Banks

The amendment to Section 36(1)(viia) of the Income Tax Act will be a major sop to scheduled banks. The section that the government seeks to amend, restricts the deduction that a bank can claim for bad and doubtful debts written off. The present case is that the write off is restricted to either 5 per cent of total income or 10 per cent of the advances from rural branches, subject to the credit balance in the provisions account. The amendment to the section now seeks to remove the restriction and banks can claim a deduction of upto 5 per cent of their gross NPAs.

In the case of a bank like SBI, the benefits can be substantial. For the last financial year the bank had a credit balance of Rs 1,300 crore in its provisions account. Even if it wrote off an amount equivalent to the limit of 10 per cent of average rural advances and 5 per cent of income before deductions underSection 80CCC and 80 U, it would have provided for roughly just Rs 1,535 crore, effectively claiming a deduction of Rs 235 crore. But now, assuming that it writes off 5 per cent of its gross NPA of Rs 11,000 crore it can claim a benefit of at least Rs 550 crore.

In addition, it has now become mandatory for these banks to disclose their gross NPAs as on the balance sheet date, if they want to claim such a benefit. This will lead to greater transparency in their annual accounts.

But one anomaly still exists. If the benefit can be extended to scheduled and non-scheduled banks then it should also be given to the DFIs.

Interest rates

That the ministry of finance was itching for a cut in interest rates was known. That the Reserve Bank of India would not be averse to a cut in rates was also obvious given both the non-monetary restrictions put on speculating in the currency as well as the anomaly that existed because of the subsidy that the RBI provided to banks on their export creditportfolio.

Export refinance was given at 7 per cent but the repo rate which is supposed to set the bench market for short-term rates was pegged at 8 per cent. This rate cut will mean that the year end YTM will be lower than the 12.15 per cent pegged last year.

The impact will be felt the most by the banking system. In the short run i.e. for the financial year 1998-99, banks will stand to benefit. One, even though deposit rates will be constant, lower lending rates will be enforced for only one month. Second, banks have made provisions for all three quarters against depreciation in the investment portfolio, which will have to be written back.

In addition the rise in asset prices will also be taken to profit and loss for the year. But if the economy does not react favourably to these measures next year, banks will be worse off than they are in the current year. Banks will find it difficult to lower deposit rates leading to a squeeze in spreads. Second, there will be no incremental benefit to theinvestment portfolio which will pull down earnings growth. Thus the long term impact on banks is contigent on a number of factors which cannot be readily assessd at present.

ESOP

Though ESOPs will continue to be taxed twice, once as a perquisite at the time the option is exercised by the employee and two, as capital gains tax at the time of sale, a major relief granted is that the cost of acquisition will be the market value on the date of exercising the option.

However, nothing has been done to overrule the judgement of the AAR in the case of Microsoft's 100 per cent subsidiary in India. In the case, employees were given stock options by the parent US company which was not the empolyer. The local subsidiary is the employer and hence in the case, an employer- employee relationship does not exist. Despite this, the AAR treated the stock option as a perquisite.

It also insisted that the corporate veil should be lifted and TDS should be levied on the US company. Ambit Corporate Finance managingdirector Ashok Wadhwa says only once--in the case of Union Carbide--was the corporate viel pierced to this extent and this is only the second instance.

The judgement of the AAR has not been overruled in the Finance Bill. One lacuna related to foreign companies taken care of in the Finance Bill (foreign companies are not required to pay 10 percent surcharge) relates to depreciation on foreign assets. Earlier, if a foreign company employed assets in India, it was entitled to claim depreciation even if their written down value was zero. The Finance Bill provides that depreciation will be allowed only on the WDV of the assets from the period they are brought into India. A major tax advantage available to foreign companies is lost.

Under Sec 143(1A), assessing officer has the authority to levy additional tax of 20 percent in two specific cases. This was a major source of corruption. The Finance Bill has omitted the section.

EMCEE (with contributions from Aaron Chaze & Urmik Chhaya)