Transforming India’s Tax System: Reforms to boost growth, innovation and sustainability

By Dinesh Kanabar

The World Bank used to publish Ease of Doing Business rankings till 2020. In its final year, it rated India 63rd out of 190 countries, a remarkable climb from 142 in 2014. The one thing which pulled India down was paying taxes (ranked 115). The survey has been scrapped but as a fast-growing country, India needs to transform its tax system. Here are some thoughts in this direction.

Streamlining dispute resolution: One of the most pressing concerns in India’s tax landscape is the time taken for resolving disputes. It can go up to 20 years for large matters to reach conclusion. A robust and efficient dispute resolution framework is vital for both taxpayers and the government. For taxpayers, timely resolution offers certainty, allowing businesses to plan effectively and deploy resources confidently. For the government, it ensures timely collection of revenue.

The government had earlier formed a direct tax code committee that made several recommendations including an independent dispute resolution committee with quasi-judicial powers to settle disputes early. This would take pressure off appellate bodies and reduce litigation. By introducing a mediation framework similar to the alternative dispute resolution mechanisms used in countries like the US and UK, disputes could be settled without extensive court proceedings.

Another key measure would be to grow the authority of the advance pricing agreement programme, which has seen success in preventing transfer pricing disputes. Implementing fast-track processes for cases involving small and medium enterprises could also provide relief, as these businesses often lack the resources to engage in prolonged legal battles.

Improving tax-to-GDP ratio: India’s tax-to-GDP ratio remains a cause for concern. At 10-11%, it is much lower than the global average. Developed economies like the US, UK, and Germany boast ratios of 25-30%. Even emerging economies such as Brazil and South Africa maintain ratios above 20%. The disparity limits India’s ability to invest in infrastructure and places an unfair burden on taxpayers.

Improving the ratio requires broadening the tax base and better compliance. Recent efforts like the goods and services tax (GST) and use of big data to detect evasion are positive steps. Strengthening enforcement mechanisms to reduce the large informal economy, which still accounts for nearly a third of India’s GDP, will be essential.

Targeted measures to simplify GST compliance, especially for small businesses, will encourage voluntary participation in the formal economy. The government should also explore tax policy reforms that incentivise digital transactions, as these are easier to monitor and regulate, and thus discourage cash-based, off-the-record transactions.

Simplification of tax laws: Complex tax law has long been a deterrent for businesses and individuals. This, coupled with frequent amendments, has made compliance challenging and costly. However, the finance minister recently announced the government’s intention to rewrite tax laws to simplify them. This is a welcome step. We have sections, sub-sections, provisos, explanations, and so on that have accumulated over decades. These need to be simplified. The move towards the new tax regime is welcome. Rather than exemptions and deductions, we need higher thresholds.

Aligning with global standards: In an increasingly interconnected world, India must remain cognisant of global tax developments, particularly those concerning cross-border transactions. As e-commerce and technology expand, India faces the challenge of effectively taxing digital transactions. Its approach to cross-border taxation must align with global standards such as the OECD’s Pillar 1 and Pillar 2 frameworks. Pillar 1 addresses allocation of profits from digital and multinational enterprises, while Pillar 2 sets a global minimum tax rate to prevent profit shifting to low-tax jurisdictions. While India has taken steps to taxing digital transactions, further alignment with global norms will be crucial to avoid double taxation and prevent disputes with other nations. India should outline its position on Pillars 1 and 2 sooner rather than later. Incorporating technology and data-sharing agreements with other countries could also help Indian tax authorities identify and track digital transactions more efficiently.

Leveraging technology: By leveraging technology for tax assessments, compliance, and audits, India can improve the efficiency of its tax system, reduce fraud, and increase revenue collection. Initiatives such as faceless assessments and the widespread use of big data analytics are reshaping the landscape, but there is room for more innovation. Technologies facing initial implementation challenges which need to be addressed.

Advanced technologies such as artificial intelligence and blockchain can be harnessed to detect anomalies, streamline processes, and enhance transparency. As businesses increasingly move online, the tax administration must continue to adopt digital tools.

Strengthening indirect tax policies: GST reform was a pivotal moment in India’s tax policy. However, there are areas where GST can be optimised, particularly in balancing the tax burden across industries and ensuring small businesses are not weighed down. There GST rate structure should be rationalised further to make it simpler for businesses to comply and issues related to inverted duty structures must be addressed.

Additionally, sectors such as real estate, healthcare, and education need careful attention so that they contribute to inclusive growth. India must also continue to address compliance issues, further integrate technology into GST processes to enhance transparency, reduce tax evasion, and improve collections.