India' s Shrinking Fiscal Headroom

 *Will India Cut Spending to Save Its Fiscal Deficit Target?

India's fiscal discipline is facing its biggest test in years. As the West Asia conflict pushes oil prices higher, the government is now exploring spending cuts to prevent its budget deficit from slipping off track.

The challenge is simple. Rising oil prices are increasing costs just when the government is trying to keep its finances under control.

*Key Highlights*

• India may cut spending to keep its FY27 fiscal deficit target at 4.3% of GDP

• Rising oil prices are increasing subsidy costs, especially fertilizers

• April fiscal deficit jumped to ₹3.6 trillion, nearly 2x YoY

• Fertilizer subsidies could rise from ₹1.71 trillion to almost ₹3.4 trillion

• Capex and defence spending are expected to remain protected

*The Oil Problem Is Becoming A Fiscal Problem*

Every dollar increase in oil prices creates pressure on India's finances.

India imports most of its crude oil, which means higher global prices quickly translate into larger subsidy bills, a weaker rupee, and higher inflation.

India's fiscal strategy now depends heavily on what happens to oil Price's over the next few months. If the West Asia conflict continues and energy prices remain high, the government may be forced to choose between spending cuts, higher borrowing, or missing its fiscal deficit target. For now, policymakers are hoping that careful spending management can prevent that difficult choice. But the prolonged West Asia conflict has complicated those plans

The government appears reluctant to touch two critical areas

Capital expenditure remains central to India's growth strategy, while defence spending has become even more important amid rising geopolitical tensions. Instead, officials are examining areas such as water resource allocations and loans provided to states.However, this creates a political challenge.Reducing welfare spending could impact rural communities, while cutting transfers to states may trigger opposition from regional governments already concerned about revenue sharing.

India – Strait of Hormuz closure Impact

We see the Indian Rupee as vulnerable and USD/INR likely rising above the 95 levels if the Iran and Middle East conflict is sustained and the Strait of Hormuz remains closed, with Brent oil prices returning back to the US$100/bbl.

In de-escalation case with oil ~US$80/bbl, 

USD/INR may trade closer to 93.50.

In US$100/bbl case, USD/INR may trade closer to 95.50

In US$120/bbl scenario, USD/INR may trade closer to 97.50 and even higher will look achievable. Of course, it is important to stress that there are many shades of grey here including the duration of the crisis, but overall we see these as reasonable given the meaningfully different nature of the crisis. 

INDIA IS DEPENDENT ON THE MIDDLE EAST ACROSS A RANGE OF ENERGY PRODUCTS, WITH AROUND 45% OF CRUDE OIL, 60% OF NATURAL GAS, AND MORE THAN 90% OF NATURAL GAS LIQUIDS SUCH AS LPG COMING FROM THE MIDDLE EAST. 

▪The indirect effects across a range of sectors could also be meaningful for India beyond the first order impact, and ultimately points to a stagflationary environment of higher inflation and weaker growth with a weaker Indian Rupee a key outcome as well.

MEANWHILE, OIL PRICES CLOSER TO US$100/BBL COULD IMPLY INDIA’S CURRENT ACCOUNT DEFICIT WIDENS TO 3% OF GDP FROM OUR BASE CASE OF 1.5% OF GDP

RBI recognizes downside risks to growth

 With benign CPI inflation prospects and a robust growth outlook, the Monetary Policy Committee (MPC) has opted to continue with the present repo rate of 5.25% while also continuing with a neutral stance.

 The growth for 1Qtr and 2Qtr of 2026-27 has been revised upwards to 6.9% and 7% and CPI inflation for these quarters is projected at 4% and 4.2% respectively. This is an optimal combination for the Indian economy at the present juncture as the growth rate in Half of 2026-27 is expected to be close to the potential growth of 7% as estimated by the Economic Survey of 2025-26. 

The CPI inflation is projected to average 4.1% for this period, just marginally above the MPC’s inflation target of 4%. 

