India: New India Budget Short On Bold Reforms But Heading In Right Direction

Last Updated: 22 July 2014
Article by Nitin Shingala

Our India expert delves into the first budget from India's BJP government; a link to our whitepaper with more detail is available at the bottom of the page.

The new government's first Union Budget for 2014-15 was presented to the parliament by Mr. Arun Jaitley, the Finance Minister, on 10 July 2014 within 45 days of a superlative win by the Bhartiya Janta Party (BJP) led by now-Prime Minister Mr. Narendra Modi.

The Indian economy over the past few years has gone through one of its worst periods in history. Growth plummeted from a 9% to 5%. Sticky inflation, populist subsidy measures, oil price shocks and a devaluing currency have left the economy in need of a much-needed boost.

It's been a very long time since the people of India overwhelmingly chose a single party, giving the government enough stability to last for the next five years and ability to take decisive actions. Expectations for the new government have soared very high.

This first budget offers a few reassuring steps and ideas of reforms the Modi government will need to deliver if 7%-8% GDP growth is to be achieved in next three years. However, investors and businesses may need to check their expectations of how quickly the economy can be turned around.

With this budget, the government has pushed for 5.4% to 5.9% growth for 2014-15 as compared to 4.7% growth in 2013-14, and has declared its intentions to aim for a sustained growth of 7-8% or above in the next 3-4 years, along with macroeconomic stabilisation that includes lower levels of inflation, less fiscal deficit and a manageable current account deficit. Mr Jaitley made it clear that it would not be wise to expect everything that can be done or must be done could be included in this first Budget. He also proposed setting up an Expenditure Management Commission to look into expenditure reforms.

In the interim budget, the previous Government set a target fiscal deficit of 4.1% - which seems daunting considering India had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy. The new government has accepted this target as a challenge and has announced reducing this further to 3.6% in 2015-16 and 3% in 2016-17.

There was also expectation that General Anti-Avoidance Rules (GAAR) would be further deferred for at least another year; GAAR provisions will become effective 1 April 2015 and will apply to all investments post-August 2010.

In order to spur investment and growth, the government has announced a partial tax pass-through regime for real estate investment trusts (REITs) and infrastructure investment trusts, collectively referred as Business Trusts (BTs). The regulator SEBI (Securities and Exchange Board of India) is expected to finalise the framework for the BTs. This is expected to provide a major boost to growth to real estate and infrastructure development in India. Long term capital gains on sale of units as well as dividends received by the BTs and distributed to the investor shall be tax exempt. Interest income received by the BTs is tax exempt and foreign investors shall be subject to a low withholding tax of 5% on interest payouts.

In another welcome move, income earned from sale of securities by foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) shall be deemed to be capital gains income. This would eliminate litigation on the issue of income characterisation.

A High Level Committee will interact with trade and industry on a regular basis and ascertain areas where clarity in tax laws is required. Based on the recommendations of the Committee, the Central Board of Direct Taxes and the Central Board of Excise and Customs shall issue appropriate clarifications, wherever considered necessary, on the tax issues within a period of two months.

On GST, the FM has expressed hope to find a solution to the backlog and approve the legislative scheme to enable the introduction of a GST with the intention to streamline the tax administration, to avoid harassment of the business and result in higher revenue collection both for the governments at the centre and the states.

Another welcome announcement made by the minister concerns clarity in implementation of Indian Accounting Standards (Ind-AS) to converge the current standards with the International Financial Reporting Standards (IFRS); we've been waiting for this for a while. It will go a long way in helping Indian companies to globalise and increase reliability of financial statements.

It is, however, disappointing that in an attempt to please all, the budget appears to be long on details and short of the sort of bold reforms one expected. The Finance Minister's statement that "the government is committed to provide a stable and predictable taxation regime that would be investor-friendly and spur growth" is welcome - and we hope it does get converted into action, not remain a gesture.

In the end, putting India back on a growth path will require the government to push reforms beyond the budget and pursue reforms to facilitate further industrialisation and increasing urbanisation. The budget aims to improve the investment climate and achieve fiscal consolidation.

India does have the advantage of a hugely aspirational younger population and is still on the growth path when compared to most other countries. We remain hopeful that in an increasingly connected and transparent era, the government and the political class cannot ignore power of the people and their aspirations and shy away from accountability.

The TMF India team has put together a whitepaper on the budget, summarising key economic indicators and the state of Indian economy, major policy proposals and details of proposed key amendments to direct and indirect tax laws. Get it here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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