Experts opinions, newspaper editorials and even comments on CA Club website lavishly talk about income tax exemptions to be distorting the tax scene of the country, leading to massive leakage of revenue to the government and ultimately responsible for high tax rates. They also almost unanimously conclude that it is necessary to do away with these exemptions so as to reduce the average rate of tax.
In my humble view, this opinion is flimsy and besides the point completely, for two reasons:-
1. EXEMPTIONS DO AND WILL CONTINUE DESPITE DTC
Even in the DTC draft, several exemptions have been continued (like income from agriculture, income from partnership firm, receipt from life insurance, gratuity, deduction for depreciation, and so on) and in fact, by increasing the rate of Minimum Alternative Tax (MAT) from 18% to 20%, govt has only conceded that the incidence of exemptions will now be even more than before (MAT has a single justification for its existence in statute book and that is, limiting the incidence of exemptions, else MAT is quite contrary to the basics of income tax which is a tax on income. If someone does not have an income, there ought to be no tax regardless of what his P&L A/c is reflecting. Afterall, income is what is defined to be income in the income tax law that starts its computations from the P&L A/c.).
If govt really proposed to reduce the incidence of exemptions, it ought to have reduced the MAT rate as well.
Besides, by continuing with exemptions, it has put an end to this discussion as to whether the exemptions are desirable or not. If they were not desirable even under todays circumstances, they ought to have been dispensed with under the new law that is, Direct Tax Code.
Then, new exemptions are being announced every other day by the govt. Most recent case is exemption to the honourable Members of Parliament after increase in their emoluments by more than three times! Several exemptions to states like North-East, Utterakhand, J&K etc were announced not too far ago.
Therefore, the thinking in the govt has not changed and the exemptions do and will remain in the income tax law, despite the act being substituted by the new Direct Tax Code.
2. EACH EXEMPTION REFLECTS A DELIBERATE POLICY DECISION OF THE GOVT OF THE DAY TO ACHIEVE CERTAIN SPECIFIED OBJECTIVE
Each and every exemption under any sub-section of the income tax act, has been announced with a certain objective in mind. Unless those objective have ceased to be relevant today, those exemptions must continue, and if the objective has become irrelevant, then the govt could have easily deleted the particular sub-section/section and abolish that particular exemption rather than using as an excuse to rewrite the income tax law to force massive litigation on everything that has been settled before, to increase massive cost of implementation and ultimately, waste national resources both financial as well as intellectual. India certainly should be focusing on things that will lift its GDP to narrow the gap with other competing economies. Sadly, the gap with many competing economies is increasing despite our impressive economic performance, take China for example.
Let us deal with a few categories of exemptions to examine the issue. We can broadly put all exemptions under the following nine categories:-
1) Exemptions to avoid double taxation
Without these exemptions, certain income like share of profit from partnership firm, HUF etc will attract double tax. Hence, such exemptions are necessary regardless of any tax reform today or tomorrow.
2) Exemptions to avoid tax on withdrawal of savings/social security benefits
Without these exemptions, all withdrawals from PF/Life Insurance/Gratuity etc which are supposed to be social security investments, critically necessary at old age post retirement of employees, will become taxable. Hence, such exemptions will stay for all times to come.
3) Exemptions to encourage investment in housing, social security, health care etc
These are exemptions to encourage people to invest in new housing, health care of themselves and their parents, education of children etc. The cost of these exemptions is negative to the govt in the sense that such exemptions result in massive investment in real estate industry which cedes massive tax revenue and employment direct and indirect; massive investment in education sector that is key to Indias emergence of a potential economic power (cut its thrust on education and you get same 3 to 4% hindu rate of growth that India was used to in 60s and 70s); massive growth of healh care sector that again churns massive revenue and employment direct and indirect etc. Take out these exemptions and you deflate the tyres on a highway!
4) Exemptions to encourage investment in certain geographical areas
Exemptions have been announced for new industrial units in certain geographical areas starting from Kutchh in Gujarat to North Eastern state, J&K, Utterkhand etc. Economic considerations for such exemptions are dubious and highly controversial but political considerations are very strong. No wonder these exemptions are a sacred cow even for first draft of DTC and hence, no govt in India can slaughter the same.
Purely on economic considerations, such exemptions must be withdrawn. They result in more inefficient application of capital whereas what we need to speed up growth is more efficient utilisation of capital. New units have been set up in these exempt areas but existing units elsewhere in the countries have suffered lower capacity utilization, resulting into higher corporate profits but lower collection for exchequer. Recognizing this, exemptions were later capped, and diluted which is not only unfair but also compromises with credibility of the institution of government which is essentially required to be Fair, Always in Public Interest and Committed to its promises, come what may! Yes, these exemptions should be abolished with or without substitution of income tax act.
5) Exemptions to certain institutions/trusts/funds of great public interest
Exemptions are available to a number of institutions such as Local Authorities, Housing Development Authorities, Approved Scientific Research Institutions, notified sports and professional institutions, public charitable trusts/societies etc. Again the cost of these exemptions is a misnomer. These institutions are creating public assets or great public value such as professional & sports advancements, or great public service such as education and health care etc.
