should the Budget do?
- Girish Vanvari and Vikram Naik
'Our government will have to focus on implementing and strengthening
the infrastructure investments' said Mr. Pranab Mukherjee on being
elected as the Finance minister for the coming 5 year term. In the
interim budget earlier, Mr. Mukherjee had emphasised the significance
of the forthcoming policies to bridge the gap in infrastructure
development by increasing investment therein to more than 9 percent of
GDP by 2014. The infrastructure currently in place is inadequate, with
port capacity needing to double by 2012, peak power deficits, and the
majority of current road projects running behind schedule. The growing
economy can be expected to put further strain on infrastructure
services. The current economic scenario is deterring private players
from investing in infrastructure, leaving room for increased
government initiative. While the government has been consciously
increasing infrastructure spend, some of the below fiscal measures may
be introduced in the forthcoming budget to provide impetus to its
plans.
The coveted '80IA Benefit'
Section 80IA of the Income Tax Act provides for deductions in respect
of profits and gains of enterprises engaged in infrastructure
development. Section 80IA (12) which earlier allowed continuity of
benefit of deduction to any enterprise transferred in a scheme of
amalgamation or demerger to the amalgamated/resultant company, was
withdrawn in the Finance Act 2007 with the introduction of subsection
(12A). While the rationale behind this withdrawal was to provide
incentive for initial investment and entrepreneur risk, we believe it
stifles the broader objective of Section 80IA benefit which is to
attract private investments in infrastructure. Enterprises now can
consider M&A activity only at the risk of losing the tax benefits.
Restructuring is crucial to global competitiveness and thus companies
need to reposition themselves quickly, especially in the current
economic environment. Additionally, 80IA does not mention anything
with respect to availability of benefit in situations other than
amalgamation or demerger, such as transfer via a slump sale.
Investment via M&A would be spurred if the restriction under
sub-section (12A) is revoked from retrospective effect and the
position on other methods of transfer is clarified.
It would also be worthwhile to explore the option of expanding the
scope of Section 80IA to exempt any income derived from modernisation,
upgradation, renovation and repair of infrastructure facilities. This
would also help attract investments in the airports and seaports,
which require extensive technological upgradation and modernisation to
meet the burgeoning demand.
Earlier benefit of deduction was available to even companies which
executed works contracts entered into with an infrastructure
undertaking. However, the same was repealed in 2007. Thus, the benefit
is now limited to entities which directly enter into an agreement with
the government to develop, operate and maintain infrastructural
facilities. However, it defeats the intent of the section which is to
provide incentive to enterprises engaged in the development of
infrastructure projects. Infrastructure contracts are spread over a
long duration and involve continuous sub-contracting. In view of this,
believe that benefit of deduction should be extended to such
sub-contractors as well.
Most infrastructure investments are capital intensive and have long
gestation periods. Although enterprises engaged in infrastructure
development are eligible for tax deduction under section 80IA, they
are liable to pay minimum alternate tax (MAT). Despite the
availability of MAT credit in the future, impact on the current cash
flows of companies strains their working capital. Thus, exemption from
MAT is sought to enable these companies to avail complete tax relief.
The finance minister should also consider extending the sunset clause
so that there is no interruption in the momentum of the investments in
this sector which requires a very strong progressive factor at this
stage of growth.
Investments in Brown-field projects
Currently, only companies in the business of development and
maintenance of infrastructure facilities, as defined under section
80IA, could be accorded the status of a venture capital undertaking
under section 10(23FB) and enjoy the benefits stated therein. However,
besides new infrastructure facilities, India also needs to make
massive and continuous investments in its existing but worn-out
infrastructure facilities. Thus, the finmin should consider including
companies undertaking restoration of such facilities to encourage
structured investment in these sectors.
Tax exemption under Section 10(23G)
Section 10(23G) exempted dividends, interest and long-term capital
gains (LTCG) of financing companies/banks investing in infrastructure
companies This reduced the cost of capital for infrastructure projects
at a time when interest and tax rates were high. These benefits were
repealed by the Finance Act 2006 on the grounds that the tax and
interest rates had come down, dividends distributed by domestic
companies were already exempt under Section 10 (34), and LTCG were
exempt on sale of investment in listed companies.
However, Dividend Distribution Tax (DDT) and MAT haven't allowed
complete freedom from tax since 2006. Also, it has made it harder for
infrastructure projects to establish credit support from lenders. This
is matter of concern as a large portion of the estimated $300 billion
in infrastructure investment over the next 5 years is expected to come
from the private sector. Investment in this sector would still be
subject to DDT, LTCG and MAT. Reinstating the 10 (23G) benefit would
address issues related to cost of capital, promote private
participation and increase capital liquidity and availability.
Double Tax Avoidance
Infrastructure companies usually have a multi-layer company structure.
Special Purpose Vehicles (SPVs) are incorporated for various reasons
one of which is required as per the covenants of the PPP Concession
Agreements entered into with the government. This means that dividend
distributed by the multi-layers of SPVs to the holding company is
subject to DDT everytime they declare dividend. Credit is available
under section 115O for the DDT paid only at one level below the
holding company. Providing relief from this double taxation in a
manner similar to the exemption granted to SEZ Developers would boost
the rate of return for private companies and encourage further
investment in the sector.
To summarise, in the recent past, the infrastructure sector has
witnessed enormous growth but it has been within the parameters of
various restrictions. However, given the need of the hour, its time to
rationalise these restrictions. The burgeoning demand for
infrastructure development not only presents a huge area of
opportunity, but will also undoubtedly augment India's impressive
growth trajectory. Hopefully, Mr. Mukherjee would translate his words
into actions to be able to justify the whole hearted mandate the UPA
government has received by the still optimistic people of this country
for an India Shining (actually).
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