The changes announced by the finance ministry in the direct taxes code has diluted the spirit of the original draft, which had essentially sought to codify a modern tax law for a rising economic power that the world sees in India. The basic spirit of the proposed law was to have one of the simplest and lowest direct tax regimes in the world, which would incentivise tens of millions, who currently avoid paying taxes, to come into the tax net voluntarily. The necessary condition to achieve this objective was to remove the plethora of exemptions enjoyed by powerful sectional interests?whether companies or individuals?on one pretext or the other. The changes in the draft code suggest some of these sectional interests have won on account of political populism.
The special interest groups, always a vocal minority, actually managed to win the perception battle because the government could not convince them that, in reality, they would not have lost out if the original draft code had been adhered to. In my view, the two seminal proposals in the original draft were a) bringing the income tax rate down to 10% for nearly 97% of the current tax paying population. The draft code proposed that all taxable incomes up to Rs 10 lakh a year will fall in the 10% tax bracket. Currently, annual taxable income of Rs 10 lakh attracts a 30% tax rate.
Thus, the draft tax code would have ensured that almost the entire individual tax paying population remained in the 10% tax bracket. In which other country will you find such low tax rates for individuals? This would actually have won UPA-2 a permanent place in the hearts of the burgeoning middle class population of India. However, with the government deciding to continue with certain tax exemptions in the modified draft, there might be a need to increase the tax rate from 10% suggested in the original draft.
Similarly, b) the original draft plumped for a corporate tax rate of 25% provided the plethora of exemptions enjoyed by capital intensive big businesses in India were withdrawn. This also got stymied because capital intensive businesses raised a howl of protest against the proposed 2% tax on gross assets of a company in lieu of the current regime of minimum alternate tax (MAT) levied on book profit. This was proposed by the draft code to make companies flog their assets more efficiently. There is evidence to show that nearly 50% of all registered Indian companies have been showing losses for years on end but continue to carry large assets in their books. This is a bit of a paradox. If you lose money for decades on end, what do you do? Simply shut down the business and not carry more assets in the books, don?t you? The tax on gross assets was aimed at curbing this unusual practice of carrying assets even while making ?losses? year after year.
However, the big business lobby succeeded in ensuring that the modified draft went back to status quo?MAT on book profit. There would be a big revenue loss on this count. This will certainly ensure that the corporate tax rate of 25% proposed in the original draft will have to be raised back to 30%.
A tax rate of 25% would have been hugely beneficial to the vast majority of the small and medium business enterprises in India who are essentially more labour intensive. In fact, the original draft was weighted in favour of small businesses. The changes in the code shifts the advantage again to capital intensive big business lobby, which is happy paying 18% MAT on book profit. There is some murmur that the finance ministry may later align MAT closer to the corporate tax rate of 30% to neutralise the advantage gained by the bigger business lobbies.
The government must realise that the next big wave of tax collections will come from small businesses for whom a moderate and transparent tax regime is a must. It is important to attract smaller businesses with a lower corporate tax rate because once they voluntarily come into the tax net, India?s black economy will progressively become white and that itself will give GDP growth a big boost.
The debate over retirees paying a tax at the time of withdrawing their provident fund savings also got a bit skewed. The principle behind imposing a tax at the time of withdrawal was to encourage savings rather than consumption. At a macro level, you do need higher savings to sustain long-term growth. Today, some of the Asian economies are not affected so much by the global economic headwinds because of the right balance struck between consumption and savings.
In any case, withdrawal up to Rs 10 lakh a year from the provident fund would have attracted only 10% tax. A better solution would have been for the government to retain the idea of taxing at the time of withdrawal of PF, while giving the individual the option of tax exemption if he or she puts the same money in another designated saving instrument, like a 5-year fixed deposit. This would prevent wanton consumption among retirees. It appears the government lost sight of the big picture while making some sections of taxpayers happy.
mk.venu@expressindia.com
