THE POLICY LAB (TPL) - 46
JUNE 03, 2024

By J B Mohapatra

MORE targeted tax incentives through the fiscal route and not as much financial incentives through subsidies or grants is a feature of developing economies including India's. But to say that tax incentives are primarily responsible for sustaining the investment in a business sector or a typical business activity across all sectors or the targeted part of geography to the exclusion of any other factor; or that the overhaul of any institutional arrangement established on the back of tax incentives will lead to a slow collapse of the sector or retardation of a business activity is reading too much too soon.

Just as political and social stability, enforcement of rules of corporate governance, relative efficiency in redressal mechanism for resolving contract and commercial disputes, certainty in the trade policy, market size, quality of labour market and availability of physical infrastructure are strong factors in a corporate's investment decisions as much as tax considerations, so also personal investment preferences depend as much on sociological factors, age, gender, income level, education, investment experience as on the tax incentives on offer. For corporates and for individuals, tax is a consideration, but not the only consideration. Two examples below, one in case of individuals and the other for the companies in recent tax history are apposite for the context under reference.

A: Life insurance and Taxation for Individuals under section 115BAC of the Income Tax Act (ITA):

Introduced through Finance Act, 2020 with effect from AY 21-22, the provision allowed individuals and HUF an option to shift to a lower 5- tier tax rate structure provided they forego claims of certain deductions and exemptions, as also claim of set off of past losses and unabsorbed depreciation. Finance Act 2023 attempted to make the trade-off more attractive by pruning the basket of non-claimable deductions and exemptions. However one deduction which was not available to the taxpayers opting for the new tax regime both in Finance Act 2021 and 2023 was any claim under section 80C of the ITA. Section 80C offers deduction up to a maximum of Rs 1.5 lakhs on payment of premium on life insurance policy, deferred annuity plans, equity-linked insurance plan, contributions to provident fund, superannuation fund, investment in government saving certificates, units of mutual funds etc.

Removing the deduction under section 80C from the available claims under section 115BAC in order that the taxpayer is statutorily permitted to avail of a concessional tax catalysed an apprehension that the legislative move would disincentivise taxpayers from investing in life insurance products. That the motivation to save through tax deductions would dissipate. That people would rather spend than save.

Published data on new business performance from year to year since FY 16-17 put out by Life Insurance Council, a forum representing 26 life insurers including the LIC of India are as below:

Individual Single Premium (Private Insurers):

Individual Non- Single Premium (Private Insurers):

Individual Single Premium (LIC of India):

Individual Non-Single Premium (LIC of India):

Consolidated for Private Insurers and LIC of India of both individual Single Premium and Individual Non-Single Premium:

Barring a slight dip in individual single premium for LIC of India qua its numbers for 2020-21, there have been actual and substantial increases in gross premiums for both private and LIC of India on a consolidated basis as much as by 31% in FY 23-24 over FY 20-21.

Data above in some way indicates that while tax relief was one of the motivators for people buying life insurance policies, it was never the driving reason. Other factors such as (a) assurance of security and (b) life-experiences including pandemic induced increased awareness of life insurance would have been relevant. Accumulating savings through money-back/endowment plans or through whole-life insurance policies whose returns are not linked to the markets and thus relatively free from market volatility have always been considered safe investment options. HNI buying of high value money back or endowment policies in any case was devoid of a tax saving motivation. Sales innovation adopted by insurers such as popularising pure life risk covers among the younger generation also helped stem the impact of taxation measures and in some significant degree expand the insurance sector. More taxpayers opting for the new tax regime and voluntarily relinquishing claim of deduction under section 80C even while the absolute number of policies and schemes of the insurers and premia for purchase of life insurance products kept increasing does demonstrate that life insurance investment has not been tax rebate dependent to the extent that it was assumed by some analysts at the time the provision under section 115BAC was introduced in 2021.

B: Weighted Deduction to R&D under section 35 of the ITA:

Another example would be the gradual phasing out of accelerated allowance under research and development (R&D) for the purposes of one's business under section 35 of the ITA and whether the withdrawal of weighted deduction impacted investment.

In addition to normal revenue expenditure under section 35(1)(i) and capital expenditure under section 35(1)(iv), 4 separate provisions within section 35 of ITA existed to incentivise research and development through a system of weighted deduction.

a) under Section 35(1)(ii) : payments to a research association which has the object of undertaking scientific research, a college, a university, or other institution which are both approved in accordance with guidelines and notified in the official gazette : Allowance was 175% of payments for a period up to 31-3-18 , 150% for a period from 1-4-18 to 31-3-20 , and 100% from 1-4-20 onwards ;

b) under Section 35(1)(iia): payments to a company to be used by the company for scientific research - conditions being a company registered in India which has as its main object the object of scientific research and development; approved by the prescribed authority in the prescribed manner and fulfilling the prescribed conditions : Allowance was 125% of payments up to 31-3-18 and 100% from 1-4-18 onwards

c) under Section 35(2AA) : sum paid to a national laboratory or university or IIIT or a specified person with a specific direction that such sum be used for scientific research undertaken under a program approved by the prescribed authority - Allowance was 200% of sum paid up to 31-3-18 , 150% of sum paid from 1-4-18 to 31-3-20 and 100% from 1-4-20 onwards ;

d) under Section 35(2AB): cost of in-house research and development expenditure as approved by the prescribed authority in case of bio technology based companies and companies in business of manufacturing and production of article and thing not being referred at eleventh schedule - Allowance was 200% of costs up to 31-3-18 , 150% for costs from 1-4-18 to 31-3-20 and 100% from 1-4-20 onwards.

Among the possible impacts that the phased withdrawal of weighted deduction would have caused and reported upon extensively at the relevant points of time - (i) impact on GDP (ii) retarding new product generation in India (iii) slow-down in indigenisation- there was also an apprehension of lower private sector investment in R&D.

The table below of sectoral investment in R&D comprising the central, state, higher education and private sector from DST- NSTIMS (S&T Indicators - R&D Statistics 2022-23) for the period before and after the phased withdrawal of weighted deduction appears as below:

On a macro level, data on impact of tax changes on private sector's R&D investment does not indicate either any extraordinary momentum in ramping up R&D intensity when the weighted deduction remained in the statute books nor any retardation in R&D investment when the weighted deductions were withdrawn. It would be hard not to infer from the data that companies would spend on R&D as an inevitable requirement of their business, whether or not there are special tax reliefs attached to those expenditure.

C: To conclude from the 2 examples above that tax deduction either under section 80C (read with section 115BAC) or under section 35 did not have any causal connection to the object of augmenting economic performance of the sectors they subserved or the entities they benefited - insurance sector or the private sector R&D - at the time they were brought on the statute books will be unfair. However, the importance of constant review of the effect of the tax deductions to potential and actual outcomes on a periodic basis and thereafter determine the continuance or possible redundancy of the provisions always remains relevant.