The Hindu Business Line : Budget expectations of financial services sector

The financial services sector has been growing at around 38 per cent year on year and with FIIs getting active in the Indian markets this sector is poised for further growth.

A key driver is the infusion of funds in sectors such as Insurance, Mutual Funds and Banking. Large-scale mergers and acquisitions and consolidation in this space hit the headlines last year and more is in store. Like any other sector the financial services space has its share of uncertain tax positions and the various associations in this space have started the pre-budget exercise. Some of the issues that have surfaced and need to beaddressed are as follows:

Insurance

Non-life insurance business is governed by the computation provisions laid out in Sec 44 of the Income tax Act (The Act) read with the First schedule. The basis of determination of the profit base is the published profits as per the Insurance Act subject to adjustments. One of the key items that form part of the profits is profit on sale of investments. Investment in approved securities is a regulated and an essential ingredient of the business model itself. Taxing the profit on sale and that too at the rate applicable to business income is illogical. The coming budget should exclude this element from tax.

Health insurance is gaining momentum in the market and Sec 80D allows a deduction up to Rs 10,000 for an assessee taking a health insurance policy. As the wording stands today credit card payment for health insurance will not rank for deduction. This unintended anomaly has to be set right.

Reinsurance is one of the essential features of the insurance business itself. A large part of the reinsurance is ceded outside the country. Disputes have arisen as to whether tax is to be deducted on the reinsurance premiums paid to non-residents. The crux of the matter is whether the income of the non-resident is chargeable to tax in India to attract the provisions of Sec 195 and the relevant Double Taxation agreements.

On the service tax front there is a strong plea that Reinsurance commission should be specifically excluded from levy of service tax, as the reinsurance commission is of the nature of reimbursement of cost incurred by the original insurer. Health insurance needs to be promoted from all quarters and to facilitate this business, which is for social security purposes, the premiums should be outside the service tax net. On the question of input credit, the present position is that reinsurance premium paid is subject to service tax. Due to the 20 per cent limit prevailing for availing input credit, a huge amount of service tax paid on reinsurance needs to be absorbed as expenses by insurance companies. It is suggested that service tax paid on reinsurance premium is included under sub rule 5 of Rule 6 of CENVAT Credit Rules, 2004 so that the entire amount paid towards service tax on reinsurance premium is eligible for input credit.

NBFCs

The legacy of tax problems continues to bother the industry. Income deferment and provision for non-performing assets, which are mandated by RBI regulations, are not accepted by the tax authorities and the NBFCs have to pay taxes on the unrealised income and legitimate provisions based on scientific criteria. There is need to amend section 43D and 36(1)(viia) of the Act for allowability on the lines applicable to the banking industry. Recently, there have been disputes on even allowability for bad debts relating to hire purchase business, which is strange since the law is clear on the subject.

The Budget of 2006 gave much-needed oxygen to hire purchase and lease transactions from service tax by providing 90 per cent rebate of the interest charges. Still interest on loans isentitled to full deduction from service tax and this differential, seemingly minimal, leads to pricing advantage for the loan product. It is felt that hire purchase and leasing should also enjoy 100 per cent deduction of the interest element from service tax.

Mutual Funds

The Mutual Funds industry is currently on a growth curve. Presently Dividend Distribution Tax (DDT) is applicable for Indian Companies distributing dividend to shareholders. Sec 115R of the Act provides that DDT will not apply on Income distributed to the unit holder of open-ended equity oriented funds. It is felt that since debt schemes are also gaining momentum in the market and as a necessary fillip to these schemes, DDT should not be applicable to these schemes and they should be placed on a par with the equity schemes.

In today's context, a fixed deposit with a scheduled bank with a lock-in period of five years is entitled to deduction under Sec 80C of the Act and it acts as a useful tax saving scheme for individuals. With more and more retail investors entering the mutual fund market, the budget should provide for an exclusive limit under Sec80C for investment in mutual funds scheme.

These issues, engaging the attention of the financial sector, need to be addressed in the forthcoming budget.

The author is Partner, Tax — Ernst & Young