Do it yourself: Budget 2024

Showing posts with label Budget 2024. Show all posts

Wednesday, July 31, 2024

The capex “nudge”

Capital expenditure (capex) has been one of the primary focus areas of the government in the past one decade. As per the Economic Survey 2024, “The focus of capex has been broad-based. Spending in sectors such as road transport and highways, railways, defense services, and telecommunications delivers higher and longer impetuses to growth by addressing logistical bottlenecks and expanding productive capacities. Government capex has also begun to crowd in private investment, as discussed earlier in this chapter. Additionally, the Government continues to disburse grants-in-aid for the creation of capital assets to the states, thereby incentivizing them to increase their productive spending.”

Accordingly, “capex” has emerged as an important driver of growth, as indicated in its rising share of nominal GDP. As per the provisional actual (PA) figures for the FY24, capex for FY24 stood at ₹9.5 lakh crore, an increase of 28.2 per cent on a YoY basis, and was 2.8 times the level of FY20.

However, despite the sharp rise in the government capex in building the enabling infrastructure and incentivizing enterprises, the private capex has not responded adequately. Lamenting the private entrepreneurs, the Economic Survey stated, “while it remains the government’s responsibility to facilitate the development of infrastructure and address logistical challenges, it is incumbent upon the private sector to take forward the momentum in capital formation on its own and in partnership with the Government. Between FY19 and FY23, the share of private non-financial corporations in overall GFCF increased only by 0.8 percentage points from 34.1 per cent to 34.9 per cent. This was mostly driven by their fast-increasing share in the additional stock of dwellings, other buildings and structures. Their share in addition to the capital stock in terms of machinery and equipment, started growing robustly only since FY22, a trend that needs to be sustained on the strength of their improving bottom-line and balance sheets in order to generate high-quality jobs.”

In the recently concluded general elections, lack of adequate job generation emerged as one of the key agenda points. The experts have held the prevalence of high unemployment rates amongst educated youth as one of the factors responsible for below par performance of the BJP.

Obviously, the government is concerned about the employment situation. The problem is that commitment to fiscal discipline and structural reform in the public sector may not permit the government to create many new employment opportunities in the public sector. The employment generation would thus be the responsibility of the private sector.

In the recent budget for FY25, the government announced some measures to encourage private enterprises to invest in building new manufacturing capacities and generate employment for the youth entering the job market. The budget adopts a carrot and stick approach for that. On one hand, it provides support for hiring more fresher employees and skill them, and on the other hand it makes outflow of funds from companies difficult. After dividends, now buybacks are also made tax inefficient. The idea seems to “encourage” companies to invest in growing their businesses and reward shareholders through share price appreciation only. Abolition of Angel Tax on startups is also a measure to encourage more new businesses to be set up and offer employment opportunities.

How much of these efforts will yield in terms of new employment and growth is to be seen, but the intent seems clear.

Thursday, July 25, 2024

The morning after

The union budget for the fiscal year 2024-2025 has been read, analyzed, criticized, and apparently brushed aside by the markets. Changes in the taxation of capital gains; changes in the custom duty and capital gain tax structure for gold; and higher rate of STT on derivative transactions are three points that have attracted the maximum attention, especially from the market participants.

I had posted my first impression of the Union Budget FY25 on Tuesday. On a second reading of the budget documents and listening to the views of a variety of experts, I have gathered some more inputs that I would like to share with the readers.

Impact of capital gain tax changes on equity markets

The long-term capital gain tax (LTCG) on sale of listed shares has been increased from 10% to 12.5% and the short-term capital gain tax (STCG) has been increased from 15% to 20%. The market reacted negatively to the announcement initially. However, all the losses were recouped within an hour. This has surprised many market participants who believed that any hike in capital gain tax would be detrimental for the markets.

My thoughts on this are as follows:

(a) Tax is a function of actual profit gained or loss incurred by an investor. Stock price of a stock is a function of the demand and supply of such stock at a given point in time. Demand and supply in turn are determined by the future price expectations. If a larger number of buyers expect the stock price to rise in future, the demand will stay higher, and vice versa. Thus, if the "return expectations" of investors stay high, stock prices may not correct regardless of the cost of transaction and/or taxation of gains. The market correction may need a bigger reset for a meaningful correction. Tax or STT alone would not do much.

