The Hindu Business Line : Buoyant tax collections in an economy on the rise

During 2006-07, Customs duty, Excise duty and service tax collections exceeded the revised budgeted target by 2 per cent. The indirect tax collections in 2006-07 were 20.5 per cent higher than collections in the previous year. For 2007-08, the Centre has budgeted indirect tax collections at Rs 2,79,190 crore. This amounts to approximately 51 per cent of the total tax revenue. However till August 2007, indirect tax collections were behind by approximately 12.5 per cent.

The increase in indirect tax revenue has largely been contributed to by higher service tax collections. The growth in service tax collections is due to rapid growth of the services sector, buoyancy in the economy and increasing coverage of service tax.

Though there has been a significant increase in service tax collections, there are several ambiguities in the service tax law. The key ambiguities relate to coverage of services within the taxable net and export/import of services.

For instance,, it is unclear whether testing of computer software is covered within the taxable service category of technical testing or within the non-taxable computer software services related consulting engineer services.

Similarly, determining whether a service qualifies as an export is complex, given that services are mostly intangible with no explicit place of consumption or use which is a condition for determining whether a service qualifies as export. For instance, in the case of marketing services provided by an Indian entity to its overseas parent, the question whether the service is used outside India and qualifies as an export does not have a simple answer, as such services can be said to be used both within and outside India. Therefore, objective tests for export of services would reduce a lot of ambiguity, which is created by several subjective tests that exist today.

As far as the reforms agenda on the indirect tax front are concerned, the major reform item is the introduction of Goods and Service Tax (GST). GST would eliminate the cascading and distortionary effects of separate VAT and excise duty/service tax levies. Apart from introducing simplicity in tax compliance, the GST system could help broaden the tax base and consequently increase overall revenue. However, introduction of GST in India would require a redistribution of taxation powers amongst the Centre and States, which is a huge challenge.

Attaining agreement among the Centre and State governments itself is the biggest barrier to the introduction of GST. Minor steps towards introduction of GST have been taken (for example, reducing the rate of CST towards ultimately eliminating this levy). Improving the tax system in India continues to be a major challenge. Though reform initiatives have been taken, tax reforms need to continue, and the task ahead is greater than the steps already undertaken.

Direct Tax

With expert opinions on Indian economy shifting like a pendulum from being considered ‘shining’ one day to ‘overheated’ on the other, reports indicating recent tax collections would probably settle the debate for at least a few days (if not weeks!!). As per recent figures released by the Finance Ministry, direct tax collections up to October 2007 have shown a phenomenal growth of 40 per cent on a year to date comparison with the previous year. Net direct tax collections, that is, after considering the refund payouts (pleasingly, which also have increased) stood at around Rs 1,28,000 crore.

Broadly, such phenomenal increase in net tax collection could be attributed to strong economic growth, better tax administration and relatively improved compliance levels. Riding on robust economic growth and extremely positive business sentiment, the buoyant and bullish equity market has also contributed significantly to the excellent growth in tax collections, with collection of Securities Transaction Tax (STT) growing by whopping 57.61 per cent.

To top it up, increased investor interest in equities induced by strong economic fundamental, robust flows from foreign institutional investors and attractive short-term capital gains tax rate has also contributed in increased tax collections.

The high number (and quantum) of refunds issued and effective administration of schemes such as the “Refund Banker Scheme” have reduced the interest payouts on refunds, thereby reducing the burden on the exchequer and improving the tally of net collections, also underlying the role of better tax administration.

Another important and significant tax administration measure which has not yet contributed to the smart growth in tax collections, but would surely do so going forward, is the pushing back of the deadline for scrutiny proceedings to December 31 (instead of March 31) to provide more time to tax officers to pursue tax collections.

Also, measures such as mandatory filing of detailed Annual Information Returns by financial institutions and mutual funds have definitely induced better tax compliance in India, while introduction of measures such as the Banking Cash Transaction Tax have contributed indirectly by preventing tax leakages on account of unauthorised transactions.

While it is commendable that India has achieved such growth in tax collections and a significantly improved tax-GDP ratio without effecting any increase in tax rates, there is still a Herculean task lying ahead if India needs to truly become a part of the developed nation’s league. The tax-GDP ratio of around 17 per cent in India pales in comparison to the significantly high world average, clearly indicating that we have a long way to go.

It may still be too soon for India to look at advanced best practices for tax collections such as ‘tax farming’, which involves upfront sale of tax receivables by the Revenue to third party professional collectors or introduction of practices such as ‘taxpayer relationship management’, modelled on the principles of customer relationship management wherein taxpayers are provided all necessary assistance with respect to payment of their taxes.

However, it may not be too late to embark on this journey and start bringing the necessary paradigm shift in the approach of tax officers. It is probably the most well known fact (but most conveniently ignored in India) that any system of taxation relies heavily on people’s propensity to voluntarily comply. Thus, it is imperative to de-emphasise revenue collection as the key role of tax authorities and instead emphasise on encouraging voluntary compliance by creating the right environment for people to pay tax. This would include introduction of measures for early dispute resolution. Early dispute resolution not only reduces interest payouts on refunds, thereby reducing the burden on the exchequer, but also provides the confidence to taxpayers that they would be treated fairly and additionally taxes paid during litigation would not be locked for unreasonably long periods.

A change in approach would also be required at lower levels where taxpayers typically have to face high pitched audits and then subsequently pressured for payment of arbitrarily high taxes. Of course, the above measures would also need to be supplemented by introduction of certain precautionary measures to prevent tax leakages like, for instance, better monitoring of real-estate deals to capture taxes on unreported deals or aligning circle rates with realistic market rates to ensure correct reporting of taxes (both stamp duty charges and capital gains taxes).

Besides, additional efforts still need to be made on increasing the tax base. The effort of the tax authorities are still directed towards revenue maximisation from the existing taxpayers rather than bringing additional people in the tax net.

(The authors are Tax Partners, Indirect and Direct, respectively, Ernst & Young.)