Dear Pranabda, extend SME tax benefits

An open letter to Finance Minister Pranab Mukherjee

Respected Pranab babu,

As the Union Budget nears, you are the only person from whom each and every Indian seeks more and more favors. To exaggerate a bit, in every budget season, finance ministers are probably the most sought after person in this country. However, the objective of this open letter is not to flatter you, but to overload you with demands and suggestions, like every other Indian.

I do not hold a brief or mandate from the Small and Medium Enterprises (SMEs) of the country. Nonetheless, I would like to share my views for a sector which comprises more than 90 percent of the total industrial units in the country, or 13 million units making over 8,000 different products, contributing 40 per cent of value addition to manufacturing, and 35 per cent to merchandise exports.

These numbers make the importance of this sector for the economy and for job creation obvious.

However, I request your attention to the important aspects elaborated below:

• Recognize SMEs as vital engine for growth and employment generation

For any country to grow, it needs to ensure that many new enterprises are set up. This will also create employment, and as these enterprises grow and become more competitive, its contribution to the economy will help the nation. SMEs should also be given support in the form of benefits in their initial years.

• Tax benefits must not be allowed for perpetuity

Tax benefits extended to SMEs should ideally be for the purpose of helping them in initial years, instead of for the sake of extending benefits. This will ensure that SMEs endeavor to grow larger instead of having multiple small units and build size, economies of scale, and efficiencies. Once the period allowed for SMEs to avail tax benefits is over, they should not be extended.

We have seen that when the economy has grown, many enterprises have continued to remain small to gain from excise exemptions – this only narrows the tax base and collection.

I am of the view that any benefits must be phased out so that SMEs are forced to either become competitive and survive or perish.

Hence, I strongly support reducing exemption limit from current level of Rs. 1.5 crore (Rs 15 million).

• Incentivize SMEs to invest in scientific and technology research and development

Many small and medium enterprises owned and managed by technocrats and enterprising research and technology development enthusiasts do not have adequate resources to undertake research to enhance productivity or develop new products.

Hence, Indian SMEs need to be incentivized to focus on technology development and research. Also, SMEs must be encouraged to invest in training its work force and build its capabilities and efficiency.

• Need to define SME

Today, there is no single definition of a SME. Excise law awards exemption for units having revenues below a stipulated limit. But there is no specific definition of SME in Income Tax Act. This would make allowing tax benefits difficult or ambiguous. We need to quantify parameters for SMEs to avail all tax benefits. 

Hence, I request you to consider following representations for SMEs in the country:

• Allow excise exemption to SMEs only for first few years

For SMEs manufacturing consumer products and selling it to end users can be allowed limited period exemption in excise duty. This would result in making SME products cost competitive. This limited period support in form of exemption would help SMEs with initial support to create a foothold in the market. Thereafter, this exemption must be withdrawn.

• Differential tax rates for varied income slabs

To encourage start-ups and SMEs in initial years, a structure of income tax slabs with differential tax rates may be introduced. This is somewhat akin to taxation for individuals and would enable SMEs to utilize this limited period breather to reinvest amount saved by lower taxes in the business and grow it rapidly. Singapore has a similar system.

• Allow tax rebate or deduction from income

Tax rebates is now history in Indian tax laws. Singaporean tax laws has an One Time Corporate Income Tax rebate of 20% of tax payable with a cap of Singaporean Dollar 10,000 or SME Cash Grant of 5 per cent of revenues with a cap of Singaporean Dollar 5,000.

Similar benefits, with adequate safeguards, in the initial years would enable SMEs to reinvest this amount. We understand that it would be difficult to reinstate rebates, while Direct Tax Code does not provide for any rebates. One solution is to include a provision for Deduction of income of SMEs in Chapter IV of Proposed Direct Tax Code.

• Accelerated deduction for investment in research and development

SMEs incurring expenditure and investments in scientific research and development must be offered higher tax deduction compared to larger corporations. Section 41 of Proposed Direct Tax code stipulates a 200 percent deduction for all revenue expenditure incurred for scientific research and development. This provision can be modified for SMEs.

• Accelerated deduction for specified investment and expenditure

Specified investments and expenditure by SMEs can be awarded higher depreciation or deduction compared to larger corporations. We need similar provisions in our Income Tax Act to incentivize SMEs to invest in specific pre-approved upgradation and efficiency enhancement projects or in training manpower from specified institutions or organizations.

All these representations might sound radical with only one underlying undertone – give something more to SMEs. But we need to recognize that this sector has greatest ability to fuel economic growth and drive employment. With the right measures, we will definitely see SMEs becoming a competitive force for the nation to be proud of.

I look forward to hear your budget speech on 16March.

Thanking You,

Yours Sincerely,

Sumeet Mehta

Managing Director

Paradigm Advisors