(b) The capital gain tax structure has not only been simplified, on an average, the effective rates of taxation may be actually lower for many investors. For example, tax rates for STCG on listed bonds, Equity FoF, Gold/Silver ETF, have been reduced and holding periods are also aligned with listed shares. Similarly, tax rates for LTCG on Equity FoF, Overseas FoF, Gold/Silver FoF, Gold Funds, physical gold, unlisted stocks and foreign equity have been materially reduced.

(c) Contrary to first impression, the budget may be positive for the real estate sector. The effective LTCG on sale of properties may be lower, despite lack of indexation benefit, in a majority of cases. Besides, the likely reduction in stamp duty may benefit the buyers.

(d) By bringing taxation of listed bonds at par with equities, while keeping bond funds taxable at a much higher rate, the government wants to kick start the growth of the retail debt market, especially after inclusion of Indian government bonds in the JP Morgan bond index.

Gold

The finance minister has cut effective import duty on gold from 15% to 6% in this budget. Besides, the capital gains tax on physical gold, gold funds and gold/silver ETFs has been reduced materially.

These proposals have baffled my market participants. They have argued that this may lead to undue rise in import of gold, this adversely affecting the trade balance. Secondly, bringing LTCG taxation of gold at par with equities and bonds is against the spirit of financialization of domestic savings. It is pertinent to note that the NDA government has strived to financialize gold holdings through Sovereign Gold Bonds and other measures in the past 8 years.

In my view, there could be three reasons behind the proposal to cut tax and duties on gold.

(a) RBI has been the largest importer of gold in India for the past couple of years. It is likely that RBI wants to further enhance its gold holdings, like the central banks of China and Russia, amidst rising global uncertainties over USD supremacy. Lower duties may help RBI to import gold cheaper.

(b) The first series of SGBs is coming up for redemption next month. The government wants to redeem these bonds at a 9-10% lower price.

(c) The policy makers have recently raised the issue of “excessive financialization” of the Indian economy. For example, the latest Economic Survey highlighted, “the financial sector should expand at a pace that is in lockstep with economic growth. In particular, India can ill-afford the economy's over-financing at its current development stage.” Cheaper gold prices may be an effort to set the clock back.

STT

The budget proposes to increase the securities transaction tax on sale of an option in securities from 0.0625% to 0.1% of the option premium, and on sale of futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such “futures” are traded. This is an effective hike of 60%.

This is obviously supposed to act as a deterrent to excessive speculation in derivative trades by retail investors. The finance minister, the SEBI Chairperson and other policymakers have categorically expressed their displeasure over the rising retail participation in the derivative trading.

It is pertinent to note that as per a study conducted by NSE/SEBI over 90% retail traders lose money in their derivative trades.

It is interesting to note that the finance minister has assumed a ~16% rise in STT collection in her budget calculations. This implies that the government does not believe any material reduction in trading volumes at stock exchanges.

Besides, the hike in STT may not serve its stated purpose, as the retail traders treat option trades as lottery tickets. A small absolute hike in transaction cost may not deter them from trying their luck. It is the high frequency traders (HFT or Algo driven traders) who will be affected the most. If this affects their volumes, it may actually have detrimental impact on the entire market. For example, some of the HFTs may shift their base to overseas; the liquidity may diminish materially affecting the returns on arbitrage funds and hedging function.

Wednesday, July 24, 2024

Union Budget FY25 – Shaking the cart, adding uncertainty

The final budget presented by the finance minister has shaken the market cart, and added material uncertainty to policy making. The efforts to minimize uncertainty after demonetization have thus been negated to some extent.

As has been the practice in the past few years, the budget speech of the finance minister materially diverges from the actual budgetary provisions. By changing the capital gain tax regime and mentioning that they are working on a new Income tax law, they have forced the stakeholders to build-in a higher degree of policy uncertainty and unmindful regulatory provisions in their business and investment plans. Claiming simplification while introducing new complications (e.g., more transactions under TDS/TCS) has been a hallmark of the taxation policy in recent years. Use of technology is invariably claimed as an achievement, as if there is an option.

