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Asian Tax Review: Reexamining Indian Tax Proposals

By Laurence E. Lipsher - Email Editor

Date : November 5, 2009

Dear Valued Reader,

Detailed analysis regarding Finance Minister Pranab Mukherjee’s proposals to alter India’s Direct Tax Code has finally been released, and it is far more critical than the Finance Ministry probably expected. The National Academy of Direct Taxes, in a report submitted to the Central Board of Direct Taxes, started off highly critical and unhappy that the plans to change the Direct Tax Code were prepared without prior consultation with either public or professional organizations or with even the India Revenue, the country’s tax bureaucracy. The academy was openly skeptical about finalizing and instituting changes by April 2011. I stated the same skepticism when I first wrote about Mukherjee’s announcement. (For prior coverage, see Tax Notes Int’l, Sept. 21, 2009, p. 1029, Doc 2009-20006, or 2009 WTD 180-16.)

The academy report was critical of revenue reduction when the country needs funding to upgrade itself. The academy believed that there would be a personal tax revenue loss of INR 25,000 crore and an INR 30,000 crore business tax revenue reduction. This was not fiscal responsibility so much as it was a payoff to the various groups that gave the United Progressive Alliance coalition the close-to-majority needed in the recent national elections.

Below are changes that the academy believes should be included within the Direct Tax Code and that I feel are relevant:

• an upward revision of tax rates and a reduction of the number of bands within which individuals are taxed;

• reduction of the wealth tax exemption limit to INR 10 crore;

• exemption of employer-paid provident fund contributions on behalf of employees;

• 100 percent tax deduction for medical reimbursement because medical reimbursements are, for all intents and purposes, less than the cost of medical treatment;

• either an increase in the corporate tax rate or maintenance at 30 percent, rather than a reduction to 25 percent;

• payment of dividend taxes by the receiver of the dividend and not the payer;

• maintenance of the differentiation between longterm and short-term capital gains; and

• revision of the draconian minimum alternative tax (MAT) proposals.

Under Mukherjee’s proposals, companies paying the MAT would have a much higher burden because it is the year-end gross value of assets that will be taxed, not income. Taxation based on asset valuation is used elsewhere, but generally it is between 0.5 percent to 1 percent. Mukherjee wants 2 percent, which would make life rather difficult for capital intensive firms if the new MAT comes into being.

What I find very interesting is that as far as the individual income tax in India is concerned, the lower tax burden will reduce the umbrella under which those with a liability for filing and paying will fall. According to an August 13 Business Standard article, tax experts said that only 27 million people in the country are subject to the individual income tax. That’s 27 million out of a 1.2 billion population. It appears the individual income tax is not very significant in India.

In mid-October, Mukherjee backpedaled from his proposals. He announced on October 10 that the government is receptive to change in seven areas of the Direct Tax Code. The areas that will be reexamined are related to proposals on the MAT (this was obvious), capital gains tax, double taxation avoidance agreements, general antiavoidance rules, taxation of charitable organizations, taxation of foreign companies in India, and taxation of investments at the withdrawal of funds stage of business.

It was Revenue Secretary P.V. Bhide who made the most noteworthy comments that day when he assured reporters that the proposal on double taxation avoidance agreements would only empower the government in the future and that it would not override the 75 existing tax treaties. Does that mean there will be no changes to the India-Mauritius tax treaty? This is one I will follow closely. I think there will be some changes to that treaty, but nothing of major impact, because there are too many important people in both government and industry who already have Mauritius offshores doing business in India who are not at all receptive to change.

South Korea

For the 11th consecutive month, South Korea announced a drop in exports — approximately 20 percent, year-on-year, from September 2008 to September 2009. This is not good news for an economy that is heavily reliant upon exports. Consequently, the government announced that it will increase corporate tax rates, rather than drop rates for 2010, as it had previously intended to do. After all, how do you finance a stimulus package when the anticipated tax revenues do not come to fruition? Raise the tax rates, of course!

In 2008 the largest South Korean companies paid an effective 14 percent maximum tax rate, down from 15 percent in 2007. This was to be cut to 13 percent in 2010, until the Ministry of Strategy and Finance announced in September that it will go back to the 15 percent rate, in hopes of raising an additional KRW 7.7 billion. The government will also ask financial institutions to pay tax on interest income from bonds on a monthly rather than annual basis.

The government also will expand its audit function to raise additional revenue. The largest South Korean companies — those with annual revenues of at least KRW 500 billion — will undergo a regular tax audit once every four years. Companies with gross revenues between KRW 100 billion and KRW 500 billion will be selected for tax audit based upon a ‘‘Compliance Analysis Function’’ evaluation. This evaluation will group companies by size and industry type, similar to the ‘‘peer group’’ evaluation that the Chinese State Administration of Taxation uses.

Past evidence of false reporting, cash outflow to overseas entities through international transactions, and expenditure of corporate funds for noncorporate purposes will also be included within this evaluation.

