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Union Budget 2020 Analysis – A Reality Check

Finally, the much-hyped Union Budget is out. Did it disappoint? Yes, it sure did!

To be fair, the backdrop of the budget was not promising to begin with. But an Indian budget has never been short of expectations. And the entire economic slowdown witnessed over the last year or so, just added to the expectations. An Indian economy growing at 4.5% is the lowest we imagined – at least under the Modi regime. The last budget (2019) was discounted to be a quick fix and more of a directional budget; but this time around February 1, 2020 was different and full of much higher expectations.

However, in my opinion, the budget fell short of those expectations. I never really expected the budget to come out with big-ticket tax changes, especially with tax reductions having historically given little, if at all any, leverage to consumer spending. Sure enough, easing of tax compliances, reducing litigation, and upping the ante on digitisation was expected – and probably delivered too. But what I did expect from the FM’s speech was more information on disinvestments, avenues of fund raising for the government, and the manner in which the funds would be spent. Some of it did come in the post budget briefing by the FM where it was clarified that funds raised through disinvestment shall be invested in asset creation.

And now, post reading the budget, it is tough to visualise the priorities of the government, the path to economic recovery it has chosen, and a mechanism in which cash flows will be organised.

It was clear that the government would be unable to meet its fiscal deficit targets for last year; and the slowing economy would only make it increasingly tougher. Hence, a widening gap was expected with the increased government spending. The questions remain – what is the real reason of the gap, higher revenue expenditure, higher capital expenditure or lower than expected revenues/inflows; At the moment, higher revenue expenditure and lower inflows seems to be the reason.

This government has invested in asset-backed spending in the past; and understandably the government seems committed to developing infrastructure. But this time around, we saw more emphasis on populist policies in the budget. A small case in point is the monies spent on purchasing agriculture products in an endeavour to increase the farmers’ income. The reality is that post procuring, the government spends huge amounts in maintaining that inventory, and then is forced to sell the produce via auction in the open market. Now this intervention uses up fiscal resources in form of losses incurred by the government; and provides little to no incentive to the farmer to improvise. Thus, leading to an overall imbalance in the ecosystem.

In fact, this issue finds its place in the Economic Survey of 2020 as well. Not only this, the survey also points out certain poignant issues such as flawed measures to improve the ease of doing business at the ground-level, the crippling banking system, the inability of India to become a key manufacturing hub, and so on.

Just to elaborate, below are some key issues that were shared with me in conversations with different businesspeople:

  1. The CEO of a Korean MNC, having bought the land for setting up a manufacturing plant in India, has put on hold the business’s decision to proceed with the plant’s construction. The reason being the government’s lack of clarity on the imposition of custom duty on the importing of fully manufactured parts. Additionally, given the trade agreements signed with ASEAN, the Korean company seems to have no incentive to manufacture in India as against importing the part from Vietnam or Thailand and only trading here.
  2. The promoters of start-ups / businesses prefer to setup entities offshore, simply to offset the time it takes to kick start a business in India. Because most of this time is spent in either incorporating the entity or opening a bank account. Admittedly, the government has done its bit to reduce the time taken to setup the entity. But banking remains a huge challenge for any business, right from opening account to routine transactions.
  3. A friend who runs an agri-commodity trading business once elaborated to me about how the government policies are adversely affecting the farmers and entire eco-system in the long-term, even though he benefited as a trader from the policies in the short-term.
  4. The fact remains that in India, most small and medium companies are essentially undertaking low-end assembly rather than actual manufacturing. The 2020 Economic Survey categorically identifies how an economy with low-skilled manpower, such as India, can work to strengthen its assembly services and subsequently move on to high-end manufacturing. And for this there is enough learning available from China’s growth story as well as the Indian auto-component sector.
  5. The lack of quality credit and its worsening impact on business has been as an ongoing for corporate finance directors. This is because the mere capitalisation of banks does not lead to credit stream into the system. And the lack of confidence in the economy has further led to lower investments and the subsequent lower demand of credit.

All of the above, and much more, has been highlighted in the economic survey. And still, the Budget does not provide answers to these persisting (and rather obvious) issues. The FM did speak of some ideas to support MSMEs in the auto-component sector who are willing to export, a credit guarantee scheme for NBFCs, and investment handholding for start-ups, including a seed fund. However, past experiences do show us that the government has done little on the various schemes that were announced in successive budgets; and most of those announcements remain as such on paper.

