OCTOBER 04, 2019

By Naresh Minocha, Consulting Editor

"If a location lags for multiple reasons that reinforce one another, a simple tax incentive package is unlikely to attract private investment as intended. It may be more effective to improve its connectivity to major markets and support skills development and industries such as agro-processing and labour-intensive manufacturing".

This observation made last week by Asian Development Bank (ADB)'s Asian Development Outlook Update is welcome. It should turn focus on the limitation of corporate tax cut (CTC) announced by India. The Government should discuss publicly limited role of direct and indirect taxes in attracting investment and its trade-off with fiscal health of the country.

Let there be a status paper that should factor in non-tax factors that attract or repel investors. The paper should ideally shed light on role of foreign capital in all forms of loans & equity in catalysing growth and jobs creation.

Prime Minister Narendra Modi marketed CTC as a "very revolutionary step" before multinationals during his recent tour of the United States. CTC might not fire up growth of gross domestic product (GDP). It might not ramp up significantly capital formation.

Existing companies might as well pass off CTC-induced surplus profit as higher dividend to shareholders. The companies might finance shares buyback with such surplus instead of ploughing back in greenfield projects and thus enhance lengthen the chain of CTC benefit flow.

CTC has not been accompanied by reduction or withdrawal of existing tax incentives. This is a departure from the original plan to phase out tax incentives and reduce corporation tax. The regulation & management of direct taxes regime is thus set to become complicated.

Businessmen are shrewd. They would prefer to wait and watch for announcement and interpretation of CTC rules by Income Tax Department (ITD). If CTC benefit is protected statutorily for new manufacturing projects for 15 years period, then they might feel assured to make new investments.

Investors have not been assured that CTC benefit would not be diluted or partly offset with new cess or surcharge or hike imposts other than corporation tax. Successive budgets over decades have shown how Finance Ministers excel in taking away what they give with one hand.

The companies would weigh the pros and cons of profit-based CTC as compared to existing cost-based tax incentives. Tax planning is the key for greenfield projects. Foreign investors, like all domestic entrepreneurs, would wait for enactment of direct tax code. The Government has not yet even made public the report of task force on direct tax reforms.

Would companies turn blind eye to Government's decision in June 2019 to extend goods and service tax-linked National Anti-Profiteering Authority (NAA) by 2 years? Has Government assured investors that NAA's tenure and powers would not be extended in future? No.

Has Ministry of Corporate Affairs scrapped statutory provision providing for jailing of non-compliance with corporate social responsibility (CSR)? No.

The list of factors that make setting up of greenfield projects remain as daunting as before CTC announcement.

There are certain up front costs for greenfield projects that blunt or erode their global competitiveness or prolong the gestation period. Reduction in them or an assurance that they won't be hiked in next five years would help improve ease of implementing projects.

The statutory upfront costs are varied and differ from sector to sector. The major ones are:Enterprise Social Commitment (ESC)and Environmental Management Plan (EMP) expenditure. These are stipulated by Ministry of Environment, Forest and Climate Change in environmental clearance. The Ministry also asks project promoters to cough up additional expenditure on wildlife care while granting wildlife clearance.

Mining companies have to bear additional expenditure for public welfare in addition to CSR, ESC, EMP expenditure, afore station and wildlife care cost.

They have to make specified payments under Pradhan Mantri Khanij Kshetra Kalyan Yojna (PMKKKY) for local development & social welfare.

The mining companies deposit money in District Mineral Foundations (DMFs), which have been formed under The Mines and Minerals (Development & Regulation) Amendment Act, 2015.

CTC-attracted companies would have also to plan projects keeping in uncertainty in import competition. This results from Government's tendency to lower import tariff under free trade area/preferential trade pacts with countries/regions.

A manufacturing project must assess & pass the worst-case test – zero % import duty on products it would produce under CTC lure. Setting up of a greenfield manufacturing project is as good as firing a short in the dark. No wonder 'Make In India' targets remain elusive.

The Government should thus not tom-tom tax incentives to lure foreign capital without managing cobweb of factors that can make projects sick right from the word go. It should instead offer a comprehensive package of business environment for greenfield projects.

