04 November, 2021
5 Min Read
TAX REFORMS IN INDIA
Context: This topic is important for GS Paper 3.
Only 6.08 cr individuals pay taxes (~4.9%) much below the desired level of 23%.
• In India, only 15.5% of net national income is reported.
• Overall, the Tax-to-GDP ratio (at 17.82% in FY 2017-18) still remains below that of emerging economies (~21%) and much below OECD average (~34%).
• Low tax base:
Income Tax: The exemption threshold of income tax has been consistently raised, well-off people are subsidized at the cost of services.
Corporate Tax: Before the recently unveiled tax cuts, India was branded as a high-tax destination with a corporate tax rate over 30%.
• Tax Evasion: Tax evasion and corruption undermine the legitimacy of the State. It creates a belief among the citizens that public resources are being wasted, reducing the willingness to pay.
• Weak Tax Administration: This is considered a key barrier to effective and fair tax collection in the country. Due to lack of technical expertise and financial resources, as well as due to corruption.
• Structural Issues: Several structural factors have impinged upon India’s tax revenue performance such as:
A) Large share of agriculture (historically untaxed sector) & service sector (lightly taxed sector).
B) Low literacy rate and largely rural population.
C) Large informal economy partly due to onerous regulations on businesses, including labour regulations and high corruption.
D) Low financial development, due to which financial transactions are conducted in cash, making it difficult to track tax evasion.
• Limited Fiscal Capacity: Low Tax-to-GDP ratio reduces the resources available to the government and puts a constraint on Government spending.
• Fiscal capacity refers to the ability of government to generate revenue.
• The fiscal capacity of governments depends on a variety of factors including industrial capacity, natural resource wealth and personal incomes.
• Identifying fiscal capacity helps governments to determine the tax rate necessary to finance such expenditure.
• Country’s existing fiscal capacity is limited, primarily due to low tax base & poor quality spending.
• Government Accountability: The state's role is to create the conditions for prosperity for all by providing essential services and protecting the less well-off via redistribution. In tax-compliant societies, Govt is more accountable to citizens. So, there is a better provision of essential services to people.
• Citizen Participation in Governance: Taxation is two-way relationship as part of the social contract. It is the responsibility of citizens to hold state accountable. If a citizen does not pay, he becomes a free rider (using the service without paying), and cannot complain if the state provides a poor quality service. If he exits (not using the service at all), he loses interest in holding the state accountable.
• It is the tax where the incidence and impact of taxation fall on the same entity.
• It is termed as a progressive tax because the proportion of tax liability rises as an individual or entity's income increases.
• It is of various types such as: income tax, corporate tax, dividend distribution tax, securities transaction tax, fringe benefit tax and wealth tax.
• Income Tax Act 1961 (ITA) has provision for income tax, corporate tax, property tax etc.
• Various committees, to consolidate the direct taxes, were constituted by the government like Raja Chelliah Committee (the early 1990s), Vijay Kelkar Committee (2002), and recently Easwar Panel.
• Recently, with the constitution of Arbind Modi Committee on Income Tax Reforms and Akhilesh Ranjan Panel on formulating a new Direct Tax Code (DTC), Government seems to be moving firmly in the direction of Direct Tax reform.
• Direct Taxes Code (DTC) aims to revise, consolidate and simplify the structure of direct tax laws (like Income Tax Act, 1961; Wealth Tax Act, 1957) in India into a single legislation.
The Income Tax Act 1961 should be redrafted to account for the structural changes in the Indian economy, new models of doing business (e.g. international businesses, digital businesses, etc.), and evolving methods of income calculation based on the objectives of economic policy.
• Wide tax base will help deal with the problem of potential revenue loss due to lower tax rates and simplified tax structure.
• Reducing tax litigation: Tendency of tax officials to initiate an action without the necessary justification or assessment is reflected from low success rate of appeals (~30%).
• Provide level playing field between large businesses and start ups & young companies: A complicated tax structure in effect helps large business groups who can manipulate the system with the help of their in-house tax experts (tax avoidance strategies).
