A wish list for Direct Taxes Code

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TOPIC: General Studies 2

• Functions and responsibilities of the Union and the States
• Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

In news: After indirect taxes, the government is now looking forward to overhaul the 56 year old direct taxes covering income and corporation tax as it seeks to make the Indian regime make more contemporary and tailor it to current requirements. Now, the finance ministry is in process of setting up a task force to write the new tax law.

Background

India needs a modern income tax law that is easy to enforce, fair to all and relevant to the current economic context. The Income Tax Act of 1961 has become somewhat outdated, and complicated with amendments and modifications introduced over the years. This is not the first time an overhaul of India’s direct tax regime is proposed.

In the late 1990s, the Planning Commission set up a taskforce to review the income tax system

In 2002, high-level panel under Vijay Kelkar suggested several radical measures to reform the tax system.

It was last time started in 2009 when the direct taxes code was released which would sharply cut tax rates, remove exemptions and offer a transparent and predictable income tax regime.

But tax reforms couldn’t be passed as the new government focused on indirect taxes.

The complicated structure

There are two things asked for corporate tax

1. Rates are too high because there are many exemptions. So the effective rate is not near to the legislated rate.
2. The plethora of exemptions-whether they all are necessarily well designed or distorting.

The taxation has become more complicated and litigation oriented. This had to be avoided and make it as simple as possible. For this there is a need to remove exemptions.

But the government will have an agenda every time- WHAT TO PUSH? Whether it is an industry at a particular place or which type of industry- like power sector and then there will be exemptions given and whole cycle of amendments will start.

Replacing income tax act 1961

It was thought about in 2008 and 2009.  But it was shelved as there was opposition from parties affected by removal of the exemptions.

Two reasons for non-implementation of DTC 2009

1. Interest groups were trying to stall the process because the exemptions would be withdrawn
2. When the tax reforms are talked about, it is about bringing the down the tax rates. The rate of foregone taxes in short term is very high. If economy is not doing well, then it will be disastrous as the risks gets further aggravated. In 2011, the economy was going down and government couldn’t introduce the DTC 2009.

At present there is a problem of investment in corporate sector drying up. If at this point there is tinkering with incentive related investments, it may worsen the situation. Around the world, exports have begun to pick up but that is not seen in India. This is now of the biggest growth concern.

Create a platform

Recently, the Standing Committee on Finance tabled a report which said that without implementation of DTC, the intended gains of GST will not be felt. The purpose of a direct tax reform will be defeated that if the government kept on doing piecemeal amendments in income tax laws.

The government can start to work out the tax reform and as it takes time to align the key stakeholders, then it’s a welcome move. The government is unlikely to move to the new regime at the start of 2019-20 financial year, but may want to complete the ground work.

GST and DTC

There is a connection between GST and Direct tax reform. GST will bring more people in formal payment system. The number of assesses and tax collection have gone up despite slowing down of economy.

The success of new DTC will rest on success seen with GST. The anagram of Good and simple tax is yet to be made a reality. The GST has to be stabilised and wait for economy to recover. When this happens, the short term pains of GST will be taken over by long term benefits of GST. If GST becomes a success, in the next budget, the government can claim to validate this success. The customers will pay less. This would actually instead of having inflationary and demand-reducing impact, it could turn around and work as upping the demand. Then the government can do few changes in the DT like allow to reduce the number of slabs and increase standard deduction rates.

Direct Tax reform in brief

As far as broad concept of direct tax bill is concerned, the heads of the incomes should be rationalised. The expenditure should directly relate to the earning of the income by giving minimum exemptions. Exemption rates are also decided by finance ministry. Thus, at the end of the day it has to be said which things are to be taxed, which persons will be taxed and what would be there allowable expenditure. If it is made simple, it will go a long way in helping to boost direct tax collections and minimize litigation.

Best practices adopted

Treatment of income from capital. For eg exemption of dividend incomes with individuals and treatment of long term capital gains.

There cannot be a situation of standardised rates when the people who own capital earn substantial income which are either de-facto tax exempt or taxed at low rate. For eg buy backs are not taxable as dividend income as it is counted as capital gains. This distortion in decision making at the corporate level should be avoided.

There should be close look at the exemption to the corporate tax and way the income is treated from ownership of capital in the hands of individuals.

Conclusion

Any tax change should be equitable to the tax payers, transparent, free from manipulation and things that facilitate better enforcement.

For corporates- a single tax structure would augment growth and if there is growth, everybody benefits.

Positive impact on economy with tax structure changes. Make it a user friendly act. There cannot be tax on agriculture sector as it is beyond domain of parliament (It is with states), but many times agriculture income is used to launder money. So when the agricultural income crosses 1 or 2 lakhs a year, they should be made to file the return, even if they don’t have non-agricultural income. The income generated in many parts of farming sector are very high to justify.

On a lighter note: A tax reform is the one which makes tax lawyers and CAs unhappy.

Connecting the dots:

• What is the journey to have direct tax reforms till now? Critically analyse its implementation in current event of other economic reforms.