Overview
Budget 2011 proposes relatively limited changes in the taxing framework for the Financial Services
industry. Though, on the face of it, it may appear that the Budget could have done more for the
Financial Services industry, on balance, it seems to be a fairly good budget as it has targeted an
annual growth rate of approximately 8.6 percent, and has put much more emphasis on the
infrastructure sector, which is closely inter-twined with the Financial Services industry. This would
help the Financial Services industry leverage off the various initiatives taken by the Government for
benefitting the infrastructure sector.
Key budget proposals
Policy announcements
Fiscal Consolidation
As part of the Government's initiative towards fiscal consolidation, the Government is in the
process of setting-up an independent Debt Management Office in the Finance Ministry.
Currently, a middle office is already operational. As a next step, the Government proposes to
introduce a new Bill in Parliament, in the next financial year, to be called the Public Debt
Management Agency of India Bill, which will help the Government achieve its objective of
having an independent Debt Management cell.
Foreign investment in Indian Mutual Fund schemes
Currently, only Securities and Exchange Board of India ("SEBI") registered FIIs / sub-accounts
and NRIs are allowed to invest in mutual fund schemes that are launched by Indian mutual
fund houses. The Government seems keen to liberalise portfolio investment from foreign
investors, into investment schemes floated by Indian mutual fund houses. To this effect, the
Government has decided to allow foreign investors who meet the KYC requirements prescribed
by SEBI, to invest in equity schemes of Indian mutual fund houses. This should help enable
Indian mutual funds to have direct access to foreign investors and widen the class of foreign
investors that access the Indian equity markets.
Budget 2011 does not specify whether this new investment window will be open to all
categories of foreign investors or to a select category of foreign investors, and we will need to
wait and see what corresponding changes are brought about by the Reserve Bank of India
("RBI") and SEBI to the Indian exchange control regulations and securities laws in this regard.
Currently, foreign corporates and foreign individuals that (i) have a sound financial track record,
(ii) are of particular size, and (iii) whose monies are professionally managed by foreign
investment managers, are allowed to invest in Indian mutual fund schemes through the FII-subaccount route. It will be interesting to see whether the new investment window spoken about by
the Finance Minister will allow other categories of foreign investors (who do not qualify for
registration with SEBI as foreign corporate sub-accounts or foreign individual sub-accounts), to
invest directly into equity schemes of Indian mutual fund houses.
Foreign Institutional Investors ("FII")
Currently, FIIs / sub-accounts are allowed to invest in 'listed' or 'to be listed' corporate bonds
that are issued by Indian corporates that engage in the infrastructure sector, up to an
aggregate limit of USD 5 billion. This is subject to the corporate bonds, inter-alia, having a
residual maturity of over five years. To enhance the flow of funds to the infrastructure sector,
the Finance Minister has proposed to increase the overall limit available to FIIs to invest in
Contacts
Bobby Parikh
Bobby.Parikh@bmradvisors.com
+91 22 30217010
Shefali Goradia
Shefali.Goradia@bmradvisors.com
+91 22 30217170
Ajay Mehra
Ajay.Mehra@bmradvisors.com
+91 22 30217030
such corporate bonds to be issued by Indian infrastructure companies by USD 20 billion;
thereby increasing the investment limit from the existing cap of USD 5 billion to USD 25 billion.
Thus, the overall cap now available to FIIs to invest in 'listed' or 'to be listed' corporate bonds to
be issued by all Indian companies is increased from the existing limit of USD 20 billion to USD
40 billion. We have tabulated these limits below:
FII investment caps
Existing caps
Proposed caps
(US$)
(US$)
5 billion
25 billion
15 billion
15 billion
20 billion
40 billion
Corporate Debt in Infrastructure Sector (as is
defined in the ECB policy) having a residual
maturity of over five years
All other Corporate Debt
Total
Recognising that most of the infrastructure companies are organised in the form of Special
Purpose Vehicles ("SPVs"), Budget 2011 proposes to allow FIIs to also invest in 'unlisted
bonds' of such SPVs, with a minimum lock-in period of three years. The FIIs will be allowed to
trade among themselves in these 'unlisted bonds' during the lock-in period. At this stage, it is
unclear whether any quantitative restrictions will apply and how the debt limits will be allocated
to the various FIIs. Hence, one will need to wait until SEBI issues its directional circulars in this
regard.
