Taxation and Policy – Page 2 – Aureus Law Partners

From Yatin’s Desk: Income Tax Settlement Scheme – An opportunity to close tax litigation

Update: 22.02.2020 – The tax settlement scheme which was initially proposed to cover litigation pending before Commissioner (appeals), Tax Tribunal, High Court, Supreme Court and international arbitration as on 31 January 2020 is expected to also cover matters under review by Dispute Resolution Panel (DRP), Revision applications before Commissioner and orders for which timeline for filing appeal has not expired as on 31 January 2020. The Government is going all guns blazing to make this scheme a success. A great opportunity for litigants.

——————————————————

The Finance Minister, in her budget speech introducing the Finance Bill 2020 had announced bringing a direct tax settlement scheme with the intent of reducing over 4.8 lacs direct tax cases pending before various appellate authorities. In furtherance of the announcement, “The Direct Tax Vivad Se Vishwas Bill, 2020” has been introduced in the Parliament for consideration. The same will become effective from the date to be notified post approval by the parliament and presidential assent.

The scheme provides an opportunity to settle arrears of tax against appeals pending as on 31 January 2020 before the appellate forums [Commissioner (Appeal), Income Tax Appellate Tribunal, High Court and Supreme Court]. Where the arrears relates to disputed tax and interest & penalty on such disputed tax, there is a complete waiver of interest and penalty on payment of disputed tax by 31 March 2020. Payment beyond 31 March 2020 but within the last date (to be notified), will require additional payments of 10% of the disputed tax. Further where the tax arrears relates to disputed interest, penalty or fee, there will be a waiver of 75% of such amount if paid by 31 March 2020 and 70% where payment made beyond 31st March 2020 till the last date to be specified. The scheme further provided for immunity from prosecution.

The scheme requires the taxpayer to file a declaration before the designated Commissioner of Income tax who will within a period of 15 days from the date of receipt grant a certificate containing particular of tax arrears and the amount of tax to be paid. The taxpayer will thereafter be required to pay the tax determined within 15 days from the date of receipt of the certificate and intimate the payment thereof to the authorities. On issue of certificate, pending appeal before the Commissioner (Appeal) and Income tax Appellate Tribunal will be deemed to be withdrawn. With regard to appeals before High Court/Supreme Court or where proceedings for arbitration, conciliation or mediation have been initiated, the taxpayer will be required to withdraw the appeals. Rules and forms in relation to the scheme are yet to be notified.

The scheme leaves some open questions such as eligibility of tax payers who are yet to file appeal as on 31 January 2020 (within the timeline prescribed), impact on appeals deemed to be withdrawn before the appellate authorities upon issue of certificate where the taxpayer is unable to pay the liability with the 15 day timeline, adjustment of past pre-deposits, etc. Hopefully some FAQ’s will clarify on such aspect. Further, given the 15 days payment timeline, this may be a challenge for foreign companies not having operative bank account in India to facilitate money transfer. The Government may consider a mechanism to facilitate this.

Overall the tax settlement scheme is a welcome move by the government to reduce pending litigation. Tax payers should critically review their litigation exposure and avail the opportunity to get closure specifically where exposure of interest (due to long pending disputes), penalty and prosecution is high.

From Yatin’s Desk: MAT credit dilemma under 25% corporate tax rate option

In light of last week’s historical reduction in the corporate tax rates applicable during FY 2019-20, existing domestic companies (not availing tax exemptions/specified deductions) have the option to avail reduced corporate tax rate of ≈25%. Such companies have also been exempted from applicability of Minimum Alternate Tax (MAT). Companies not opting for such scheme will continue to be taxed at the current rate (≈29%/35%) and subject to MAT, albeit at the reduced rate of ≈ 17.5% vis-a-vis 21.5%.

In absence of MAT application to such companies or any change in MAT credit provisions specifically permitting set-off of MAT credit against 25% liability, the debate will continue for the next few days on the entitlement to set of unutilized MAT credit. However, if the view emerges against the set-off, it will be vital for companies to consider their MAT credit position before jumping into the perceptibly lucrative 25% tax regime. As a big picture, so long the companies have sufficient MAT credit, the liability can be restricted to 17.5% (MAT liability) by setting off excess liability computed (at general rate of 29%/35%) against MAT credit entitlement. Accordingly, it may be beneficial for companies to continue with the existing regime till the MAT credit is completely absorbed. There is always the option to exercise the 25% regime in future.

