Yana Chandak and Dhruv Pamecha
ABSTRACT
A significant source of revenue for the government is taxation. It also promotes socioeconomic stability and economic development. A nation’s tax policy must play a crucial component, especially by making the best use of this weapon benefit of the country’s economy. Particularly, in a developing nation such as India, taxes have been utilized to encourage a variety of goals, such as raising the pace of decrease in wealth and income disparities due to domestic savings as well as to preserve price stability. The tax revenue has significantly bolstered the government’s financial resources.
Daily revenue from direct taxes is rising, because they are more direct than indirect taxes, taxes are preferred, equitable, administratively effective and can be related to individual’s ability to pay.
The income tax is the most ancient type of direct tax and accounts for a significant portion of the total revenue collected. In addition, professional and agricultural income taxes are crucial for maintaining economic stability. Thus, these levies contribute significantly to direct taxes in India.
INTRODUCTION
Though the nature of taxes and their collection varies across countries, there are predominantly two types – direct taxes and indirect taxes.[1]
Direct taxes are so-called because they are levied and collected directly from the individual or organization who finally pays the tax (legally). Direct taxes are levied on personal and corporate income, personal wealth, and professions. Personal and corporate income taxes are the two most important direct taxes in India. Both are still levied under the same statute, the Income Tax Act of 1961. The most major direct tax, a tax on income, was imposed for the first time in 1860 in order to raise revenue for the government. Following independence, India’s direct taxation structure underwent substantial modifications, primarily in response to the recommendations of the Taxation Enquiry Commission (153-54) and Kaldor’s Report on Indian Reforms (1956). The purpose of this research work is to examine and evaluate the need of simplification of direct taxes structure in India.
Income taxes are levied on a variety of sources of income, including revenue from business and professions, salaries, real estate, capital gains, and other sources (such as interest and dividends). The wealth tax and the securities transaction tax are two more direct taxes. Other forms of direct taxes that existed in India at one point but were phased out as part of various reforms include inheritance duty, gift tax, expenditure tax, and fringe benefits tax. The estate duty was imposed on a deceased person’s estate. Employers were assessed a fringe benefits tax based on the value of in-kind non-cash benefits or perquisites obtained by employees from their employers.
In recent years, India’s economy has seen significant growth, which can be attributed to the government’s dedicated efforts to enhance the country’s business environment. The primary focus has been on reducing the complexities of interactions between the government and businesses. This has been achieved by streamlining and simplifying regulations, incorporating information technology measures to facilitate foreign investment, and enhancing domestic productivity. India has had a byzantine tax regime since its independence, but post liberalisation, it has become an appealing business destination largely because of its consumer base, which spends about $600 billion in a year.[2] The Indian tax landscape is marked by its complexity, particularly when it comes to direct taxes as indirect taxes are now to an extent simplified after the introduction of GST, as it replaced various direct taxes and the manufacturer and the supplier just have to do formalities and compliances of just one tax rather than various other taxes. Direct taxes, which primarily include income tax and corporate tax, are a fundamental source of government revenue and play a pivotal role in shaping economic policies and social welfare programs. They are progressive taxes charged on the income of an individual and increases with the increasing income in the economy. However, tax regulations, exemptions, and compliance requirements has created a challenging environment for both taxpayers and tax authorities. So, it is a dire need of the simplifying the tax structure for fostering economic growth, enhancing tax compliance, and promoting ease of doing business. As John Andrew Holme said “If the Lord loveth a cheerful giver, how he must hate the taxpayer!”. So, in this research paper we will study need for simplify India’s direct tax system, examining the benefits it can bring to the government, taxpayers, and the broader economy.
CHALLENGES IN THE CURRENT DIRECT TAX STRUCTURE: IDENTIFYING AND ANALYSING KEY ISSUES
I) Insufficient Revenues: Most developing countries are plagued by chronic fiscal deficits and by inadequate social and economic infrastructure. Increasing tax revenue provides an obvious avenue to address these problems. Since the primary function of a tax system is to generate revenue, the first goal of tax reform must be to ensure that this function is discharged adequately.
i) Diverse Tax Structure: India has a complex tax system with various taxes at the central, state, and local levels. The key revenue sources include income tax, corporate tax, goods and services tax (GST), customs duties, excise duties, and more. The diverse tax structure aims to collect revenue from various sources.
ii) Direct and Indirect taxes: Direct taxes, such as income tax and corporate tax, are levied on individuals and businesses based on their income and profits. Indirect taxes, like GST, are imposed on the sale of goods and services.
iii) Tax Compliance and Evasion: Tax evasion is a significant challenge in India. The government has taken steps to improve tax compliance through the use of technology, data analytics, and stricter enforcement measures.
iv) Tax Incentives: India offers various tax incentives to promote investment in specific sectors and regions. These incentives are aimed at stimulating economic growth and attracting foreign direct investment (FDI).
v) Taxation of the Informal Sector: A substantial portion of the Indian economy operates in the informal sector. Bringing these businesses into the formal tax net is a challenge but can contribute to increased revenue collection.
vi) Economic Growth and Revenue: India’s economic growth is closely linked to revenue collection. As the economy expands, there is potential for higher tax revenues. However, economic fluctuations can impact revenue generation.
