4. The move towards the goods and services tax (GST), the direct taxes code
(DTC), the manufacturing policy and the introduction of other insurance and
financial instruments are all intended to promote growth and employment.

5. The support to education has been increased by 40% with a total allocation
of `21,000 crore. This includes a revised Centrally sponsored scheme for
“vocationalization of secondary education” to improve the employability of
youth. The assistance for states in setting up new polytechnics has
increased from `500 crore to `736 crore, a huge jump.

6. Budget 2011 has infused an additional `500 crore into the National Skill
Development Fund (NSDF) to continue to approve projects leading to the
fulfilment of the objective to skill 150 million persons by 2022.

7. The increase in wage rates under the Mahatma Gandhi National Rural
Employment Guarantee Scheme (MGNREGS) and the linkage to the
Consumer Price Index for agricultural labour and the increase in wages for
the ‘anganwadi’ workers and helpers. The additional wages could be used for
skill development in the first case and perhaps attract more persons in the
second case.

8. The industrial training institute (ITI) upgradation scheme and the amount
for public private participation for the modernisation of ITIs has an outlay of
`720 crore, enabling this scheme to continue.

9. The move across the economy toward greater transparency and improving
the capacity of departments and local bodies to increase utilization of funds
by introducing direct to beneficiary transfers and the use of information
technology to enable this. This includes the proposed separate accounting
for expenditures in the LWE areas. These initiatives in Budget 2011 provide
the finances.
GENDER ECONOMICS

The allocations earmarked for women as a proportion of the total Union budget
outlay has gone up from 3% in 2007-08 (revised estimate) to 6.1% in 2010-11
(budget estimate). At 6.1% of the total Union budget outlay, the total quantum of
funds earmarked for women appears grossly inadequate, especially if we take into
account the persistence of deficits in women’s development. If we probe deeper into
the composition of total resources earmarked for women, it is seen that education
and health account for nearly half, while equally crucial issues such as support
services for women in distress and economic and political participation of women
remain neglected. In fact, despite the introduction of Protection of Women from
Domestic Violence Act in 2005, no funds have been allocated by the Union
government for facilitating implementation of this legislation.
SECTORAL ANALYSIS

AUTO

PROPOSALS

 No announcements on FDI in multibrand retailing;

 increased investments in improving supply chain efficiencies;
 Service tax on rentals not removed.

IMPACT

 The announcement on allowing FDI in multibrand retailing did not

materialize.
 However, the thrust on improving supply chain efficiencies through
investments in mega food parks, storage capacities and cold chains is a step
towards reducing the bottlenecks in modern retailing.

ROADS & PORTS

PROPOSALS

 Operationalization of infrastructure debt funds,

 Increased FII investments and lowering of withholding tax;
 Increase in budget allocation for road projects;
 Increase in MAT from 18%to 18.5%;
 Exemption from custom duty on bioasphalt and tunnel boring machines

IMPACT

 The increased outlay on road transport would favourably impact firms

involved in road construction.
 The government also seeks to increase the funding options for the
infrastructure projects by allowing SPVs to raise funds from FIIs.

STEEL

PROPOSALS

 Increase in export duty of iron ore to 20%.

 Exemption of stainless steel scrap from basic customs duty.
 Reduction of basic customs duty on Ferro nickel to 2.5%.

IMPACT

 The proposal to increase ad valorem export duty on all types of iron ore from
5% (fines) and 15% (lumps) to a uniform rate of 20% would adversely impact
the profitability of iron ore exporting companies. This, however, may benefit
domestic steel firms.
TEXTILES

PROPOSALS

 Conversion of optional levy of excise duty to mandatory levy on branded

readymade and made up garments.
 Levy of excise duty on automatic and projectile looms.
 Concessional excise duty rates on few textile intermediaries and goods hiked
from 4% to 5%.
 Basic customs duty reduced on raw silk from 30% to 5%.

IMPACT

 Levy of excise duty to impact demand.

 Reduction in customs duty on raw silk, etc., to support cost structure.

AVIATION

PROPOSALS

 Increase in service tax on air travel.

 Budget support of `1,700 crore to aviation ministry and `280.15 crore to
Airports Authority of India.
 Budget support of `1,200 crore for financial restructuring of Nacil.
 SPVs implementing infrastructure projects permitted to raise funds from FIIs
through unlisted bonds.

