India’s tax challenge is not the rates per se, it lies in the complexity of compliance. This point appears to have been addressed by the Task Force report on revamping the Direct Tax Code. As reported in this newspaper on August 20, 2019, the recommendations are not yet public, but appear to be directed toward reducing tax rates, and changing the assessment and litigation management processes to simplify and share information among the various tax departments.
While details of the report and the government’s responses are awaited, it is important to understand that the government is currently facing a constrained fiscal space and may not be eager to cut rates so easily. We have a tax conundrum on our hands. First, these are indeed tough times—our tax/GDP ratio has dropped and was 10.9% last year, according to the Economic Survey 2018-19; total expenditure/GDP stood at 12.2%. The last quarter of FY19 saw tax revenues grow at an abysmal 1.4% year-on-year, as per estimates from the Controller General of Accounts. In fact, tax collections were the lowest for the June quarter in ten years.
Second, India’s effective corporate tax rates are quite high—with indicative estimates running between 26% and 30%. Hit by the slowdown, industry is pleading for relief and our finance minister has assured corporate leaders that the tax rates will come down, but only after revenues begin growing again.
Third, our tax base is narrow and quite skewed. Less than 10% of Indian adults file or pay income tax. The top 1% individual taxpayers contribute nearly one-third of India’s income tax. There are just around 12 lakh GST registrants out of India’s 6.3 crore enterprises. 373 companies with profits before taxes exceeding Rs 500 crore contributed 52% of corporate tax last fiscal. Surcharges on this narrow top segment hurt more.
As a welfare state, the Indian government needs revenues for growth and development goals, but this calls for a prudent and judicious choice of tax rates and tax base. For India to become a $5 trillion economy, investment has to rise significantly. Studies show that high tax rates impact investment and formalisation of the economy—a 10 percentage point increase in the effective corporate income tax rate has been shown to be associated with a reduction in the investment/GDP ratio of up to 2 percentage points; a tax rise equal to 1% of GDP can reduce output over the next three years by nearly 3%. At the present juncture, the government may be reluctant to cut rates, but the current narrow, skewed tax base, with high effective tax rates, is definitely not the recipe for higher growth.
There is a way out of this conundrum—and the answer lies in easing compliance. There is considerable global evidence that shows that compliance costs can be large, particularly for small businesses. When it comes to finance and taxation, Indian businesses struggle with more than 9,000 compliances and 600+ filings; there have been more than 600 updates over the past year. For small businesses, managing this paperwork and keeping up with frequent changes can put a heavy strain on resources and lead to businesses staying under the radar—either not registering for relevant taxes or worse, reducing activities to a level at which tax is not payable. Either way, productivity and growth are hit.
India desperately needs a holistic review of the compliance burden on firms. We rank 121 out of 190 countries in the Paying Taxes category of the World Bank’s Ease of Doing Business Index, recording 275 hours per year in time paying taxes last year; China clocked 142 hours, and ranked 114. A simple exercise shows that, all else remaining constant, just by halving the number of hours firms spend in paying taxes, India’s rank in this category jumps to 99 while the overall rank goes three places, up to 74.
In June, there were reports of a proposed National Ease of Doing Business Policy, where ministries and departments were to be made accountable for the paperwork they inflict on companies, and were to measure the time and cost incurred by companies on compliance. The re-engineering of tax compliance should take place within the three-vector frame of “Rationalisation, Simplification, Digitisation”. The finance ministry has been the leader in easing compliance so far, through this framework—digitisation of tax returns, straight-through-processing of GST filings, e-assessments, etc. If the finance ministry moves ahead immediately to measure the costs and time spent by firms, especially small ones, in paying taxes, it would make for a radical reform, with a significant impact on incentivising firms to emerge from under the radar and count themselves within the formal sector.
The finance minister could also consider removing the mandate of Corporate Social Responsibility (CSR) for this year. Apart from raising compliance costs, at a time when India needs to raise investment and growth, businesses should focus their attention on what they know and do best. In the present atmosphere, making CSR voluntary would go a long way in regaining the goodwill of industry. CSR rules can be reviewed in consultation with industry and implemented once the economy picks up steam.
These are difficult times indeed, but we do not really need big-bang reforms. Easing compliance is the game-changing move India needs for the economy to grow to its $5 trillion goal. The finance ministry can lead, as it has done before. It is hoped that the new Direct Tax Code will show the right way forward now.
Author is with Avantis Regtech, a TeamLease company. Views are personal.
