Income Tax law must have suffered the most volatility and changes since enactment in 1961. Government has been twisting it at will in order to extract more and more revenue. This must have the dubious distinction of being subject matter of highest litigation in India as well, probably even more than criminal law. After several decades of massive litigation, most concepts and definitions have been settled. All this is going to be wasted with substitution of income tax act, 1961 with Direct Tax Code that the finance minister is determined to push through sooner or later. In the process, almost everything is being changed. Most terms and definitions are being changed (for instance, “capital asset” is now “investment asset”) with the result none of the existing case laws that have frozen the definitions and concepts will be relevant, and the wheels of litigation will start afresh. Country is being forced into massive litigation once again, notwithstanding the fact that our courts are already loaded with over 3.5 cr pending cases which will take over 300 years to deal with! Finance Minister is ensuring job opportunities for lawyers and judges for 600 years!
In other words, we do not need a nuclear armed Pakistan to hurt India. Our government is doing the job very well. Careless experiments with the country are costing us dear. Merger of Air India with Indian Airlines was one such experiment. Substitution of Companies Act 1956 was another such experiment. Substitution of sales tax laws with Value Added Tax only for substitution once again with Goods and Services Tax (still pending) is this kind of experiment as well.
It is difficult to appreciate asto why the government cannot enlist the real changes it wants to make in a statute and go about making those specific amendments. Surely, it is not shy of amending laws frequently. It is doing it with exemplary frequency every year through Finance Act, and then, frequently during the year through circulars and notifications. In fact, our laws are already among the most unstable laws. Government has mentioned two Justifications for this exercise of DTC:
(i) expansion of tax base and
(ii) stopping leakage of revenue through numerous exemptions.
Total tax collection by central and state governments is more than Rs 30 lac crore from a GDP size of Rs 113 lac crore. Considering that agriculture does not pay taxes, the GDP net of agriculture should be about Rs 98 lac crore which is subject to Rs 30 lac crore taxes. This is almost 1/3rd of the GDP. This is already very high. India should qualify for being among the highest taxed nation, despite massive easy of tax rates during liberalization. In fact, there is no scope for any further expansion of tax base. The government must concentrate on increase the economy size which will automatically contribute more tax revenue. Hence, this justification is counter-productive.
Finance Minister is equally aggrieved with various exemptions offered in the income tax law and feels that revenue is lost through such exemptions. He has attempted to convince the people that by withdrawing these exemptions, he will be able to reduce the average rate of tax. This seems to be a flimsy argument or justification, for two reasons:-
1. EXEMPTIONS WILL CONTINUE DESPITE DIRECT TAX CODE
a. 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). 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 be more than before as otherwise one would not need any MAT. The only justification of MAT is limiting the incidence of exemptions, else it is contrary to the basics of income tax. If there is no taxable income as per income tax law, there should be no income-tax regardless of what is stated in Profit & Loss A/c.
b. If govt really wants to reduce exemptions, it could easily delete those sections dealing with exemptions, and then, also the one dealing with MAT. This will be much easier to do than to substitute the entire income tax act. But “if” is a very big “if” and it hides a lot more than it reveals, as usual with our governments.
c.By continuing exemptions in DTC, it has exposed the fallacy of its own argument, the justification for this massive wastage of productive time of Indian economy. Even now, 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.
d. 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
a. Each and every exemption under any section/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, these exemptions must continue, and if the objective has become irrelevant, then the govt can easily delete the particular sub-section/section and abolish that particular exemption. This is easier than rewriting the income tax law and restarting litigation on everything that has been settled before. This can only 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 Provident Fund / 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 government in the sense that such exemptions result in massive investment in real estate industry which generate massive tax revenue and employment, direct and indirect; massive investment in education sector that is key to India’s 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 health care sector that again churns massive revenue and employment direct and indirect etc. Besides, without these investments, government will have to spend much more on these aspects. Take out these exemptions and you deflate the tyres on a highway!
4) Exemptions to encourage investment in certain backward areas
Exemptions have been announced for new industrial units in certain geographical areas starting from Kutchh in Gujarat, North Eastern states, 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 government in India can slaughter the same.
Purely on economic considerations, such exemptions must be withdrawn. They result in inefficient deployment of capital whereas what we need to speed up growth is more efficient utilisation of our scare capital. New units have been set up in these exempt areas by closing down in full or part existing units elsewhere, 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 a compromise with credibility of the institution of government. Government is required to be Fair, a custodian of 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 in 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. 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. and hence, the exemptions are required to continue.
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 government 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 government and therefore, all such exemptions must continue.
6) Exemptions to foreigners as foreign policy or international relations 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 into these funds/schemes. As a consideration for such exemptions, most such schemes yield much lower 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. Besides, 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. This will hurt the economy directly. Counter-productive indeed!
8) Exemption to encourage exports
There used to be a time when all income from exports used to be exempt. Not anymore. Most such exemptions are vanishing sending undesirable signal that government 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 still has to use significant labour, and petty supplies 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 employment and economic growth. What else will government do with revenue?
In fact, there is an urgent need to be aggressive about exports. Recent global meltdown showed that India’s exports are insignificant. Although that protected its economy from recession, it underlined the fact that we have not exploited our potential at all. We must make our industry export-focused and if that requires more exemptions on export profits, let it be.
9) Exemption to recognize non-cash cost such as depreciation
Finally, depreciation is also viewed by many supporters of MAT as an exemption, though it is a genuine deduction from taxable income. No business income can be computed without considering depreciation, for any purpose whatsoever. That is not payable 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 most 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 becomes sales tax where all sales are regarded as income and any deduction allowed would be a favour to business community to be reversed one 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 growing 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 built by them earlier. The 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, India’s growth is much later and much slower, but the driving force behind China’s massive growth is a commitment of unifocused government while in India, government is busy putting more hurdles on the way of its business on one pretext or another. Despite that the vibrant private sector has come of age in India. 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 entrepreneurs for your short sightedness. Let business take care of itself and if you better 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 boost to GDP growth. Any change is good provided it encourages higher GDP growth and not otherwise!
Tags Income Tax