IMPACT

 Increase in service tax rates may be passed on by the carriers in the form of
higher air fares.

BANKING/HOUSING FINANCE

PROPOSALS

 Government to recapitalize select public sector banks to help them reach 8%

tier I capital and 58% Union government holding.
 Increase in FII limit for infrastructure corporate bond market to $25 billion.
 Increase in credit flow to farmers from `3.75 trillion to `4.75 trillion.

IMPACT

 Recapitalization of banks may be helpful.

 Increased investor base in infrastructure corporate bond market may help
banks correct asset-liability mismatches.
CAPITAL GOODS/ENGINEERING

PROPOSALS

 Higher FII limit for investment in bonds.

 Reduction in excise duty from 10% to 5% and exemption of countervailing
excise duty on the basic components of LEDs.
 Reduction in basic customs duty from 10% to 5% on solar lanterns.
 Excise duty exemption for capital goods supplied to UMPPs by domestic
suppliers.

IMPACT

 Provisions for LEDs to improve demand.

 Excise duty exemption for supplies to UMPPs to aid competition.

CEMENT

PROPOSALS

 Rationalization in excise duty rates;

 Change from MRP based excise duty to ad valorem excise duty.
 Customs duty on petcoke and gypsum cut from 5% to 2.5%.

IMPACT

 The change in excise duty computation may result in a marginal reduction

in effective excise duty incidence and, thus, improved margins.
 Cut in customs duties may result in a marginal decrease in input costs.

CONSTRUCTION

PROPOSALS

 FII investment limit in corporate infrastructure bonds increased by $20

billion.
 Tax-free bonds worth Rs. 30,000 crore can be issued by government
undertakings in the roads, ports, railways and housing sectors.
 Allocation for Bharat Nirman scheme increased by 20% in 2011-12.

IMPACT

The increase in FII limit is expected to lead to better mopping up of funds by the
bond issues.
DRUGS & PHARMACEUTICALS

 Increase inweighted reduction from 175% to 200% on R&D activities

outsourced to specific institutions.
 Basic customs duty reduced on lactose used in homeopathic medicines from
25% to 10%.

IMPACT

 The impact of most proposals unlikely to have a material impact on the

sector.
 Increase inweighted reduction on R&D activities in line with exemption
available on in-house scientific research.

FERTILISERS

PROPOSALS

 Extension of nutrient based subsidy (NBS) for urea under consideration.

 Direct payment of subsidy to farmers living below poverty line (BPL).
 Continuation of payment of subsidy in cash to fertiliser firms.
 Thrust on agriculture through higher agricultural credit and subvention of
interest on farm loans.

IMPACT

 NBS for urea or direct payment of subsidy to BPL farmers is a positive for
cost efficient fertilizer firms.

CONSUMER GOODS

PROPOSALS

 Increased allocation towards rural development, agriculture-centric and

employment generation schemes.
 Infrastructure status for cold storage chains; excise exemption for cold
storage equipment.

IMPACT

 Proposals to improve farm production and increase rural consumer

spending.
 Infrastructure status for cold storage chains and excise duty exemption for
cold storage equipment may aid investments and improve efficiency.

HOTELS/ TOURISM

PROPOSALS

 Service tax on air-conditioned restaurants owning licences to serve alcoholic

beverages.
 Service tax on hotel accommodation, in excess of declared tariff of `1,000 per
day.
 Tax on domestic air travel (other than economy) at 10%.
IMPACT

 Service tax on room tariffs/restaurants, the impact of which will be passed

on to the customer, may reduce demand.
 Air travel bill also likely to go up.

HOUSING

PROPOSALS

 Interest subvention of 1% extended for housing loans up to `15 lakh.

 Priority sector lending limit increased from `20 lakh to `25 lakh.
 Investment linked deduction for affordable housing projects.

IMPACT

 Above proposals and allowing HUDCO to issue tax-free bonds up to `5,000

crore to boost growth.
 The proposed investment linked income tax deduction will benefit companies
operating in this segment.

INFORMATION TECHNOLOGY

PROPOSALS

 The Software Technology Parks of India (STPI) scheme, which offered

complete tax deduction on profits, has been discontinued.
 MAT to be levied on SEZ units.

IMPACT

 The levy of MAT on IT SEZ units and non-extension of STPI benefits will
increase tax outgo and hence impact cash flows of IT companies across the
board.
 Non-extension of STPI benefits expected to impact small and mid-tier players
more.

