Budget 2015 – Income-Tax laws need simplifying

The overarching theme of Bollywood movies of sixties and seventies was simple – the hero was a poor, educated, unemployed yet honest young man. And the villain? Well it was an entrepreneur who invariably indulged in illegal acts to make money.

This idea was repeated in several Hindi films [and also in every other Indian language] till the nineties when the Indian economy underwent tentative doses of liberalisation. And pray why not? After all, the dominant thinking within the Indian establishment was that every businessman was a scoundrel – a direct fallout of Nehruvian thinking.

This thinking was rooted in a colonial mindset where the British had a vested interest in dynamiting Indian businesses even within India. If we had thought things would improve dramatically post-independence, we were wrong.

In the name of socialist ideology every Indian businessman, ever after independence, was held to be a suspect till proved otherwise. Importantly, for a civilisation that venerated Goddess Lakshmi, celebrating poverty became the way of life – all in the name of an alien ideology. Never mind in neighbouring Communist China comrade Deng Xiaoping had observed that it was glorious to be rich.

That in turn implied that if you are rich you must be a businessman. And if you are a businessman you must be a law-breaker. In this paradigm, where is the question of profits when laws were designed to ensure that an average Indian businessman could never carry any business, not to speak of legitimate profits?

India’s tryst with Income-Tax

Nothing exemplified this obnoxious idea better than the Income-Tax law. Elders in the profession tell me that the rate of taxes in the sixties were punishing – sometimes even 90 per cent or more of the income earned! Little did we realise the consequence of taxing at such unacceptable rates. And when we realised in the late eighties, most countries had overtaken us.

The Income-Tax Act is of 1961 vintage. In the past five decades, this enactment has undergone close to 10,000 Amendments, of which 350 or so are reportedly retrospective. That implies that one could have planned his affairs according to the law of the land only to find rules of the game changed from a distant past.

But that is not all. The very design of this legislation is extremely complicated and offers enormous latitude as well as discretion for the assessment officers which in turn breeds corruption. What is galling to note is that while post liberalisation the rates of Income-Tax had indeed moderated to more reasonable levels, the complexity of this legislation has increased manifold.

What may be “Income” or a “legitimate deduction” invariably depends on the eye of the assessing officer. Of course, there are several layers of appeals and finally justice may be delivered. But in most cases, than otherwise, it would be a pyrrhic victory attained at extraordinary cost, mental trauma and loss of reputation.

As a student in late eighties I had watched the late Nani Palkhiwala while addressing a post Budget meeting tell his audience that this law was a goldmine to practicing chartered accountants and lawyers. Three decades later, nothing seems to have changed. If anything, things have become extremely complex and corrupt.

Simply simplify it

In my considered opinion the greatest deterrent for investment [both domestic and foreign] into India is our Income-Tax law and the manner in which it is administered. Most investors are also chary as this legislation is now rumoured to be used by competitors to settle business scores. The net result is that over the past few years all these complexities have converted our tax department into an extortionist one.

One of the peculiarities of this enactment is the idea of “deeming fiction” – one that deems [irrespective of the factual position] to hold that an event has indeed happened when it might not have! Naturally for a “price” this could be altered to suit conveniences.

One of the unchartered areas of liberalisation of the Indian economy is the Income-Tax law and the manner in which it is to be administered. The UPA regime had realised the magnitude of the problem and tried to bring in a new law – popularly called as Direct Taxes Code. Unfortunately, even a cursory reading would demonstrate that it is as disastrous as the sequel of a horrible movie.

The central issue is not the Law but the manner in which the law is administered. The Income-Tax law first defines income [which is all-inclusive], then lays the scope of allowable expenditure [which is restrictive] and taxes on the resultant profit. But this is where the complexity sets in. What is profit as understood by a common man may not be profit under the Income-Tax law.

This requires some explanation. Over and above the claim for expenditure, an assesse can claim “deductions and allowances.” For instance, depreciation claimed under the companies act is entirely different from that of Income-Tax Act.

Further, there are several rates of depreciation depending on the “nature of asset” and also when the “asset was actually put to use.” Needless to emphasise, most of the provisions are loosely worded, convoluted and hence lend themselves to needless litigation. But who cares?

Likewise, deductions from “profits” are available for companies engaged in certain types of business, located in certain areas and on carrying out certain types of expenditure. Added to this are assessment and re-assessment procedures, law for deduction of taxes at source and cross-border transaction involving international business which simply stuns ordinary minds.

The transfer pricing provisions that “presume” transfer of profits by an enterprise doing business in India to a “related” enterprise abroad has given enormous leeway to the tax authorities to fix any assesse.

Has the lawman converted the law into a complex affair or is it the other way around? I leave it to the readers. But what about rationalisation of this law? Remember, there are vested interests who would prevent simplification of this law. And even if simplified, given years of training, our lawman cannot resist complicating matters all over again.

Therefore, the only way out is to do a grand simplification of this enactment. It is in this connection “The Statement of Revenue Forgone” appended to Budget documents of 2014 provides us some fascinating details of the manner in which this law is administered.

Accordingly, based on 618,806 returns filed in 2013-14, 334,109 companies reported a profit aggregating to Rs 10.87 lakh crores while 250,865 companies reported a loss of Rs 3.59 lakh crore and the balance 33,832 companies reported nil profits. The average effective tax rate [tax paid expressed as a ratio to profit before taxes] of these companies worked out to 22.44 per cent.

As already pointed out there is a difference between profits under company law and profits that can be subject to tax on account of deductions. For instance, while the profits of 334,109 companies is Rs 10.87 lakh crore as explained above, the taxable profits after deductions worked out to Rs 7.50 lakh crore.

Therefore legally one can avail of deductions legally and end up paying zero tax. It is here there is yet another twist in the tale.

It is to be noted that these deductions are restricted up to a point as the law mandates every company to pay a minimum tax of approximately 20 per cent on profits – technically called as Minimum Alternate Tax [MAT].

Theoretically, it may be noted that the companies are liable to a maximum tax rate of round 34 per cent but in reality as explained by the Budget documents end up paying approximately 22.44 per cent as effective rate of taxes, thanks to deductions and other allowances.

The tax foregone under each section is highlighted by this Tax Foregone Statement. Accordingly, for 2013-14 the tax foregone [the difference between maximum rate possible i.e. 34 per cent and actually levied i.e. 22.44 per cent] is Rs 102,606 crore.

Nevertheless, thanks to MAT, Budget documents also estimate that corporate sector ended up paying Rs 26,490 crores at 20 per cent MAT. In short, the entire debate on tax is between paying taxes at a higher rate of 34 per cent [but subject to a complex deduction regime] and a mandatory [yet simple regime without deductions] minimum rate of 20 per cent. Why not choose the second one even as the effective tax rate of the first is only 22.44 per cent?

Put in marketing terms the entire market for tax litigation is a mere Rs 76,116 crores [Rs 102, 606 crores tax saved on deductions less Rs 26,490 crores collected under MAT]. As tax administrators and tax payers play Tom and Jerry, the resultant harm to India as an investment destination is incalculable.

Will the Budget have to do away with a plethora of discretionary deductions and allowances and simply tax through MAT provisions? This means every company would simply end up paying 20 per cent taxes on book profits and no litigation on infructuous deductions. Do we realise the positive impact on Brand India with a simple and effective tax regime?

Source: http://www.niticentral.com/2014/12/08/budget-2015-income-tax-laws-need-simplifying-248486.html