While the taxpayers do their math, it will be worthy if the government clarifies its position.

From Yatin’s Desk: Withholding tax (TDS) default, no more business as usual

Indian tax laws mandate payers to withhold taxes at source on payments to residents (in case of specified payments) and also non-residents (where their income is taxable in India). Non-compliance has penal consequences. While failure to withhold tax has interest and penalty implications (i.e. financial costs), consequences are severe in case of non-deposit or late deposit of tax collected leading to additional prosecution implications (financial+ criminal implications). Given the humongous amount of data collated by the Revenue Authorities and use of data analytic, it is not unusual to find show cause notices being issued to defaulter now days. However what should raise alarm for the defaulters is the fact that where the default relates to non/delayed deposit of taxes leading to prosecution proceedings, the Magistrate Courts are taking a serious view on the matter with defaulters being sentenced to imprisonment.

One recent case before the Ballard Pier Magistrate Court (Mumbai), related to a delayed payments of approx. INR 850K, which was paid with interest and also penalty. The Magistrate Court disregarded the plea of financial constraint and proceeded to convict the defaulter sentencing to 3 months imprisonment. Though, the decision is appealable before higher Appellate Courts, one needs to take note that such proceedings are highly complex, time consuming and financially expensive. Take for instance this specific matter – it related to withholding default in financial year 2009-10, criminal complaint before Magistrate Court was filed in 2004 and after almost 30 odd hearings/adjournments before the Magistrate Court, the proceedings concluded in April 2019; a 10 year saga, which will further continue for years before higher Courts.

It is also relevant to take note that where the defaulter is a Company, the direct impact is on the directors, who generally are proceeded against leaving it for them to defend their innocence. A clear message – by no means delay or fail to deposit taxes deducted if you want to be on the right side of law, else don’t complain of government action!!

From Yatin’s Desk: Changes proposed to the rules for attribution of income to Permanent Establishment

Attribution of profits to a Permanent Establishment (PE) of a Multinational Enterprises (MNE) in India has been a commonly ligated matter and marred with uncertainty. The Indian tax administration has placed for public comments report of the Committee constituted to examine the existing scheme of profit attribution to PE, with the intent of framing guidelines for profit attribution, bringing certainty and transparency. While the debate on the proposals will surely continue for long, the document is a valuable read for India’s position which highlight India reservation to the authorized OECD approach for PE income attribution.

The Committee in its report emphasizes the fact that the Indian tax treaties are predominantly based on UN Model Convection which under Article 7 legitimizes attribution of profits to a PE on the basis of apportionment of the total profits of the enterprise to its various parts. Such methods is adoptable where profits cannot be determined through a direct method i.e. based on verifiable books of accounts prepared as per acceptable accounting standards. In contrast, Article 7 of OECD model convention post 2010 advocates the approach of allocation taking into account the functions performed, assets used and risks assumed (FAR analysis) by the enterprise through the permanent establishment and through the other parts of the enterprise.

The Committee has observed that business profits are contributed by both demand and supply of the goods. Article 7 of the OECD Model Tax Convention and approach recommended by OECD (based on FAR) is purely supply side approach towards profit attribution and disregards the role of demand in contributing to profits attributable to PE. Further, the Indian tax treaties have not included the concept of Income attribution based on FAR as advocated by OECD model convention, thereby permitting attribution of profits in a manner different from the authorized OECD approach i.e. by resorting to the direct accounting method and where that may not be possible, by apportionment of profits.

Accordingly, the Committee has suggested PE profit attribution based on a combination of (i) profits derived from Indian operations and (ii) three factor method based on equal weight accorded to sales (representing demand), manpower and assets (representing supply including marketing activities). In other words, profits of the multinational enterprise will first be apportioned for India sales (amount arrived at by multiplying the revenue derived from India x Global operational profit margin). As a second step, such profits will be attributed proportionately to (a) sales within and outside India; (b) employees and wages within and outside India; and (c) assets deployed within and outside India for Indian operations, each with 33% weightage. Further to address a situation whether the multinational enterprise suffers losses or has profit margin less than 2%, a margin of 2% of revenue derived from India sale is proposed to be regarded as deemed profit for India operation, thereby recommending minimum base level taxation. With regard to digital economy, where nexus to taxation is attributed to the concept of significant economic presence, considering the role of users, a fourth factor (i.e. user intensity) needs to be further built into the income attribution formulae.