OIL & GAS

PROPOSALS

 Provision of subsidy for sensitive petroleum products;

 Continuation of payment of subsidy in cash to oil firms.
 Direct payment of subsidy to people below poverty line on LPG and superior
kerosene oil.
 Hike in MAT from 18% to 18.5% and cut in surcharge from 7.5% to 5%.

IMPACT

The subsidy seems grossly inadequate and gross under recoveries could cross `1
trillion, even assuming a 50% share to be borne by the Union government.
RETAIL

PROPOSALS

 No announcements on FDI in multibrand retailing;

 Increased investments in improving supply chain efficiencies;
 Service tax on rentals not removed.

IMPACT

 The announcement on allowing FDI in multibrand retailing did not

materialize.
 However, the thrust on improving supply chain efficiencies through
investments in mega food parks, storage capacities and cold chains is a step
towards reducing the bottlenecks in modern retailing.
Budget 2011-12: Key proposals and likely impact

DIRECT TAX CODE:

Proposals:

 Personal tax slabs enhanced (minimum slab to Rs180k from Rs160k) mid-
way to proposed DTC bill.
 Corporate tax rates rationalized with reduction of surcharge from 7.5% to
5% on course to move towards 30% DTC norm.
 MAT rate at 18.5% (from 18%).
 Overall direct tax proposals to result in net revenue loss of Rs115b.

Likely Impact:

 Marginal relief for taxpayers to guard against inflation.

 With DTC to be implemented by April 2011, this goes mid-way in to the DTC
prescribed minimum slab of Rs200k.
 Reduction in corporate surcharge is a welcome move and seems on course to
phased abolition of corporate surcharge in order to bring the corporate tax
rate to 30% in consonance with DTC.
 Increase in MAT rate is to plug the loopholes.

GOODS AND SERVICES TAX (GST):

Proposals:

 Mean rates left unchanged but a lot of existing rates rationalized.

 Service tax extended to cover new areas of services.
 Rationalization of indirect tax rates is expected to yield Rs113b.
 Hence overall tax proposals expected to result in a loss of Rs2b.

Likely Impact:

 This is the clearest indication of government’s resolve to move towards GST.

Thus one can expect much greater stability of indirect tax after the
rationalization exercise is complete.
 Leaving the service tax rates unchanged too signifies laying the groundwork
for unified rollout of goods and services tax.
 Quite evidently revenue mobilization has been a secondary goal of such
rationalization exercise.

GOVERNANCE CHALLENGE:

Proposals:

 Five point program and measures to curb black money announced earlier
reiterated.
 Highlighted the progress in various international tax and co-operation
treaties in this respect.
Likely Impact:

 Government at the later stage seems to rely more on executive action to

address the issues of corruption than relying on articulated policy measures.
 However, the key lies in its sustenance of such executive actions.

FOREIGN INVESTMENT:

Proposals:

 Discussions underway on opening up of key sectors.

 Mutual funds allowed to accept subscription from foreign investment.
 FII limit on corporate bonds enhanced to US$40b.

Likely Impact:

 On FDI in multi-brand retail, enough indications have been given by the

Government of the measure in the offing including pronouncement of
commerce minister.
 Increase in the FIIs ceiling in the corporate bond market is a big positive as
this would infuse activity in the bond market, help infrastructure, help
garner capital flows and reduce pressure on liquidity.
 Permitting MFs to accept foreign subscription is also likely to help capital
flows and ease liquidity.
 Hence, the government has been on overdrive on attracting capital flows and
also indicates a shift in the long standing policy preference in favour of
equity flows.

DELIVERY MECHANISM:

Proposals:

 Government will move towards direct subsidy for Below Poverty Line by April
2012 (LPG, Kerosene and Fertilizer). The necessary IT infrastructure in this
regard is being put in place.

Likely Impact:

 This would pave the way for efficient delivery of welfare schemes riding on
the UID infrastructure.

DISINVESTMENT:

Proposals:

 Target set at Rs400b.

