A wishlist of top five direct tax reforms to boost India’s economic health

Published: June 30, 2020 5:48 PM

There is a dip in the collections with a steep decline in advance tax outgo of companies – this may well be an indicator of how the annual collections this financial year are going to be. 

new tax regime, income tax, CBDT, Exempt allowances for salaried taxpayers, New Tax Regime, Transport allowanceTax collections are an indicator of the nation’s economic activity.

The Central Board of Direct Taxes (CBDT) recently said that the decline in tax collections for FY 2019-20 was “on expected lines and is temporary in nature due to the historic tax reforms undertaken and much higher refunds issued during the FY 2019-20”. Tax collections are an indicator of the nation’s economic activity. Such trends do call for attention and action especially in these unprecedented times where there is an urgent requirement to strike a balance between lives & livelihood. However, our nation’s deteriorating health is not a sudden event – the Indian economy has been witnessing a persistent slowdown in annual and quarterly growth rates in recent years. As acknowledged in the Economic Survey 2019-20 (Survey), the GDP growth rate is estimated to be 5% in 2019-20 as compared to 6.8% in 2018-19. A recent article on the first-quarter advance (of FY 2020-2021) tax collections suggests that there is a dip in the collections with a steep decline in advance tax outgo of companies – this may well be an indicator of how the annual collections this financial year are going to be.

Some other reports suggested that the growth rate as of the second quarter of FY 2019-20 GDP fell to 4.5%. The Survey noted that sluggish growth of consumption and consequent decline in fixed investment led to the decline in GDP growth during this period.

One other reason that may be deciphered from data/reports of agencies is that there has been a continuous decline in our nation’s saving and investment rates. In this economic backdrop and the turbulent times, the Government of India may consider a direct-tax reform package that is led by a policy change. Some reforms that may be considered are as follows –

Easing of gift tax regulations – The Indian Income-tax Act, 1961 (ITA) subjects to charge transactions of issue of shares which are carried out at a price less than the fair market value in the hands of the
recipient of such shares on the difference between the FMV and price paid to acquire the shares. Also, the ITA subjects to tax, in the hand of the receiving company, share premium that is received from a resident investor at a price higher than the FMV; the difference between the price paid and the FMV. FMV in the case of equity shares is calculated using a clinical formula based on the financial statements and for other shares (such as preference shares) is based on valuation and intangibles (in specified cases). These rules were introduced in the tax law as the Revenue was suspicious of the bonafide of the transactions involving share issuances/transfers of private companies. However, in these times, it is
likely that companies may want to raise capital or carry out other capital transactions (rights issues/buy-back) to align the capital structure of a company and that the pricing arrangement may not necessarily always pass the aforesaid clinic approach. Often also, the Revenue authorities challenge the valuation reports.

All of this makes it difficult for a private company to raise capital freely. A limited liberalization of these provisions could be of great help.

Permitting loss carry-back – Some jurisdictions permit rollback of tax losses to year(s) to a year prior to the year in which the tax losses was incurred, at the option of the taxpayer. For example, if the
loss was incurred in FY 2019-2020 they could be used for a previous FY to settle the tax bill. India may also consider introducing loss carry-back rules which can offer a taxpayer the choice to carry-back all or part of a tax loss (including depreciation) from an income year against settling income-tax payable that may arise pursuant to a tax assessment or finalized pursuant to litigation. This can be an alternative to carrying tax losses forward. This will significantly help taxpayers managing cashflow in these unprecedented times.

Enhancing limits for chapter VIA deductions to facilitate domestic savings/investments – Various studies and data will suggest that domestic savings (gross domestic saving, as is referred to) in an economy plays a pivotal role in not just achieving growth but also cultivates sustainable growth. This also enables households to have domestic savings which may reduce the social security burden on the Government in the long run.

Given the fall in the domestic savings/investment over the years, enhancing the limits for deductions under chapter VIA of the ITA may help bolster domestic savings and also provide much-needed investment capital where the investment avenues are notified in the relevant provisions of the Act.  Consider, illustratively, a situation where interest yielding bonds issued either by Government (central or State) or a Bank was to be notified in this list. This could provide much-needed investment capital
for institutions that can revive economic growth.

Restoring profit linked deductions for exports including SEZs – As Mr. Nitin Gadkari remarked at the 92nd Annual Convention of FICCI, the most important thing for the $5 trillion economy is the export-import balance and India increasing its share in global trade. With China being under the scanner and facing some difficulties, an export incentive program the akin to the erstwhile provisions of Section 10A and 10B or the revival of them will be a very welcome step. Particularly, extending the sunset date in
the provisions that grant tax holiday to newly set-up units in the Special Economic Zones under section 10AA of the ITA will be a very positive, investment & employment generating measure.

Incentivising home purchases, recreating value in the asset class – In the current situation where the real estate sector is in such distress and the Government not able to support help the sector, a few tax
incentives may go a long way in providing relief to the sector. With home loans getting attractive after the recent rate cuts, the cost of funding a real estate purchase may be further eased if the caps introduced by this government on interest deductions for housing loan can be deleted – essentially asking for the earlier regime to be restated. This will incentivize a meaningful section of the society to
reconsider residential real estate as an interesting class. As a further incentive to projects that are under construction (for which an occupancy certificate has not been applied for), the Government may
consider waiving 50% of the stamp duty on property registration.

Another significant measure the Government may consider is to implement the recommendation of the task force on the Direct Tax Code as regards the personal income tax rates, with the creation of five
slabs versus the existing system. This will put additional cash-flow in the hands of the population that is capable of spending thereby reviving demand and boosting consumption.

The philosophy of tax reform has undergone significant changes and should undergo further changes in the years to come such that our tax law becomes one of the architects of the modern Indian business environment. The Government should take a lead role and plows the field for building trust (and ending
mistrust). This changed perception and continuous moderation of the tax laws will in the long run boost confidence, change the perception, and increase transparency while in the near-term offer an economic incentive for economic activity.

  • Ritesh Kumar S is Executive Director, IndusLaw. Views expressed are the author’s own.

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