In conclusion, the administration of direct taxes in India faces complex issues related to complexity, evasion, corruption, and political interference. While there have been positive steps towards reform, addressing these challenges requires ongoing efforts to simplify the tax code, improve information systems, enhance enforcement capabilities, and ensure a level playing field for all taxpayers. This will not only strengthen tax administration but also contribute to improved revenue collection and fiscal discipline.[3]
2. Distortions that reduce economic welfare and growth: Taxation frequently creates distortions in the economy that reduce the real income of society by more than the amount of revenue raised by government. The reduction in real income is often referred to as the economic efficiency costs of taxation. Poorly designed and implemented tax systems can also encourage companies and individuals to waste effort on avoiding and evading taxes. A second goal of tax reform, therefore, must be to reduce the efficiency costs of taxation.
i. Resource Misallocation: Taxes that are not well-designed may lead to the misallocation of resources. For example, if certain industries or activities are heavily taxed while others receive preferential treatment, resources may flow inefficiently, hindering overall economic growth.
ii. Reduced Investment: High taxes on capital gains or investment income can deter individuals and businesses from making investments, which are crucial for economic growth. This can lead to a decrease in productivity and job creation.
iii. Market Distortions: Taxes that differentiate between similar goods or services can create market distortions. These distortions can lead to consumers and producers making choices that are not in their best economic interest but are driven by tax considerations.
iv. Tax Evasion and Avoidance: Poorly structured tax systems often create opportunities for tax evasion and avoidance. Companies and individuals may resort to legal or illegal means to reduce their tax liability, diverting resources away from productive activities and into tax planning or evasion strategies.
v. Compliance Costs: Complex tax regulations and frequent changes in tax laws can significantly increase compliance costs for businesses. These costs include the time and money spent on tax planning, legal consultations, and record-keeping, which could otherwise be used for productive purposes.
vi. Inefficient Behavior: In response to high taxes, individuals and businesses may engage in tax-driven behaviors that are economically inefficient. This can include shifting income offshore, investing in tax shelters, or engaging in non-productive tax-avoidance strategies.[4]
In summary, the Indian taxation system is a critical tool for generating revenue to address fiscal deficits and invest in social and economic infrastructure. Tax reforms, such as the introduction of GST, have been aimed at improving revenue collection and simplifying the tax system. However, challenges remain, and ongoing efforts are needed to ensure that the tax system is efficient, equitable, and conducive to economic growth.
3. Inequities: The poor often bear significant tax burdens. At the same time, many of the better-off pay little in taxes because a large part of nonwage income, self-employment income, or in-kind income is excluded by design or by weak administration. As a result, both horizontal equity (treating taxpayers with the same amount of income equally, irrespective of the source of income) and vertical equity (distributing the tax burden among the nonpoor in line with their ability to pay) suffer. Lifting the tax burden off the poorest households and ensuring that actual tax structures become more equitable both horizontally and vertically is a third goal of tax reform. Detailed analysis of how inequities manifest in India’s current tax situation and how they relate to horizontal and vertical equity:
i. Horizontal Equity:
Horizontal equity refers to the principle of treating taxpayers with the same amount of income equally, regardless of the source of income. In India, there are several areas where horizontal equity issues arise:
- Diverse Taxation: India’s tax system has various tax rates and exemptions based on different sources of income. For instance, income from capital gains is taxed differently from income from salary. This leads to disparities in the effective tax rates paid by individuals with similar overall income levels.
- Tax Evasion: High compliance costs and complex tax regulations can incentivize tax evasion, which often disproportionately affects those with less income and fewer resources to engage in tax planning or evasion.
- Inefficient Enforcement: Weak administration and enforcement of tax laws can result in some taxpayers evading their tax obligations, while others diligently comply. This undermines horizontal equity as it allows certain individuals or businesses to pay less than their fair share of taxes.
ii. Vertical Equity:
Vertical equity includes distributing the tax burden amongst the non-poor in line with their ability to pay. In India, various issues impact vertical equity:
- Exemptions and Deductions: The tax system contains various exemptions, deductions, and incentives that primarily benefit higher-income individuals and corporations. These provisions can lead to the better-off paying a smaller portion of their income in taxes compared to lower-income individuals.
- Wealth Inequality: India faces significant wealth inequality, with a small segment of the population holding a substantial portion of the country’s wealth. The tax system should ideally place a higher burden on the wealthiest individuals, but weak enforcement and the prevalence of tax havens can lead to reduced tax contributions from this group.
- GST Regressivity: The Goods and Services Tax (GST) system, while a significant reform, can be regressive as it applies a uniform tax rate on essential and non-essential goods, impacting lower-income individuals more heavily since they spend a larger portion of their income on essentials. The purchasing power of lower income group is less therefore, imposing higher taxes would demoralize individuals to pay taxes. [5]
Therefore, another important objective of tax reform is to minimize the negative impact of taxation on economic efficiency, which includes addressing these disruptive elements and creating a tax system that encourages efficient resource allocation, investment, and productive economic activities.
However, it’s worth noting that striking the right balance between equity and revenue generation is a challenge. While addressing tax inequities is a critical goal of tax reform, policymakers must also consider the overall impact on economic growth, compliance, and administrative feasibility.
4. Progress Towards Equity:
India has been taking steps to address these equity concerns:
- Direct Benefit Transfer (DBT): The government has initiated various social welfare programs with direct cash transfers to target the poorest households, helping to alleviate their tax burden.
- GST Reforms: Efforts are being made to refine the GST structure, with potential rate adjustments to reduce its regressive impact and ensure it’s more equitable.
- Wealth Tax Discussions: There have been discussions about reintroducing a wealth tax or imposing higher taxes on the super-rich to enhance vertical equity.[6]
5. Administrative problems: In most developing countries the administration of taxes is weak, and the problems of evasion and corruption are serious. The weakness in tax administration stems from several interacting factors, inducing unduly complex tax laws and procedures, poor information systems, corruption, and political interference in tax administration. Strengthening tax administration, which will often require simplifying the determination of the tax base, is a fourth objective of tax reform. [7]
Detailed analysis of the situation in direct tax administration in India:
I. Complexity of Tax Laws:
- Complex Tax Code: India’s direct tax system, primarily composed of the Income Tax Act, is known for its complexity. Numerous provisions, exemptions, and deductions can make it difficult for both taxpayers and tax officials to interpret and apply the tax laws accurately.
- Changing Regulations: Frequent changes and amendments to the tax code add to the complexity, making it challenging for taxpayers to stay compliant and for tax authorities to enforce the laws effectively.
II. Poor Information Systems:
- Data Management: Tax authorities in India often struggle with efficient data management. This can result in difficulties in tracking income and assets, identifying potential evasion, and ensuring that tax assessments are based on accurate information.
- Data Integration: The lack of seamless integration between various tax databases, like the one for income tax and another for wealth or property tax, can lead to incomplete and inaccurate assessments.