Likely Impact:

 The target is challenging in the current investment climate. The intent is a

steady inroad into broader public ownership and market supervision of
PSUs.
FINANCIAL SECTOR REFORMS AS THE BUDGET PROPOSALS

INSURANCE

The Insurance Laws (Amendment) Bill 2008

Objective: To deregulate the insurance sector through greater foreign presence and
more operational freedom for insurers

Proposals

• Raise foreign-equity ceiling in insurance companies from 26% to 49%

• Indian promoters need not reduce their stake to 26% over a period of time, as
currently mandated

• Let insurers set premiums, making the Tariff Advisory Committee redundant
• General insurers have to offer third-party cover in motor insurance. Since this is
a loss-making proposition, many insurers currently don't offer it to customers
• Allow entry of Lloyd's, the London-based insurance specialist

Impact

The greater leeway on stake holdings will allow promoters to adopt business
strategies that suit them. So, Indian promoters can opt for a high stake or sell to
foreign partners, who can hold more.

Legislation

Was introduced in the Rajya Sabha in September 2009. A Parliamentary committee

is currently examining the bill.

LIC

The Life Insurance Corporation (Amendment) Bill 2009

Objective: Make LIC conform to the same regulatory requirements as other life
insurers

Proposals

• Raise LIC's paid-up capital to Rs 100 cr, from Rs 5 cr

• Distribute 90% of LIC's annual surplus to policyholders, against 95% currently
• An actuary to investigate LIC each year on operational and solvency parameters,
as against the current norm of once in two years
• Create a general reserve from surplus, which will help it offer social-security
schemes and improve its solvency margin—how much buffer it has to meet
exigencies. As of January 2010, LIC needed 50,000 cr, but had only 40,000 cr
• Government to offer sovereign guarantee, but review it periodically
Impact

 Brings uniformity among life insurers in capital norms.

 Strengthens LIC by building it a greater buffer, but this comes at the cost of
policyholders, who are likely to receive lower bonuses because of lower
surplus distribution.

Legislation

Its earlier avatar died with the last Lok Sabha. Re-introduced in 2009 and a house
panel presented its report to Parliament in March 2010.

PENSIONS

The Pension Fund Regulatory And Development Authority (PFRDA) Bill

Objective: Make the New Pension System (NPS) the first and last word in pension
planning

Proposals

• The PFRDA has been the pensions regulator for about seven years, but through
an executive order. So, it has to keep going back to the government for approval. Its
aim is to provide old-age security to all workers, but its NPS hasn’t taken off.
Instituting PFRDA as an act of Parliament will give it the sanctity, visibility and
universality it needs.

Impact

Government finances should improve as the NPS shifts the onus from the employer
to the employee. The NPS is a ‘defined contribution’ scheme—a person’s pension is
based on her contribution and the returns earned. The old system was based on
‘defined benefit’, where the government paid a person a pre-decided sum for life.
Government employees will not get a pension handout. But they can invest their
pension savings in equities. And nongovernment workers can access an investment
plan.

Legislation

Introduced in March 2005, panel report in July 2005, but the bill died with the Lok
Sabha in 2009. Needs to be reintroduced.

PRIVATE BANKS

Banking Laws Amendment Bill 2011

Objective: Give shareholders in private banks voting rights in proportion to their

holding

Proposals

Although details of the bill haven't been released officially, statements from the
government and finance ministry officials indicate the following:
• Shareholders in private banks will have voting rights in proportion to their equity
shareholding. At present, voting rights are capped at 10%, irrespective of
shareholding. In state-run banks, it is capped at 1%

• Reserve Bank of India (RBI) may get the power to inspect the books of financial
conglomerates that might be given bank licences

• Will answer if the Competition Commission of India would have the powers to
approve bank mergers

Impact

Gainers would be private banks such as Kotak Mahindra Bank and IndusInd Bank,
whose promoters hold more than 10%. If the RBI removes the 10% cap, private
banks can attract more investment, especially foreign.

Legislation

Likely to be introduced for the first time in the current session.

SBI

The SBI (Subsidiary Banks) Amendment Bill, 2009

Objective: Speed up decision-making in subsidiary banks of SBI

Impact

The Centre having the final say will make for faster decision-making at the SBI
arms.

Proposals

The bill pertaining to the merger of the five remaining SBI associates with its parent
is a separate one. This one pertains to decisionmaking at the subsidiaries. This bill
shifts some powers from the RBI to the Centre, notably on capital, bonus shares,
preferential allotment or private placement, appointment of chairmen, and
supersession of the board of directors in public or depositers' interest.