On the tax front, the Budget did include various proposals – which, honestly, only seem to be a repackaging of existing laws; and the government appears to have figured out a mechanism to improve its tax collections on cash basis. Some of these budget-related changes and their real-world impact are discussed below:

Changes in Personal Income Tax Rates

On the face of it, in this too changes don’t seem to be significant. While there are new slabs and rates proposed, it was apparent on reading the fine print that the effective tax may actually be higher than what it was in the old regime. Hence, it seems unlikely that a lot of individuals will opt-in for the new tax regime. This is similar to what happened with the changes in corporate tax rates that were announced last September

Tax Amendments for Start-Ups

The threshold turnover for a company to be categorized as a start-up has been increased to Rs. 100 crores from the existing Rs. 25 crores, and the period of 7 years has been increased to 10 years. Again, if one looks at the start-up scenario today, any kind of e-commerce player can quickly reach a turnover of Rs. 100 crores, which basically is the value of gross merchandise sold on its platform. So, the revenue-based threshold may render exemption meaningless for a significant number of start-ups. Further, period of 10 years also may not be enough if we look at some of the best of Indian start-ups today.

A welcome move is to defer the tax on ESOPs granted by start-ups to their employees. ESOP is an effective instrument for start-ups to attract and retain talent. But this has been little ineffective in Indian context due to tax outflow on exercise of ESOP by employees. This stand to change with the new proposal, whereby tax on ESOP availed shall be deferred for 4 years or cash realisation or employee’s exit from the company, whichever is earlier

Deposit of Tax Demand

Going forward, there will be a requirement of depositing 20% of the tax demand for availing a stay of tax demands from tax tribunals. This may only lead to an increased cash blockage for businesses and a reduced motivation for the tribunals to dispose cases – especially considering the fact that a higher percentage of cases are decided in favour of taxpayers.

Increased Threshold for TDS On Foreign Borrowings’ Interest
Pushing the threshold for lowering TDS on the interest paid on foreign borrowings is a welcome step. The lower cost of foreign borrowings is an attraction for a lot of Indian businesses and the reduced TDS rate has been useful in the past as well.

Abolition of Dividend Distribution Tax (DDT)

While this seems to be a welcome step considering the lesser participation of small retail investors in the equity market, large dividend pay-outs happen more so in the case of corporate or HNI investors, most of whom are already taxed at a rate higher than the DDT rate. This abolition will be useful for foreign investors who are not able to claim tax credit of DDT paid in India. But beyond that, this amendment seemingly is just a change of pocket from which tax will be taken.

Tax Residency

There are certain other changes as well which seem to be superficial. But one significant proposal is to amend the definition of tax residency for individuals and an effort to bring into tax-net, those citizens who are able to avoid Indian taxes by using different global tax residency rules. While I am all in favour of taxing anyone who is illegitimately avoiding taxes, at the moment, working on India’s image as a tax jurisdiction and boosting consumption needs to be the priority. The government did come out with an immediate clarification to ensure legit Indians are not brought under the tax-net but relevant rules are yet to notified.

The FM concluded her speech mentioning that the fiscal deficit will remain under 4%, even for FY 2020-21. To achieve this, it assumes a significant increase in tax collections; but isn’t this subject to the generation of income at the first place? If the investment cycle is not rejuvenated, income generation, consumption, and savings will be affected. And India seems to have entered that vicious cycle where since consumption and income visibility is low, investments made by businesses too remains low.

To summarise, if the intent of all these changes was to put more money in the hands of taxpayer and boost consumption, the core purpose of the budget itself seems to have been defeated. Overall, the FM did touch upon literally every aspect of Indian economy, but the budget sounded more like a vision document rather than an actionable charter. Knowing the track record of this government over the recent past, I would be nervously cautious to watch out for other announcements during the year. Gone are the days when the budget was one significant big event. Now, the entire budget session has become more of a customary annual proceeding. A lot of big changes are brought about through ordinances and notifications, during the rest of the year. Coming out of the current situation will require taking quick and firm steps; and I am sure, post this budget, each step of the government will be watched closely.

Written By

Nitin Garg

Nitin Garg is a Founding Partner at Coinmen and its group companies.

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