Union Budget 2020: Investors deserve their fair share

Union Budget 2020: Investors deserve their fair share

By V.P. Nandakumar 

The key to bringing India’s economic growth back on track is to rekindle the animal spiritsof entrepreneurs,   including the   small   and   marginalentrepreneurs. An   economy   needs investments to grow, and investments need the savings tap to flow without friction.

The forthcoming Union Budget must address the issue of how to improvetheflow of savings to investments, whether in the form of equity or debt. Earlier,only equity capital was thought to takeonthe risks in business and hence deserving of preferential tax treatment, which led to  differentiated  capital  gains  taxation  for  equityas against  regular  income  tax for interestincome. However, if the experience of the past several quarters have taught usanything,it is that  even  debt  capital  takes on business  risk,  maybe not  as much as  equity  but significant none the less. Several savers(investors)in Co-operative Banks, NBFCs, and corporates have faced the brunt of businesses failing to honour their commitment and repay theirdues. It is time  that  policymakers  took  another  look  at  the  long-standing presumption  that only equity investment is about risk-taking while debtinvestments are risk-averse.

For the Indian economy to grow at rates over 8-10%(which in my view is feasible), we must be willing to address the taxation deterrents to savings and investments. India’s savers are hurt less by low real interest rates and more by its taxation.Interest income is taxed at the marginal tax rate,while equity capital gets better treatment under capital gains. 

Further,  under  Section  115BBDA  of  the  Income  Tax  Act,  shareowner  returns  on  equity investments are taxed three timesin case of dividend income. Firstly, when the shareowner’s profit share (of the profit made by the company) gets taxed as income tax on corporate profit. The  second  instance  is  the deduction  of dividend  distribution  tax from profitsbefore the company makes the  dividend  payment to shareowners  (coming  after payment  of corporate income tax)and the third is when thisdividend, having already paid income tax and dividend distribution tax, gets further taxed in the hands of the shareowner when such income exceeds Rs.10 lakhs annually.

There is no rationale for taxing listed companys’dividend payments thrice. There may be some logic in the taxation of dividend income from unlisted companies,etc., but certainly none for the  regulated and listed  corporates.  Such  tax  policies deter long-term investments in the economy besides distortingcapital allocation. At the very least,the FM should revert to the pre-2016 position where dividend income was tax-free for all shareowners. 

The second urgent issue is the tax arbitrage in case of interest income. At present, the law offers  an  unfair tax advantage  to  debt  funds  of  mutual  funds  and  insurance  investment schemes because investments  made  through  these  channels  get the  benefit of  indexation. This benefit is  not  available  to bank  deposits,  postal  savingsscheme  orother direct debt investments, including government bonds. 

When the government’s fiscal deficit is a constraint to paying favourable interest rate to savers, we can still encourage savings by giving tax-free status to direct interest income, or at least for the interest income receivedfrom market-linked products like bank depositsand listed debt investments. After all, why should tax benefit in the form of indexation etc.be given only when savings are channelled through the mutual funds and not when directly invested in FDs and NCDs? This sort of tax arbitrage is distortionary and must be done away with. Let all interest income be tax-free in the hands of the end-user. Such relaxation will offer banks and financial institutions much  needed leeway  to  raise  deposits  at  a  lower  cost  andwill  increase  credit offtake besides enabling faster transmission of policy rate cuts to spur economic growth.

To further encouragedebt investments, it is also desirable to make it easier for savers to investin debt instruments. Allowing institutions toborrow as and when required through op-tap bond issuance is a good idea. Such on-tap insurances would also help in increasing the liquidity of the securities, further encouragingdirect debt investments from savers. 

There  is also  a case  to  be  made  for  relaxation  of  external commercial borrowings (ECBs), especially in these times when the international market is flush with liquidityand on the prowl for yield.  Policymakers  need  to  re-evaluate  the  pros  and  cons of the  current restrictions  on external borrowings, especially for the funds starved NBFC sector. 

NBFCs should be allowed external borrowings even for lowertenure, say, one year (instead of  three  years), and  also  be  allowed  to repayexisting rupee  debt or refinance foreignborrowings with the proceeds of the ECB. As NBFCs borrow more from external markets and narrow  their  dependence  on  domestic  banks,  the interlinkages  within  the Indian financial systems  would reduce,  making  the  system  more  stable  and  less  prone  to  the  spread  of contagion, and lowering the “systemic risk”in the Indian financial services sector. Yes, it would make the task of the RBI a little harder in terms of having to manage the currency risks. But, isn’t it better to have the RBI manage some extra external risks than continuing to have India’s NBFCs starvedof capital? It would also be a tiny step towards capital account convertibility, a long-cherished desire ofindustry and policymakers alike.

(Author is MD & CEO of Manappuram Finance Ltd. Views are personal)

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