Legislation:

Introduced in Lok Sabha in 2009. A Parliamentary panel is considering the bill and
the government aims to pass this in the current session.

WORKING CAPITAL

The Factoring And Assignment Of Receivables Bill, 2011

Objective: Enable companies to encash receivables and reduce working capital

Impact

No stamp duty for factoring companies and companies manage their working
capital better
Proposals

In factoring, a company due to receive Rs 100 from a customer collects Rs 95 from

a factoring company. The factoring company collects Rs 100 from the customer.
Factoring companies have to pay stamp duty on sale/purchase of accounts
receivables, which is a major disincentive for them. The bill does away with this
requirement. It also proposes a central registry where any assignment of a
receivable will be recorded.

The legislation : Likely to be introduced for the first time in the current session.

DEBT RECOVERY

Bills to amend RDBFI Act 1993 and SARFAESI Act 2002

Objective: Who has the first right to recovering dues from a defaulter of loans ?

Proposals

Details are not available, but sources say a proposal looks to create ‘first charge
holder’ on a borrower’s assets. Recovery of excise duty, customs duty and service
charges will take precedence over secured creditors. The Recovery of Debts due to
Banks and Financial Institutions (RDBFI) Act fast-tracked loan recovery. The
Securitisation And Reconstruction Of Financial Assets And Enforcement Of
Security Interest (SARFESI) Act lets lenders sell distressed assets to recovery
specialists.

Legislation :

Government looking to introduce it in the current session.

CORPORATE SECTOR

The Companies Bill, 2009

Objective:
Overhaul the legislation that governs companies by increasing focus on corporate
governance, self-regulation, disclosures and enforcement

Proposals

• Stakeholders can initiate 'classaction suits'. Satyam Computer, for example, paid
$125 million to its US shareholders for fraud, but nothing to Indian ones because
this clause doesn't exist in India

• One-person company: Sole proprietors will be able to run businesses with limited-
liability concept. A business loss will not mean unlimited personal liability

• Statutory auditors will be rotated and cannot do non-audit work for a client
company

• CEO, CFO and the company secretary are designated as ‘key managerial
personnel’, and can be named in lawsuits. So far, it's the chairman and MD

• Consolidated financial statements to be mandatory

• A dedicated law tribunal to bypass lower courts and handle offences under the
bill, as well as liquidation and winding-up petitions

• Investigations under company law ssto be carried out by Central government, not
by sector regulators. Statutory status to the Serious Fraud Investigations Office
proposed

Impact

Companies will face fewer bureaucratic hassles while forming and running
business. At the same time, stronger enforcement creates space for harassment.
Shareholder and creditors benefit from greater transparency.

Legislation

The Companies Bill 2008, its predecessor, was introduced in October 2008, but it
lapsed. Its 2009 version was introduced in August 2009. A Parliamentary
committee has cleared it and it is waiting for a vote.
CORPORATE TAX:

Surcharge Budget Change:

Surcharge will be reduced —

(i) domestic companies from 7.5 per cent to 5 per cent

(ii) foreign companies from 2.5 per cent to 2 per cent.

Impact: These proposals would result in a marginal reduction in the corporate tax
rates:

Particulars From To
Corporate Tax
*Domestic 33.23% 32.45%
companies
*Foreign 42.23% 42.02%
companies
Dividend Distribution Tax (DDT)
*Domestic 16.61% 16.22%
companies

Minimum Alternate Tax (Mat) Budget Change:

Increase in MAT from 18 per cent to 18.5 per cent with effective rate for (i)
Domestic companies — 20.01 per cent (from 19.93 per cent)

(ii) Branches of Foreign companies — 19.44 per cent (from 19.53 per cent).

Impact: The additional tax burden would offset reduction in surcharge for MAT
paying companies. However, foreign companies would see a marginal reduction.
MAT for domestic companies at 20.01 per cent would align with the proposed rate
of 20 per cent in Direct Tax Code (DTC).

Power sector:

Power units commencing power generation, distribution or transmission, or

completing substantial renovation and modernisation before March 31, 2012 will
be eligible for tax holiday under section 80IA (4).

Impact: This extension would benefit existing investments missing the completion
deadline of March 31, 2011 who can enjoy grandfathering of benefits under DTC.
Investment/Expenditure Based Incentives Budget Change:

Housing and fertilizer industry — Businesses such as cold-chain, warehousing

facilities enjoy 100 per cent deduction of certain capital expenditure. This benefit
would now be extended to notified affordable housing projects and fertilizer units.