Banks
Close on the heels of the discussion paper that was issued by the RBI in August 2010, on entry
of new banks in the private sector, the RBI has proposed some amendments to the Banking
Regulation Act, 1949. The Finance Minister has reiterated his commitment to bring about
suitable legislative amendments in this regard, in the current session of Parliament. He has
also indicated that the RBI is planning to issue the guidelines for new bank licenses before the
end of the current financial year ("FY") (ie before March 31, 2011).
The Government proposes to provide INR 60 billion to Public Sector Banks for FY 2011-12 to
enable them maintain a minimum Tier I Capital to Risk Weighted Assets ratio of 8 percent.
As part of an initiative to financially strengthen Regional Rural Banks, the Government
proposes to recapitalize Regional Rural Banks by INR 5 billion to enable them maintain a
minimum Capital to Risk Weighted Assets ratio of 9 percent as on March 31, 2012.
Financial inclusion
In last year's budget, the Government had advised banks to provide banking facilities to
habitations having a population of over 2,000 by March 2012. The banks identified about
73,000 such habitations for providing banking facilities using appropriate technologies. A multimedia campaign, 'Swabhimaan', has been launched to inform, educate and motivate people to
open bank accounts. During FY 2010-11, banks are expected to cover 20,000 villages, while
the remaining villages are expected to be covered during FY 2011-12, thus achieving what the
Government sought to do last year.
In last year's budget, the Government had announced a co-contributory pension scheme called
'Swavalamban'. Workers in the unorganised sector have welcomed the scheme. Over 400,000
applications have already been received. On the basis of the feedback received, the
Government proposes to relax the exit norms for participants in this pension scheme, whereby
a subscriber under 'Swavalamban' will be allowed to exit (i) at the age of 50 years instead of 60
years, or (ii) a minimum tenure of 20 years, whichever is later. The Government also proposes
to extend the benefit of Government contribution from three years to five years for all
subscribers of 'Swavalamban' who enrol during FY 2010-11 and FY 2011-12. The Government
anticipates that an estimated 2 million beneficiaries will join the scheme by March 2012.
Under the on-going Indira Gandhi National Old Age Pension Scheme for Below The Poverty
Line beneficiaries, the eligibility for pension is proposed to be reduced from the present age of
65 years to 60 years. Further, for those who are 80 years and above, the Government has
increased the monthly pension slightly.
Microfinance sector
Budget 2011 recognises the critical role played by Micro Finance Institutions ("MFIs") in
financial inclusion, and recognises that creation of a dedicated fund for providing equity to
smaller MFIs would help them maintain growth and achieve scale and efficiency in operations.
Russell Gaitonde
Russell.Gaitonde@bmradvisors.com
+91 22 30217045
To this end, the Government has announced that during the course of the year it will create a
'India Microfinance Equity Fund' with SIDBI, with a corpus of INR 1 billion, to focus on such
initiatives.
The Government also proposes to create a 'Women's Self Help Group's Development Fund',
with a corpus of INR 5 billion, which will help empower women and promote Women Self Help
Groups.
The Malegam Committee that was set-up by the RBI to look into the issues relating to the
micro finance sector in India has submitted its report to the RBI. The Government has indicated
that it is considering putting in place an appropriate regulatory framework to protect the
interests of the small borrowers in India.
Infrastructure financing
To attract foreign investment in infrastructure financing, the Government proposes to create
Special Vehicles in the form of notified infrastructure debt funds, which will focus on providing
financial assistance to the Indian infrastructure sector. The notified infrastructure debt funds will
be given tax-exempt status and the investors in these funds will be taxed at concessional
rates.
