INDIA
08 August 2014
India’s budget 2014-15
Mukul G Asher has shared with us his work on Indian’s budget 2014-15, and the initial steps towards professionalizing tax administration.
Mukul G Asher has shared with us his work on Indian’s budget 2014-15, and the initial steps towards professionalizing tax administration.
There has been widespread concern that the current organizations and systems of tax administration and compliance require fundamental reform. The economic cost to the society, including costs of compliance by the taxpayers, and distortions in economic decision making due to inconsistency in tax administration procedures, poor design of tax laws and regulations, inappropriate skill sets and work process of tax organizations, and insufficient use of technology, are regarded as disproportionate to the tax revenue obtained. The tax system and its administration are also widely and correctly perceived to leave substantial scope for improving fairness.
As India’s economy continues to grow (2013 GDP at current exchange rates is estimated to be about INR 120 trillion equivalent to USD 2 trillion); and as India accelerates its engagement with the rest of the world (India’s international trade in goods and services was USD 1.1 trillion in 2012), modern professional tax administration has become even more essential.
During the financial year 2012-13, combined Union and State government expenditure was estimated to be about 26 percent of GDP; (INR 23,000 per person); while the corresponding ratio for tax revenue was 16 percent of GDP; (INR 14,000 per person). Thus, tax revenue financed only about three- fifths of total expenditure, which is lower than many other emerging economies such as Indonesia.
As the level of expenditure and taxes are already relatively high, improving tax administration and compliance efficiency and effectiveness, while improving fairness, represents an avenue for improved public financial management.
The first budget of the Prime Minister Narendra Modi led NDA (National Development Alliance), presented on July 10, 2014, recognizes the importance of enhancing trust and confidence of the tax payers in the organizations involved in tax administration, particularly in those administering income tax, service tax, and excise taxes.
The key points of the Budget proposals concerning tax administration, contained in paragraph 10 to 15,204 and 209-210 of the Budget Speech, may be summarized as follows:
· The damage to India’s investment climate and competitiveness due to retrospective taxation measures introduced in 2012 are recognized. The proposal is that any fresh cases under these provisions are unlikely to be pursued, and ongoing cases will be brought to a closure expeditiously.
· Some analysts would have preferred the retrospective tax features to be withdrawn. But this view has not been reflected in the Budget. It is hoped that in the future, drafting of tax laws and implementing regulations will be undertaken with greater care, keeping in mind the need to encourage maximum voluntary compliance. This is recognized in part as the Budget expands the scope of Advanced Tax Rulings, under which tax implications of a proposed transaction can be established in advance of the decision.
· The budget has recognized that India’s Transfer pricing regulations need to be made more consistent with international practices (Para 204). The consequent Amendments are expected to bring greater clarity in international taxation.
It would be useful to consider developing specialties in international taxation within the tax organizations, with appropriate longer term tenure and work environment.
· The Budget expresses concern that tax demands of more INR 4 trillion (equivalent to 3.6 percent of GDP) are under dispute and litigation. (Para 11).
To address this issue and to enable better utilization of skill-sets of professional tax administrators, relatively small incremental changes in administration and regulation, while welcome, would however be insufficient. Substantive reforms in tax provisions, work processes and in incentive structures of tax officials will be needed to minimize litigation.
· The Budget hopes that the Income- tax Department would transform itself from being just an enforcer of tax regulations to a facilitator. The Budget proposed 60 more Aykar Seva Kendra (ASK) across the country during the 2014-15 financial year (Para 209).
Transforming an Income Tax (or any other Tax) Department accustoms for decades to relaying on the statutory powers to a service- oriented facilitator is however a difficult exercise requiring skills in managing organizational change.
The Budget proposals are in the right direction, and will be helpful in addressing some of the immediate concerns such as retrospective taxation, and transfer pricing issues.
However, as the first Report of the Tax Administration Reform Commission (TARC), submitted on May 30, 2014. http://www.finmin.nic.in/the_ministry/dept_revenue/First_report_TARC.pdf emphasizes, there is a need for far reaching changes in the spirit, purpose, organizational structures, skill sets, internal work processes, external communication and dispute management of tax organizations involving both direction and indirect taxes. Greater synergy between the two (including sharing of certain services to save costs), and emphasis on functional specialization in their activities are needed.