The level of uncertainty could be gauged from the fact that the priorities outlined in this budget are materially different from the interim budget presented just five months ago

Regardless, there are some positive take away from this budget that need to be commended.

Positive take away

Land reforms including digitization of land records got prominent mention in the finance minister’s speech. The minister mentioned that “Land-related reforms and actions, both in rural and urban areas, will cover (1) land administration, planning and management, and (2) urban planning, usage and building bylaws. These will be incentivized for completion within the next 3 years through appropriate fiscal support.” Linking central assistance to lower stamp duty could be a material impetus to urban development.

Fiscal consolidation. The finance minister refrained from splurging the extra resources generated through higher dividend from RBI &, PSUs, and additional tax revenue. She utilized it to bring the fiscal deficit down to 4.9% (vs 5.1% in the interim budget). Even the new development projects announced for the key coalition partners (JDU of Bihar and TDP of Andhra Pradesh) are proposed to be funded by the loans from the multilateral agencies like World Bank etc., where the Central Government might provide guarantee. The commitment to bring the public debt on a declining path from next year is also commendable.

Savings for children. Allowing pension accounts for minor children is a positive step for developing the social security framework. Retirement planning from birth should benefit a large number of savers in participating in the golden age of Indian financial markets and accumulating a decent retirement corpus.

Abolition of Angel-Tax. Angel tax is levied on the capital raised via the issue of shares by unlisted companies from an Indian investor if the share price of issued shares is seen in excess of the fair market value of the company. The excess realization is considered as income of the company and is taxed accordingly. The finance minister has proposed to abolish this tax (Section 56 (2)). This is a welcome step as it has been causing hardship to innovators.

Rental housing for industrial workers. The finance minister proposed, “Rental housing with dormitory type accommodation for industrial workers will be facilitated in PPP mode with VGF support and commitment from anchor industries.” This scheme if implemented properly can be a major reform in labor migration, urban planning and ease of living for poor laborers.

Issues that need deeper scrutiny

Forcing private capex: The Economic Survey highlighted that the private sector has not adequately responded to the incentives for capex. It seems the government now intends to force the private enterprises to invest more money in building capacity and generating employment. The budget adopts a carrot and stick approach for that. On one hand, it provides support for hiring more fresher employees and skill them, and on the other hand it makes outflow of funds from companies difficult. After dividends, now buybacks are also made tax inefficient. The idea seems to “encourage” companies to invest in growing their businesses and reward shareholders through share price appreciation only.

New income tax law. The Direct Tax Code had been hanging on the taxpayers’ head for almost two decades. It was shelved a few years ago. However, the finance minister has revived the proposal adding uncertainty about the tax provisions.

Backdoor entry of Estate duty. The changes in the capital gain tax regime give an impression that the government is testing the introduction of a wealth transfer scheme (Estate Duty) in future. The effective capital gain tax on legacy assets (Large Real Estate, legacy precious metals, jewelry etc.) has been increased by taking away the indexation benefit. It is to be seen whether this effort is widened and deepened in the coming years.

Taxation of bonds. The tax on gains made on sale of unlisted bonds has been enhanced to the marginal rate of taxation. This brings bonds at par with bank fixed deposits. This is in tandem with the concerns expressed by the RBI on money being diverted away from bank deposits. On the positive side, this may provide impetus to development of retail debt market by encouraging companies to list their bonds.

Gold and financialization of the economy. Ever since the government embarked on the path of economic reform and liberalization in 1991, the emphasis of policy has been to achieve higher degree of the financialization of the Indian economy. Low level of financialization of economy has in fact been sold as an USP of Indian markets, for it offered huge growth potential. Lamenting higher degree of financialization of the Indian economy in the Economic Survey, raising effective tax on bonds and bringing duty of gold lower contradict this concept.

New rum in old bottles. The finance minister has presented many ideas as path breaking, while these are already running schemes and execution has been below par. For example, rural roads, mission for pulses and oilseeds, organic farming, horticulture, blue economy (shrimp etc.), Employment incentive and support for MSME (introduced during Covid), Skill India, Industrial Parks, etc.

