BFSI sector: Structural changes needed along with tax clarity

Driven by a recalibration of the Chinese economy, falling commodity prices, and over supply of oil, the global economy faces strong headwinds and India has had to deal with the spill-over effects of these. There is, therefore, a significant onus on the forthcoming Union Budget to set the appropriate tenor and direction for the Indian economy.

As the debate around the Budget gathers steam, we look at some of the expectations from the upcoming Budget from a financial services industry perspective. Financial services sector being a crucial barometer of the economy, it is imperative for the government to focus on this differentially and continue the journey towards both structural and tax changes for the industry.

One would expect the government to undertake certain structural reforms in areas such as simplification of the KYC norms to open demat accounts, measures to increase retail participation in mutual funds, capitalisation of ailing banks and controlling NPAs of banks, enhancing penetration in the two flagship insurance schemes and the pension scheme announced last year, and encourage savings under the NPS, etc. to boost the confidence of the industry.

Ever since the Securities and Exchange Board of India (SEBI) brought all the different venture funds within the omnibus Alternative Investment Funds (AIF) Regulations in 2012, AIFs have seen significant investor interest and the capital commitments of AIFs as on 30 September 2015 was around Rs 28,000 crore.

With a view to further drive the progress and contribution of the AIF industry, there needs to be a stable and predictable tax regime for the funds as well as the investors. While some progress has been made in the previous Budget, there is still an unfinished agenda on tax.

Some of the key expectations of the industry include clarification on the characterisation of gains earned by AIFs as capital gains (similar to the amendment for foreign portfolio investors), making the pass-through status work effectively by passing on the losses to investors, limiting the withholding tax obligations on AIFs for only taxable income and in relation to investors that are not otherwise exempt from tax, elimination of deemed income for AIFs and investee companies, etc.

These suggestions also find place in the report of a committee set up by SEBI, headed by N.R. Narayana Murthy. The government should implement the measures suggested to boost investments made by AIFs. This in turn could help in reducing the burden on the banking sector and increase the confidence of start-up ventures, an imminent focus of the government.

The move by the government to incentivise fund managers to manage offshore funds from India, introduced in the last Budget via a much needed clarification on business connection, signifies 'Make in India' for the financial services industry.

However, there has not been any traction on this given the stringent eligibility conditions imposed by the law on both the offshore fund and the domestic fund manager. The government should revisit these conditions and rationalise the same, thereby placing India on par with other modern jurisdictions that have similar regimes.

The regulatory framework in relation to the 'masala bonds' has been issued by the Reserve Bank of India. However, clarity from a tax perspective is a must for these bonds to become a reality.

While the Finance Ministry clarified vide a circular that interest income on such bonds will attract a lower tax rate of 5 per cent and gains arising in case of appreciation of rupee against the foreign currency in which the investment is made would be exempt, this treatment should be codified in the law.

It is also expected that the government would introduce additional tax incentives for Gujarat International Finance Tec-City (GIFT), India's global financial centre set-up in Gujarat.

The GIFT city is aimed at attracting firms to open offshore banking units as well as those of insurance and capital market intermediaries. Tax incentives have been provided by global financial centres such as Dubai, Malaysia, Ireland, etc.

Along with the sector specific changes, it is also imperative that the tax regime and the tax administration is per se fair to tax payers and supports the government's intent of "ease of doing business in India".

In this regard, the government should implement some of the measures suggested by the Income Tax Simplification Committee such as clarification on characterisation of income on sale of shares and securities, deferment of ICDS, rationalising the disallowance of expenses in relation to the exempt income, avoidance of undesirable delay in issue of refunds, etc.

Over to the Finance Minister!

The author is Tax Partner, EY India. Mamta Shroff, Senior Tax Professional, EY, also contributed to the article. Views expressed are personal.