Will this raise revenue for the South Korean government? I’m skeptical because enforcement has always been quite lax (unless you are a foreign entity doing business in South Korea). South Korea has many problems, and I really do not think that the country is addressing the reality of the situation.

China, Hong Kong, and Macao

There are three types of legal gambling in Hong Kong: horse racing, the stock market, and the real estate market. Of the three, I feel most comfortable playing the horses. One can go to the racetrack in Macao or Singapore, but there’s little that the Chinese can gamble on other than the stock or real estate markets.

There’s a bubble growing in those two markets in China, and the government is actively involved in trying to prevent any bursting. I always thought it to be the other way around: When sales decline, prices should decline simultaneously to rectify the supply and demand balance. That’s a basic of free market practices.

Then how does one account for a 50 percent rise in Beijing real estate prices since April? Of course sales have declined. During the National Day holiday, real estate sales sank to a three-year low. During the first six days of the holiday, 472 units were sold this year, compared with 1,411 last year. I think the government had a hand in this, ‘‘urging’’ property developers to substantially increase prices on a temporary basis, encouraging money to flow elsewhere, as a means of managing that bubble. Effectively, this is what has been happening throughout China. According to a group of articles in the October 7 South China Morning Post, real estate transaction volume in 20 key cities fell 7.1 percent in August and 14.5 percent in September. Benedict Ma, associate director of research at CB Richard Ellis, said, ‘‘As long as Beijing maintains a relatively loose monetary policy, which I believe it is committed to do for the time being to maintain economic growth, then mainland investment (outside China) will continue.’’

Reinforcing Ma’s comments about the current ‘‘loose’’ P.R.C. monetary policy is the recently announced relaxation of travel restrictions imposed on Guangdong residents wanting to travel to Macao to gamble more than once a month. Much of the reasoning behind Beijing’s relaxation of the travel rules for trips to Macao also has to do with the Macanese finally figuring out that they have to contribute to rebuilding earthquake-ravaged Sichuan Province. A while ago, I mentioned that while Hong Kong has been paying its dues (more like a tithe, actually) for reconstruction, Macao has been quiet about any participation in the efforts required for a timely reconstruction from the devastation of an area with the size and population of Germany. (For prior coverage, see Tax Notes Int’l, Aug. 24, 2009, p. 643, Doc 2009-17093, or 2009 WTD 161-16.) For that, I believe, Macao was ‘‘punished’’ by fewer visits from Guangdong residents.

It’s boom time in Hong Kong, with leading real estate developers Cheung Kong Holdings and Henderson Land Development Co. Ltd. reporting that over 30 percent of the buyers during the National Day holiday were from the mainland. Mainlanders are getting financing from Hong Kong banks, although the due diligence from the banks is not really that thorough. Most borrowers borrowed less than 70 percent, coming up with cash and qualifying simply by providing proof, if necessary, of income via Chinese tax statements. I question the legitimacy of the tax statements reviewed. Has a market developed for bogus tax statements? Is this an area of potential cooperation between the Inland Revenue Department and the State Administration of Taxation?

In an in-depth story in the October 11 South China Morning Post, Peggy Sito, Maria Chan, and Chloe Li described how money is flowing out of the country to Hong Kong.

Beijing started a visit program allowing mainlanders to take CNY 20,000 and the equivalent of US $5,000 on each trip outside of China. It takes a good number of visits to build up investment funds, but patience is truly a virtue in this type of situation, and apparently there have been many patient Chinese.

In addition to the per visit cash limit, the visitor can use mainland-issued bank cards to withdraw from Hong Kong ATMs — that’s an additional CNY 10,000 per day. You might also have a Hong Kong dummy offshore company for trading purposes — cooking the books is a universal art. That’s another way to get money in, as well as having friends and business associates in Hong Kong who, because of currency restrictions, are limited in the amount of yuan renminbi they can bring into China during the year. If you are a mainlander with a Hong Kong associate, you can simply ‘‘trade’’ across the border: While your friend in Hong Kong is providing the Hong Kong dollars for you, you’re giving him the yuan renminbi in China in exchange. While this definitely is ‘‘free trade,’’ I do not think that the OECD would approve because it’s all unreported.

Again, mainlanders are entitled to buy a maximum of the equivalent of US $50,000 per person, per year. Just imagine getting 15 friends and family who will not be using that US $50,000 quota, accumulating those quotas for yourself (with your money, probably not declared for tax purposes). Voila! You’ve got your Hong Kong real estate down payment.

How do you get the money to Hong Kong, though, with those per visit currency restrictions? Underground banking. It thrives between Shenzhen and Hong Kong and Zhuhai and Macao, despite the steep commissions that must be paid for these transactions. The people carrying the cash are usually pensioners who have the time and patience to stand in lines on both sides of the border. Their payment is low, but they make it both ways: coming home as well as leaving China. On the return trip, they bring back consumer goods that local retailers happily pay for because as they are tax free this way. Obviously, the Customs Department does not like this.

Thus, free trade (at least free-of-tax trade) flourishes in times of loose monetary policy.

Until next time,

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