The OECD approach for income attribution based on FAR analysis, which the Committee regards as factoring only supply side attributes (and not demand) finds favour with the Committee where no sales takes place in India. For instance, where a multinational enterprise constitutes a PE in India and compensates the PE at arm’s length basis FAR analysis and further such enterprise does not have any sales in India, no further income will be attributable to India (in absence of any play of demand side factor). However, where sales are made in India, the reading of the Committee report suggests formulae based attribution would become the rule and additional income attributable would become taxable in India (post allowance of income apportioned to supply factors and offered to tax in India).

Given the development, there will be a significant transformation to the concept and impact on income attribution to permanent establishments in India, should the proposed recommendation be formulated into mandatory rules. The demand side factors which the Committee consider as an important consideration would seemingly lead to attribution of 33 percent of the profits derived from sale in India even if no further attribution is required to be made in absence of other factors. It will be interesting to see how the courts view the principles around income attribution in light of the divergence in OECD approach and Indian tax administration position.

From Yatin’s Desk: Non tax filing prosecution risk

The Indian tax administration is taking strict action for non compliance under the India tax laws. The authorities have been launching penalty & prosecution proceedings for failure to file a tax return within the due date. While the tax provisions provide for an extended period for filing a belated return (till the end of the assessment year), the tax authorities have been identifying non filers and late filers and initiating penalty & prosecution proceedings, even if filed within the prescribed belated period.

Where prosecution proceedings are launched, the taxpayers may unfortunately have to go through the rigour of long drawn criminal proceedings before the Criminal Court to establish that the failure was not willful and absence of culpable mental state. Tax payers impacted by such action typically attempt as a first recourse quashing of prosecution proceedings through petition before the High Court. This unfortunately is unlikely to have much success considering the courts in such matters do not dwell into fact finding to establish bonafide of the taxpayer, (a domain of the criminal court) established through evaluation of facts and examination of witnesses.

Where penalty proceedings are simultaneously launched, which would ordinarily be the case, a favourable outcome before the Appellate Tribunal, on merits, would have a direct bearing on the prosecution proceedings before the trial court. The Appellate Tribunal being a final fact finding authority, if on appreciation of facts does decided that the tax payer had bonafide reasons for not being able to comply with the filing obligation, such determination would be a significant finding for discharge from criminal proceedings or alternatively quashing of prosecution proceedings through application to the High Court. A tax payer will be better off establishing the facts and circumstance before the Tax Tribunal than the Criminal Court. Proceedings before Criminal Court can rather be intimidating for an ordinary tax payer who may just be overwhelmed by the sheer thought of seeking a bail, examination and cross-examination of witness, the longevity of proceedings, etc.

Given the serious implications of prosecution proceedings, it will be extremely important for the impacted tax payers to have a well thought through strategy to address the challenges of such proceedings.

Case Update: Supply of foods/beverages on-board a train to be treated as pure supply of goods

Taxpayer is involved in the business of supplying food to passengers travelling via Rajdhani Trains and other mails/express trains on basis of the menu approved by Indian Railway. Primarily, the Taxpayer was supplying food via three different modes. Firstly, supply of food through the food plaza / food stalls on the railway platforms; Secondly, supply of food on board the trains, including mandatory supply of newspapers; Thirdly, supply of food on board the mail/express trains. The Taxpayer preferred the application for advance ruling under Section 97 of the Central Goods and Services Tax Act, 2017 (“CGST Act”) before the Authority for Advance Ruling (“Authority”). On basis of the materials and records placed before the Authority, an advance ruling was sought in relation to the rate of GST applicable on the said supply of foods/beverages, and the mandatory supply of newspapers on board the trains by the Taxpayer.

Taxpayer was of the view that the supply of foods/beverages from food stalls / food plazas at the platforms and on board the trains would be taxable at the rate of 5% integrated tax (“IGST”) in terms of the Entry No. 7 of Notification No. 11/2017 – Central Tax (Rate) dated June 28, 2017 (“Rate Notification”). Further, the supply of newspaper would be exempt from GST as per the Entry No. 120 of Notification No. 2/2017 – Central Tax (Rate) dated June 28, 2017 (“Exemption Notification”). The jurisdictional Commissioner (CGST) agreed to the views of the Taxpayer except with respect to supply of foods/beverages on board the trains, which would be taxable at the rate of 18% IGST, being the supply of ‘outdoor catering’ services.Basis the perusal of contracts / agreements, the Authority observed that for supply of food on the trains, there are three transactions, one between the passengers and the Indian Railways, second between Indian Railways and Indian Railway Catering and Tourism Corporation (“IRCTC”) and third between IRCTC and the Taxpayer. The present application pertains to the third transaction vis-à-vis between IRCTC and the Taxpayer.