The two major pending tax initiatives, Goods and Services Tax (GST) to replace plethora of sales and related taxes levied by Union and state governments, and the Direct Taxes Code (DTC) modernizing income tax laws and regulations, should also be reviewed and where appropriate modified to be consistent with the reforms in tax administration suggested above. There is also a need to review the Companies Act 2013 with the objective of minimizing compliance costs of the companies, and ensuring greater clarity on rules with tax implications (such as mandatory spending on corporate Social Responsibility, CSR)
The focus of modern professional tax organizations should not primarily be on revenue collection. It should instead be on creating a tax organizational culture and environment in which maximum voluntary tax compliance occurs. This requires, among others, tax rules and regulations which are sensitive to economic and commercial conditions, and which are system-oriented and not individual- oriented.
Among the most important factor generating tax revenue is the level and growth of economic activities which in turn impact on the tax bases. Thus, tax administration should not be a hindrance to legitimate economic activities.
In India, there is considerable potential to increase the number of tax payers for each tax, and the proportion of true tax-base that is reported. Thus, it is estimated that currently only 35 million individuals are active income tax payers in the country, when the potential under existing provisions is more than double that number. In many occupations, the proportion of true income reported ranges from 25 to 50 percent.
Thus, to expand tax base, a more effective and fair method to generate revenue, a systematic empirical – evidence based approach to tracking the missing tax payers, and to improve the true-income reported is needed. Tax Research and Analysis Division (TRAD), covering all Union Government Taxes, therefore deserves consideration. The first report of TRAC has recommended. Tax Council and Tax Policy and Analysis Unit, with a broader mandate than what is suggested for TRAD. TRAD could be a part of a broader Unit.
The analysis suggested that to expand tax base needs to undertaken for other Union Taxes as well as for taxes at the State level.
There is a strong case for not resorting tax revenue targets, determined in an ad-hoc manner, without regard to economic costs and distortions generate. Instead, revenue projections need to be based on the basis of a rigorous analytical model. It is potential revenue generation, rigorously estimated which should drive expenditure, not the other way round as appears to be the current practice, which gives adverse incentive to both tax official and taxpayers, and which constraints legitimate economic activities.
In conclusion, as with many areas of governance, tax administration and compliance issues need to be addressed with much greater degree of professionalism, outcome- orientation, and taxpayers-citizen centric manner; and approached from a systemic rather than fragmented perspective.
It is hoped that the NDA government will take further initiatives to accelerate the progress of India’s tax organizations and policymaking process in the directions outlined above.
This article was first published in Pragati, The Indian National Interest Review, on 18 July 2014.
There has been widespread concern that the current organizations and systems of tax administration and compliance require fundamental reform. The economic cost to the society, including costs of compliance by the taxpayers, and distortions in economic decision making due to inconsistency in tax administration procedures, poor design of tax laws and regulations, inappropriate skill sets and work process of tax organizations, and insufficient use of technology, are regarded as disproportionate to the tax revenue obtained. The tax system and its administration are also widely and correctly perceived to leave substantial scope for improving fairness.
As India’s economy continues to grow (2013 GDP at current exchange rates is estimated to be about INR 120 trillion equivalent to USD 2 trillion); and as India accelerates its engagement with the rest of the world (India’s international trade in goods and services was USD 1.1 trillion in 2012), modern professional tax administration has become even more essential.
During the financial year 2012-13, combined Union and State government expenditure was estimated to be about 26 percent of GDP; (INR 23,000 per person); while the corresponding ratio for tax revenue was 16 percent of GDP; (INR 14,000 per person). Thus, tax revenue financed only about three- fifths of total expenditure, which is lower than many other emerging economies such as Indonesia.
As the level of expenditure and taxes are already relatively high, improving tax administration and compliance efficiency and effectiveness, while improving fairness, represents an avenue for improved public financial management.
The first budget of the Prime Minister Narendra Modi led NDA (National Development Alliance), presented on July 10, 2014, recognizes the importance of enhancing trust and confidence of the tax payers in the organizations involved in tax administration, particularly in those administering income tax, service tax, and excise taxes.
The key points of the Budget proposals concerning tax administration, contained in paragraph 10 to 15,204 and 209-210 of the Budget Speech, may be summarized as follows:
· The damage to India’s investment climate and competitiveness due to retrospective taxation measures introduced in 2012 are recognized. The proposal is that any fresh cases under these provisions are unlikely to be pursued, and ongoing cases will be brought to a closure expeditiously.
· Some analysts would have preferred the retrospective tax features to be withdrawn. But this view has not been reflected in the Budget. It is hoped that in the future, drafting of tax laws and implementing regulations will be undertaken with greater care, keeping in mind the need to encourage maximum voluntary compliance. This is recognized in part as the Budget expands the scope of Advanced Tax Rulings, under which tax implications of a proposed transaction can be established in advance of the decision.
