Finance ministry mulls re-entry of investment allowance

An intense debate is taking place within the finance ministry over a proposal to reintroduce investment allowance for companies implementing new projects or creating productive assets to expand their businesses.

Within the ministry, there are strong views against and in favour of the proposal. But the fact that the ministry has informally sought clarifications from industry on the matter is a sign that the proposal is under consideration.

Investment allowance for expenditure incurred by industry on plant and machinery stood withdrawn with effect from April 1990. Till then Indian companies could claim a deduction of an amount equal to 20 per cent of the cost of plant and machinery installed or put to use while computing their profits from business.

Madhu Dandavate, finance minister at that time, had argued that since his Budget had reduced the corporation tax rate by 10 percentage points to 40-50 per cent, incentives and concessions like the investment allowance needed to be withdrawn.

Proponents of a reintroduction of the investment allowance are using this as their main argument. Since an across-the-board cut in corporation tax rates is unlikely because of its adverse impact on the government's fiscal deficit, the ministry should consider concessions such as the investment allowance to promote investments during an economic downturn.

Significantly, in a rare meeting of minds, both the Confederation of Indian Industry and the Federation of Indian Chambers of Commerce and Industry have pleaded for a reintroduction of the investment allowance in their respective pre-Budget presentations to the finance minister. Finance ministry officials are now examining industry studies on the impact of the withdrawal of the investment allowance in 1990-91. According to one such study, by Ficci, the introduction of investment allowance in the 13-year period ended 1989-90 saw gross domestic capital formation rise over six percentage points to 24.5 per cent of GDP at market prices in this period.

The study has argued that in sharp contrast, gross domestic capital formation in the previous decade stagnated at 17-18 per cent of GDP at market prices. Similarly, there was no sharp increase in the gross domestic capital formation after the withdrawal of the investment allowance for about a decade. The rate, however, began to rise sharply from 2001-02 till last year, when it was estimated at 36 per cent of GDP at market prices.

Those who oppose the proposal for reintroducing the investment allowance point out these incentives are effective only when there is full or near-full capacity utilisation in industry. At present, most industries are suffering from low capacity utilisation because of a decline in demand. Hence, reintroducing investment allowance may lead to inefficient allocation of resources at the cost of the central exchequer.

Another argument against its reintroduction is that most developed and emerging economies have done away with incentives like investment allowance. A counter-argument to this view in the ministry is that the government should treat India's economic situation as unique and consider such measures as the Indian economy needs high growth through such specific policy interventions.