Today, vigorous growth with strong macro-economic fundamentals characterises the Indian economy. The only caution factor is the increasing inflation rate. Against this backdrop, the Finance Minister (FM) announced the tax proposals for the financial year 2007-08 on February 28, 2007.
Whilst providing certain measures for small-scale manufacturers and service providers keeping the income tax and service tax rates stable, the minister has proposed certain other measures, which could, besides other consequences, impact the retail businesses significantly. Broadly speaking, these are introduction of service tax on commercial rentals and works contract, increased dividend distribution tax and changes in the method of valuation of toll manufacturing transactions.
Income tax rates
Marginal changes in corporate tax rates: The proposed change in income tax rates for domestic companies. The lower limit of taxable income begins is Rs 10, 000,000 with proposed effective rate of 30.90 per cent against existing rate of 33.66 per cent. For incomes, which are above this limit, proposed effective rate is 33.99% against exiting rate of 33.66 per cent.
Dividend distribution tax increased: The rate of dividend distribution tax has been increased from 14.025 per cent to 16.995 per cent.
Exemption limit for individual enhanced: The basic exemption limit for individuals has been increased to Rs 1,10,000 (Rs 1,45,000 for resident women and Rs 1,95,000 for senior citizens).
Increase in tax cost
Secondary education cess: A secondary and higher education cess @ one per cent of the aggregate duty has been introduced. This is in addition to the education cess @ two per cent currently payable. Accordingly, the effective tax rate of service tax is 12.36 per cent and excise duty is 16.48 per cent.
Service tax on rentals: The rentals in the tier I and II cities, which, according to certain studies, account for 30 per cent of the operating costs, are set to further increase due to a service tax of 12.36 per cent. The minister has proposed to tax the renting, letting, licensing or leasing of immovable properties for commercial purposes (such as factories, shops, showrooms, warehouses and offices).
The impact of this proposal within the retail supply chain would be dependent upon which participant bears this incidence. While the manufacturers and franchisors could avail a credit of the service, tax paid under the CENVAT scheme against the output excise or service tax payable, thereby lowering its impact, this would surely be an incremental cost for a retailer simplicitor or a franchisee. The corporate retail is likely to consider designing innovative contracting structures to enable optimisation of the service tax incidence.
In addition to this, it is likely that the constitutionality of this levy would be contested on two folds (i) income from land is a State subject, and thus, Central government is ineligible to levy tax (ii) mere renting of properties does not constitute any service, and thus, imposing tax by deeming it to be a service would be incorrect.
Service tax on work contract: Work contracts are typically indivisible transactions, which involve a mix of services and goods. Certain examples of work contracts are repairs and maintenance, installation activities, construction activities, job work transactions where certain materials are provided by the principal, development of customized computer software etc. While certain activities are already taxable under specific heads, the minister has now proposed to levy service tax on the value of services in case of all transactions, which constitute work contracts.
Where a distinct value for the service element is unavailable, the minister has proposed to introduce an optional Composite Scheme for levy of service tax @ 2 per cent of the contract value. The details of the scheme are yet to be notified. It is to be seen whether this composite scheme would be extended to work contracts, which are already taxable under different heads, for example, repairs and maintenance contracts.
The levy of service tax on work contracts would only tend to increase the cost of operations of the retail segment where no CENVAT benefit would be allowed. From a retailer’s viewpoint, commonly used services such as refurbishing and maintenance of office spaces would be dearer henceforth.
Widening the service tax net: In addition to the service tax on lease rentals and work contracts, the minister has proposed to bring certain other services also within the tax net. Some of the taxable services, which are likely to increase the cost of operation in the retail supply chain, include the followings:
A) Service involving development and supply of content for use in telecommunication services, advertising agency services or online information and database access or retrieval services.
B) Design services in relation to furniture, consumer products, industrial products, packages, logos, graphics, websites and corporate identity designing and production of three- dimensional models.
C) Sale of space for advertisements in business directories, yellow pages and trade catalogues meant for commercial purposes.
Increase in excise duty for toll manufacturers
The toll manufacturing or the job work mechanism is akin to the retail sector. The minister has proposed to amend the mechanism for valuation of such goods for levy of central excise. Toll manufacturers, who were hitherto paying central excise on cost of processing and cost of materials supplied by the principal, would henceforth have to pay duties on the selling price charged by the principal. The margins of the principal, which currently are liable to only value added tax or the central sales tax, would have an incremental cost of 16.48 per cent towards central excise.
Fringe benefit tax on stock options: Any security or share allotted to employees as part of an employee stock option plan or sweat equity plan would be taxed as a fringe benefit. The employer would be liable to fringe benefit tax on the value of benefit arising to the employee at the time of exercising the option.
This would lower the value proposition of such instruments. Therefore, today when retail sector is stressed in attracting, and more importantly, retaining talents, this proposal appears untimely.
Reduction in tax cost
Increase in basic exemption thresholds: The basic exemption threshold for small service providers (service tax) has been enhanced from Rs 4 lakh to Rs 8 lakh and for small scale manufacturers (central excise) from Rs 100 lakh to Rs 150 lakh.
Central sales tax reduced: Inter-state transactions and the continuance of CST have been a matter of concern since April 2005. Though the minister had committed to eliminate CST by 2007, the steps to do away the same were yet to be implemented. This has finally begun. The rate of CST has been reduced from 4 per cent to 3 per cent with effect from April 2007 and is expected to be nullified over the next 3 years. This would make inter-state procurements less expensive by 1 per cent. From the management’s perspective, if the contracted prices are inclusive of tax, it would need a re-look.
Reduction in customs duty: In furthering the government’s declared policy of bringing the customs duty structure to the ASEAN levels, the peak rate of duty on non-agricultural products has been reduced from 12.5 per cent to 10 per cent.
Free samples no longer liable to FBT: Manufacturers and retailers, both can breathe a sigh of relief about distribution of samples. That distribution of samples is not a fringe benefit to an employee and is necessarily a sales promotion and a business driven activity has finally got attention of the minister. Expenses incurred for display of products and distribution of samples, free or even at a concessionary cost, would henceforth not be liable to fringe benefit tax.
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