The Authority observed that the train is a mode of transport and hence cannot be treated as a restaurant, eating joint, canteen, etc. Accordingly, the catering services provided on-board a train are not covered under S. No. 7(i) of the Rate Notification, as claimed by the Taxpayer. Further, with respect to the treatment of said supply of food/beverages on-board a train as composite supply of services, the Authority ruled that since no element of service is involved, the same shall be treated as pure supply of goods. In similar terms, the supply of foods/beverages from the food stalls on the platform shall be treated as pure supply of goods. Further, the supply of newspapers, which is separately invoiced, shall be exempted from GST in terms of the S. No. 120 of the Exemption Notification. Accordingly, the application for Advance Ruling was disposed off by the Authority.

(In Re: Deepak and Company; Advance Ruling No. 02/DAAR/2018; Authority for Advance Ruling, New Delhi)

In case of any queries or clarifications on this subject, please feel free to reach out to Manish Parmar, Senior Associate, Aureus Law Partners at manish.parmar@aureuslaw.com. Views are personal.

Liquidated Damages – Implications under the Goods & Services Tax Laws

Liquidated damages (“LD”) mean a fixed or pre-determined sum that is required to be paid upon breach of a contract, which may arise due to non-fulfilment of the obligations, delay in fulfilling the obligations or abandonment or termination etc. Hence, LD damages are directly connected to the actual injury and losses incurred by a party due to failure or delay in performance of obligations under the contract by either party. These LD clauses/ obligations are prevalent in construction contracts where the provisions relating to timely and milestone performance of the project are incorporated. For instance, EPC onshore/ offshore sub-contracts have milestone-based implementation, hence any delay in execution / completion of the same causes huge losses to the project owners. LDs cover this contingency.

Commercially, the LDs are considered to be a measure of compensation for a pre-determined loss arising out of breach of contract. However, in a recent matter of In re Maharashtra State Power Generation Company Limited dated May 18, 2018, the Authority for Advance Ruling, Maharashtra (“Authority”) under GST ruled that the amount of LD deducted from the payments made to the contractor/ vendors would amount to supply of service by the project owner / Taxpayer. The said ruling along with the factual background is discussed hereunder:

Factual Background

The Taxpayer approached the Authority under Section 97 of the Central Goods and Services Tax Act, 2017 (“CGST Act”) seeking an advance ruling on levy of GST on the amount of LD deducted from the contract price agreed with the contractors/ vendors. The main issue for this ruling was as to: (i) whether the LD would be treated as ‘sale’; and (ii) whether this would be liable to GST as separate from the contract value/ price. The Taxpayer relied upon the ruling in GSTR 2003/11 issued by the Australian Tax Office under the Australian Goods and Services Tax Act, 1999, wherein the deduction from the contract price was held to be towards deficiency in the provision of services, and therefore the same would not attract GST. Also, reliance was placed in the matter of Commissioner of C. Ex., Chandigarh-I v. H.F.C.L. (Wireless Division) reported as 2015 (11) TMI 893 – CESTAT- New Delhi, wherein it was held that if a taxpayer is liable to pay a lesser amount than the generically agreed price as a result of a clause stipulating variation in the price, on account of liability to ‘liquidated damages’ on account of delay in delivery of manufactured goods then such resultant price would be the ‘transaction value’. Further, the Taxpayer submitted before the Authority that the provision of such a clause in the contract is to ensure that the completion of the project does not get delayed.

Observations of Authority

The Authority observed that contract price and LD are two distinct aspects of the contract, and deduction of LD from the contract price merely facilitates the settlement of accounts. The Taxpayer contended that LD helps in mitigating the impact of higher costs in form of interest during construction and administrative charges. Taxpayer further contended that it was never its intention to get supplies/ project delayed nor did the contractors want to make delay and thereby causing it to tolerate. Therefore, LD could not be termed as service provided to the contractor. However, the Authority observed that the provision of LD in the contract is squarely covered by the clause (e) of the Para 5 of the Schedule II annexed to the CGST Act. The said entry provides that ‘agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act’, shall be treated as supply of services. The Authority ruled that the amount of LD deducted from the payments made to the contractor/ vendors is income in the hands of the Taxpayer and would amount to supply of service by the Taxpayer. Accordingly, the Authority held this would be classified under Heading 9997, and GST at the rate of 18 percent would be levied on the amount of LD deducted from the contract price.