III. Evasion and Corruption:
- Tax Evasion: Tax evasion is a significant issue in India’s direct tax administration. High-net-worth individuals and businesses sometimes underreport income, overstate deductions, or engage in other tax-avoidance activities.
- Corruption: Corruption within tax administration can involve tax officials accepting bribes to underreport income or assets, leading to significant revenue losses for the government.
IV. Political Interference:
- Political Pressure: In some cases, political interference can influence the tax assessment process, potentially resulting in certain individuals or businesses receiving preferential treatment or leniency.
V. Tax Reform Efforts:
India has undertaken several initiatives to address these administrative challenges in direct taxation:
- Digital Transformation: The introduction of digital platforms like the Centralized Processing Center (CPC) for income tax returns and the implementation of e-assessment have improved the efficiency and transparency of tax administration.
- Simplification of Forms: Efforts to simplify tax return forms and procedures aim to reduce the compliance burden on taxpayers.
- Anti-Avoidance Measures: Measures like the General Anti-Avoidance Rule (GAAR) have been introduced to curb tax avoidance.
- Compliance Programs: The government has launched compliance programs to encourage voluntary compliance and deter tax evasion.
In summary, India’s tax system does face challenges related to horizontal and vertical equity, and addressing these issues requires a combination of policy reforms, improved enforcement, and a more equitable distribution of the tax burden. These reforms should aim to ensure that the poor are not disproportionately burdened and that the tax system is fair and just.
the administration of direct taxes in India faces complex issues related to complexity, evasion, corruption, and political interference. While there have been positive steps towards reform, addressing these challenges requires ongoing efforts to simplify the tax code, improve information systems, enhance enforcement capabilities, and ensure a level playing field for all taxpayers. This will not only strengthen tax administration but also contribute to improved revenue collection and fiscal discipline.
UNDERSTANDING THE CONTEXT: INFORMATION BACKGROUND, KEY FACTS, AND CRITICAL ISSUES
The payment of taxes is a mandatory responsibility for every citizen of India, and this practice has deep historical roots dating back to ancient texts like “Manu Smriti” and “Arthasastra.” “Manu Smriti” emphasizes that it was the king’s duty to organize tax collection in a way that did not burden the taxpayer. It recommended that Traders and Artisans contribute 1/5th of their profits in silver and gold, while Agriculturists were to pay 1/6th, 1/8th, or 1/10th of their agricultural produce based on their individual circumstances.[8]
Similarly, “Kautilya” provided a comprehensive account of the tax administration system during the “Mauryan Empire.” His taxation principles underscored the importance of fairness and justice in tax collection. “Arthasastra” clarified that each tax had specific guidelines, leaving no room for arbitrary decisions in the tax collection process. These ancient texts illuminate the historical commitment to a just and systematic tax system in India.
In the post-independence period in India, the taxation policy was oriented towards achieving several economic goals. These included promoting employment by offering tax incentives to encourage new investments, reducing income and wealth inequality through progressive taxes, easing pressure on the balance of payments by increasing import duties, and stabilizing prices by granting tax rebates on excise duties for consumer goods. Due to the limited tax base, the focus of taxation was predominantly on indirect taxes.
The first significant effort to reform the tax system came through the Taxation Enquiry Commission (TEC) of 1953-54, with John Matthai serving as its Chairman. This Commission conducted a thorough examination of the income tax structure, as well as an extensive study of central taxes and their administration. Its recommendations included broadening and deepening the tax structure at both the central and state levels. The primary objectives were to fund development initiatives and reduce significant income disparities. Where necessary, these reforms were adjusted to provide tax incentives aimed at stimulating capital formation.
The Commission also emphasized the necessity of conducting regular assessments to provide the effectiveness of tax incentives granted for the promotion of production and investment, ensuring that they indeed served their intended purposes.[9] In the year 1956, an examination conducted under the guidance of Professor Nicholas Kaldor, commissioned by the government, identified the tax system then in place in India as both “inefficient and inequitable.” This assessment primarily arose from the observation that the taxation of income alone was an insufficient measure of an individual’s taxable capacity. Consequently, Kaldor’s review proposed a series of measures to address these concerns, encompassing the broadening of the tax base through the introduction of an annual wealth tax, the taxation of capital gains, the implementation of a general gift tax, and the introduction of a personal expenditure tax. These recommendations were subsequently put into practice by the government, although certain suggestions aimed at curbing tax evasion through the establishment of a comprehensive reporting system for transactions involving capital assets and the reduction of the maximum income tax rate to 45 percent were not adopted.[10]
At the central level, alterations in the income tax structure until the mid-1970s were predominantly ad hoc and driven by the imperative of establishing a socialist societal model. By the year 1973-74, the personal income tax system featured eleven tax brackets, with rates steadily increasing from 10 percent to 85 percent. When factoring in a 15 percent surcharge, individuals with incomes exceeding Rs. 0.2 million (2 Lacs) faced a staggering top marginal tax rate of 97.5 percent.
A comparable approach was adopted for corporate taxation. The conventional taxation system involved the taxation of profits at the company level and dividends at the shareholder level. Distinctions were drawn between widely held companies and various categories of closely held companies, resulting in tax rates ranging from 45 percent to 65 percent for certain widely held companies. Despite these high nominal rates, effective tax rates were significantly lower due to the availability of generous depreciation and investment allowances. In fact, some companies benefited so extensively from these preferences that they effectively paid no corporate tax year after year.
The Direct Taxes Enquiry Committee, chaired by Shri Justice K.N. Wanchoo, issued a report in 1971, attributing widespread tax evasion to excessively high tax rates. The committee recommended a reduction in marginal tax rates to 70 percent. This change was implemented in 1974-75 when the tax rate was lowered to 77 percent, which included a 10 percent surcharge. Concurrently, there was an increase in wealth tax rates.
Subsequently, in 1976-77, the marginal tax rate was further reduced to 66 percent, and the wealth tax rate was decreased from 5 percent to 2.5 percent. In 1979-80, there was an increase in the income tax surcharge, and the wealth tax rate returned to a maximum of 5 percent.[11]A significant simplification and rationalization effort occurred in 1985-86. This initiative reduced the number of tax brackets from eight to four, lowered the highest marginal tax rate to 50 percent, and brought down wealth tax rates to 2.5 percent.
