The Hindu Business Line : The policy hurdles NBFCs face

Each Budget season the NBFC industry has its wish-list, seeking parity with banks and housing finance companies, or sops. This year is no different. Some of the key issues that need attention and consideration are discussed hereinafter.

The classification criteria of asset financing/loan/investments are now fairly well settled with asset financing companies clamouring for more incentives for their contribution in asset creation. Micro finance has emerged as a fast growing sector with prominent presence in rural India.

Given the progress that these companies have made recently and their active partnerships with NGOs, it is important to carve out a separate classification for them with different regulatory norms.

FDI policy

Given the recent economic turmoil, the FDI regulations in the NBFC space might need a little bit of fine tuning. Under the existing FDI policy, investment in an NBFC is permitted subject to $50 million capitalisation to be brought within a period of 24 months.

Considering the overall slowdown, the sector could do well with contracting this cap to, say, $30 million or by extending the period to, say, 36 months. This might encourage flow of capital in NBFCs. Further, the list of 18 permitted activities falling under the automatic route does not include investment activity; investment advisory activities are however included. It is urged that investment activity be also included, as it is anyway a permitted classification under the RBI regulations.

Parity with banks

One of the most repeated pleas on the direct taxes front is the issue of parity with banks and housing finance companies in the areas of allowing provision on non-performing assets as a deduction. This provision, made in accordance with the prudential norms of the RBI, can be claimed as a deduction for tax purposes under Section 36(1)(viia) of the Income-Tax Act, subject to overall limits. The banking industry is independently representing that these limits be freed.

Similarly, income deferred in respect on non-performing assets of NBFCs is unjustly subject to tax on the basis of ‘accrual’. However, banks in general are well protected by Section 43D of the I-T Act. This dichotomy is drawing the attention of the courts, including the apex court. A concrete solution is clearly an amendment to the tax laws to ensure parity.

Tax deduction at source (TDS) is an effective machinery to collect taxes in advance, also results in litigation. Interest paid to an NBFC on borrowings is subject to a 22.44 per cent tax deduction at source. Banks, cooperative societies, public financial institutions, etc., are given shelter under Section 194A of the I-T Act, which does not extend to NBFCs. While tax laws provide for a nil or lower withholding, the tax department has shown resistance in granting this relief. As a result, the yields on lending have dropped significantly.

With some NBFCs still actively engaged in leasing of passenger cars, office equipment, etc., the TDS on the rentals paid by the lessee to the leasing company is a dampener. The rate of deduction in accordance with Section 194-I of the I-T Act erodes the entire margins on the transaction.

Leasing as a product has its own sets of complexities like accounting guidelines, deferred tax, etc., and the TDS hurdle imposed from 2007 has virtually knocked the oxygen out of the what was a revival of sorts to this product in the recent years.

TDS hurdle

There must be a dispassionate analysis of the cost and benefit of such TDS measures and the how they affect the business model. Else, the idea of TDS as purely a revenue raising mechanism could be counter productive.

The single levy which killed hire purchase and leasing as financial products from July 16, 2001, was the levy of service tax on hire purchase and financial leases. Today, at the service tax rate at 10 per cent and with a 90 per cent rebate on the interest portion, it seems a manageable cost.

But interest on loans is not liable to service tax, thus the loan model became popular, even as the rights of repossession of assets is less superior under this model. Today, whether hire purchase is liable for service tax is a contentious issue, with the Madras High Court recently dismissing the petitions filed by the industry association.

Earlier, the Kerala High Court too held that hire purchase transactions are liable for service tax. The battle is now at the Supreme Court, which will decide the fate of hire purchase transactions between July 16, 2009 and March 1, 2006 (the date of introduction of 90 per cent rebate). The lasting solution is to amend the service tax law to exempt hire purchase and leasing from the purview of service tax.

One hopes that these issues will be resolved through suitable amendments in tax laws in the forthcoming Finance Bill.

(The author is Tax Partner, Ernst & Young, India)

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