Conclusion

While the said ruling is binding on the Taxpayer and the Revenue in respect of the particular issue in question, the same may have a persuasive precedential value. Also, it may have a bearing on how the clauses relating to LD is negotiated in contracts in the future.

Run Up to the Budget 2018-19

Economic Survey of India 2017-18:

Policy Reforms in Zeitgeist of Stigmatized Capitalism

Economic Surveys have sometimes been seen as portends of the Budget that follows. It is often used to engage in a sort of crystal ball gazing and guess work to predict the Budget proposals. However, a more useful manner of looking at these is that the Economic Surveys provide a much needed context to the Budget.

Economic Survey 2018-19¹ in much the same manner is not only a report card of the Government for the year past, but also provides a context in which the Budget proposals would arrive. In the following paragraphs, we have attempted to flesh out those areas that we perceive may see an amount of thrust in the Budget proposals. Not just that, we believe that the following paragraphs will supply you, the reader, with a certain amount of clarity vis-a-vis the "Why" of the Budget proposal, providing, as it were, the context within which the Finance Minister would stand to deliver his speech. Between these lines, there could be technical monsters that present themselves - for instance, certain tax proposals may be a necessary concomitant of what the Government may seek to achieve via the Budget in the context of the economic scorecard of the country. These have, in some places, been sought to be presented as separate highlights within this page.

Our reading of the Survey indicates that while at an overall level, there are no immediate causes for alarm, nonetheless, the Government has a tight rope walk ahead of it, in balancing the need for economic growth with the deficit levels. This nuance appears in paragraph 1.29, and therefore, in the very first chapter, where the Economic Survey notes:

"It is that zeitgeist (or Maahaul) of stigmatized capitalism—an accumulated legacy inherited by the government—that made policy reforms so difficult and makes the recent progress in addressing the Twin Balance Sheet challenge noteworthy."

In any event, based on High frequency indicators² in its outlook for 2017-18, the Economic Survey suggests that a robust recovery is taking hold. However, the level of indicators remain below potential.

The CSO³ has forecast the real GDP⁴ at 6.5 percent. However, the Economic Survey pegs this the expectation of GDP growth in 2017-18 at 6.75 percent. The Current Account Deficit remains well below the 3 percent of GDP threshold beyond which vulnerability emerges, and foreign exchange reserves are at US$432 billion (spot and forward) at end December 2017 (well above prudent norms, as the Survey notes).

On GST

GST revenue collections are robust. The Survey predicts the GST revenue growth as compared to the Annual revenues of indirect taxes in 2016-17 at 12 percent.

GST Revenue Collection (in lakh crores)

Particulars of collection agency and tax	2016-17 (Annual)	Nature of Tax (in GST regime)	2017-18 (Estimated Annual Steady State revenues)
States	4.4	SGST	2.5
Center	5.3	CGST	2.5
Excise	1.4	IGST	4.9
Service	2.5	Cesses	0.9
CVD / SAD	1.4	Not applicable
Total			10.9
*Estimated Growth of GST*			*12%*

With the rate of growth in GST being 12 percent (on an estimate basis), and the nominal GDP growth of 10.5 percent projected in the Survey, the buoyancy of GST amounts to 1.14. This is a major change from the historic buoyancy of indirect tax that has been at around 0.9 percent.

GST as an information mining tool

"The GST has been widely heralded for many things, especially its potential to create one Indian market, expand the tax base, and foster cooperative federalism. Yet almost unnoticed is its one enormous benefit: it will create a vast repository of information, which will enlarge and surely alter our understanding of India’s economy."⁵ With this statement the Survey establishes GST as a game changer in the information that it acts as a tool to gather. Some exciting new findings arising out of GST data mining are highlighted here:

the assumption that the B2C firms (i.e. the smaller firms) would opt for composition has been proved wrong as such firms nonetheless purchase from large enterprises
distribution of GST base among the states appears closely related to their Gross State Domestic Product allaying fears that the shift to GST would undermine major producing states' tax collections
there is a strong correlation between export performance and states' standard of living
Internal trade of India is a whopping 60 percent of the GDP, which beats the estimates by 10 percent
India's formal non-farm payroll is substantially greater than believed - social security measures hint at 31 percent of the non-agricultural work force as formal sector payroll, but GST data suggests formal sector payroll of 53 percent

