The Hindu Business Line : Empowering States to tax services

Kelkar's Task Force proposes a `grand bargain' whereby States will have the power to tax all services concurrently with the Centre. At the same time, they would be required to abide by certain principles governing the rate structure. Will the `grand bargain' be translated into reality to achieve the objectives set by the Fiscal Responsibility and Budget Management Act, asks T. C. A. Ramanujam.

DR KELKAR is irresistible. There is a legal maxim which lays down that if you are bidden to imagine a putative state of affairs as real, you should not allow your mind to boggle and all the consequences of imagining that state of affairs as real must inevitably be given effect to.

The terms of reference necessitated that the Kelkar Task Force must draft the medium-term framework for fiscal policies to achieve the objectives set by the Fiscal Responsibility and Budget Management Act (FRBM).

The Task Force was given the mandate to formulate the annual targets indicating the path of adjustments and the required policy measures. It has submitted the report laying down the strategy for tax reforms.

The report covers the direct tax law, the indirect taxes and the service tax and devotes more importance to collecting more revenue and the emphasis is on the need to augment revenue resources without touching much on the expenditure aspect of Budget policy.

The grand bargain

The Task Force proposes a `grand bargain' whereby States will have the power to tax all services concurrently with the Centre. Consequently, both Central and State governments would exercise concurrent, but independent, jurisdiction over common or almost common tax bases extending over all goods and services and, in both cases, going up to the final consumer.

At the same time, both the Centre and States would be required, under the proposed `grand bargain', to abide by certain principles governing the rate structure. There will be a Dual Goods and Services Tax system which will integrate imports and exports, Cenvat, State VAT and the service tax.

The introduction of the Goods and Services Tax (GST) at both the Central and State level will be accompanied by the withdrawal of all cascading taxes such as Octroi, Central sales tax, State-level sales taxes, entry tax, stamp duties, telecom licence fees, turnover taxes, tax on consumption or sale of electricity, and taxes on transportation of goods and passengers.

This removal of inefficient and distortionary taxes would constitute a major milestone for reforms in Indian public finance. The Central Excise Act and the taxation of services by the Finance Act, 1994, will be subsumed under the central goods and services tax. This should be implemented through a legislation which may be named Indian Goods and Services Act.

The States will need to simultaneously introduce corresponding legislation for taxation of goods and services which will subsume their existing State-level cascading taxes.

The idea of the single national VAT within the existing federal structure will no doubt constitute a major milestone for the modernisation of the indirect tax system. Dr Kelkar is justified in visualising an additional gross tax revenue of 2 per cent of GDP from this measure.

There can be no disputing the fact that the present regime of the three-tier tax levies by the Central, State and the local bodies has resulted in fragmenting the market and promoting trade and tariff wars among the States. This, at a time when the European Common Market is moving more and more towards an integrated market mechanism to secure the benefits of globalisation.

India's fiscal system still presents the idea of the middle-ages with States fighting for their share of the pie, whether it be with regard to the sharing of tax revenues or river waters.

It must be immediately conceded that the Kelkar `grand bargain' will merely remain in the realm of ideas which will never be translated into reality in the foreseeable future, leave alone the target date of April 1,2005.

Direct taxes

In the field of direct taxes, Kelkar is on familiar grounds. He would like to reduce the corporate tax to 30 per cent for domestic company and 35 per cent for foreign companies. He will continue the present structure with regard to dividend. However, depreciation rates under the I-T law will be reduced to 15 per cent and over time, the divergence between the company law and the tax law will be reduced.

Tax incentives will be eliminated. In this situation, there will no need for MAT. To tackle the problem of tax evasion, Kelkar does not suggest any amendment of the tax law. Instead, the Task Force proposes the creation of a system named Risk Intelligence Network (RIN) to build up a comprehensive database about firms. It will be integrated to work both for Central Board of Excise and Customs (CBEC) and Central Board of Direct Taxes.

The suggestion that tax administration by itself can tackle evasion by mere RIN is, to put it mildly, naïve. It is not for want of information that the income-tax department is not able to tackle evasion. The IRS Officers are forbidden from scrutinising the returns on their own.

A special procedure has been prescribed for random scrutiny of a small percentage of returns. Such random selection will never result in detection of evasion. It is a pity that for well over a decade, successive governments have not reposed trust in the integrity and ability of the IRS Officers to choose cases for scrutiny in order to tackle evasion.

The Kelkar Task Force has boldly suggested amendment of Article 252 of the Constitution to authorise the Union of India impose agricultural income tax by a central levy and to allocate the whole revenue from such tax to the states. It has recognized that such a levy is warranted both on considerations of horizontal and vertical equity and for preventing money-laundering of non-agricultural income.

Here again, the recommendation will only fall on deaf years, not withstanding the fact that in the earlier report, Dr Kelkar had highlighted an approximate revenue leakage of over Rs 1,000 crore in a study of fake agricultural farms in Mumbai.

SSI sector

The Kelkar Task Force has been harsh on the small-scale industry. It has recommended that the threshold exemption for small-scale industries should be reduced from Rs 1 crore to Rs 40 lakhs. This has been fixed keeping in view the economics of optimal threshold and the fact that such taxable entities are subject to tax audit under the income tax act and therefore may not have to bare any significant additional compliance burden.

The Task Force acknowledges that the small-scale sector with over 40 lakhs units accounted for 95 per cent for the industrial unit in the country and 40 per cent for the value-added in the manufacturing sector. It contributes 7 per cent to the GDP.

Outside the agricultural sector, the small industries have the maximum employment potential. Trying to tinker with the exemption limit of SSI will only result in harassment and splitting of the units. It will also open the KTF to the charge of catering to the interests of the multinational corporations operating in India on huge profit margins.

There can be no doubt that the report of the Kelkar Task Force proposes a paradigm shift in the tax system as the main means of achieving the FRBM Act requirements. However, when it claims that the report will give India a fair and equitable world-class fiscal system, many will demur.

(The author is a former Chief Commissioner of Income-Tax.)