Taxation
Taxation of investment vehicles: Will the Budget set right the distortions - I

Financial markets are hopeful that the Budget will clarify different and confused tax provisions regarding investment vehicles such as mutual funds, trusts and private equities

 

All over the world, there are clear rules for being eligible for pass-through status, but unfortunately, the principles on representative taxation in India have never been designed to tax collective investment devices. These principles have been created over the years to tax trusts where tax payers may create pools of assets/ income which beneficially belong to a tax payer, but are not legally his. Therefore, there are situations where such a “representative assessee” is required to pay tax at maximum marginal rate (MMR) which defeats the purpose of these collective investment vehicles at the first place.
 
The least what Finance Minister Arun Jaitley should do, in Budget 2015, is to set right the highly distorted scene of taxation of investment vehicles. These vehicles include the private equity (PE) funds and venture capital funds (VCFs), collectively called alternative investment funds (AIFs), securitisation vehicles, real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). Lest you should think these are some esoteric instruments that don’t matter to the country’s economy in general, you are actually mistaken. Each of these investment vehicles is crucial for the country’s economy:
 
A large part of the foreign direct investment into the country comes through these vehicles. Over years, private equity funds have brought billions of funds into the country.  The India Private Equity Report, 2014 states that in 2014, Indian PE industry did deals worth $11.8 billion -- lower than the 2011 levels which were at $14.8 billion. It is important to note that capital is much more important than debt- capital and is like the foundation of a business on which the edifice of debt is built.
 
Securitisation activity is crucial for the business model of the non-banking finance companies in the country which supplement bankers’ access to the so-called priority sector lending market. NBFCs are instruments of financial inclusion, and their business model substantially hinges on securitisation. 
 
REITs have been proposed in the last Budget, but have not taken off at all. REITs are expected to be crucial in reviving or unlocking investments in commercial real estate. Commercial real estate has a substantial multiplier effect - it brings employment, affects core sector industries, and so on.
 
Infrastructure investment trusts, another non-starter, was expected to revive the so-very-crucial infrastructure sector in the country. 
 
Tax issues continue to baffle funds:
 
Currently, the tax law pertaining to taxation of investment conduits is either legislatively uncertain, or is lopsided. The different taxing principles under the Income Tax Act, 1961, for taxing different forms of investment vehicles in India are as follows:
 
Mutual funds, taxed under Section 115 R
 
Venture capital funds, taxed under Section 10 (23FB) read with Section 115U
 
Alternative investment funds – no tax provisions, hence, taxed under normal tax principles of representative taxation
 
Securitisation trusts – taxed under Section 115TA to 115TC (Chapter XII EA)
 
Real estate investment trusts – Section 10 (23FC), 10 (23FD) and 10 (38) read with Section 115 UA
 
All other collective investment vehicles – no tax provisions, hence, taxed under normal tax principles of representative taxation
 
The various fund structures existing in India are covered by different tax regime. Even though the fund structures are similar, the practice of applying different tax principles on them is not clear. This divergence creates much ambiguity on the whole. In some investment vehicles there is a partial pass-through and in some cases there is representative taxation made applicable. While the intent with which each of these vehicles is set up is similar, the tax implications vary across vehicles.
 
Most of these vehicles are set up in a trust form (a non-charitable business trust) and there have several issues with regard to such trusts being revocable, determinate, discretionary or otherwise. The tax treatment of these trusts has been dependent on the nature of these trusts.

The critical issue in taxation for consideration, for all these conduits is whether there will be a pass-through for tax purposes, or the fund is a tax-opaque entity. A pass-through taxation is the most convenient form of taxation, as the investors pay their own taxes, and the fund as a collective investment device is not required to pay any taxes at the fund level. All the more there is no duplication of taxes or leakage of taxes. On the other hand, if there is a claim to tax as an AOP, company, firm or as a representative assessee, the fund itself is not tax transparent. The tax officer taxes the fund; the distributions made by the fund may not be chargeable to tax. 
 
Far from following a clean pass-through principle, the Indian system is extremely muddy, allowing for contradictory interpretations. A recent ruling of Bangalore Income Tax Tribunal has shown this. We explain that in the next part, and also how to clean things up.
 