The RBI recognizes downside risks to growth emanating from the continuing geopolitical tensions and volatility in global financial markets as also in international commodity prices. If any of these risks lead to an adverse impact on growth, the RBI may consider revising the repo rate downwards in its next monetary policy review. 

Venezuelan Oil and the Limits of U.S. Refining Capacity

RBI Notifies Transition to its Benchmark Rates from Overseas Borrowings

 With the imminent discontinuation of the publication of the London Interbank Offered Rate (LIBOR) by the end of 2021 for most currencies, the Reserve Bank of India (RBI) by its circular dated 8 December 2021 (Circular) amended the RBI’s Master Direction - External Commercial Borrowings, Trade Credits and Structured Obligations dated 26 March 2019 (ECB Master Directions) to provide for a risk free benchmark rate as an alternative to the LIBOR (which has been used since inception for majority foreign currency borrowings).

LIBOR has been a preferred benchmark rate for the syndicated loan markets and as a pricing source by financial markets globally and in India for a wide array of financial instruments including loans and derivative products. In view of the cessation of publication of LIBOR, the RBI in August 2020 had indicated to all the banks and the financial institutions to frame a board-approved plan, outlining an assessment of exposures linked to the LIBOR and the steps to be taken to address risks arising from the cessation of LIBOR, including preparation for the adoption of the Alternative Reference Rates (ARR) and putting in place a framework to mitigate risks arising from such exposures on account of transitional issues including valuation and contractual clauses.

The amendments to the ECB Master Directions provide much-needed clarity to the financial institutions, hedge providers and borrowers on the new applicable alternative reference rates for external commercial borrowings and encourage them to use any widely accepted ARRs as soon as practicable in lieu of the cessation of LIBOR from December 2021.

Increase to overseas investment limits for mutual funds

The Securities and Exchange Board of India has announced amendments to the overseas investment limits for mutual funds. The amendments provide that:

• mutual funds can make overseas investments subject to a maximum of US$1 billion per mutual fund, within the overall industry limit of US$7 billion;
• mutual funds can make investments in overseas exchange traded funds subject to a maximum of US$300 million per mutual fund, again within the overall industry limit of US$1 billion; and

in respect of investment limits to be disclosed in the scheme documents at the time of a new fund offer as specified in the relevant Circular and the investment limits on ongoing schemes as specified in the relevant Circular, such limits will henceforth be soft limits for the purpose of reporting only by mutual funds on a monthly basis in the prescribed format.

SEBI introduced a new rules for mutual funds companies.

 On April 28, 2021, SEBI introduced a new rule. They mandated key employees of asset management companies i.e. mutual fund companies to invest about 20% of their salary in the schemes they run or oversee. They’ll have to tie it up for 3 years or for the duration of the scheme, whichever is shorter.

Basically, it’s a diktat forcing fund managers and other key personnel to have their skin in the game. 

Rumour has it that SEBI only acted after Franklin (an asset management company) wound down 6 different mutual funds overnight sending ripples across the entire sector. Reports allege that the fund managers, in this case, took on inordinate amounts of risks, acted recklessly, and pulled out their money when things took a turn for the worse. A few days later they wound down the funds leaving hundreds and thousands of investors in the lurch. There were no consequences for their actions. No penalties, no harm, and no damage done.

Because remember, fund houses are paid despite how their schemes perform. Most companies seek a fee (1–2% of the sum you invest), without promising much. According to one report from 2019, 82% of active large-cap funds have underperformed the S&P BSE 100 index, which includes the 100 largest Indian companies. Imagine that — You could pick a passive basket of the 100 largest Indian companies and still outperform those who are paid ludicrous amounts of money to actively manage a mutual fund scheme.

Bottom line —Most fund managers aren’t really that good at managing money and it’s probably why you’re seeing some backlash from the incumbents. 

SEBI wants mutual fund companies to have skin in the game. But other key stakeholders in the industry want the rule gone. The only question remaining —What do you think?.... 

S. 90, 91: An Indian taxpayer is not entitled to claim refunds from the Government of India of taxes paid by the said taxpayer outside India, i.e., to the foreign Governments, in respect of the income taxes paid abroad on income earned in the respective tax jurisdictions, if the said income is not taxed in India due to a loss. However, the taxes paid abroad are allowable as a deduction in the computation of the business income of the assessee .