The Government has updated that the India Infrastructure Finance Company Ltd ("IIFCL"),
which it set-up to provide long-term financial assistance to infrastructure projects is expected to
achieve a cumulative disbursement target of INR 200 billion by March 31, 2011 and INR 250
billion by March 31, 2012. The take out financing scheme that was announced by the
Government during Budget 2009 has also been implemented and seven projects have been
sanctioned with a debt of INR 15 billion, with an additional INR 50 billion to be sanctioned
during FY 2011-12.
In order to give a boost to infrastructure development in railways, ports, housing and highway
development, the Government proposes to allow various Government undertakings to issue
tax-free bonds of INR 300 billion during FY 2011-12. This will include Indian Railway Finance
Corporation – INR 100 billion, National Highway Authority of India – INR 100 billion, HUDCO –
INR 50 billion and Ports – INR 50 billion.
Rural Infrastructure Development Fund
The Rural Infrastructure Development Fund, which is popular among State Governments, is an
important instrument for routing bank funds for financing rural infrastructure projects. The
Government has pledged its commitment to support this Fund and has proposed to raise the
corpus of the Fund by INR 20 billion, from the existing corpus of INR 160 billion to INR 180
billion. The additional allocation of INR 20 billion is to be used for creation of warehousing
facilities in rural India.
Micro, Small and Medium Enterprises
The Government has recognised that Micro and Small enterprises play a critical role in
furthering the objective of equitable and inclusive growth. The Government now proposes to
provide INR 50 billion to SIDBI, to refinance incremental lending by banks to such enterprises,
out of the shortfall of banks on priority sector lending targets.
The Government has also recognised the economic stress that handloom weavers are facing in
India, because of which the weavers are unable to repay their debts owed to handloom weaver
co-operative societies. This has made the handloom weaver co-operative societies in India
financially unviable. The Government now proposes to provide INR 30 billion to NABARD, in a
phased manner, to help bail out these co-operative societies. This initiative of the Government
is expected to benefit 15,000 co-operative societies and about 300,000 handloom weavers.
The details of the scheme are to be worked out by the Ministry of Textiles in consultation with
the Planning Commission.
Housing sector
To stimulate growth in the housing sector, the Government proposes to liberalize the extant
scheme of interest subvention of 1 percent on housing loans by extending it to housing loan up
to INR 1.5 million (presently INR 1 million) where the cost of the house does not exceed INR
2.5 million (presently INR 2 million).
Recognizing the increase in prices of residential properties in urban areas, the Government
propose to raise the existing housing loan limit for dwelling units under priority sector lending
from INR 2 million to INR 2.5 million.
To provide housing finance to targeted groups in rural areas at competitive rates, the
Government proposes to enhance the provision under the Rural Housing Fund to INR 30 billion
from the existing INR 20 billion.
The Government has announced creation of a Mortgage Risk Guarantee Fund, to address the
issue of credit enablement of Economically Weaker Sections ('EWS') and Low Income Group
('LIG') households. The proposed fund is expected to guarantee housing loans taken by EWS
and LIG households and enhance their credit worthiness.
To prevent frauds in loan cases involving multiple lending from different banks on the same
immovable property, the Government has facilitated setting up of a Central Electronic Registry
under the SARFAESI Act, 2002. The Registry is expected to be operational by March 31, 2011.
Financial Sector legislative initiatives and sectoral reforms
In last year's budget, the Government had announced that a Financial Sector Legislative
Reforms Commission ("Commission") would be established to rewrite and streamline the
financial sector laws, rules and regulations and bring them in harmony with the requirements of
a modern financial sector. The Government has now updated that the Commission is expected
to complete its work in 24 months.
