Income Tax 29 Jan,2020
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Budget 2020: Tax expectations for healthy growth of NBFCs
CA Amit KediaChartered Accountant

National Banking Financial Companies (NBFCs) have played a vital role in the development of the economy. It may be either in the form of financial intermediation in rural and semi-urban areas or financing activities that are engines of growth, such as transport, small and medium enterprises, leasing, hire purchase etc. NBFCs being an alternative to bank lending, have played a vital role in the nation's drive to become a USD 5 trillion economy by the year 2024-25.

However, in the recent past NBFCs have been facing severe funding difficulties on account of defaults by some large corporate borrowers which has led to slowdown in growth of the NBFC sector. This impact on the credit delivery by NBFCs is leading to a multiplier effect on sectors such as automobiles, small and medium enterprises and consumer goods. While the NBFCs battle around liquidity, the economic slowdown coupled with the decrease in consumption has also affected the business of lenders thereby affecting the lending business of NBFCs.

In order to address some of the above mentioned challenges being faced by the NBFCs, the Government may consider providing the following benefits to battle down the liquidity crunch faced by NBFCs:

Exemption under section 194A of the Income-tax Act, 1961 (the Act)

Section 194A of the Act requires the borrower to withhold tax at the rate of 10% on the interest payments made to the NBFCs, which is otherwise exempt in case of interest payments made to banks and other public financial corporations. These provisions increase the burden of liquidity crunch currently being faced by the NBFCs as the spread/ margin on the interest charged by the NBFCs in certain cases may be lower than 10%. Additionally, given the huge number of borrowers, the tax deducted at source by such borrowers may not always be captured/ incorrectly captured on the TDS portal and accordingly, the claim for tax deducted at source by the NBFCs may be rejected by the tax officers. This results in blocking of funds for NBFCs till they get tax refunds from Income-tax authorities.

Given the above, it is necessary to extend the exemption of the provisions of section 194A of the Act to NBFCs which will to a certain extent address the liquidity issues faced by the NBFCs.

Extending the benefit under section 43D of the Act to other categories of NBFCs

The Government of India in the Finance (No 2) Act, 2019 had provided the benefit of interest income on bad and doubtful debts being subject to tax on receipt basis for deposit taking and systematically important non-deposit taking NBFCs. This benefit is not currently available to non-systematically important NBFCs and hence, leads to higher tax outgo for such NBFCs on income not earned/ received by them, thereby adding to the liquidity crunch. Given the above, the Government in a measure to address the liquidity issue, may consider to extend the said benefit to all categories of NBFCs.

Limitation on deduction of interest expenditure under section 94B of the Act

Section 94B of the Act exempts banks and insurance companies from the rigorous provisions that restrict the deduction of interest paid or payable directly or indirectly on debt from overseas associated enterprises. This has led to an industry outcry, since it has adversely affected the business model of many NBFCs, who rely on offshore funding guaranteed by their overseas associated enterprises. Since lending and borrowing money is an integral part of the business operations of NBFCs, it is hoped that the Union Budget would amend the provisions of section 94B of the Act so that it helps the NBFCs to raise capital, without any restrictions on interest deductions from their overseas associated enterprises.

Higher rate of depreciation allowance for construction equipment

To encourage various sectors, in the past, the Government has allowed depreciation allowance at higher rate. Similarly, the Government may consider extending the benefits of depreciation allowance at higher rate to construction equipments and other plant and machinery which are typically financed by NBFCs. This would create more demand for such construction equipment and thereby boost the NBFC lending.

Allowing Category I Alternate Investment Fund (AIF) – Venture Capital Funds (VCF) to invest in NBFCs

VCF have been categorised specifically under the AIF regulations to invest in start-ups or early stage ventures or other sectors or areas which the government or regulators consider as socially or economically desirable. Presently, such VCFs are not permitted to invest in NBFCs. To attract more capital and thereby address liquidity issue, the Government may consider permitting Category I AIF – Venture Capital Funds to invest in NBFCs.

Addressing the aforementioned issues for NBFCs would be a welcome step forward towards fulfilling the long-awaited demand of NBFCs.

CA Amit Kedia (with inputs from CA Paresh Kubadiya and CA Ritika Wasan)