The most recent wave of reforms in personal income taxation was initiated based on the recommendations of the Tax Reforms Committee (TRC) in 1991, led by Shri Raja J. Chelliah. The TRC proposed a series of measures to expand the tax base by minimizing exemptions and concessions, significantly simplifying tax laws and procedures, establishing a comprehensive information system, computerizing tax returns, and thoroughly modernizing administrative and enforcement mechanisms.[12]
As part of these reforms, the tax structure was simplified to include only three tax brackets, with rates set at 20 percent, 30 percent, and 40 percent, starting in the fiscal year 1992-93. These reforms also excluded financial assets from wealth tax, and the maximum marginal tax rate was reduced to 1 percent. Subsequent reductions occurred in 1997-98 when the three tax rates were further lowered to 10 percent, 20 percent, and 30 percent. Since 1997-98, personal income tax rates have remained unchanged at 10 percent, 20 percent, and 30 percent.
However, later on, surcharges and cesses were introduced to allocate revenues for elementary and higher education. Currently, income tax is levied at a rate of 10 percent for incomes ranging from above Rs. 2.5 lakh up to Rs. 5 lakh, 20 percent for incomes between Rs. 5 lakh to Rs. 10 lakh, and 30 percent for incomes exceeding that. Additionally, there is a 3 percent education cess. For incomes above Rs. 1 crore, a 12 percent surcharge is applied, resulting in a marginal tax rate of 36.66 percent for those earning above Rs. 1 crore.[13]
In 1985-86, the corporate tax rate was reduced to 50 percent for widely held companies, while different rates for closely held companies were unified at 55 percent. Subsequently, based on the TRC recommendations in 1993-94, the distinction between these categories was eliminated, and a uniform 40 percent tax rate was introduced. In 1997-98, the corporate tax rate was further reduced to 35 percent, and the 10 percent tax on dividends was shifted from individuals to companies. Tax preferences centered on investment and depreciation allowances, and incentives were offered to businesses in underdeveloped areas. This led to some companies structuring their operations to fully benefit from these concessions, resulting in “zero-tax” companies. To address this, a minimum alternative tax (MAT) was introduced in 1996-97, requiring companies to pay tax on 30 percent of their book profits. Companies paying MAT were later allowed a partial credit against future income tax liabilities.
India is working actively to increase the ease of doing business[14] the initiatives like simplifying company registration[15], forming the Tax Administration Reforms Commission (TARC)[16], Introduction of GST, removal of various deductions available in the new tax regime[17]. Although Government is taking a lot of steps in simplifying the tax structure but there are a lot of complex provisions in direct taxes which need to be addressed. Tax strategy is always bound to change even further as a response to changing economic strategies and changing needs of the economy[18]
The government in 2010 Direct Taxes Code Bill, the primary objectives of it were to simplify tax system which will subsequently minimize tax litigation and to have a broad implication of tax. The necessity to consolidate and unify all direct tax laws into a single legislation arose when the existing Income Tax Act of 1961 became excessively burdened with numerous amendments introduced by yearly Finance Acts. As a result, the language of the Act became convoluted and challenging to comprehend. Consequently, in 2009, lawmakers strongly recognized the imperative to replace the existing direct tax laws with a comprehensive single legislation. In 2013, the Direct Taxes Code underwent another round of revision, and the comprehensive title of the draft code explicitly indicates its purpose, which is to consolidate and revise the laws concerning Income Tax and Wealth Tax and it is comprised of 21 Chapters, 325 Clauses and 23 Schedules[19]. In 2013, the Direct Taxes Code was restructured, taking into consideration the suggestions put forth by the Standing Committee on Finance (SCF) and the changes introduced to the Income Tax Act, 1961, and the Wealth Tax Act, 1957 through the Finance Acts of 2011, 2012, and 2013. During the drafting of the revised Code, the provisions of the earlier Direct Taxes Code (DTC) of 2010 were also considered, alongside the recommendations provided in the Kelkar Committee’s report on ‘Road Map for fiscal consolidation.’[20] The 2013 revised Code encompasses the provisions originally outlined in the DTC of 2010 and those introduced into the Indian Tax Laws through subsequent Financial Amendments in 2011, 2012, and 2013. Additionally, if this revised Code is successfully approved by both houses of Parliament, it is poised to have a favorable impact on the country’s economy. This is because it will expand the tax base and facilitate the more efficient collection of direct taxes from the populace.[21]
MINIMUM ALTERNATE TAX REGIME: The concept of MAT was introduced under the ITA to tax ‘zero-tax’ companies, i.e., companies that make high book profits and declare substantial dividends to their shareholders but have no or insignificant taxable income under the ITA because of the exemptions, deductions and incentives provided therein in the form of a liberal rate of depreciation, sector and region-specific exemptions, deductions etc. [22]under Part IV, Sec. 115JB of the ITA.
But there are certain problems related to the applications of the provisions: MAT requires companies to calculate their taxable income by both the general provision of the ITA and by the provisions of the Companies Act relating to calculation of book profits. This increases the costs for record-keeping and compliance on companies. When the AMT was introduced on companies in the US, studies showed that firms spent 18 percent more on compliance costs where such tax was applicable to them.[23] MAT is identified as a ‘legal hot spot’ that increases costs of compliance. [24] Another issue associated with the Minimum Alternate Tax (MAT) is its inadvertent negative impact on investments. Certain companies, despite having minimal or no tax liability, are heavily reliant on capital investments, enabling them to utilize tax deductions related to the depreciation of machinery and assets during the early years.
The dividends tax rate fluctuated, increasing to 20 percent in 2000-01, then reverting to 10 percent in 2001-02, levied on shareholders instead of the company. This policy was changed once more in 2003-04, with the dividend tax reimposed on the company. [25]
To enhance tax compliance and establish an audit trail, a securities transactions tax was introduced in April 2004, and in April 2005, a 0.1 percent tax on cash withdrawals over Rs. 25,000 from current accounts of commercial banks was implemented. In 2005-06, the corporate tax rate was further reduced to 30 percent and remained unchanged in subsequent years.