Other Determinants of Growth

Personal income tax collections have been pegged at 2.3 percent for the FY 2017-18 at the back of measures such as demonetization and GST. The other two significant aspects that have been highlighted by the Survey are:

Exports (hailed, as it were, as the biggest source of upside potential) and
Implementation of the Insolvency and Bankruptcy process

Based on the above, inter alia, the Survey pegs the growth rate between 7 and 7.5 percent.⁶

Timely Justice - A Measure of Ease of Doing Business

It has been widely acknowledged, and stated extremely succinctly by Amrit Amirapu that "Justice Delayed is Development Denied".⁷ Especially taken note of are tax cases - with the average pendency of 6 years per case, the situation has been rather politely deemed to be acute! Per illustrative data quoted by the Survey, the value of government projects in six infrastructure ministries that are currently stayed by court injunctions, as well as the average duration of their stays has been tabulated as given below:

Stayed Projects - Stock (6 ministries as on October 31, 2017)

Ministry	Stayed Projects	Total Value (Rs. Crores)	Duration of Stay (Years)
Shipping	2	2,620	5.9
Power	11	23,913	3
Road	30	11,216	3
Petroleum	2	342	0.9
Mines	12	106	3
Railways	12	13,882	3
Total	52	52,081	4.3

The total legal expenditure of the Corporate India between 2015-16 was close to 20 thousand crores. Other damning statistics relate to tax cases where the Survey notes that the success rate of the Department at all three levels of appeal - Appellate Tribunals, High Courts, and Supreme Court - and for both direct and indirect tax litigation is under 30 percent. "The Department unambiguously loses 65 percent of its cases. Over a period of time, the success rate of the Department has only been declining, while that of the assessee has been increasing".

From a Policy perspective, the Survey suggests the following measures:

Expanding judicial capacity in the lower courts and reducing existing burden on the higher courts via additional capacity to deal with economic and commercial cases at the lower levels, reducing the original side jurisdiction from the High Courts and lesser exercise of discretionary jurisdiction by the higher courts
Tax department should limit its appeal - recognizing the bureaucratic risk aversion, the survey suggests the constitution of an independent panel to decide on further appeals
Increasing state expenditure on judiciary
Creation of more subject matter and stage specific benches
Reduction of reliance on injunctions and stays and stricter timelines for decision on these
Better court case management and court automation on the lines of Crown Court Management Services of the UK

Deep Dive - Selected Highlights of the Survey

Fiscal Developments during the year

The Survey notes that there are 3 distinct patterns on revenue front till November 2017.

the gross tax collections are reasonably on track
non tax revenues have visibly underperformed
non-debt capital receipts, mainly proceedings from disinvestments are doing well

%age Growth in Items of Receipt (April to November)

	2014-15	2015-16	2016-17	2017-18
Gross tax revenue	6.5	20.8	21.5	16.5
Net tax revenue	4.3	12.5	33.6	12.6
Non tax revenue	20.5	34.9	1.0	-29.7
Total revenue receipts	7.8	17.8	24.8	1.1
Non-debt capital receipts	-17.3	180.3	57.1	89.9
Non-debt receipts	7.3	20	25.8	4.6

In contrast to revenue, the expenditure had been robust - which in the present context of the data, appeared to be a euphemism for "tearaway". In any event, the rationale provided by the Survey appears to be sound inasmuch as that:

due to advancing of the budget cycle the spending agencies planned in advance and could implement their expenditure plans effectively, and before time, as it were and
front loading of certain expenditure as a pat of prudent expenditure management

In any event, this had led to a certain amount of pressure on the revenue and fiscal deficit on a year on year basis - note the inordinately high percentages for 2017-18 in the table below.

Deficit Indicators (%age of BE)

	2015-16	2016-17	2017-18
Revenue Deficit	87.5	98.6	152.2
Fiscal Deficit	87	85.8	112

Renegotiation of PPAs⁸ by certain states

One of the key objectives of the Electricity Act, 2003 is promotion of competition in the electricity sector. Section 63 of the Act specifies that (notwithstanding anything contained in section 62), the Appropriate Commission shall adopt the tariff if such tariff has been determined through transparent process of bidding in accordance with the guidelines issued by the Central Government. A tariff order shall, unless amended or revoked, continue to be in force for such period as may be specified in the tariff order. The revised tariff policy was published in January, 2016.

