Tax breaks don’t equal export growth

Why exporters shouldn’t seek restoration of 80HHC benefits

Ashok Jha

Exporters and industry associations such as Ficci and the Federation of Indian Export Organisations (FIEO) have pleaded for the continuation of the benefits under Section 80HHC and other similar provisions of the Income Tax Act which exempted export profits from the purview of income tax. Last year the Finance Act had put in place a policy for phasing out the benefits under 88HHC, etc, over five years. The moot points are whether the income tax exemption to exporters is a subsidy compatible with the Subsidies Code of 1979 or the Agreement on Subsidies and Countervailing Measures (ASCM) of the WTO, and whether such exemptions are the optimal policy choices to promote exports.

The ASCM governs subsidies in sectors other than agriculture while the WTO Agreement on Agriculture (AoA) regulates subsidies in agriculture. The ASCM has classified subsidies into three types:
a) Prohibited or red subsidies. These are further sub-divided into:
i) those contingent upon export performance; and
ii) those that favour the use of domestic over imported goods.

b) Non-actionable or green subsidies. These are subsidies that are non-specific to an enterprise or industry as well as certain subsidies which are specific but are covered under Article 8.2, for example, assistance for research, for disadvantaged regions, for the adoption of environmental standards, etc.

c) Actionable or amber subsidies are those that are neither prohibited nor non-actionable. These are specific to certain enterprises.

As a measure of Special and Differential treatment, developing and least-developed countries were permitted to use subsidies contingent upon the use of domestic over imported goods up to December 31, 1999 and December 31, 2002 respectively. Developing countries like India, listed in Annex-VII of the ASCM, may use subsidies contingent upon export performance till their per capita GNP remains below $1,000 per annum.

The income tax exemption under section 88HHC and other related income tax exemptions are prohibited subsidies as they are contingent on export performance. The prohibition is expressly contained in clause (e) of Annexure I which lists some typical export subsidies under the ASCM. The government of India has notified the WTO that this is a prohibited subsidy. However, since our annual per capita GNP is below $1,000, the continuation of this subsidy would not be incompatible with our WTO obligations. This subsidy is, however, actionable and can be countervailed.

While theoretically therefore the government can continue with the income tax exemption of export profits, three aspects merit closer analysis. The first is a pure revenue consideration. While no reliable estimate has been computed, the tax forgone annually only on account of Section 80HHC (concerned with merchandise exports) is assessed at Rs 5,000 crore. This does not include software exports (80HHE) or project exports (80HHO).

The second aspect concerns equity and the canons of taxation. Equity considerations demand that those who earn high profits, whether from domestic or export operations, are taxed at the same rate. By exempting export profits from tax, even a small domestic company is disadvantaged vis-a-vis a large company that derives its profits from exports.

The third aspect relates to countervailing duties. Not taxing exports is a prohibited subsidy, which can be and has been countervailed. In effect, while the government does not levy or collect any tax from exporting enterprises, the enterprises, through importers, pay a “tax” to foreign governments which impose countervailing duties. This is clearly an unintended result!

On the other hand are export promotion considerations. It has been argued that because of various inbuilt inefficiencies in the economy exporters’ margins are very slender and that removing the income tax exemption on export profits will render our exports uncompetitive. There is some merit in this view, but the question is whether exemption of export profits from taxation is the right instrument. Would not an active exchange rate management be a better tool considering that, in the past year, the Indian rupee appreciated against all major currencies except the dollar? Aren’t exports hindered by transportation bottlenecks, congestion at ports, inadequacy and poor quality of power and a bureaucracy with too much discretion and too little accountability?

Moreover, is there a significant positive correlation between tax exemption and export growth? Despite the exemption of export profits from tax being phased out, export growth in the last financial year has been healthier than in the past four.