Scientific research — Contribution to scientific research programmes of national

laboratory/university/IITs, etc. would enjoy weighted deduction of 200 per cent
(from 175 per cent).

Impact:

The proposals are in line with the government’s policy shift towards incentivising
investments. These benefits would provide impetus to low cost housing and R&D in
the country. These benefits should be continued under DTC.

Special Economic Zones Budget Change:

MAT — SEZ developers and units would pay MAT AT 20.01 per cent

DDT — SEZ developers would also pay DDT at 16.22 per cent on dividends
distributed from SEZ profits

Impact: This proposal would advance levy of MAT and DDT on SEZs by a year
(from introduction of DTC). It may negatively impact cost of operating in an SEZ
and reduce investments in hitherto attractive SEZ Scheme.

Transfer Pricing (Tp) Budget Change:

1. Allowable variation between mean and transfer price to be notified.

Impact: The government has recognized that a one-size-fits-all variation of 5 per

cent does not address the dynamics of industry sectors. Customizing such
variation to diverse sectors is expected to lean towards an industry-friendly safe
harbor regime.

2. TPO’s powers are proposed to be extended — (i) to scrutinise international

transactions beyond those referred by the AO, (ii) to on-site survey.

Impact: The amendment seeks to overturn the Delhi Tribunal ruling in Amadeus
India Pvt. Ltd’s case, which restricted the TPO’s power to examine only AO referred
international transactions. On-site surveys will enable the TPO to verify the
function-asset-risk analysis given considerable importance in Tribunal rulings and
appreciate the comparability analysis better.

3. Due date for filing of tax return extended to November 30 for assessees
subject to TP compliance.

Impact: This proposal seeks to facilitate preparation of TP documentation based on

contemporaneous comparable data pertaining to the year of the international
transaction. The databases would also need to be suitably updated. The proposals
do not contain deferral of timeline for Tax Audit Reports.
Dividend From Foreign Subsidiary Company Budget Change:

Dividend received by domestic companies from overseas subsidiaries is proposed to

be taxed at 15 per cent on gross basis.

Impact: Taxation of such overseas dividend will be at par with domestic dividends
subject to DDT, with no benefit for losses. This would facilitate repatriation of
funds to India and taxation thereof in line with proposed Controlled Foreign
Corporation regulations under DTC.

Limited Liability Partnerships (LLPs) Budget Change:

LLPs are proposed to be charged Alternate Minimum Tax (AMT) of 18.5 per cent
(effectively 19.06 per cent). The tax will be charged on total income without
deductions under Chapter VI-A and that for SEZs. Credit for AMT paid can be
carried forward for set-off up to 10 years.

Impact: Whilst liberalization of FDI in LLP is still awaited, AMT has been
introduced. AMT is not on “book profits” but effectively, on gross total income. This
charge would affect LLPs having profit from businesses enjoying tax holiday under
SEZs. Unlike for companies, adjustment in income under the normal provisions
would vary AMT. Provisions for carrying forward AMT needs to be grandfathered
under DTC.

Infrastructure debt funds Budget Change:

Notified Infrastructure debt funds would be tax exempt. Non-residents receiving

interest from such funds would be taxed beneficially at 5 per cent.

Impact: The tax benefits would reduce funding costs for infrastructure
development. The government may consider extending the benefit to domestic
investors.
Reforms under the direct tax

Tax threshold Budget Change:

The Finance Bill proposes upward revision of the minimum threshold of taxation:

Current Proposed Savings

Category
(Rs) (Rs) p.a. (Rs)
Individuals < 60 years 160,000 180,000 2,060
Resident women < 60 years 190,000 190,000 Nil
Senior citizens (Men) 60-64 years 160,000 250,000 9,270
Senior citizens (Women) 60-64 years 190,000 250,000 6,180
Senior citizens 65-79 years 240,000 250,000 1,030
Very senior citizens =/> 80 years 240,000 500,000 26,780

Impact Analysis:

The real benefit of this measure would be for senior citizens between 60 and 64
years who will save Rs.9,270 and persons above 80 years who will save Rs.26,780
p.a. provided they have matching income at that age.