With the recent rounds of auctions, very low tariffs came to be discovered. Auction for wind based power held by SECI ⁹ held in February 2017 realised a tariff of INR 3.46/unit. The lowest feed in tariff for wind on the other hand is at INR 4.16/unit. Second wind auction led to a tariff of INR 2.64/unit - which while welcome in some ways, led to renegotiations of PPAs already signed from certain discoms. Per CRISIL, such renegotiations have the potential of risk to investment worth INR 48000 crores. The Survey takes note of this risk and suggests that "affordable financing holds the key for financing sustainable energy projects". The Survey notes that risk mitigating instruments such as payment guarantee fund or a foreign exchange fund available to developers could be a way forward. Renewable energy has already been placed under the priority sector lending and the bank loan for solar roof-top systems is to be treated as a part of home loan/home improvement loan with subsequent tax benefits. Currently, the levelized tariff is approaching grid parity. The Survey advocates a case for revisiting the subsidies and incentives being given to the renewable energy sector.

Logistics - Challenges and Suggested Plan

With GST, the next big step has to be logistics, given the avowed objective of a single market economy. However, there is much to be desired in this sector. Amongst the challenges are multiple policy making bodies, unfavourable modal mix, and general apathy towards logistics, that plagues the industry. If the benefits of GST are to be harnessed, logistics would have to play a key part therein. The Survey suggests certain key action plans

Formulation of National Integrated Logistics Policy to bring in greater transparency and enhance efficiency in logistics operations
Develop integrated IT Platform as a single window for all logistics related matters and act as a Logistics marketplace
Usher in ease of documentation, faster clearance, digitization.
Bring down logistics cost to less than 10% of GDP by 2022
Faster clearances for setting up of logistics infrastructure like Multi-modal logistic parks (MMLPs), Container Freight Station (CFS), Air Freight Station (AFS) & Inland Container Depot (ICD).
Introduce professional standards and certification for service providers
Promote introduction of high-end technologies like high-tech scanning equipment, RFID, GPS, EDI, online Track & Trace systems in the entire logistics network.
Improve Logistics skilling in the country and increase jobs in Logistics sector to 40 million by 2022

Hybrid Annuity Model in Infrastructure Development

While addressing Industry and Infrastructure sector, the Survey takes a special note of the Hybrid Annuity Model. This model, mooted for road construction, is a combination of EPC (Engineering, Procurement and Construction) model and BOT - Annuity (Build, Operate, Transfer) model. Under the EPC model, the private players construct the road and have no role in the road’s ownership, toll collection or maintenance. National Highways Authority of India (NHAI) pays private players for the construction of the road. The Government with full ownership of the road, takes care of toll collection and maintenance of the road.

Under the BOT model

private players have an active role in road construction, operation and maintenance of the road for a specified number of years as per agreement. After the completion of the years of operation, the private players transfer the asset back to the Government.
the private players arrange all the finances for the project, while collecting toll revenue (BOT toll model) or annuity fee (BOT annuity model) from the Government, as agreed.

In the BOT annuity model, the toll revenue risk is taken by the Government. The Government pays private player a pre-fixed annuity for construction and maintenance of roads.

Hybrid Annuity Model combines EPC (40 per cent) and BOT-Annuity (60 per cent) Models. On behalf of the Government, NHAI releases 40 per cent of the total project cost, in five tranches linked to milestones. The balance 60 per cent is arranged by the developer. The developer usually invests not more than 20-25 per cent of the project cost, while the remaining is raised as debt.

In BOT toll model, the private players did not show their willingness to invest, since they had to fully arrange for the entire finances, either through equity contribution or debt. NPA-riddled banks were reluctant to lend to these projects. Since there was no compensation structure such as annuity, the developers had to take entire risk in low traffic projects. The essence of Hybrid Annuity Model arose due to requirement of better financial mechanism where the risk would be spread between developers and the Government.

Issue of vacant housing

The Survey takes a special note of the issue of vacant housing. Of the total residential stock. the Survey finds that 12.38 percent are vacant. The Survey states that "India’s housing requirements are complex but till now policies have been mostly focused on building more homes and on home ownership. The above data suggests that we need to take a more holistic approach that takes into account rentals and vacancy rates. In turn, this needs policy-makers to pay more attention to contract enforcement, property rights and spatial distribution of housing supply vs. demand." However, with a strong stress on this issue, the possibility of tax proposals impacting vacant housing could be expected.