· The budget has recognized that India’s Transfer pricing regulations need to be made more consistent with international practices (Para 204). The consequent Amendments are expected to bring greater clarity in international taxation.
It would be useful to consider developing specialties in international taxation within the tax organizations, with appropriate longer term tenure and work environment.
· The Budget expresses concern that tax demands of more INR 4 trillion (equivalent to 3.6 percent of GDP) are under dispute and litigation. (Para 11).
To address this issue and to enable better utilization of skill-sets of professional tax administrators, relatively small incremental changes in administration and regulation, while welcome, would however be insufficient. Substantive reforms in tax provisions, work processes and in incentive structures of tax officials will be needed to minimize litigation.
· The Budget hopes that the Income- tax Department would transform itself from being just an enforcer of tax regulations to a facilitator. The Budget proposed 60 more Aykar Seva Kendra (ASK) across the country during the 2014-15 financial year (Para 209).
Transforming an Income Tax (or any other Tax) Department accustoms for decades to relaying on the statutory powers to a service- oriented facilitator is however a difficult exercise requiring skills in managing organizational change.
Comments on the Budget proposal:
The focus of the 2014-15 Budget on bringing greater clarity and competence to tax administration, and on reducing compliance costs of taxes is welcome.The Budget proposals are in the right direction, and will be helpful in addressing some of the immediate concerns such as retrospective taxation, and transfer pricing issues.
However, as the first Report of the Tax Administration Reform Commission (TARC), submitted on May 30, 2014. http://www.finmin.nic.in/the_ministry/dept_revenue/First_report_TARC.pdf emphasizes, there is a need for far reaching changes in the spirit, purpose, organizational structures, skill sets, internal work processes, external communication and dispute management of tax organizations involving both direction and indirect taxes. Greater synergy between the two (including sharing of certain services to save costs), and emphasis on functional specialization in their activities are needed.
The two major pending tax initiatives, Goods and Services Tax (GST) to replace plethora of sales and related taxes levied by Union and state governments, and the Direct Taxes Code (DTC) modernizing income tax laws and regulations, should also be reviewed and where appropriate modified to be consistent with the reforms in tax administration suggested above. There is also a need to review the Companies Act 2013 with the objective of minimizing compliance costs of the companies, and ensuring greater clarity on rules with tax implications (such as mandatory spending on corporate Social Responsibility, CSR)
The focus of modern professional tax organizations should not primarily be on revenue collection. It should instead be on creating a tax organizational culture and environment in which maximum voluntary tax compliance occurs. This requires, among others, tax rules and regulations which are sensitive to economic and commercial conditions, and which are system-oriented and not individual- oriented.
Among the most important factor generating tax revenue is the level and growth of economic activities which in turn impact on the tax bases. Thus, tax administration should not be a hindrance to legitimate economic activities.
In India, there is considerable potential to increase the number of tax payers for each tax, and the proportion of true tax-base that is reported. Thus, it is estimated that currently only 35 million individuals are active income tax payers in the country, when the potential under existing provisions is more than double that number. In many occupations, the proportion of true income reported ranges from 25 to 50 percent.
Thus, to expand tax base, a more effective and fair method to generate revenue, a systematic empirical – evidence based approach to tracking the missing tax payers, and to improve the true-income reported is needed. Tax Research and Analysis Division (TRAD), covering all Union Government Taxes, therefore deserves consideration. The first report of TRAC has recommended. Tax Council and Tax Policy and Analysis Unit, with a broader mandate than what is suggested for TRAD. TRAD could be a part of a broader Unit.
The analysis suggested that to expand tax base needs to undertaken for other Union Taxes as well as for taxes at the State level.
There is a strong case for not resorting tax revenue targets, determined in an ad-hoc manner, without regard to economic costs and distortions generate. Instead, revenue projections need to be based on the basis of a rigorous analytical model. It is potential revenue generation, rigorously estimated which should drive expenditure, not the other way round as appears to be the current practice, which gives adverse incentive to both tax official and taxpayers, and which constraints legitimate economic activities.
In conclusion, as with many areas of governance, tax administration and compliance issues need to be addressed with much greater degree of professionalism, outcome- orientation, and taxpayers-citizen centric manner; and approached from a systemic rather than fragmented perspective.
It is hoped that the NDA government will take further initiatives to accelerate the progress of India’s tax organizations and policymaking process in the directions outlined above.
Acknowledgements
Mukul G Asher is Professorial Fellow, National University of Singapore, and Councilor, Takshashila Institution.This article was first published in Pragati, The Indian National Interest Review, on 18 July 2014.