As a true visionary leader, Prime Minister Narendra Modi has charted out a clear pathway for India to become a $30-trillion economy and a developed nation by 2047. This vision has spawned various salutary ideas on key enablers across the spectrum to reach this ambition. As PM Modi himself has confidently predicted his third term in office, this article focuses on one of the critical enablers to achieve this vision—India’s tax system, which the Modi 3.0 regime could consider implementing.
It is recognised that the increasing digitisation of the economy and of tax administration has already laid a great foundation for the tax system to keep up with the potential growth of India’s economy. It is, therefore, the right juncture to turn to some critical design changes in the laws governing direct and indirect taxation.
Design of GST
There is now a quiet recognition of the need to streamline the proliferation of GST rates across the various categories of goods into no more than three rates—merit, standard, and demerit. With the recent buoyancy in GST collections, it is hoped that the Centre and states can display the maturity and sagacity required to agree on this much-desired simplification along with the long pending necessity to bring in the few remaining items like electricity and petroleum products into the GST system.
Simultaneously, a number of useful suggestions have been made by the industry to simplify and facilitate input tax credits in certain sectors and also across certain items of goods and services. A revamped GST law should have minimal friction in achieving pass through of all input tax credits in the entire chain of value addition till final charge at the point of consumption. Finally, whilst increasing use of data analytics has rightfully resulted in chasing down fraudsters and wrongdoers, there have been far too many instances of overzealous investigations eating up precious time and resources of both the revenue department as well as taxpayers without any resultant impact on GST revenues. This reveals the need to institute a more robust internal process to enforce greater accountability in such investigations.
TDS provisions in direct tax
The exhaustive coverage of TDS provisions for a variety of transactions has certainly helped in reducing tax evasion and enhancing tax collections. However, with increasing adoption of technology and data analytics, even nominal TDS rates can successfully track various taxable transactions and achieve the same objective. Similarly, the current spread of rates from 1-30% can surely be crunched into a narrower range and avoid unnecessary ‘classification’ controversies. India is perhaps the only significant economy with such a complex TDS system for purely domestic transactions which is counter-intuitive to the strides achieved in digitisation of various facets of the economy.
Capital gains taxation
Ever since its introduction in 1947, India’s capital gains tax system has had a tumultuous journey of dramatic shifts between very high rates (with attendant complexities and exemptions) and low rates (with various conditions on the holding period etc). All popular financial jurisdictions in developed economies have ensured a fairly simple and predictable capital gains tax regime to attract large pools of institutional capital which, in turn, has fuelled continuous growth of their main economies over the decades. India’s current capital gains tax provisions have a mind-boggling range of holding periods (for long term capital gains tax consideration) as well as rates (though the last budget has somewhat addressed the anomalies relating to debt products).
It is high time for India to have no more than two kinds of holding periods, namely for all financial instruments and other ‘real’ assets (including properties and gold) and corresponding tax rates for long term capital gains. Moreover, as the recent episode of valuation-related capital gains provisions for start-ups and other early-stage companies has shown, an overzealous attempt to catch a few ‘round trippers of taxable income’ has the danger of adversely impacting the entire ecosystem of clean capital finding its way to India’s promising economy. As India looks to stand tall with other developed economies, it is time to steer the mindset of lawmakers and administrators towards the principle of ‘capital is good’ and not an ‘evil’ to be shunned.
Smarter alternative tax dispute mechanisms
While many attempts have been made to provide for alternative tax dispute forums to reduce the burden on traditional tax tribunals and courts over the years, a cursory glance at the relevant statistics will reveal that a much more concerted effort on capacity-building and consistent messaging from tax administration leadership is required. Simultaneously, a pragmatic approach to aspects like providing certainty in transfer pricing on simpler transactions like those between Global Competency Centres (GCCs) in India with their principals abroad will ensure that the GCC sector will continue to exponentially grow by adding more value accretive functions, leading to a much-needed increase in relatively high-skilled jobs in the country.
Interventions in income tax law
Over the years, various interventions have been made in income tax law to either promote a particular behaviour or economic activity or to prevent some misuse either real or perceived.
At this critical juncture, it is time to undertake a complete and objective analysis of these various interventions over the years to determine their effectiveness and desirability so as to remove unnecessary cluttering of the law as also not to invariably scuttle much needed entrepreneurial zeal and decision making. Some examples of ‘incentive’ provisions pertaining to favourable tax on patents developed in India, weighted deduction on Indian R&D, deduction pertaining to job creation etc. show minimal impact on the desired outcomes. Similarly, over the decades, taxation of the not-for-profit (NFP) sector has been conflated with tax exemption and consequential misuse in many cases. However, this historical approach is currently impeding, for example, the increasing willingness of first-generation entrepreneurs to contribute their own shareholding in their businesses to a public charity. (Such contributions need to liquidated promptly into the prescribed investment categories). This is a classic case of the legislature dictating the choice of the financial instrument for charity based on historical notions of ‘riskiness’ of various financial instruments. This approach is impeding the growth of this much-needed sector to enable supporting the government in its ambitious social welfare programs to ensure not just aggregate GDP growth but also access to better quality of living for the larger population.
A true transformation in design, implementation, and mindset is required for India’s tax system to be geared up for the laudable ambition to be a developed nation by 2047.
Sudhir Kapadia, Tax Partner, EY
Views are personal