Mr FM, You Must Take The Bull By The Horns

Updated: Nov 24 2002, 05:30am hrs
Last week, I had commented on the report of the taskforce on direct taxes headed by Dr Vijay Kelkar. For want of space, I could not include my comments on some other recommendations in the report. There is one particular recommendation that has caused considerable anxiety among business people. This relates to section 36 (iii) of the Income Tax Act. Under that provision, in computing the income liable to tax, a business is entitled to deduct the interest paid in respect of capital borrowed for that business. The taskforce has recommended that section 36 (iii) be deleted.

The question is not an academic one. Should interest expenses be deducted from income or not ought not to be turned into an ideological issue. The correct approach is to understand the nature of Indian businesses and their sources of capital. Indian industry, and for that matter, agri business and service businesses is heavily dependent upon borrowed capital. Equity resources are quite scarce and only modest amounts are raised through public and rights issues. For example, during 1999-00 and 2000-01 the total resource mobilisation from the primary equity market was Rs 7,817 crore and Rs 6,107 crore respectively. During the nine months up to December 01, the amount raised was a meagre Rs 3,777 crore. Obviously, these amounts are not enough to finance industry and business. So, what do they do They raise debt. The proportions of equity and debt raised in the primary market during 1999-00 were 58 per cent and 42 per cent, respectively. During 2000-01, the proportions were 53 per cent and 47 per cent.

In specified industries, and for individual companies, it is not unusual to have equity to debt ratios of 1:2 or 1:3 or even 1:4. This would be unthinkable in the developed countries. If the debt, as a proportion to equity, crossed 0.5 or 0.7, alarm bells would ring through the company and the stock market. Companies and businesses in the developed countries can manage with low debt because they have vibrant capital markets, millions of retail investors and thousands of venture capital funds. That is not the situation in India.

If debt plays such an important part in the capital resources of Indian business and industry, how does one receive a recommendation that the interest paid on borrowed capital should not be tax deductible With horror, I suppose. If this recommendation is accepted, it will knock the bottom out of most businesses. Besides, there will be virtually no start-ups or new business ventures.

I was relieved to read an interview given by finance minister Jaswant Singh. He has firmly rejected the recommendations which would amount to reneging on the promises or commitments made by the government (for instance sections 10A and 10B of the I-T Act). Nothing would spell greater disaster for economic reforms than a government going back on statutory promises on the basis of which investments have been made. Mr Singh should, with equal firmness, dismiss the recommendation to delete section 36 (iii).

I now turn to the report of the other taskforce, the one on indirect taxes, also chaired by Dr Kelkar. The report has two parts, the first on customs duties and the second on excise duties. The recommendations on customs duties are quite simple and straightforward. The taskforce has suggested 0 per cent for life-saving drugs and government imports, 10 per cent for raw materials and inputs, and 20 per cent for final goods. The target year is 2004-05. If any criticism is merited, it is that the suggested pace of reforms is conservative. The collection rate on imports during 2000-01 was 21 per cent. With burgeoning forex reserves (which have a monetary impact), it would seem that liberal imports and a quicker alignment with Asean levels of tariffs is the road to take.

It is on the excise side that the taskforce has bungled. It swears by Cenvat - a single rate. But it recommends no less than five rates, besides special excise regimes for the petroleum and textile sectors. There is also a clutch of recommendations that seems to have been made from a purists point of view - and without regard to the impact on employment and investment. The taskforce has suggested:

* SSI exemption limit be brought down to Rs 50 lakhs;

* Reduction in the percentage of sales by export oriented units in the domestic market from 50 per cent to 10 per cent; and

* Abolition of the duty entitlement pass book scheme on the presumption that an efficient duty drawback system will be in place by April 1, 03.

The declining indirect tax to GDP ratio should not surprise anyone because both customs and excise duties were reduced sharply during the 90s. In the long-run, customs will cease to be the biggest or even an important source of revenue. That distinction will go to excise, but eventually service tax will grab the honour. It is the Indian government, through the levy of high and crippling rates of taxes, which fostered a culture of non-compliance with tax laws. Thankfully, that is changing.

While automation and human resource development recommended by the taskforce will be helpful, the key lies in lower rates. Once low rates are in place, compliance should be rewarded and non-compliance should attract stiff penalties.

The fundamental problems plaguing our customs and excise administration are multiple rates, discretionary powers with the assessing officer and corruption. Pre-shipment inspection, low tariffs and online assessment are the answers to the problems on the customs side. On the excise side, more far-reaching changes are necessary. There is an advantage on the excise side that few recognise. Excise falls only on 100,000-150,000 points of assessment in the whole country.

With the countrys vast capabilities in information technology and software, a radically different system of levy, assessment and collection of excise duties can be put in place. And if there is Cenvat, the new system can be implemented in two-three years. There may be stiff resistance from the huge army of excise officers, but nothing that a strong, stable and determined government cannot overcome.

The taskforce on indirect taxes has made many useful recommendations, but has skirted the issues of discretionary decision-making and corruption. The taskforce sees the bull, but refuses take it by the horns. The ball is now in the finance ministers court.