Alternative will be to collect tax from all these institutions which will most certainly cut down on the size and numbers of such institutions immediately as well as their capacity to service the public, and then, use that revenue to provide that service to the public directly. We all know that only 5 to 15% of govt expenditure reaches the beneficiary and rest is siphoned off in corruption and costs, hence, there is urgent need to encourage more such services independent of the govt and therefore, all such exemptions must continue.
6) Exemptions to foreigners as foreign policy or international relations matter or to facilitate technology transfer
Many exemptions are allowed to foreign expatriates, foreign dignitaries, diplomatic staff etc. They are either given in deference to foreign policy matter or international gesture of goodwill, or to encourage foreigners visiting India to facilitate technology transfer. The first consideration is entirely political and the second consideration was very important a few decades ago, but its significance is fading. Deliberations could be done on such matter in current scenario and if most industry representatives believe that it is not necessary, the same could be abolished. No substitution of the entire income tax act is required for this small exercise, and not sure, if it has been attempted in the DTC as yet.
7) Exemptions to encourage investment in certain govt schemes/funds
Exemptions are given for investment in capital gains exemptions schemes, rural electrification bonds etc. Without these exemptions, no such investment will be made by the public. As a consideration for such exemptions, most such schemes yield very little interest to the depositors and hence, the exemptions are indeed a misnomer. Take out these exemptions and govt not only misses the funds invested in such schemes but also, end up paying much more interest on regular borrowings directly or indirectly. Even forced borrowings from RBI at lower interest rates or forced investment in lower interest rate govt securities by other banks will reduce investible amount with these banks which will not only increase cost of borrowing to private borrowers but also reduce availability of funds. Counter-productive indeed!
8) Exemption to encourage exports
There used to be a time when all income from exports used to be exempt. Hardly anymore. Most such exemptions are vanishing making a firm statement that India does not value exports too much now. Exemptions to SEZ units are also an irritant to policy makers without any accountability and with no great reputation for being well informed either. They have proposed MAT on SEZ units in the DTC already.
SEZ units are supposed to be off-shore units, focusing entirely on export business. Unless such business is profitable and attractive, it will not be successful and India will be back to domestic tariff business as usual. SEZ business is only an additional business to India and no matter how much it imports for its requirements, it cannot help but use significant labour, petty supplies etc from domestic tariff areas which are revenue generating for the govt. Support services to these SEZ are mainly domestic. Apart from revenue which SEZ units are definitely generating for the govt directly or indirectly, they are contributing what a revenue is ultimately required for, generation of employment and leading to higher economic growth!
In fact, there is an urgent need to be aggressive about exports. Recent global meltdown showed that Indias exports are insignificant. Although that protected its economy from recession, it underlined the fact that we have not exploited our potential at all.
9) Exemption to recognize non-cash cost such as depreciation
Finally, we land on depreciation which is also viewed by many supports of MAT as an exemption, though it is a genuine deduction without which no business income can be computed for any purpose whatsoever. That this cost is not incurred in cash every month is irrelevant. Also, need for showing consistency in profitability over the years to the stakeholders is the only justification for using a straight line method of charging depreciation, otherwise written down value method is the only appropriate method for accounting for such costs. Even under going concern value, a fair valuation of a depreciated asset will be much closer to market value when depreciation is charged at WDV and not straight line method. Fortunately, income tax computation permits deprecation at WDV but the short sighted babus in finance ministry believe that they are losing revenue by permitting even deprecation as an exemption. During last budget, govt cribbed over loss of revenue of over Rs 75000 crore in exemption, which amount to Rs 55000 even if deprecation is ignored. At this rate, day is not far when income tax become sales tax where all sales are regarded as income and any deduction allowed would be a favour to business community to be reversed once day!
Therefore, talking of massive exemptions as a justification for revamping the income tax law and forcing India back into litigation for next decade on every simple thing, long settled after massive litigation already, is colossal wastage of productive energy at a time when India needs to focus on ways and means of expanding faster and catching up with the developed world. If India is indeed the second largest destination for FDIs, it has a lot of work to do to absorb so much of FDI and catapult into a genuinely developing country. Our preparations for Common Wealth Games have once again highlighted the capability and culpability of our ruling class, babus and netas. India is emerging as a major economy not because of any positive moves made by this ruling class but because of dismantling of some of the shackles created and designed by them, by govt of the day in 1993. The entire success story of India is the story of capability, ambition and commitment of its private sector and nothing more than that.
In fact, the major difference between India and China is precisely here. While China is growing much faster and for much longer, Indias growth is much later and much slower, but the driving force behind Chinas massive growth is a commitment of unifocused government while in India, govt is busy putting more hurdles on the way of its business on one pretext or another and despite that, the vibrant private sector has come of age in India which is the only force behind its growth. Take our private sector out, and we would fall like the East Europe in early 90s.
Conclusion therefore is, pls do not waste time of the business community for your short sightedness. Let business take care of itself and if you can, remove some of the hurdles they are facing. There are no exemptions in income tax which justify any overhaul in the system. The consideration of revenue is sick. The real consideration should be a boost to GDP growth. Any change is good provided it encourages higher GDP growth and not otherwise!