The Hindu Business Line : Rocking the foundation

This long-standing exemption available to enterprises investing in power, housing, hospitals, and so on, has been withdrawn by the latest Finance Act.

It was the Rakesh Mohan Committee which focused on the need for development of infrastructure in India. The Committee estimated a minimum investment of Rs 7,500 crore for basic infrastructure. The amount has leapfrogged since. To offer tax incentives for infrastructure enterprises, Section 10(23G) was inserted in the Income-Tax Act, 1961 by Finance (No. 2) Act, 1996 with effect from April 1, 1997. This was amended by Finance Act, 1997 and Finance (No. 2) Act, 1998 re-cast the section w.e.f. April 1, 1999.

The sub-clause exempts dividends, interest and long-term capital gains of companies or funds, which have invested in infrastructure enterprises, housing projects referred in Section (80IB) and hotel and hospital projects. The investment in such projects may be either by way of acquisition of shares or providing long-term finance to such an enterprise. The enterprise should be approved by the Central Government. Such approval was not required till assessment year 1998-99.

This long-standing exemption available to enterprises investing in power, housing, hospitals etc., has been withdrawn by the latest Finance Act. Long-term capital gains on disposal of shares, interest on long-term financing and dividends have become taxable with effect from assessment year 2007-08. The reasons for the omission are given in the Explanatory Memorandum: "This exemption was intended to ensure low cost of raising capital for thrust area projects during an era of high interest rates and high tax rates. The tax rate as well as interest rate for borrowing of funds has since come down, reducing the overall cost of such projects. Exemption for dividends distributed by domestic companies is already available under Section 10(34) of the Act. Long-term capital gains from transactions on which Securities Transaction Tax has been paid are also exempt under Section 10(38). It is, therefore, proposed to omit Clause 23(G) of Section 10 so as to make income from existing as well as future investments in eligible business taxable."

The rationale

Does this mean that the Government is now satisfied about the fiscal structure vis-à-vis infrastructure projects? The amendment proceeds on the assumption that only listed companies enter the infrastructure scene. The truth is that most of the infrastructure and power projects are set up with the help of private funding. Long-term capital gains tax on disposal of such shares will not be exempt, as no STT would have been paid because of the company being private.

The Government has admitted that exemption from long-term capital gains tax proved a great fillip to infrastructure investment. Companies could access funds either through debt or equity. Equity investments through unlisted companies will suffer because of long-term capital gains tax. The withdrawal of exemption for interest income will also deter investments through the debt market.

The doctrine of legitimate expectation

Section 10(23G) was removed from the statute book from April 1, 2006. No exemption will be available from assessment year 2007-08. There is no other provision that enables existing investments the benefit of Section 10(23G). It is true that Parliament is competent to make a law withdrawing tax exemption even in respect of on-going projects. It is unfortunate that the Government does not recognise the adverse effect on ongoing projects by withdrawing the exemption. Commenting on a similar action with regard to investment allowance in 1986, Palkhiwala observed:

"We should be stung by shame in committing a breach of faith by changing our laws to the determent of those who act on the basis of our existing enactments". Clearly a case of the law permitting what honour forbids.

The English principle of the `law of legitimate expectations' has been approved by our own Supreme Court. Within the contours of fair dealing, a reasonable opportunity has to be given to make representation against change of policy. The doctrine has both substantive and procedural aspects. The Supreme Court ruled that claim on legitimate expectation required reliance on representation, and result in detriment in the same way as claims based on promissory estoppels. The principle was developed in the context of reasonableness and the context of natural justice. This is an extension of the Doctrine of Promissory Estoppels. The Government is bound by the promises made by the Finance Acts, 1996, 1997 and 1998 and the benefits of Section 10(23G) should be made available for on going projects. By all means, the amendment can be made prospectively to cover projects set up after April 1, 2006, and, at the same time, protect ongoing projects launched on the basis of earlier promises of exemption.

(The author is a former Chief Commissioner of Income-Tax.)

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