The Government has indicated that it is committed to financial sector reform and proposes to
move the following legislations in Parliament, that are relevant to the Indian financial sector:
The Insurance Laws (Amendment) Bill, 2008
The Life Insurance Corporation (Amendment) Bill, 2009
The revised Pension Fund Regulatory and Development Authority Bill (first introduced in
2005)
The Banking Laws Amendment Bill, 2011
The Bill on Factoring and Assignment of Receivables
The State Bank of India (Subsidiary Banks Laws) Amendment Bill, 2009
The Bill to amend the Recovery of Debts due to Banks and Financial Institutions ('RDBFI')
Act, 1993, and SARFAESI Act, 2002
Direct tax proposals
Notified Infrastructure Debt Funds
To attract foreign investment in infrastructure financing, the Government proposes to create
Special Vehicles in the form of Infrastructure Debt Funds, which will focus on providing financial
assistance to the Indian infrastructure sector. Budget 2011 proposes to grant a beneficial tax
regime for such funds as well as the foreign investors in the funds. We have highlighted below
the key tax issues associated with the Funds and the foreign investors in the Funds:
Taxation at the Fund level
The Funds are to be set-up in accordance with prescribed guidelines and are to be
notified by the Central Government in the Official Gazette.
The Funds are to enjoy tax-exempt status.
They are required to file annual tax returns with the Indian Revenue authorities.
The Funds are required to withhold tax at the concessional tax rate of 5 percent (as
opposed to the current tax rate of 20 percent), while making interest payments to the
foreign investors in the funds.
Taxation at the foreign investor level
Foreign investors in the funds would be taxable at the concessional tax rate of 5 percent
on interest received from the funds.
If such interest is the only source of income that is earned by a foreign investor, on which
adequate tax has been withheld at source, then the foreign investor need not file a tax
return in India reporting the interest income to tax.
They would be entitled to tax treaty benefits, if any.
Open issues
The proposed tax law, which is to become effective from June 1, 2011, is silent on how the
prescribed guidelines are to work in the context of the Infrastructure Funds. The tax law is also
silent on whether the foreign investors in the Funds will be able to earn income in the form of
any other source from such Funds (eg profit on redemption of units to be issued by the Funds,
which could arise in case of a Growth option). In such a situation, the concessional tax rate of 5
percent that has been prescribed above, may not apply to the foreign investors and they may
be liable to tax on such income as normal capital gains or business profits. Correspondingly,
the Funds would need to withhold tax at source at the applicable tax rates, while making the
payments to the foreign investors. However, foreign investors should continue to be eligible for
tax treaty benefits, if any.
Mutual Funds
Budget 2011 proposes to increase the distribution tax that is payable by Indian mutual funds on
the income they distribute to the unit holders in their non-equity oriented investment schemes.
This is to be made effective from June 1, 2011. We have tabulated the existing and proposed
tax rates:
Type of mutual fund schemes
Existing tax rate
Proposed tax rate
25%
25%
Money Market Mutual Funds or Liquid Funds
- Payable to all other categories of investors
25%
30%
Other
non-equity
oriented investment
schemes - Payable to Individuals or HUFs
12.5%
12.5%
20%
30%
Money Market Mutual Funds or Liquid Funds
- Payable to Individuals or HUFs
Other
non-equity
oriented investment
schemes - Payable to all other categories of
investors
Housing expenditure
Budget 2011 proposes a tax deduction for capital expenditure (other than expenditure incurred
on land, goodwill and financial instrument) incurred by a taxpayer on or after April 1, 2011 for
developing and building a housing project under a scheme for affordable housing framed by
the Central Government or the State Government, as the case may be, and notified by the
CBDT in accordance with the guidelines as may be prescribed by the Government.
Contributions to the New Pension Scheme
Currently, contributions made by an employee as well as by the employer to the New Pension
System ("NPS") account, on behalf of the employee, are allowed as a tax deduction for the
employee subject to overall limit of INR 100,000. Budget 2011 proposes that the employer's
contribution to NPS shall be excluded from the overall limit of INR 100,000 of permissible
deductions.
Additionally, under the current tax law, contributions made by an employer to the NPS are not
allowed as tax-deductible expenditure. Budget 2011 proposes that such employer's contribution
to NPS would be allowed as a tax-deductible expenditure subject to an overall limit of 10
percent of the salary of the employee.
Subscriptions to Long-term infrastructure bonds
Under the current tax law, an additional tax deduction of INR 20,000 (over and above the
overall limit of INR 100,000) is allowed in computing total income of an individual or a HUF if
the sum is paid or deposited during the FY 2010-11 in long-term infrastructure bonds as are
notified by the Central Government. Budget 2011 proposes to extend this benefit for one more
year and continue granting the additional tax deduction of INR 20,000 for investments in such
notified long-term infrastructure bonds during FY 2011-12.