 Bank of India vs ACIT ( ITAT MUMBAI) 

In the present case, our entire focus was on whether these foreign tax credits could be allowed even when such tax credits lead to a situation in which taxes paid abroad could be refunded in India, but that must not be construed to mean that, as a corollary to our decision, these foreign tax credits would have been allowed, even if there is no domestic tax liability in respect of the related income in India if it was not to result in such a refund situation. At the cost of repetition, we may add that, for the detailed reasons set out earlier, we have our reservations on the applicability of the Wipro decision (supra) on this bench, being situated outside of the jurisdiction of Hon’ble Karnataka High Court, and we are of the considered view that full tax credit for source taxation cannot, as such and to that extent, be extended in the residence jurisdiction when a tax treaty sanctions only proportionate credit, and does not, in any case, specifically provide for the full foreign tax credit. A full tax credit, which goes beyond eliminating double taxation of an income, actually ends up subsidizing the foreign exchequer, to the extent that the taxes paid to the foreign exchequer are allowed to discharge exclusive domestic tax liability, rather than eliminating double taxation of an income, and that is the reason that even in the solitary full credit situation visualized in the Indian tax treaties, in the Indo Namibia tax treaty (supra), it’s one-way traffic inasmuch as while India, as a relatively developed nation, offers, under article 23(2), full credit for taxes paid in Namibia, whereas, in contrast, Namibia, as a developing nation, offers, under article 23(1), proportionate credit for taxes paid in India. It reinforces our understanding that the full foreign tax credits cannot be inferred to be permissible as a matter of course and normal practice

Cabinet approves participation of Private Sector into Space exploration

The government’s recent reforms for the space sector will not only enable private companies to build rockets and satellites but also let them use the Indian Space Research Organisation’s (Isro’s) facilities,  It was perhaps the first admission that existing regulations impeded the private sector from fully participating in space exploration. And just a few days back, the Union cabinet finally approved the formation of a new organization- the Indian National Space Promotion and Authorisation Centre (IN-SPACe) under the Department of Space (DoS). IN-SPACe will now be in charge of regulating, guiding and promoting the activities of the private sector in the space industry. More importantly, through INSPACe, private companies will be allowed to build their own facilities on DoS premises after they vet their application.

And this is a big positive. Here's ISRO chairman, Dr. Sivan explaining this bit.

“Under the present situation, ISRO has reached its limit on providing our services due to manpower limitations and we can’t scale up more than 3 per cent market share. That’s why we need private players to get involved and that will also boost market share when they diversify into many  

services" 

Essar Shipping Limited vs. CIT (Bombay High Court)

S. 28(iv): The Dept's argument that the waiver of a loan constitutes an operational subsidy which is taxable is not correct. There is a fundamental difference between “loan” and “subsidy” & the two concepts cannot be equated. While “loan” is a borrowing of money required to be repaid back with interest; “subsidy” is not required to be repaid back being a grant. Such grant is given as part of a public policy by the state in furtherance of public interest. Therefore, even if a “loan” is written off or waived, which can be for various reasons, it cannot partake the character of a “subsidy”. The waiver of a loan cannot be brought to tax u/s 28(iv) of the Act

Conceptually, “loan” and “subsidy” are two different concepts. As per the Concise Oxford English Dictionary, Indian Edition, the term “loan” has been explained as a thing that is borrowed, especially a sum of money that is expected to be paid back with interest; the action of lending. Black’s Law Dictionary, Eight Edition, describes “loan” as an act of lending; a grant of something for temporary use; a thing lent for the borrower’s temporary use, especially a sum of money lent at interest; to lend, especially money. In Supreme Court on Words and Phrases, it is stated that “loan” necessarily supposes a return of the money loaned; in order to be a loan, the advance must be recoverable; “loan” is an advance in cash which includes any transaction which in substance amounts to such advance