In the 2015-16 budget, the finance minister announced a gradual reduction in the corporate tax rate from 30 percent to 25 percent over the next four years. This reduction is to be achieved through the rationalization and elimination of various tax exemptions and incentives for corporate taxpayers. One of the significant recent tax administrative reforms involves requiring individuals in large cities to file a tax return if they meet at least one of six conditions: owning a house, owning a car, holding club membership, possessing credit cards, engaging in foreign travel, or subscribing to a telephone connection. Additionally, the tax deduction at source has been expanded to encompass a broader range of transactions, including interest and dividend receipts and payments to contractors.
The Tax Administrative Reform Committee of 2014, chaired by Parthasarthi Shome, highlighted that the primary objective of tax administration is not merely revenue maximization but rather the encouragement of voluntary compliance and reduction of compliance gaps. Efforts have been undertaken to simplify the Income Tax Act. In 2015, a committee led by Justice R.V. Easwar (Retired) was formed to identify provisions in the Act that lead to disputes due to varying interpretations, hinder ease of doing business, and can be simplified.
Over the years, there has been a shift in India’s tax revenue composition. Direct tax’s share of gross tax revenues rose from 19.1 percent in 1990-91 to 55.9 percent in 2013-14, while the share of indirect taxes declined from 78.9 percent to 43.8 percent. The direct tax revenue as a percentage of GDP increased from 1.9 percent to 5.7 percent during this period.
Despite several reforms, the Indian tax structure still needs significant improvement. The narrow tax base means that a large portion of the population remains outside the tax system. According to an IMF Country Report, India, with a population of 1.2 billion, has only around 40 million direct taxpayers, both corporate and individual. In the last decade, direct tax collections have grown by more than 700 percent, while the number of taxpayers has increased by only about 35 percent, indicating the need for improved data capture and monitoring.
A significant problem contributing to the narrowing of the tax base is the extensive use of tax preferences, which include incentives and concessions for various financial activities, investments, and income sources. Corporate tax preferences, such as investment and depreciation allowances, have distorted investment returns and eroded the tax base.
Details of the exemptions utilized by companies and individuals are provided in the budget document, indicating that the gross revenue foregone for the corporate sector was projected to be Rs. 62,398 crore in 2014-15, representing 15 percent of total corporate tax collections for that year. Compounding these challenges are the weaknesses in tax administration. The sole pursuit of revenue targets has led to issues in the behavior of tax officers and harassment of taxpayers. The outstanding tax arrears increased from Rs. 5,80,326 crores in 2012-13 to Rs. 6,74,916 crore in 2013-14, revealing deficiencies in tax policy and administration.
STREAMLINING DIRECT TAX STRUCTURE: REFORMS FOR SIMPLIFICATION
The government’s policy of simplifying the Income-tax Act, 1961 by reducing exemptions and incentives while lowering corporate tax rates has several key components:
i. Corporate Tax Rate Reduction: The government has been progressively reducing corporate tax rates. This initiative began with the Finance Act of 2016 and has continued in subsequent finance acts. The objective is to make the tax system more competitive and attractive for businesses.
ii. Option for Concessional Tax Rate (Sec 115BAA): The Taxation Laws (Amendment) Act of 2019 introduced a significant provision under Section 115BAA. This provision allows domestic companies to opt for a concessional tax rate of 22% (plus applicable surcharge and cess) if they choose not to avail certain exemptions and incentives. This means that companies can opt for a lower tax rate in exchange for forgoing certain tax benefits.
iii. Option for New Domestic Manufacturing Companies (Sec 115BAB): The same 2019 amendment introduced Section 115BAB, which is specifically designed to benefit new domestic manufacturing companies. These companies, established after October 1, 2019, and commencing manufacturing on or before March 31, 2023, have the option to pay tax at an even lower rate of 15% (plus applicable surcharge and cess) without claiming specified exemptions and incentives. This provision is aimed at encouraging investment and growth in the manufacturing sector.
iv. Minimum Alternate Tax (MAT) Exemption: It’s worth noting that companies choosing to pay tax at these concessional rates under Section 115BAA and 115BAB are not required to pay Minimum Alternate Tax (MAT). MAT is typically applicable when a company’s taxable income falls below a certain threshold due to exemptions and deductions.
v. No MAT Credit: Additionally, companies opting for the concessional rates under Section 115BAA and 115BAB are not eligible for the Minimum Alternate Tax (MAT) credit. This means that they will not be able to set off MAT paid in the past against their regular tax liability.
These measures are designed to simplify the tax system by reducing the complexity associated with various exemptions and incentives. The government aims to make the tax system more transparent, efficient, and business-friendly while still encouraging investments and growth, especially in the manufacturing sector. By offering lower tax rates, these provisions incentivize companies to choose a simpler tax regime and promote economic development.
In an effort to simplify the personal income tax structure and promote compliance, the Finance Act of 2020 introduced significant reforms through the following provisions:
1. Lower Slab Rates for Individual Taxpayers (Section 115BAC): The Finance Act, 2020 has granted individual taxpayers the option to pay income tax at lower slab rates. This means that individual taxpayers can choose to pay taxes at reduced rates, provided they are willing to forgo specified exemptions and deductions.
– This reform is aimed at making the personal income tax system more straightforward and less cluttered by eliminating certain exemptions and deductions.
– It gives taxpayers the flexibility to opt for a simplified tax regime and potentially reduce their overall tax liability.
– This approach is designed to provide greater clarity to individual taxpayers and minimize the complexities associated with calculating their tax liability.
2. Concessional Tax Rates for Co-operative Societies (Section 115BAD): Additionally, the Finance Act, 2020 introduced a provision under Section 115BAD, which allows co-operative societies the option to pay taxes at concessional rates of 22% (plus applicable surcharge and cess). However, this lower rate is subject to co-operative societies forgoing certain specified deductions or incentives.
– This provision is intended to encourage co-operative societies to adopt a simplified tax structure by reducing their tax liability, similar to the approach for individual taxpayers.
