In his maiden budget, finance minister Yashwant Sinha has made it virtually unviable for private sector corporates to access the international debt markets.
In the finance bill, the government has removed the exemption from withholding tax on interest payments given to Indian corporates borrowing from the international markets.
This means that Indian companies, henceforth, will have to pay a withholding tax of 20 per cent on interest payments to foreign lenders. "This effectively raises the borrowing cost for Indian companies by 20 per cent, as this tax burden will be passed on to the debtor by the investors," said sources at a leading international investment bank.
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"Since there is no justification for the government to subsidise the commercial borrowing by corporate assessees, the bill seeks to amend omit items (c), (e), and (f) of subclause (iv) of clause 15", says the Finance bill. Sub-clause (iv) of clause 10 (15) in the Income Tax Act provides exemption in respect of interest payable by specified Indian entities on borrowings on foreign currency.
However, the finance minister has spared the financial institutions by not removing sub clause (d) of the same section. This section lists the institutions like IFCI, IDBI, ICICI, Export Import Bank of India, National Housing Bank, and SIDBI.
But, one institution to be effected will be IDFC, which is not listed in this sub clause (d) of Section 10 (15) (iv of the Income Tax Act 1962.
Investment banking sources said that in future, Indian companies will have to pay at least 20 per cent more than the prevailing market rates for fresh borrowings. "Lenders will demand that their yields are grossed up to the extent of tax payable", said a banker.
However, the government has indicated that these proposed amendments will only take effect from April 1, 1999 and will accordingly, apply in relation to assessment year 1999-2000 and subsequent years.
As a result of this move, investment bankers say that the international debt market where rates had already risen sharply since the east Asian turmoil began, has been made completely unviable for Indian companies.
For example, say bankers, if a company borrowed at a spread of 200 basis points over Libor (currently round 6 per cent), then the company would have to pay a withholding tax of about 1.6 per cent before paying interest. This will effectively hike the price by that amount.
Bankers also questioned the logic of applying these only from April 1, 1999. "its not as if the government will benefit from additional revenue flows from this year. Then what was the need to make such an announcement", said a baffled investment banker.