Liaison Offices ("LO") – Filing of tax returns
Non-residents operating in India through LOs (eg foreign banks that set-up LOs in India)
typically do not file tax returns in India on the basis that they are not permitted to carry out any
commercial activity and hence do not earn any income in India. With an objective to seek
regular information, Budget 2011 proposes that every non-resident taxpayer that has a LO in
India must file an Annual Information Statement with respect to the activities being undertaken
by the LO. Such statement must be filed with the jurisdictional Assessing Officer, in the
prescribed form and with the prescribed details within sixty days from the end of the FY
concerned. This amendment is proposed to be made effective from June 1, 2011.
Indirect tax proposals
The basis of levying service tax on purchase or sale of foreign exchange has been changed
with effect from April 1, 2011. Service tax would now apply at 0.1 percent of 'value' determined
as under:
For a currency exchange from / to INR, amount equal to the difference between the
buying rate or the selling rate, as the case may be, and the RBI reference rate for that
currency for that day, multiplied by the total units of currency.
In case where the RBI reference rate for a currency is not available, amount equal to 1
percent of the gross amount of INR provided or received, by the person changing the
money.
In case where neither of the currencies exchanged is INR, amount equal to 1 percent of
the lesser of the two amounts the person changing the money would have received by
converting any of the two currencies into INR on that day at the reference rate provided
by the RBI.
The option of paying service tax on an amount charged as 'fee' for such purchase or sale of
foreign exchange appears to have been withdrawn.
The scope of exempt services has been specifically amended to cover 'trading'. Thus, all
proprietary trading activities would now be specifically treated as exempt services triggering
(specifically) denial of input credits relatable and attributable to such trading activities. The
amendment seems to be clarificatory, and its retroactive application needs to be examined.
Service providers providing taxable and exempt services (which now also includes trading) and
classifying their (taxable) services under 'banking and other financial services' ("BOFS") have
faced challenges on determining the proportion of credits that are eligible. An option that has
always been provided under the regulations is to maintain separate records for inputs and input
services used for taxable services and exempt services, else proportionate reversals (based on
ratio of exempt turnover) apply.
A specific provision has been added to the effect that such service providers would be eligible
to only 50 percent CENVAT credit available to them. The manner in which this would operate is
that the service provider would avail eligible credits, and then be required to "pay" back (or
reverse) 50 percent of the credit. This scheme applies by default and other options (of
proportionate reversal) are not available to such service providers. The provision would be
effective from April 1, 2011.
Similar provision has been inserted for insurers providing 'life insurance' related services and
services of 'management of ULIPs'. For these services, a cap of 20 percent (instead of 50
percent above) has been prescribed. In other words, 80 percent of the credit would have to be
reversed / paid back. Again, this scheme applies by default and other options (of proportionate
reversal) are not available to such service providers. The provision would be effective from April
1, 2011.
The scope of life insurance services has been expanded to cover all services in relation to
management of investments for policy holders. Service providers have been allowed an option
to pay tax at standard rate on premium not invested or to pay composition rate of tax of 1.5
percent of gross premium.
BMR comments
Budget 2011 has largely remained focussed on macro-economic issues and development of the
infrastructure sector in India. It has not covered many of the fiscal measures that could have
provided additional support to the Financial Services industry. Notably, proposals relating to equal
tax treatment for NBFCs vis-à-vis Banks, alignment of accounting and tax treatment of loan
provisioning by Banks, restoration of tax exemption to venture capital funds for investments across
all sectors, clarity on characterisation of securities trading income, clarity on certain tax issues on
payment to overseas offices, etc did not find mention in the Budget. However, on balance, the
Budget does provide a positive signal as the Finance Minister has shown his resolution to push
through key policy level and regulatory reforms, which are critical for the development and growth of
our financial services sector.
© Copyright 2011, BMR Advisors. All Rights Reserved
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