– Co-operative societies can choose to avail this option in exchange for not claiming certain deductions or incentives, thereby simplifying their tax calculations and promoting tax compliance.
In both cases, the key objective is to simplify the personal income tax system for individuals and the tax structure for co-operative societies. These reforms provide taxpayers with the flexibility to opt for a more straightforward tax regime by forgoing specific exemptions and deductions, making the tax system more transparent and conducive to compliance.
Abolition of Dividend Distribution Tax (DDT):
The Finance Act of 2020 implemented a significant change by eliminating the Dividend Distribution Tax (DDT). This move aimed to enhance the appeal of the Indian Equity Market and offer relief to a large segment of investors. Prior to this change, dividend income was subject to taxation through DDT, with companies responsible for paying this tax. However, effective from April 1, 2020, this tax was removed.
Instead, under the new system, dividend income would be taxed directly in the hands of the recipients at their applicable tax rates. This change streamlined the taxation process, making it more investor-friendly, as it no longer required companies to pay DDT.
Enhancing Ease of Compliance for Taxpayer:
The government has implemented several measures to simplify tax compliance and create a more efficient and transparent system for taxpayers. These initiatives aim to reduce direct interaction between taxpayers and tax authorities, streamline processes, and make tax compliance more convenient. Some key reforms in this regard include:
1. Faceless Assessment Scheme (2019): Launched on September 12, 2019, this scheme revolutionizes the assessment process by eliminating face-to-face interactions between the Assessing Officer and taxpayers. It promotes functional specialization and introduces team-based assessments, optimizing resource utilization.
2. Faceless Appeal Scheme (2020): Building on the success of the Faceless Assessment Scheme, the Faceless Appeal Scheme (2020), launched on September 25, 2020, takes the reform a step further. It minimizes human interface in the appellate function, ensuring that appeals are processed electronically with notices issued by a Central Cell and cases allocated to Appeal Units randomly.
3. Document Identification Number (DIN): Starting from October 1, 2019, all communications from the Income-tax department, including those related to assessments, appeals, investigations, penalties, and rectifications, are assigned a unique, computer-generated Document Identification Number (DIN). This enhances efficiency and transparency in departmental operations.
4. Pre-filling of Income-tax Returns: To simplify tax compliance, pre-filled Income Tax Returns (ITR) are made available to individual taxpayers. These ITR forms include pre-filled details of specific incomes, such as salary income, and the government is expanding the scope to include more categories like house property income, capital gains, bank interest, and dividends.
5. Simplification of Compliance Norms for Start-ups: Start-ups benefit from a hassle-free tax environment. The assessment procedure is simplified, and they receive exemptions from Angel Tax. A dedicated start-up cell is established to provide support and guidance.
6. Relaxation in Norms for Prosecution: The government has substantially raised the threshold for initiating prosecutions. Moreover, a collegium of senior officials is responsible for decisions related to prosecution, ensuring a fair and balanced approach.
These initiatives collectively aim to reduce the burden of tax compliance, enhance transparency, and promote a more efficient tax system in India. The focus is on minimizing direct interactions and leveraging technology for smoother, more convenient processes.
Initiatives to Reduce Tax-Related Litigation:
Efforts to Mitigate Litigation:
At present, a substantial number of unresolved disputes related to direct taxes exist at various levels of adjudication, ranging from the Commissioner (Appeals) level to the Supreme Court. These tax disputes consume considerable resources on both the Government’s part and taxpayers. Moreover, they lead to the delayed collection of revenue for the Government. Recognizing these challenges, there was an urgent need to establish a mechanism for resolving these pending tax disputes. Such an initiative would not only be advantageous for the Government in facilitating the timely collection of revenue but would also provide relief to taxpayers by curtailing the burgeoning costs associated with litigation. This, in turn, would allow for a rechanneling of efforts and resources towards expanding business activities.
Vivad se Vishwas Act, 2020, was enacted on March 17, 2020. This legislation allows for the submission of declarations to settle unresolved tax disputes, offering a more streamlined and expedited resolution process.
Furthermore, in an effort to minimize taxpayer grievances and litigation and enable the Income Tax Department to concentrate on cases involving intricate legal matters and significant tax implications, the monetary thresholds for filing departmental appeals have been revised. Specifically, the threshold has been increased from Rs. 20 lakh to Rs. 50 lakh for appeals before the Income Tax Appellate Tribunal (ITAT), from Rs. 50 lakh to Rs. 1 crore for appeals before the High Court, and from Rs. 1 crore to Rs. 2 crore for appeals before the Supreme Court. This adjustment aims to simplify the appeal process and focus on cases with more significant financial and legal complexities, thereby reducing the burden of litigation on taxpayers and tax authorities alike.
Promoting Digital Transactions:
1. Introduction of TDS on Certain Cash Withdrawals: The Finance (No.2) Act, 2019 introduced section 194N in the Income Tax Act, which imposes a 2% Tax Deducted at Source (TDS) on cash withdrawals exceeding Rs. 1 crore from a Bank/Post Office/Co-op society account. In an effort to encourage return filing and monitor cash withdrawals by non-filers, the Finance Act, 2020, reduced the threshold for cash withdrawals to Rs. 20 lakh. It also mandated a higher TDS rate of 5% on cash withdrawals exceeding Rs. 1 crore by non-filers (Section 194N).
2. Promotion of Digital Transactions: The rate of deemed profit under the presumptive scheme for small businesses was reduced from 8% to 6% in the case of digital turnover. Additionally, it was made mandatory for business entities with turnovers exceeding Rs. 50 crore to provide facilities for accepting payments through prescribed electronic modes, without Merchant Discount Rate (MDR) charges (Rule 119AA).
3. Prohibition of Cash Transactions: Cash receipts of Rs. 2 lakh or more were prohibited. The limit for cash donations to charitable organizations was reduced from Rs. 10,000 to Rs. 2,000 (Section 80G). Acceptance of cash donations exceeding Rs. 2,000 was prohibited for political parties (Section 80G). The limit for cash business expenditures was reduced from Rs. 20,000 to Rs. 10,000 (Section 40A(3)).
