Stalled tax reform
With national elections around the corner and political parties spelling out their economic agendas, there has been renewed interest in the debate around stalled tax reforms in India. In the last few years, a number of tax reforms have been envisaged which could potentially change the Indian tax policy tremendously and help India establish a stable tax regime. The Direct Taxes Code (DTC) and the Goods and Services Tax (GST) are two such tax reforms that would bring greater stability and transparency to the taxation of businesses, producers, consumers and salaried professionals alike. It is also anticipated that these critical tax reforms would widen the tax base and increase revenues collected from taxes. According to the Planning Commission’s report on the twelfth Five Year Plan, net tax revenue for the Centre is expected to increase from 7.4 percent of GDP in 2011-12 to 8.91 percent in 2016-17. In accordance, the gross tax to GDP ratio is projected to rise from 10.36 percent of GDP in 2011-12 to 12.3 percent by 2016-17. It appears that the planners will be relying on critical tax reforms, especially the GST, to deliver much needed revenue.
The Direct Taxes Code (DTC)
The direct taxes code seeks to consolidate and integrate all direct taxes laws, with the objective of simplifying the tax regime, broadening the tax base and minimizing litigation. It brings all direct taxes under one code, and will replace the two taxation acts, namely the Income Tax Act of 1961 and the Wealth Tax Act of 1957. The DTC was first unveiled by the Indian Government in 2009 for public comments. Subsequently, it was revised, taking into account stakeholder concerns. It was introduced to the Parliament for consideration in its revised form in 2010.
While some of the niggling provisions from the first draft of the DTC have been fittingly removed after representations, a number of propositions in the DTC are still likely to force corporations to rethink their existing configuration and mode of conducting business. Critics have found the proposed terms on international taxation particularly problematic. For instance, the DTC proposes to tax the transfer of shares of a foreign company, on the basis that there is a transfer of a capital asset situated in India, if the fair value of the asset situated in India constitutes at least fifty percent of the assets directly or indirectly held by the foreign company. Further, an overseas company with a place of effective management in India will now be treated as a tax resident in India and would be consequently liable for taxes in India on its global income. In spite of the procedural simplifications that it offers, the DTC has received only a lukewarm response from Indian industry, perhaps because the effectual tax rate in the DTC (30 percent) is only marginally lower than the present rate of 33 percent. An earlier draft of the code offered a standard corporate tax rate of 25 percent, but this has since been revised upwards based on the recommendations of the Standing Committee on Finance.
The DTC still remains to be passed in the Parliament.
The Goods and Services Tax (GST)
The Goods and Services Tax is another key reform measure modeled along the lines of an in-step consumption tax system. In other words, the GST will be levied on purchase of goods and services at every level of the supply chain in a manner that the incidence of taxation is uniform at all levels. As a result, it would do away with differential taxation of goods and services and harmonize the prevailing system of multiple indirect taxes. The indirect tax system is presently caught up in multi-layered taxes levied by the Centre and state governments at various levels of the supply chain such as excise duty, octroi, central sales tax (CST) and value-added tax (VAT), among others. In GST, all these will be included in a single regime.
The GST, if implemented, will dramatically change tax administration. Goods and services will be taxed at identical rates by both the Centre and the states. The proceeds will be shared according to the devolution formula recommended by the Finance Commission. However, this can only be put in practice after the passage of the Constitution Amendment Bill, which has been pending since March 2011. The Parliamentary Standing Committee on Finance hasn’t yet submitted its report on the Bill and it looks unlikely that the Bill will be passed before the general elections due in April/May 2014.
There are, however, a number of concerns that need to be addressed pertaining to the formulation and eventual implementation of the GST: if there should be a separation at the state and central level; whether certain items should have lower taxation; if real estate should be exempted; the deadlines for enforcing the GST at the various levels; and the associated extent of compensation. One issue that must be addressed before the GST can be implemented is the need for a strong and seamless country-wide IT network and infrastructure.
Its passage will require at least two-thirds of the parliament’s votes and, additionally, at least half of the state assemblies will have to give the Bill the go. The most important concern on which consensus between the states and the Centre is compromised is regarding the states. The GST will likely face political obstacles as it may be against the interest of state governments and their discretionary fiscal power. The states are afraid that they will face heavy revenue losses. For example, Maharashtra earns more than $2 billion annually from octroi, while Gujarat earns about $800 million from the CST. Agriculture-intensive states such as Punjab and Haryana earn more than $300 million from purchase taxes. All of the states worry that they will have to surrender these revenues once the levies get subsumed under the GST.
General Anti-Avoidance Rules (GAAR)
Internationally, tax avoidance has been considered an area of concern and countries have taken steps to tackle tax evasion and avoidance. General Anti-Avoidance Regulations (GAAR) were introduced in the Finance Bill 2012. The GAAR’s overarching principle is that tax mitigation should be distinguished from tax avoidance before invoking GAAR. The “main purpose” test to obtain a tax benefit must be satisfied as opposed to the “one of the main purposes” test that was specified earlier. This is to say that GAAR can only be implemented in situations where the main purpose is for obtaining tax benefits and not in a case where obtaining tax benefits is merely one of the purposes. Also, an arrangement will be deemed to lack commercial substance if it does not have a significant effect on business risks or net cash flows other than the tax benefit effect.
GAAR was to become effective from April 01, 2013. However, it was deferred by two years due to apprehensions about retroactive application. It will now apply from tax year 2015–16 onwards. While the deferral of GAAR was welcomed by the business community, the continuing concern about its potential scope – together with the additional tax burden and uncertainty around the taxation of foreign companies doing business in India – shows that there is still a lot of work to be done to present India as an attractive investment destination.
India’s Financial and Taxation Outlook
Recent efforts at fiscal consolidation indicate that policymakers have acknowledged strict budgetary constraints, while attempting to maximize resources for developmental activities. The Planning Commission, in its preparatory reports for the twefth Five Year Plan (2012-17) projects the Centre’s fiscal resources at an average fiscal deficit of 3.25 percent of GDP for the entire plan period with the fiscal deficit projected to come down from 4.1 percent in 2012-13 to 3.5 percent in 2013-14. At the same time, non-debt capital receipts (mainly proceeds from disinvestment) are expected to fall. Therefore, as the government tries to rein in the twin deficits, it will most likely give attention to reforms on both the tax and expenditure fronts. With regard to tax policy, changes can be expected in terms of legislation as well as administrative reforms to improve efficiency.