ECB launched bond buying Program to ease euro zone economy

The 3Cs - Coronavirus, Crude oil and Credit Risk seem to have shocked the whole world. The infection from the pandemic and the economic fallout is taking a toll on equity markets. Though central banks and the government are pacifying sentiments through rate cuts and liquidity infusion, the fall in the markets is highly disturbing due to the rising confirmed coronavirus cases and deaths in Europe surpassed China on Wednesday, the ECB launched a €750B bond-buying program to stop a pandemic-induced financial rout shredding the eurozone's economy. The new policy brings this year's planned purchases to €1.1T, with the new round alone worth 6% of the bloc's GDP. Eurozone government bonds surged after the decision, with 10-year Italian bond yields dropping as much as 90 bps to 1.40%. Spanish and Portuguese 10-year bond yields slid around 30 bps each, while benchmark 10-year German Bund yields were down 12 bps at 0.35%.

Global Economy getting worse.

The Price of oil tumbled overnight and could go much lower still.

Global supply disruptions and slackening demand could lead to global recession.

Quarter 1 earnings reports will generally be bad and forward guidance could be even worse.

Expect another rate cut from the Fed and possibly a fiscal stimulus package from Washington, with maybe a short-term rally coming soon.

Further downside in equities appears likely as fear and economic disruptions create global uncertainties.

Rosneft acquire Essar Oil 49.13% stake

A consortium led by Rosneft  announced the completion of a $12.9B deal to acquire Essar Oil, strengthening ties between the world's largest oil producer and the fastest growing fuel consumer. Rosneft will get a 49.13% stake in Essar, while the Trafigura-UCP consortium via Kesani Enterprises will get another 49.13% holding. The remaining 1.74% stake will be held by retail shareholders.

Moody downgrade China's rating

China's great wall of debt! Moody's has lowered the nation's credit rating to A1 from Aa3, citing Beijing's waning financial strength and rising liabilities. It marks the first time a major ratings agency has downgraded the country in more than 25 years. The move also received a backlash from China's finance ministry, which said the decision was "absolutely groundless" and was based on an "inappropriate calculation method."

President Trump's first budget proposal

President Trump's first full budget proposal lands on lawmakers' desks, with a proposed $3.6T in spending cuts over the next decade. Congress will still be allowed to spend $4.1T in 2018, including a big boost to defense, border security and infrastructure, while cutting Medicaid, food stamps and other social programs. The plan also calls for selling half of the nation's Strategic Petroleum Reserve and permitting drilling in the Alaska refuge.

S. 54/ 54F: There is no requirement that the investment in the new residential house should be situated in India prior to the amendment by the Finance (Nos.2) Act, 2014 w.e.f. 01/04/2015

ITO vs. Nishant Lalit Jadhav (ITAT Mumbai)

A similar situation, though in the context of section 54F of the Act, has been considered by the Hon’ble Gujarat High Court in the case of Smt.Leena J. Shah (supra); notably, so far as the impugned issue is concerned, the requirement of sections 54F & 54F of the Act is pari-materia, inter-alia, requiring the assessee to make investment in a new residential house in order to avail the exemption on the capital gains earned. As per the Hon’ble High Court, prior to the amendment the only stipulation was to invest in a new residential property and that there was no scope for importing the requirement of making such investment in a residential property located in India

S. 56(2)(vi): A HUF is a "group of relatives". Consequently, a gift received from a HUF by a member of the HUF is exempt from tax as provided in the Explanation to s. 56(2)(vi)

DCIT vs. Ateev V. Gala (ITAT Mumbai)

From a plain reading of section 56(2)(vi) along with the Explanation to that section and on understanding the intention of the legislature from the section, we find that a gift received from “relative”, irrespective of whether it is from an individual relative or from a group of relatives is exempt from tax under the provisions of section 56(2)(vi) of the Act as a group of relatives also falls within the Explanation to section 56(2)(vi) of the Act. It is not expressly defined in the Explanation that the word “relative” represents a single person. And it is not always necessary that singular remains singular. Sometimes a singular can mean more than one, as in the case before us. In the case before us the assessee received gift from his HUF. The word “Hindu Undivided Family”, though sounds singular unit in its form and assessed as such for income-tax purposes, finally at the end a “Hindu Undivided Family” is made up of ‘a group of relatives”