Measures to Curb Tax Evasion & Expand Tax Base:
1. Black Money Act: The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015, commonly known as the Black Money Act, was enacted to combat the flow of unaccounted wealth stashed abroad. It came into force on July 1, 2015.
2. Benami Law: The Benami Transactions (Prohibition) Act, 1988, underwent comprehensive amendments through the Benami Transactions (Prohibition) Amendment Act, 2016. These changes enabled the confiscation of benami property and the prosecution of both benamidars (persons in whose name the property is held) and the beneficial owners, aiming to tackle tax evasion through benami transactions.
Enhancements in Deductions and Exemptions for Senior Citizens:
i. The maximum deduction limit for medical expenses for senior citizens was raised from Rs. 30,000 to Rs. 50,000 (as per Section 80D).
ii. Senior citizens were granted a deduction of Rs. 50,000 on interest income from deposits, resulting in an increase in the threshold for the applicability of Tax Deducted at Source (TDS) on interest income from Rs. 10,000 to Rs. 50,000 (as per Section 80TTB).
iii. The deduction limit for medical expenses related to critical illnesses for senior citizens was increased from Rs. 60,000 to Rs. 1,00,000 (as per Section 80DDB).[26]
To conclude the reforms, The Indian government has undertaken significant tax reforms to simplify tax laws, reduce litigation, promote digital transactions, and combat tax evasion. These initiatives aim to streamline the tax system and make it more efficient while providing tax benefits to senior citizens. Key measures include lower corporate tax rates, faceless assessment and appeal processes, Document Identification Numbers (DIN) for transparency, pre-filled income tax returns, and restrictions on cash transactions.
To reduce litigation, the government introduced the Direct Tax Vivad se Vishwas Act, raised monetary thresholds for departmental appeals, and encouraged digital transactions through reduced profit rates for digital turnover and mandatory electronic payment facilities for large businesses.
To curb tax evasion and broaden the tax base, the government enacted the Black Money Act and amended the Benami Law, targeting undisclosed foreign income and benami property transactions. Additionally, senior citizens now enjoy higher deduction limits for medical expenses and interest income, along with a basic exemption limit of Rs. 3,00,000. These combined efforts seek to create a more efficient, transparent, and taxpayer-friendly tax system in India.
PROPOSED TAXATION REFORMS AND RECOMMENDATIONS
1. Revised Basic Exemption Limit and Rebate: The proposal is to increase the basic exemption limit for Individuals and HUF to 6.50 lakh directly, eliminating the need for the 12,500-rupee rebate provided under Section 87A. Please refer to the third point for a more comprehensive taxation suggestion for Individuals and HUF.
2. Elimination of New Tax Regime (Section 115BAC): The recommendation is to remove the recently introduced tax regime for Individuals and HUF, as it hasn’t garnered widespread adoption. Very few have chosen this new regime, and the likelihood of more taxpayers switching to it in the future is low. For a detailed proposal regarding the taxation of Individuals and HUF, please read the third point.
3. Tax Rate Rationalization for Individuals/HUF: The main suggestion is to directly raise the basic exemption limit to 6.50 lakhs for Individuals and HUF.
4. Recognition for High Taxpayers: For individuals who have paid over 1 lac in taxes, the government should consider giving them benefits as a token of appreciation for their significant contributions to the economy over the last 70 years. This will not only boost taxpayer trust but also show respect for their loyalty and honesty. The benefits could include priority services in passport and airport queues, railway reservations, government department work, retirement benefits, and healthcare coverage like health insurance.
5. Enhanced AIS TIS (Annual Information Statement and Taxpayer Information Section): Incorporate additional financial information like LIC, mediclaim, donations, PPF, NSC, KVP, home loan details, NPS, 80G, 80GGB, GGC into the AIS TIS. Simplify the user interface on the new IT portal by categorizing 26AS and AIS TIS buttons under a single “information” heading near the Help section for easier access.
6. Taxation of Agriculture Income: Tax agriculture income at a flat rate of 2% regardless of other income sources, similar to special rate incomes like LTCG and STCG. This proposal should include a basic exemption limit for total income while introducing taxation for agriculture income.
7. Taxation of Partnership Firms: Align the tax rate for partnership firms and LLPs with companies at 25%.
8. Simplified Tax Audits and Presumptive Scheme: Streamline and simplify Sections 44AB and 44AD. Mandatory tax audits should be required for businesses exceeding 2 crore in turnover, and the presumptive scheme’s benefit should extend to 2 crore (gradually increasing both limits to 5 crore for both sections).
9. Extended ITR Filing Period: Allow taxpayers to file ITR for up to 3 years beyond the assessment year, with a monthly late fee of 2000 and 2% interest under sections 234A/B/C, in cases of tax payable. This extension will help the government collect higher revenue, especially from high-income individuals. (Previously, only a 2-year filing window was allowed).
10. Income Disclosure Scheme: Implement an Income Disclosure Scheme every 5 years, offering a one-time opportunity for individuals to declare undisclosed money, property, or financial assets. The scheme would entail a flat 50% tax payment and the remaining 50% to be invested in a 5-year fixed deposit, ensuring that all undisclosed funds are integrated into the formal economy.
CONCLUSION
Being a ‘Revenue Law’, it should be as dynamic as ‘Mercury’. To reward those ‘cheerful givers,current expected number of taxpayers is anywhere between 9 to 10 crores, fast-tracking its overhaul is need of the hour.[27] It is appropriate to recall Sri. Nani Palkhivala, the greatest jurist and economist’s precious words on taxing statutes, “the tax laws, like all other laws, to be respected, must be made respectable. Revenues rise with tax cuts, when income tax is scaled up, income is scaled down. If there is widespread tax evasion, it may be more meaningful to search for the cause in the tax system than in the taxpayer“. Income tax is a important form of Direct tax and managing the rates of income tax is one of the most important responsibility of the government as the change in Income tax have a high effect on the economy as a whole. Reducing income taxes has the potential to boost economic growth by enhancing incentives for work, saving, and investment. However, it’s important to acknowledge that tax cuts can also have the unintended consequence of reducing the motivation for productive economic activities. When states implement tax cuts without corresponding reductions in spending, it can lead to budget deficits. Prolonged tax cuts financed by increasing deficits are likely to have a negative impact on the nation’s long-term income.