In Conclusion

Amongst the various issues discussed in the Economic Survey, the aspects analysed by us are essentially areas of concern that may potentially impact both policy making and law in relation to taxation as well as other sectors. One of the factors stressed upon in the Economic Survey is effective enforcement of contracts, through a more effective judicial process; this will significantly contribute to the ‘ease of doing business’.

From this analysis of the Economic survey, the key policy measures in the near to medium term could be in the road, logistics, judicial and energy sectors.

We believe it relevant to mention that this is the first in the many exercises to be undertaken by us with respect to the analysis of the upcoming Budget. We would be happy to have you, our readers, researching and reflecting on our analysis to engage with us about your thoughts and perceptions to encourage fluid dialogue.

With special thanks to Siddharth Sharma and Shivangi Nanda.

Team Aureus.

#IndiaBudget2018Aureus

Footnotes

Amendments in FDI Policy – January, 2018

Viineet V. Srivastav & Astha Srivastava

The following amendments have been introduced by Department of Industrial Policy and Promotion (DIPP) in the Foreign Direct Investment (FDI) regime on January 10, 2018:

100% FDI in single brand retail

The prevailing FDI policy allowed 49% FDI through the automatic route and beyond 49% and upto 100% through the Government approval route in single brand retail trade (SBRT) sector, the said limit has been increased to 100% through automatic route.

Single brand retailing entities would be allowed to begin incremental sourcing of goods from India for global operations during the first 5 years from the first day of the opening of the first store against the mandatory sourcing requirement of 30 percent purchases from India. After completion of the said 5 year period, the entities would be required to meet the mandatory sourcing requirement of 30 percent purchases from India.

A non-resident trading entity or entities, whether owner of the brand or otherwise, would be permitted to undertake SBRT in the country for the specific brand, either directly by the brand owner or through a legally tenable agreement executed between the Indian entity undertaking SBRT and the brand owner.

Civil Aviation

Foreign airlines have been permitted to invest upto 49% in Air India under approval route, subject to the following conditions:

FDI in Air India including that of foreign airline(s) shall not exceed 49% either directly or indirectly

Substantial ownership and control of Air India would continue to vest in Indian Nationals.

Construction Development

It has been clarified that since real-estate broking service does not amount to real estate business, therefore the same would be eligible for 100% FDI through automatic route.

Power Exchanges

While the existing FDI policy provided for 49% FDI through automatic route in Power Exchanges registered under the Central Electricity Regulatory Commission (Power Market) Regulations, 2010, however, Foreign Portfolio Investors (FPI) / Foreign Institutional Investors (FII) purchases were restricted to the secondary market only. Accordingly, the Government has allowed FPIs/FIIs to invest in Power Exchanges in the primary market as well.

Other Approval Requirements under FDI Policy

Issue of shares against non-cash considerations like pre-incorporation expenses, import of machinery etc. would be permitted under automatic route in case of sectors under automatic route.

FDI in an Indian company engaged only in the activity of investing in other Indian companies or LLPs and in Core Investing Companies would be aligned with the FDI provisions in the “Other Financial Services” category. Accordingly, if the said investor companies in India are regulated by any financial sector regulator, then foreign investment upto 100% under automatic route would be allowed and if they are not regulated by any Financial Sector Regulator or where only part is regulated or where there is doubt regarding the regulatory oversight, foreign investment up to 100% would be allowed under approval route, subject to conditions including minimum capitalization requirement, as may be decided by the Government.

Competent Authority for examining FDI proposals from countries of concern

The competent authority for dealing with FDI proposals will be the Department of Industrial Policy and Promotion (DIPP) for investments in automatic route sectors requiring approval only on the matter of investment being from Countries of Concern. The competent authority would be concerned Administartine Department/ Ministry in the case of investments made in sectors requiring government approval and also requiring security clearance with respect to Countries of Concern.

Pharmaceuticals

With respect to the Pharmaceuticals industry, it has been decided to change the definition of medical devices under the existing policy. Further, the existing policy provided that medical devices with respect to FDI policy would be defined with reference to the Drugs and Cosmetics Act and since the definition in the FDI policy is complete in itself, it has been decided to do away with this reference to the Drugs and Cosmetics Act.

Prohibition of restrictive conditions regarding audit firms:

In cases where the foreign investor specifies a particular auditor/ auditing firm having international network for the Indian investee company, then audit of such company would take place in the form of a joint audit in which one of the auditors should not be from the same network.