Transfer Pricing: Law explained as to when the “Resale Price Method” (RPM) can be used with respect to related parties under Rule 10B (1)(b) + Law on determining arm’s length rate of the corporate guarantee commission/fee explained

Zee Entertainment Enterprises Ltd vs. ACIT (ITAT Mumbai)

The Transfer Pricing Officer has selected RPM as most appropriate method for determining the arm’s length price of the transaction of sale of programmes and film rights to ATL in contrast to the TNM method selected by the assessee. The first controversy is as to whether the Transfer Pricing Officer was justified in selecting the RPM as most appropriate method. Section 92(1) of the Act provides that the arm’s length price in relation to the international transaction shall be determined by any of the methods prescribed therein, being the most appropriate method. Notably, the phraseology of section 92C(1) of the Act makes it clear that the selection of the most appropriate method is to be made “having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors………………..”. Further, Rule 10B of the Rules enumerates the various methods to determine the arm’s length price of an international transaction and for the present purpose, what is relevant is clause(b) of Rule 10B(1) of the Rules, which prescribes the manner in which the RPM is to be effectuated.

S.14A disallowance has to be made also with respect to dividend on shares and units on which tax is payable by the payer u/s 115-O & 115-R. Argument that such dividends are not tax-free in the hands of the payee is not correct. S. 14A cannot be invoked in the absence of proof that expenditure has actually been incurred in earning the dividend income. If the AO has accepted for earlier years that no such expenditure has been incurred, he cannot take a contrary stand for later years if the facts and circumstances have not changed

Godrej & Boyce Manufacturing Co Ltd vs. DCIT (Supreme Court)

While it is correct that Section 10(33) exempts only dividend income under Section 115-O of the Act and there are other species of dividend income on which tax is levied under the Act, we do not see how the said position in law would assist the assessee in understanding the provisions of Section 14A in the manner indicated. What is required to be construed is the provisions of Section 10(33) read in the light of Section 115-O of the Act. So far as the species of dividend income on which tax is payable under Section 115-O of the Act is concerned, the earning of the said dividend is tax free in the hands of the assessee and not includible in the total income of the said assessee. If that is so, we do not see how the operation of Section 14A of the Act to such dividend income can be foreclosed. The fact that Section 10(33) and Section 115-O of the Act were brought in together; deleted and reintroduced later in a composite manner, also, does not assist the assessee. Rather, the aforesaid facts would countenance a situation that so long as the dividend income is taxable in the hands of the dividend paying company, the same is not includible in the total income of the recipient assessee. At such point of time when the said position was reversed (by the Finance Act of 2002; reintroduced again by the Finance Act, 2003), it was the assessee who was liable to pay tax on such dividend income. In such a situation the assessee was entitled under Section 57 of the Act to claim the benefit of exemption of expenditure incurred to earn such income. Once Section 10(33) and 115-O was reintroduced the position was reversed. The above, actually fortifies the situation that Section 14A 44 of the Act would operate to disallow deduction of all expenditure incurred in earning the dividend income under Section 115-O which is not includible in the total income of the assessee.

Article 5 India-UK DTAA: Entire law on what constitutes a "permanent establishment" in the context of the 'Formula One Grand Prix of India' event explained after extensive reference to case laws, OECD Model Convention and commentary by Philip Baker, Klaus Vogel and other experts

Formula One World Championship Limited vs. CIT (Supreme Court)

The term “place of business” is explained as covering any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. It is clarified that a place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. Further, it is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A certain amount of space at the disposal of the enterprise which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is required. Thus, where an enterprise illegally occupies a certain location where it carries on its business, that would also constitute a PE. Some of the examples where premises are treated at the disposal of the enterprise and, therefore, constitute PE are: a place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot (e.g. for the storage of dutiable goods). Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise. At the same time, it is also clarified that the mere presence of an enterprise at a particular location does not necessarily mean that the location is at the disposal of that enterprise.