(Vinod Kothari is a chartered accountant, trainer and author. Nidhi Bothra is executive vice president at Vinod Kothari Consultants Pvt Ltd)

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Will the Budget provide tax relief to civil aviation sector?
Once the Budget provides some tangible relief to civil aviation sector, chances are that some airlines would come forward to adopt certain airports as their own, establish their hubs, look at regional connectivity closely and help generate employment opportunities
 
The general feeling in the aviation sector is that the Union Budget to be presented by Finance Minister Arun Jaitley on 28th February, may provide them with some cheer, particularly on the reduction of taxes on the aviation turbine fuel (ATF). Many states levy value added tax (VAT) ranging from 4% to 30% and the industry hopes that this should be unified across the States to be not more than 3% or 4%.
 
Direct import of ATF is possible but the infrastructure needed to facilitate its transportation is actually dominated by the oil marketing companies (OMCs).  If, as a sequel to the Budget, the Centre ensures that this infrastructure is made accessible or shareable with private airlines, which are willing to import ATF directly. This would not work to mutual advantage.
 
It is reported in the press that, according to Vivek Gour, MD and CEO of Air Works, the tax implications are a great burden on the maintenance, repair and overhaul (MRO) industry.  He points out that the service tax amounts to 12.36% while VAT varies from 12%-15% (average) and Royalty charged by airport operators comes to 13% to 20%.  He feels that the MRO industry, which can hopefully provide for employing 12,000 to 15,000 skilled workers is giving away this business opportunity to Singapore, Sri Lanka and Nepal, who can offer the facility practically 30% to 35% cheaper than their counterparts in India.  
 
In the meantime, Karnataka State Government are trying woo Vistara to set up its hub in Bengaluru, as the Kempegowda International Airport (KIA) has already crossed the 7 million passenger traffic and is growing at a fast pace. To entice Vistara to make Bengaluru its hub, like its distant cousin, Air Asia, talks are afoot with their CEO, Phee Teik Yeoh to tackle the high incidence of sales tax on ATF.
 
Vistara, like Air Kerala, has also made its intent known that, whenever the Civil Aviation Ministry comes out with the new regulations, replacing the 5/20 rule, they would seriously work on taking long haul trips to the West, which, according to their study accounts for as much as 70% of outbound Indian traffic goes to West. They aim to cover flights to reach New York and Washington DC, and, presumably stop at suitable locations in Europe.
 
Once the Budget provides some tangible relief to this industry, chances are that some airlines would come forward to "adopt" certain airports as their "own", establish their hubs, look at regional connectivity closely and help generate employment opportunities. The Budget could also provide some extra special facilities, in terms of taxes and the like, if private airlines come forward to build low cost terminals. This will enable the low cost carriers to use them on a regular basis, and serve the purpose well.
 
With the recent change in the ownership of SpiceJet, the aviation industry may be able to meet the growing needs of the air travellers and any relaxation that can be given in the budget would enable the industry to overcome the tax hurdles currently faced by them.
 
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)

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Finance Commission suggests higher share for states in central taxes

As per the increased devolution suggested by the 14th Finance Commission, states will get a share of Rs3.48 lakh crore in 2014-15 and Rs5.26 lakh crore in 2015-16 in central taxes

 

The Finance Commission has suggested raising share of states, including taxes and grants, in central taxes to 42% from current 32%. 
 
As per the increased devolution suggested in the report of the 14th Finance Commission, the states will get Rs3.48 lakh crore in 2014-15 and Rs5.26 lakh crore in 2015-16.
 
"The higher tax devolution will allow states greater autonomy in financing and designing of schemes as per their needs and requirements," the report tabled by Finance Minister Arun Jaitley in Parliament on Tuesday says.
 
The commission, headed by former Reserve Bank of India governor Y V Reddy, said the states should use this extra fiscal space for productive assets.  
 
The report, however, has a dissenting note from Abhijit Sen, a member of the now defunct Planning Commission. 
 

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COMMENTS

MG Warrier

3 years ago

The rise in the states' share of central taxes is indicative of Centre'sresolve to respect the rights of, and extend a helping hand to, states. This should be followed up with support to states to mobilise resources to meet internal needs.

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