• Taxation based on Ease of Doing Business: Traditionally, for the sake of administrative convenience, the tax laws have segregated tax-payers only on the basis of ability to pay. It has seldom tried to differentiate between high-risk & low-risk income; legal & illegal income; recurring & non-recurring income etc. Considering such nuances in tax policy would make the structure more equitable. E.g. treating income from earned for Government securities (one of the most secure sources of investment) at par with high risk business income or share holder income is an anomaly that needs to be addressed.
• Ensure balance between direct and indirect taxes: Contribution of direct taxes has declined from 60% in 2010-11 to 52% in 2017-18. Increasing share of indirect taxes in revenue is alarming as indirect taxes are regressive which hurt poor people more.
• Clarity in cross border transactions: Till now, source rule of taxation for non-residents was linked to physical presence (permanent establishment) which has led to protracted litigation, base erosion and profit shifting.
• Better sync with global economy: Since India is much more integrated with the world globally in terms of business linkages and capital account convertibility, the differential treatment of foreign and domestic companies in the country should be gradually phased out.
• Need of Technology infusion in the tax administration to improve efficiency of tax collection as well as to aid the taxpayer.
A) Advanced Pricing Agreements (APAs): APA is an agreement between a taxpayer and tax authority determining the transfer pricing methodology for pricing the taxpayer’s international transactions for future years.
B) GAAR (General Anti-Avoidance Rules), effective from April 1st, 2017, is a set of rules which helps the revenue authorities to decide:
? It enables Government to tackle instances of tax avoidance due to practices like transfer pricing, round tripping (parking money in low tax jurisdictions and rerouting it as FDI or FII) etc. E.g. Vodafone Case
? GAAR provisions are applicable on firms who claim a tax benefits of over ? 3 crore.
C)Place of Effective Management (POEM) guidelines were introduced for the determination of residency of foreign company, applicable from FY 2017-18. If PoEM of a firm is in India, then its worldwide income would be taxed here.
? It intends to curb the formation of shell companies, which are located abroad but controlled from India, mainly for the purpose of avoiding taxes.
• Efforts to curb black money/tax evasion
• Corporate Rate Cut: To boost industrial activity and increase compliance, tax rate for all corporates is reduced from 30% earlier to 22%. Effective tax rate for all domestic companies would now be 25.17% – nearly 10% less than the existing 34.94%, providing they don’t avail any exemptions. New manufacturing companies will have to pay an even lower corporate tax rate of 15%.
• Administrative Reforms: Based on the recommendations of Tax Administration Reforms Commission under Parthasarthi Shome, a Tax Policy Research Unit headed by Revenue Secretary has been created for better research capability on fiscal topics and a Tax Policy Council chaired by Union Finance Minister to help the government make better policy decision on tax policies. The panel also recommended integration of CBDT & CBIC for holistic tax compliance regime.
• Tax treatment of cross border transactions: Arbind Modi Panel on Income Tax Reforms recommended that an income shall be deemed to be derived from a source in India, if the payment has been made from India, for any goods/services consumed or towards interest, dividend, bonus, or any other return on capital.
• Reintroduction of wealth tax: Moderate rates of personal income tax are not sufficiently progressive to contain growing inequality. Thus, wealth tax can be reintroduced.
• E-assessment: New Income Tax Act should provide a complete legal framework for the introduction of e-assessment based which will be paperless and faceless. It will enhance efficiency, effectiveness and accountability and eliminate all opportunities for rent seeking behaviour.
• Dispute resolution mechanism: A Directorate for Public Rulings has been created mandated to issue preassessment clarifications to prevent litigation and provide certainty. Similarly, in-house dispute resolution panel must be empowered to settle disputed issues.
The economic recovery remains fragile; rebooting tax policy may help
Well-planned and structured taxation as per economic needs would make people self-reliant just as the nation aspires to be, and that would trigger a virtuous cycle for the economy.
Source: The Hindu
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