Exemption on filing Income tax returns

India’s government may soon exempt some salaried taxpayers from filing income-
tax returns if they do not have any other source of income besides their salary and
the employer has already deducted the tax before the payment of wages.

The aim is to reduce paper work if salary is your only source of income and your
employer has deducted tax at source.

Priorities are directed towards making taxes moderate, payments simple for the
taxpayer and collection of taxes easy for the tax collector.

Experts expect few to benefit as a salaried person with even a basic savings
account may be excluded from the category. Other income may include interest
earned on a savings account or a fixed deposit with a bank and capital gains made
from sale of property or stock among other items.
Reforms under the indirect tax regime

Budget widens service tax net

(Certain types of hotel rooms, air conditioned restaurants, air travel and healthcare
services brought under the services tax purview)

The increasing contribution of the service sector to gross domestic product (GDP)
and an effort to bridge the gap between the present service tax regime and the
proposed goods and services tax (GST) have prompted Pranab Mukherjee to bring
some more services under the service tax net. While the rate of service tax has been
retained at 10%, new services have been added to the list of those to be taxed and
the scope of existing service categories expanded or rationalized. The new services
for which you will have to pay more are certain types of hotel accommodation, air
conditioned restaurants, healthcare services and air travel.

The service tax will be levied on half the billed amount, effectively reducing the
burden to 5% of the amount charged. Similarly, there is an abatement of 70% on
restaurants that serve alcohol, reducing the service tax applicable to just 30% of
the bill. Most of these establishments already bear luxury tax imposed by the state
governments, and hence, are likely to pass this additional burden on to the
consumer.

The service tax on economy class airfare has been increased by Rs.50 to Rs.150 on
domestic sectors and by Rs.250 to Rs.750 for international travel. Domestic travel
by business class or any other class higher than economy will attract a service tax
of 10% on the value of the service provided by the airline, which will have a steep
increase from the earlier Rs.100 per ticket.

A nominal 1% central excise duty has also being imposed on 130 items, many of
them consumer goods that were earlier exempt from certain indirect taxes. Certain
types of hotel accommodation, air conditioned restaurants, healthcare services and
air travel brought under the services tax purview.

Going the FII way to MFs

Budget 2011 wants foreign individual investors to invest in Indian equity-oriented

mutual fund (MF) directly. Presently, foreign institutional investors can directly
invest in Indian equity schemes. However, foreign individuals cannot directly put in
their money. Typically, they can invest in foreign fund houses.

This move will enable them to invest in Indian funds managed by Indian fund
managers.

Such investors who wish to invest in Indian MFs will need to meet know-your-client
(KYC) norms before investing. Effective 1 January 2011, KYC has been made
compulsory irrespective of the amount you invest in an MF. Earlier, KYC was
required only for investments worth Rs. 50,000 and more. The requirement is
aimed at preventing money laundering as key documents and details —such as
bank details, permanent account number (PAN), residence proof — are captured by
way of the KYC process to ensure that the investor is genuine.
New synergies:
MF houses will need to tie up with foreign distributors to be able to push their
schemes and attract investors. For instance, HDFC Asset Management Co. Ltd
has tied up with Credit Suisse’s Asset Management (a Switzerland-based
fund house that has an international presence) for the latter to distribute the
former’s schemes wherever Credit Suisse is present.

Although it has been a welcome move, it has been observed that allowing foreign
individuals to invest may also lead to volatility

Something that is concerning MFs: Higher dividend distribution tax

Budget 2011 has increased the dividend distribution tax paid on dividends
distributed by liquid and debt MF schemes to corporate investors. The dividend
distribution tax (DDT) for corporate investors now stands at 32.45% (all rates
including surcharge and cess), up from 27.68% a year back.

Impact:
From 1 June 2011, corporates may not find liquid funds to be an attractive parking
vehicle.
Incremental inflows in long bond funds will be affected. Though that tax paid on
parking funds in these funds will attract a higher tax outgo, liquidity is the main
purpose of corporates parking their money in these schemes.

CONCLUSION

Union Budget 2011-12 stays on fiscal corrective course perhaps aided by a few
optimistic assumptions. While there is no new big bang reform, already announced
measures such as DTC and GST remain on track. Revenue estimates appear
reasonable. On expenditure, infrastructure, agriculture and various inclusive
development programs received renewed attention. A key risk to all of this is a
further flare-up in oil prices.

Thus, all’s well if oil’s well!