LEGAL UPDATE: INDIA
Issue 14 ... Budget 1997-98
Published by:
Nishith Desai Associates International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.
E-mail: desai.nishith@gems.vsnl.net.in
The contents of the "Legal Update: India" should not be construed as legal opinion or professional advice. Since the sources are varied, at times it is difficult to verify the correctness of the information mentioned herein.

Content

  • Personal income-tax
  • FEMA and Money Laundering Bill
  • Corporate sector
  • Infrastructure
  • Insurance
  • Venture capital
  • FIIs
  • NRIs
  • Companies Bill and Direct Taxes Bill
  • Capital account convertibility
  • Information technology
  • Indirect Taxes
  • Market reaction
  • Non-Budget matters
  • - Profit earning record for public issues
  • - Companies Act amendment
  • - Indian depository receipts
  • - Takeover code
  • - FIIs permitted to invest proprietary fund

Budget 1997-1998

The corporate sector as well as the capital markets are virtually euphoric over the Union Budget 1997-1998 (Budget) presented to the nation by Finance Minister Mr. P. Chidambaram on February 28, 1997. In fact, the Budget has something for everyone. It is a budget which must go down in the Indian history as one of the most progressive budget ever presented.

Personal income-tax

The Budget reduces the rates of personal income-tax across-the-board in a significant manner. The current rates of 15%, 30%, and 40% are being replaced by the new rates of 10%, 20%, and 30%.

Currently, employees are entitled to standard deduction at 33.33% of salary earned or Rs. 15,000, whichever is lower. A higher deduction of Rs. 18,000 is allowed to women whose total taxable income (before allowance of standard deduction) does not exceed Rs. 75,000 and to other persons if their taxable salary (before standard deduction) does not exceed Rs. 60,000. It is proposed to enhance the upper limit of standard deduction to Rs. 20,000 for both men and women employees.

The table below provides the revised tax structure proposed for personal taxation. 
Income Bracket                  Tax Rate

Up to Rs. 40,000		   Nil
Rs. 40,001 - Rs. 60,000	  	   10%
Rs. 60,001 - Rs. 150,000	   20%
above Rs. 150,000	   	   30%

FEMA and Money Laundering Bill

The Foreign Exchange Regulation Act, 1973 is proposed to be replaced by a new law consistent with full current account convertibility and the objective of progressively liberalizing capital account transactions. The Finance Minister proposes to introduce, later this year, a Bill titled the Foreign Exchange Management Act (FEMA).

A Bill dealing with money laundering is also being prepared and will be tabled for discussions during the current session of Parliament.

Corporate sector

For the first time India has achieved international levels of taxation. The corporate tax rate currently pegged at 40% has been reduced to 35% and corporate surcharge (currently 7.5% of corporate tax) has been abolished.

Dividend income in the hands of shareholders has been pronounced tax-free, although, the corporate sector has to contend with an additional tax of 10% on the amount declared, distributed, or paid by such company by way of dividend (whether interim or otherwise) on or after June 01, 1997. Chapter XII-D (section 115-O, section 115-P, and section 115-Q) relating to the aforementioned provisions is proposed to be inserted in the Indian Income-Tax Act, 1961 (ITA).

Although the Minimum Alternate Tax (MAT) continues, export profits eligible for deduction under section 80-HHC of the ITA will be exempt from the MAT.

It seems, that through legislative oversight, the exemption from MAT has not been extended to profits from export of computer software under section 80HHE of the ITA. It is expected that this provision will be included in the Act.

A tax credit system for MAT taxes has also been introduced. Thus, companies paying MAT can carry forward for a period of five assessment years, the tax credit (i.e. the MAT paid) and adjust it against the regular tax payments, if any, made in the future years. For example, if a company is liable for regular tax payments in a given year, the difference between the regular tax and tax computed under MAT will be set off against the MAT credit.

The table below gives the proposed tax rates for domestic and foreign companies. 

                     		Domestic Co.   Foreign Co.

