By Ramesh Vaidyanathan, Rashna Jehani and Meghna Punjabi
After a spectacular victory for the Narendra Modi led BJP in India’s national elections held recently, expectations were running high from the newly elected government’s first annual budget exercise (‘Union Budget 2019-2020’ or simply ‘Budget’). This year’s Budget was particularly noteworthy as it was being presented by the first full-time woman Finance Minister, Ms. Nirmala Sitharaman.
Termed as a ‘Green Budget’, the Budget sets the ambitious target of taking the Indian economy to a 5 trillion-dollar mark in the coming few years. The focal point of the Budget appears to be the ‘Make in India’ idea as it lays emphasis on infrastructure, banking & finance and start-ups.
Some of the key Budget announcements are discussed below:
FDI in Insurance Intermediaries, Aviation and Media
Insurance
Foreign Direct Investment (‘FDI’) upto 49% is presently permitted under the automatic route in insurance companies, intermediaries such as insurance brokers, surveyors, etc. The Budget has proposed to extend the FDI limit for insurance intermediaries to 100%. This increase will bring them on par with the other financial services intermediaries in which 100% FDI is permitted. There is, however, no indication as to whether such investment would be permitted under the automatic route or the approval route.
As regards carrying out the core insurance business itself, the insurance regulations continue to require insurance companies to be owned and controlled only by Indian residents. There is currently no proposal to dispense with this requirement.
Aviation
In aviation, FDI up to 100% is permitted currently in Scheduled Air Transport Services, which includes Domestic Scheduled Passenger Airline and Regional Air Transport Services. 49% of such foreign investment is under the automatic route and the remaining is under the government approval route.
The Budget does not specify the relaxations for this sector but a stakeholder consultation is expected prior to their implementation. Foreign airlines can currently invest only up to 49% of the share capital in Indian companies operating Scheduled and Non-Scheduled Air Transport, subject to certain conditions. It is hoped that the proposed FDI relaxations will help find takers for Jet Airways and Air India, the two airlines that are slated to come up for sale soon.
Media
The Budget also announced relaxations for foreign investments in the field of media, animation, visual effects, gaming and comics. Presently, 26% FDI is permitted in the publication of newspapers and periodicals through the approval route. Further details of the proposed changes are awaited.
Relaxation of Local Sourcing Requirements
Currently, FDI upto 100% in ‘single brand retail’ is permitted under the automatic route. Single-brand retail refers to a business that sells goods of a single brand to individual customers and not to other businesses. Single-brand retail is particularly important from the FDI perspective as the investments for such businesses come from the brand themselves rather than from the local partners or franchisees. However, in the case of foreign investment exceeding 51% in an Indian company operating a single brand retail business, 30% of the value of goods purchased is required to be sourced from India.
The Budget again does not specify the proposed relaxations. Regardless, any relaxation would be welcome for companies like Apple. Apple has been facing a tough time in the smartphone market in India in the wake of stiff competition from the Chinese players like OnePlus. International companies have time and again reiterated that it has been difficult for them to procure goods from India to meet the 30% condition. Any relaxation of this local sourcing requirement will help attract new foreign investors and also enhance the market interest of the incumbent investors.
Corporate Tax
There will be a preferential corporate tax rate of 25% for companies having an annual turnover of INR 4 billion or less. Until now, this rate was available only to companies having a turnover of INR 2.5 billion or less. Although the proposal covers 99.3% of the total taxable companies registered in India, the 0.7% companies that are the biggest tax contributors in the country have not received any tax relief. Had the proposal provided a respite to these large companies, it would have perhaps encouraged an accelerated FDI inflow particularly to the advanced technology areas.
Start-Up Space
Recognizing the importance of start-ups and the role they play in the growth of the economy, the Budget has attempted to resolve issues of start-ups and also accorded certain relaxations to them.
Presently, under Section 56(2) (vii) (b) of the Income Tax Act, 1961 (‘IT Act’), the aggregate share consideration received by a company from a resident that exceeds the fair market value of the shares is chargeable to tax. A specific exemption exists for the consideration received by a venture capital undertaking from a venture capital company or a venture capital fund. It is now proposed that this exemption be made applicable even to consideration received from Category II Alternative Investment Funds.
