The first argument for a threshold is that the costs of collection, from a host of small payers, are not worth the revenues. Past studies, duly supported by government statistics, have shown the cost of collecting the tax from a very large base of payers had exceeded the revenues realised. This has been held true for income taxation and excise taxation. Then, given the limited resources the revenue authorities have, in terms of infrastructure, personnel, skills, etc., allocating a disproportionate amount of these resources to the activity of tax gathering from the large base of small tax payers has deflected attention from focusing on large tax payers, where the chances of enhancement of revenues are far higher. As a result, there have been revenue-significant leakages at the top of the payer pyramid. The typical 80/20 rule, i.e., 80% of revenues would typically flow from 20% of the taxpayer base, does apply. And it makes sense to concentrate on these payers and not in monitoring collections from the vast small taxpayer community. The third point in favour is about reduced costs of compliance. Small businesses arent well-geared to bear the costs of complying with an indirect tax. Hence, it is prudent to let them function without the necessity to incur compliance costs.
On the arguments against, the foremost is that it encourages evasion at the margin. This has been borne out by past behaviour, when thresholds have been introduced in the Cenvat and sales tax areas. Businesses which approach the threshold levels have been discontinued and the owners have set up as different businesses, to ensure they do not cross the thresholds and, hence, come under the tax net. This problem has been endemic in the small scale exemptions relevant for excise taxes. Tax evasion also happens by falsification of turnover. Another important point against thresholds in indirect tax is that it militates against enlargement of the payer base. It is sound public finance policy to ensure all economic activities are charged to some level of taxation. The introduction of thresholds goes against the grain of this objective.
Evidence suggests the costs of collecting a service tax from the small payer is not worth the effort. Taxes are now applicable on 77 services: to hair dressers, beauty parlours, mandap keepers, dry cleaners and a variety of such businesses. Administering the tax on these businesses, by their nature widespread and pervasive, is very costly. On the second point, it is seen from experience that a disproportionate amount of time and resources of the authorities have been spent in surveys, assessments, compliance weeks and other related initiatives to encourage and, somehow, persuade the small payers to come forward, register themselves and pay the service tax. All these initiatives have probably deflected from the need to focus on the large service taxpayer.
A related point is the enormous time and attention spent by the excise department in administering the levy. It has had to grapple with changing the mindset of its employees, from a commodity or goods taxation to a nebulous concept such as services. And, the burden of complying with the service tax has been heavy for the small payers. For all these reasons, introduction of thresholds in service taxes seems merited. However, the department says that, given the importance of services, the introduction of thresholds militates against the aim of ensuring all payers pay a reasonable amount of indirect taxes. The argument is that the introduction of thresholds ensures a narrow tax base continues and also encourages tax evasion.
On balance, the pros of an introduction of thresholds in service taxes would far outweigh the cons. It is still not too late to introduce thresholds, focus on the large payers, ensure a steadily growing stream of tax revenues from services and to, thereafter, consider a progressive reduction of thresholds. After all, thresholds have operated throughout in excise taxation, in the form of small scale exemptions and in sales taxes. Also, the state Vat to be introduced from April envisages thresholds as well. If thresholds have been found to be feasible in both Cenvat and the state Vat, these are certainly feasible in service tax. And, international experience does support the introduction of thresholds and, very certainly, at the inception of a tax. For all these reasons, the introduction of thresholds in service taxes appears a good idea and worth considering for introduction in the coming Budget.
The writer is ED, PricewaterhouseCoopers