On the other hand, tax reductions in income tax rates that are offset by cuts in government spending can have a positive influence on economic growth. However, for a developing nation like India, significant spending cuts may not be a viable option for the government. It’s worth noting that in both linear and non-linear regressions in the long term, income taxes do not appear to have a significant impact on economic growth. Yet, in the short term, income taxes do influence growth negatively, particularly affecting household savings and labour supply, which are considered crucial drivers of economic growth.
In conclusion, it is crucial to recognize that a country’s “Tax Culture” encompasses not only its tax system and practices but also the relationship between tax authorities and taxpayers. The clarity and precision of tax laws, as well as how violations are addressed, play a significant role in shaping this culture. To foster a healthy tax culture, it is essential that tax revenue is used judiciously, and taxpayers can witness how their contributions benefit society. This transparency can encourage voluntary and even cheerful tax compliance.
Addressing corruption and tax evasion is paramount in this endeavor. Every rupee that is misused through corruption reduces the funds available for government development initiatives. Corruption discourages tax payment, and the fight against it must be ongoing. Taxpayers should be treated with respect and fairness, as they are the foundation of tax assessment and revenue generation, essential for economic growth.
However, in India, many taxpayers feel unfairly treated, with punitive provisions applied rigorously. This perception has led to an increasing number of individuals refraining from filing tax returns. Negative notions held by tax collectors, indifference, and an assumption that taxpayers are trying to manipulate figures and evade taxes undermine the development of a healthy Tax Culture.
A robust Tax Culture can only emerge when both taxpayers and tax authorities fulfill their obligations effectively. This entails mutual trust and accountability, with all taxpayers being responsible and transparent in their dealings with the government. In return, the government must be accountable to its citizens on all taxation-related matters.
While various committees have recommended changes in the Indian tax system, taxpayers often still lack assurance that tax administration is truly in their best interests. It is essential to work toward a tax culture where the perceived well-being and interests of taxpayers are safeguarded, fostering mutual respect and a sense of responsibility between both parties. This approach will ultimately lead to a more equitable and prosperous society.
[1] Centre for Budget and Governance Accountability (CBGA), A Primer on Taxes, p. 5-6
[2] Apoorv Ashit and Nitin Pandey, CHANGING PUBLIC POLICY FOR FOSTERING COMPETITIVE BUSINESS, CNLU LJ (7) [2017-18] 142.
[3] Lesson of Tax Reforms by World Bank, pp. 2-4.
[4] RBI, Empirical Fiscal Research in India by RK Patnaik and others, pp. 4-5.
[5] Trends and Issues in Tax Policy and Reforms in India by M Govind Rao and R Kavita Rao, India Policy Forum 2006, pp. 68-69.
[6] Tax Reforms in India: Achievements and Challenges by M. Govinda Rao, Asia Pacific Development Journal, Vol. 7. No. 2, 2000, p. 66
[7] Op.cit., Trends and Issues in Tax Policy, p. 69.
[8] JUSTICE R.K. AGRAWAL, Proper Tax Reforms are necessary for Developing Tax Culture in India, [2020] 120 taxmann.com 57 (Article).
[9] The Challenges of Reforming India’s Tax System by M Govind Rao, NCAER- India’s Policy Forum 2015, p. 10.
[10] Trends and Issues Op.cit., pp 69-71.
[11] Lok Sabha (16th) Committee on Finance 2015-16, Twenty Third Report, p15.
[12] India, Ministry of Finance, Tax Administrative Reforms Commission (TARC), 2014,3rd Report, p. 775.
[13] Corporate Taxes and Exemptions by Kavita Rao, EPW Volume 50, 21st March, 2015, p. 28.
[14] Doing Business 2016, (2016), available at http://www.doingbusiness.org/˜/media/GIAWB/Doing %
20Business/Documents/Annual-Reports/ English/DB16-Full-Report.pdf.
[15] Form INC-29: Procedure for Fast Track Company Registration, Indiafilings.com (2016), available at
https://www.indiafilings.com/learn/form-injc -29-fast-track-company-registration/.
[16] TARC/Report/36/2014-15, efaidnbmnnnibpcajpcglclefindmkaj/https://dea.gov.in/sites/default/files/TARC2ndReport_0.pdf 26/09/2014.
[17] Finance act, No 08 act of parliament, 2023.
[18] Trends and Issues in Tax Policy and Reform in India, (2016), available at http://www.nipfp.org.in/media/medialibrary/2013/04/wp05_nipfp_037.pdf.
[19] The Direct Taxes Code, 2013.
[20] “Kelkar Committee Report” <http://fmmin.nic.in/reports/Kelkar_Committee_Report.pdf> (October 20, 2023).
[21] Gaurav, DIRECT TAX CODE; DEVELOPMENT OF TAX REGIME IN INDIA, 22 ALJ (2014-15) 372.
[22]Sanjay Kumar, Minimum Alternate Tax: Is there any Alternative, (2011) 4 NUJS L Rev 595.
[23] M. Gujarathy & S.K. Barua, Minimum Alternate Tax in India: Lessons to be Learnt from the Foreign use of
Alternate Minimum Tax, 24 INT’L TAX J. 65 1998.
[24] Arindam Dasgupta, The Income Tax Compliance Cost of Corporations in India, 2000-01, available at
http://ssrn.com/abstract=466041 (Last visited on November 15, 2011).
[25] Tax System Reforms to put Economy on Growth Path by Satya Poddar in Business Today, January 1, 2015 and Committee on Finance Op.cit.,p.11.
[26] Recent reforms in tax structure//efaidnbmnnnibpcajpcglclefindmkaj/https://incometaxindia.gov.in/booklets%20%20pamphlets/direct-tax-reforms.pdf (October 1, 2023)
[27] PRABHAKAR K.S., Union Budget 2022–Time for Speeding up of Income Tax Reforms, [2022] 134 taxmann.com 285 (Article)
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