It is pertinent to quote the World Bank's Global Investment Competitiveness Report 2017/2018. It says: "Incentives are rarely among the top characteristics that multinational corporations (MNCs) initially consider in their location decisions, but they can play an important role in the final decision among shortlisted locations ".

The Survey adds: "Tax incentives should be targeted at efficiency-seeking investors, but fundamentals of the investment climate must be addressed first ".

The main factors influencing FDI inflow for projects are market size and real income levels and skill levels in the host economy. Availability of infrastructure and other resources that facilitates efficient specialisation of production is a key determinant of FDI. So are trade policies and political & macroeconomic stability of the host country. The relative importance of the different factors varies depending on the type of investment, according to OECD's ' Tax Incentives for Investment – A Global Perspective: experiences in MENA and non-MENA countries ' released in 2007.

India's investment climate is like an ocean. The more you go deeper, the more you see entrapments. Significant jump in India's Ease of Doing Business is not the only indicator of investment climate. Sector-specific policies matter a lot. So do regulatory transparency and credibility.

A few draft macro policies such as New Industrial Policy and National Resource Efficiency Policy have not yet been finalized. They too have fiscal proposals. The latter, for instance, has several tax proposals including landfill tax. It moots tax incentives for secondary products made from recycled inputs.

Similarly, several sector policies are delayed or are on the anvil. Would domestic and foreign companies overlook sector-specific policy uncertainty to lap up CTC?

CTC is unlikely to enthuse sectors such as pharmaceuticals and fertilizers that are subject to price controls. Entire healthcare sector is worried over aggressive and ever-expanding price controls over drugs& other medical products such as bone implants & pace-makers.

So are multinational seed companies and their joint ventures with Government putting cap on the royalty on supply of seed breeding know-how. The cobweb of litigation and arbitration in the domain of oil & gas exploration and production has kept off most MNCs for many years.

No due-diligence report on greenfield investment would overlook the fact that the Government is yet to disclose its decision on report of Inter-Ministerial Group (IMG) on " Outflow of Royalty ".

Metallurgical MNCs won't find CTC attractive in absence of timely and protected access to minerals such as bauxite for aluminium manufacture, coal for coal-gasification-cum-manufacturing complexes, sand minerals for producing specialty metals.

They would thus wait for implementation of National Mineral Policy (NMP) 2019. NMP says "efforts shall be made to benchmark and harmonize royalty and all other levies and taxes with mining jurisdictions across the world to make India an attractive destination for exploration and mining".

The analysis so far should draw Government's attention to a 15-country pilot study titled 'Comparing tax incentives across jurisdictions' released by Tax Justice Network in January 2019.

As put by the Study, "Our literature review and research reveal a growing consensus among academics, policy makers and civil society that profit based tax incentives are very costly, and often not effective in attracting (largely) desirable greenfield investment".

Apart from adopting holistic approach towards investment climate, the Government should optimise use of bilateral and foreign loans to improve country's economic competitiveness.

A country imports foreign capital to cover up its inability to earn adequate foreign exchange through exports. The imported capital should ideally improve growth and export competitiveness of the country.

India has failed to generate foreign exchange surpluses in spite of liberal inflow of foreign capital, both as debt and equity, in all forms since 1991 big-bang reforms. India thus runs a current account deficit (CAD), which is viewed with alarm if it exceeds 3% of gross domestic product (GDP).

What World Bank President John J. McCloy,said about "international investment of capital" On 16th April 1947 is relevant for India.

McCloy observed: "there are two fundamental characteristics of the international investment of capital of which I speak: First, that the investments are made primarily by or through funds derived from those countries which, by reason of their superior resources or productive mechanisms, are in a position to enjoy an export surplus: and, second, that they are made for the purpose of developing the productive resource sand capacities of less favourably situated nations".

He added: "It is not a wise international investment if the flow of capital does not equally benefit the borrower and the lender ".

Foreign capital should thus be attracted primarily to enhance country's total factory productivity and expand base for production and export of goods and services. Portfolio investment by foreign investors on Indian stock market does not help us in any way except in managing foreign exchange market.