Normal                  	    35%        	 48%
Dividend    		  	      -	         -
Royalty & Fees for 
Technical services	            35%          20% (gross)
Interest			    35%          20% (gross)

Infrastructure

Section 80-IA of the ITA grants a five year tax holiday for certain infrastructure projects. With retrospective effect from April 01, 1996, telecommunication (basic or cellular) services will qualify as 'infrastructure' for the purposes of tax benefits under Section 80-IA.

Furthermore, with effect from April 01, 1998, operation of industrial parks will also qualify as infrastructure for the purposes of the tax benefits under this section.

Insurance

The Life Insurance Corporation of India (LIC) will continue to enjoy a monopoly in the life insurance business and the General Insurance Corporation of India (GIC) will enjoy a monopoly in the non-life, non-health insurance business. Only a few Indian companies, with majority Indian ownership and control, will be permitted to enter the health insurance business.

Venture capital

At present, the Venture Capital Funds (VCFs)/Venture Capital Companies (VCCs) willing to claim exemption from tax on dividends and long-term capital gains, can invest only up to 5% of their corpus in the equity of any single company. This limit is being proposed to be increased to 20%.

The Budget also proposes to widen the definition of VCUs (i.e. companies in which VCFs/VCCs invest in order to claim certain tax exemptions), to include unlisted domestic companies which are engaged in the business of generation and distribution of electricity or any other form of power, or in the business of providing telecommunication services.

Section 10(23G) of the ITA exempts from tax, income by way of dividend, interest, or long-term capital gains of an infrastructure capital fund/ infrastructure capital company from investments made by them in any enterprise carrying on the business of developing, maintaining and operating any infrastructure facility.

The definition of 'infrastructure facility' is proposed to be widened to include projects for the generation, or generation and distribution of electricity or any other form of power, and projects for providing telecommunication services.

FIIs

The aggregate investment by Foreign Institutional Investors (FIIs), Non-Resident Indians (NRIs) and Overseas Corporate Bodies (owned to the extent of at least 60% by NRIs) in an Indian company has been increased from the current limit of 24% to 30%, subject to the condition that the board of directors of the investee company approves the limit and the general body of the investee company passes a special resolution in this behalf.

There will also be no tax on dividends earned by FIIs.

NRIs

Currently, NRIs are subject to tax on long-term capital gains arising on the transfer of specified foreign exchange assets at the rate of 20%. The Budget proposes to reduce the rate of tax to 10%.

Companies Bill and Direct Taxes Bill

The expert groups set up to draft a new Companies Bill and Direct Taxes Bill have submitted their reports. Copies of both the Bills will be distributed widely so that there will be a wide and informed debate on the Bills.

The committee appointed to draft a new Companies Bill has also made valuable suggestions. Some of the recommendations are mentioned below :

The principle of buy-back of shares by companies subject to certain conditions will be introduced in the Companies Act, 1956 (Companies Act).

Section 370 and section 372 of the Companies Act dealing with inter-corporate loans and investments are proposed to be merged. Furthermore, the limit which is presently pegged at 30% is proposed to be increased to 60%.

Companies raising funds from the capital market will be required to give an annual statement disclosing the end-uses of such funds.

Capital account convertibility

Foreign exchange earners currently have the facility of the Export Earners Foreign Currency (EEFC) account.

The Budget proposes to allow EEFC account holders to open offices abroad and to meet the expenses thereof. EEFC account holders will also be permitted to make investments in overseas joint ventures from the balance in their EEFC accounts up to a limit of US$ 15 million without reference to the Reserve Bank of India (RBI).

The Finance Minister is also asking the RBI to appoint a group of experts to lay out the road map toward capital account convertibility, prescribe the economic parameters which have to be achieved at each milestone, and work out a detailed time table for achieving the goal.

Information technology

It has been decided to permit Electronic Hardware Technology Park (EHTP) units, 100% Export Oriented Units (EOUs) producing electronic hardware, and electronic hardware units in Electronic Processing Zones (EPZs) to sell 50% of the value of their products, in the domestic market and to export the other half.