Protection to local manufacturing cut. The finance minister has cut basic custom duty on mobile phone, mobile PCBA and mobile charger to 15 per cent, reducing protection for the local manufacturers. This should be kept in mind by the analysts who are assuming status quo on policy for many EMS players for decades while making earnings forecasts.

Union Budget 2004-25

The following are the key highlights of the final Union Budget for FY25

Budget priorities

1) Productivity and resilience in Agriculture

2) Employment & Skilling

3) Inclusive Human Resource Development and Social Justice

4) Manufacturing & Services

5) Urban Development

6) Energy Security

7) Infrastructure

8) Innovation, Research & Development and

9) Next Generation Reforms

Key direct tax proposals

Corporate/firms Tax

· For foreign companies the rate of tax reduced from 40% to 35%, on income other than income chargeable at special rates, specified in respective sections of Chapter XII of the Act.

· Deduction under section 36(1)(iva) in respect of contribution to pension fund approved u/s 80CCD increased to 14% of salary from earlier 10% of salary, provided the employee concerned has chosen the new tax scheme.

· Section 56(2)(viib) imposing Angel tax on companies is proposed to be abolished.

· Payments to partners by way of salary, remuneration, commission, bonus and interest etc. to be liable for 10% TDS.

Personal taxation

· Amount of standard deduction on salary income increased to Rs75000 from the present Rs50000 for assessees filing return under the new tax scheme. For family pension standard deduction under new scheme will be Rs25000 instead of Rs15000.

· Any Tax Collected at Source from an employee to be adjusted in computation of TDS by the employer.

· Tax collected at source for a minor can be claimed by the parent if the income of such minor is clubbed with such parent.

· The entire amount received from tendering of share under a buy back will be taxed as dividend income. The cost of acquisition of shares can be claimed as capital loss that can be set off against capital gains as per the prevailing rules of set off. (applicable from 1 October 2024)

· Rent from house property cannot be shown as business income. It must be shown separately under the head income from house property and taxed accordingly.

Rationalization of capital gains tax (applicable from 23^rd July 2024)

· Holding periods for various assets reduced to two – 12 and 24months from the present three –12, 24 and 36 months.

· Assets divided into three categories – Listed financial securities, Equity MFs & Business trust (e.g., REITS), and other assets. Listed financial securities, Equity MF and Business Trust held for less than 12 months shall be short term assets and otherwise long term. All other assets to be long term if held for more than 24 months.

· Listed financial securities (STT paid), Equity MFs and Business Trust – STCG Tax would be 20%.

· LTCG Tax for all other assets would be 12.5% without any indexation benefit. LTCG of upto Rs1,25,000 exempted from tax for Listed financial securities (STT paid), Equity MFs and Business Trust.

· STCG Tax on all other assets would be the marginal rate of taxation.

· Unlisted bonds, debentures to be taxed at the marginal rate.

· Capital gain tax rates to be same for both Resident and Non-Resident assessees.

· Gift of assets by assessees other than individual and HUF to be fully taxable.

Rationalization of TDS

· Sale of more goods with sale price exceeding Rs10 lacs to be made liable to TCS.

· Rs 50 lac limit for TCS on sale of property to be considered as total sale consideration and not the consideration per buyer, where there are multiple buyers.

STT rates

· It is proposed to increase the said rates of securities transaction tax on sale of an option in securities from 0.0625% to 0.1% of the option premium, and on sale of a futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such “futures” are traded.

Others

· Notice u/s 148 for reassessment can be issued only upto three years where income suspected to have escaped assessment is less than Rs50 lacs. In other case time limit would be six years.

· Provisions for registration of charitable organization u/s 10(23C) and u/s 11 to 13 found overlapping. Accordingly, it is proposed to make section 11 to 13 the operational sections. Section 10(23C) will be used for transitory provisions only. The timeline for application for eligibility u/s 80G also rationalized.

· New Vivaad se Vishwas 2024 Scheme to be launched.

· Moveable foreign assets worth less than Rs20 lacs not to attract provisions of section 42 and 43 of Black Money Act.

Key Budget features