The Budget has tried to resolve the infamous ‘angel tax’ issue. Start-ups and their investors who file requisite declarations and returns will not be subjected to any scrutiny in respect of valuation of the share premium. Thanks to this change, the scrutiny on start-ups is likely to be less rigorous. Additionally, the Budget proposes that no inquiry can be carried out by the Assessing Officer without obtaining the approval of a supervising officer.
To stimulate transparency, an e-verification system is proposed to be introduced for identifying the investors of the start-ups and their source of funding. This change is expected to promote digitization and minimise human interface.
The IT Act provides that if an assessee sells his/her residential property (say, a House) and invests the entire proceeds in a start-up, he/she is not required to pay any capital gains tax. The benefit extended under this section was earlier available to transfers of residential properties that took place until March 31, 2019 but the Budget has now extended the provision to be applicable to the transfers of residential properties that take place until March 31, 2021. Additionally, to avail the above benefit earlier, the assessee should have been the owner of 50% of the share capital or voting rights of the start-up. This threshold is proposed to be reduced to 25%. These proposals would certainly incentivize more investments in start-ups.
Presently for an ‘eligible start-up’ that has incurred a loss in its earlier year is allowed to carry forward and set off the loss (‘Loss’) against its income of the previous year if 100% of the shareholders holding shares carrying voting power on the last day of the year(s) in which the loss was incurred (i.e. the loss was incurred within 7 years of its incorporation) continue to hold those shares on the last day of the year of the set-off. The Budget proposes to provide that eligible start-ups will be allowed to carry forward and set off the Loss if shareholders holding 51% shares of the company carrying voting power (in the year in which the Loss was incurred) were holding 51% shares of the company in the previous year in which the carried forward loss is set off. For the purpose of availing this exemption, a ‘start-up’ has to comply with the conditions stipulated in the explanation provided to Section 80-IAC of the IT Act.
Increase in minimum public shareholding
Presently, all listed companies are required to have a minimum public shareholding of 25%. The Budget proposes to raise this to 35%. At one end of the spectrum this will boost liquidity and strengthen corporate governance while on the other hand it might be a cause of worry for several MNCs like Tata Consultancy Services, Bosch, Monsanto, Whirlpool, Bluedart, Wipro and HDFC Life Insurance that will have to offload shares to meet the revised threshold. The increase in the threshold could lead to disinvestments and delisting of promoter driven companies who would be looking to avoid further dilution.
Foreign Portfolio Investors and NRI
Budget has also sought to encourage Foreign Portfolio Investment (‘FPI’) into India.
Currently, the aggregate holding of all FPIs in one company is capped at 24% of the paid-up equity value of the company. The Budget proposes to increase this to the sectoral foreign investment limit for the relevant sector, with an option given to the concerned corporates to limit it to a lower threshold. The intent behind this seems to be to create more room for FPIs to invest in Indian stocks.
Real Estate Investment Trusts (‘REITs’) and Infrastructure Investment Trusts (‘InvITs’) are investment vehicles where people pool in small sums of money in a similar fashion like in a mutual fund. Both are regulated by the Securities and Exchange Board of India. The Budget expands the list of instruments through which FPIs can invest to include listed debt securities issued by REITs and InvITs. This expansion will further broaden the horizon of cross border investments.
Securities Transaction Tax
Presently, in option contracts that are exercised, the purchaser has to pay the securities transaction tax (‘STT’) at 0.125% of the settlement price. In case the option is not exercised, the seller has to pay STT at the rate of 0.05% on the option premium. Since the settlement price is typically many times the option premium, the high STT levy was discouraging the exercise of options, leading to price distortions closer to settlement.
The Budget is now proposing to levy the STT on the price that would be the difference between the settlement and strike price in case of exercise of options. This would remove the anomaly that currently exists as regards the STT payable in respect of option contracts.
Rationalizing Labor Laws
To bring parity between the state specific labor laws and streamline the process of registration and filing of returns, the Budget underscores the legislative intent to consolidate multiple labour laws into a set of four labor codes that will deal with wages, social security, industrial safety and welfare, and industrial relations. The code will amalgamate the existing legislations on wages and prescribe a minimum wage threshold applicable across all states. The minimum wage fixation power presently rests with the states, which the Budget proposes to dispense with. Further, the filing of a single online annual return will substitute the existing practice of filing separate returns under 8 different labor legislations. The unification of labor laws and the ease of compliance is expected to create a conducive atmosphere for the industry.