The sale in the domestic market will be on payment of excise duty equivalent to full customs duty, including the additional customs duty.

Indirect taxes

The customs duty on software imports which is currently pegged at 10% is proposed to be abolished. Customs duty on computer parts (except populated PCBs and color picture tubes) are proposed to be reduced from 20% to 10%.

However, the special import duty of 2% introduced last year, continues.

Market reaction

UTI wants units dividends tax-exempt

The Unit Trust of India (UTI) will be requesting the Ministry of Finance to exempt from tax, dividends declared by mutual funds in favor of the unit-holders.

They contend that dividends distributed by mutual funds are akin to those declared by corporates and should be treated at par. As per the Budget provisions, dividends distributed by domestic companies are tax-exempt.

Incidentally, income on units held by offshore funds in schemes of domestic mutual funds will continue to be taxed at 10% as no change has been made to section 115AB of the ITA.

BSE Sensex zooms to 4000 mark

The stock markets appear to have entered a new bull phase, with the stock prices continuing to rise.

On March 03, 1997, the Mumbai Stock Exchange's (MSE) sensitive index (Sensex) breached the 4,000 point mark during the mid-session, before slipping back to close at 3,871.06.

Non-Budget matters

Profit earning record for public issues

The SEBI is considering the possibility of amending the track record stipulation for companies contemplating public issues. SEBI wants the stipulation of a three-year dividend paying record to be replaced with a three-year profit-earning record.

Companies Act amendment

In January 1997, the President of India, Mr. Shankar Dayal Sharma consented to the Companies (Amendment) Act, 1996 through the issuance of a notification.

Section 610(A) has been introduced in the Companies Act making facsimile copy and micro-film of a document as well as the reproduction of the image embodied in such micro-film as evidence admissible in any proceeding.

It has also been made mandatory for the Registrar of Companies to preserve the computer media by duplicating, transferring, mastering and storing sans the loss of date. These evidences will be applicable even without further proof or production of the original as authentic.

Companies defaulting on payment of deposits will be debarred from raising further deposits or making inter-corporate loans and investments under section 372 of the Companies Act.

Indian depository receipts

The report of the working group set up to re-draft the Companies Act, 1956 (Companies Act), was made public on March 03, 1997. The report, in addition to other suggestions, recommends introduction of Indian Depository Receipts, and optionaal consolidation of group accounts.

There is no recommendation however, for the introduction of non-voting shares.

The report also recommends the incorporation of employee stock option plans (ESOPs) in the new Act. According to the report, these options can be in the form of warrants or other securities that have pre-specified dates of conversion in the future. ESOPs should be permitted up to 5% of the increased capital of a company and the rules should allow for buy-back of options.

Takeover code

According to press reports, the new Securities and Exchange Board of India (SEBI) takeover regulations has been in force since February 20, 1997, although the SEBI is yet to issue a notification in this regard.

The takeover regulations are likely to be tabled in the current session of Parliament.

FIIs permitted to invest proprietary funds

The Securities and Exchange Board of India (SEBI) is now permitting FIIs to invest their proprietary funds in the Indian capital makets.

Proprietary Funds are permitted to invest through the FII route, provided such funds belong to the FIIs and subject to the condition that these FIIs are regulated by their home regulators or are registered with their tax authorities.

Thus, even registration with the home tax authority may now be considered as being regulated outside India.

FIIs can henceforth, also invest in government securities.

In addition, SEBI's press release dated January 30, 1997, states that the condition that FIIs or their sub-accounts be broad-based would be removed. However, this is yet to be notified.

Edited by: DeAnne D'Souza

Published by:
Nishith Desai Associates International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.
The contents of the "Legal Update: India" should not be construed as legal opinion or professional advice. Since the sources are varied, at times it is difficult to verify the correctness of the information mentioned herein.
Last update: March 10, 1997.