Dealing with FTA hit on direct taxes

V Kumaraswamy | Updated on November 04, 2019 Published on November 04, 2019

Ignored issue What is not generally discussed in free trade forums is the impact of trade on direct tax collections   -  Sitthiphong

India loses direct tax revenues on the value of its imports. The answer is to tax imports, and review levies such as MAT, DDT

Most free trade agreements seek to introduce a level-playing field; in other words, the government collects the same tax irrespective of source, for domestic output or imports. This is apart from providing certain incentives for exports, and for transaction with free trade zones (FTZs).

Importers pay the equivalent of GST (CGST and SGST) as IGST on the value of goods they import. Similarly, when there is an import of service, the importers pay full GST as IGST on reverse-charge mechanism. When there are inward investments into India, any payment of interest and dividend is subject to withholding taxes, TDS, dividend distribution tax (DDT), and corporate taxes. These establish a level-playing field for the domestic manufacturers/service providers and exporters to India.

But what is not generally discussed in free trade forums is the impact of trade on direct tax collections. No doubt, exporters pay the direct taxes imposed by the host country in the country of manufacture and hence there is generally no discrimination, under the MFN principle.

But the point often missed is that the government of the importing country tends to lose that much revenue by way of lost direct taxes (corporate tax on profits, personal/corporate income taxes on salaries, interest and rent) which it could have gathered had the goods under import been manufactured within India. The shares of these in the value of output in India (as per ASI 2017-18) are 7.2 per cent, 0.27 per cent, 2.32 per cent , and 5.87 per cent respectively (15.66 per cent cumulatively).

India’s trade deficit was about ₹10.4 lakh crore in 2017-18. If the value equivalent to exports had been manufactured and sold within India, it may have yielded an additional direct tax revenue of ₹41,000 crore at, say, 25 per cent.

In the case of domestic production, there is also a secondary impact; this is of recipients spending their money leading to further goods/services being bought yielding taxes thereon. Even if one assumes a multiplier of three, the level of direct taxes would be around ₹1.23 lakh crore — or around 12 per cent of the trade deficit of ₹10.4 lakh crore.

Since this level of ‘opportunity taxes’ escape the system, the government has to look for alternative avenues of taxation either as direct or indirect taxes, both of which are detrimental to domestic manufacturers and citizens.

A host of taxes

In order to make good this deficit, the government has been finding new ways to milk the nation. In the last about two decades, the government came up with dividend distribution tax, the reasoning being it wants to encourage reinvestment (taking Germany’s example). But the tax tripped soon on its own logic.

Thus if the DDT is 15 per cent and a company wanted to distribute ₹100 as dividend, it would deduct ₹15 and pay the government and remit the balance ₹85 to the shareholder. This is if the levy is not ‘grossed up’.

But under the current system, the company pays ₹17.65 to the government and remits ₹100 to the shareholder. Moreover, the government has sought to tax those receiving more than ₹10 lakh as dividend (those who are most likely to reinvest) once again in their individual capacity. Ridiculous indeed.

Then came MAT. None of the ASEAN countries has it, that too at almost normal tax levels. The two countries that do — the Philippines and Cambodia — require an entity to pay 1-2 per cent and forget about all other requirements, including book-keeping.

To cap the high rate of MAT, we have CSR (Corporate Social Responsibility) levies and this year’s steep increase in surcharge.

An equivalent tax

Instead of these measures, the government should levy a withholding tax (or with any other with a suitable nomenclature) on imports equivalent to the loss in domestic direct taxes such imports cause. This may merit a levy equivalent to about 12 per cent of the import value.

It is true that other countries would be tempted to levy similar taxes. Hence, it would be preferable to agree on a common rate in both countries and document the same through the free trade agreements. The importing country should collect the direct tax equivalent against which credit should be allowed to the exporter in the exporting country.

This mechanism would neutralise the unfair advantage created by countries exempting exports in various ways.

It is true that other countries would levy such a tax on India’s export of services. India’s net service exports in 2017-18 were ₹4,99,968 crore and its net trade deficit was ₹10,31,727 crore, as per the Economic Survey.

The net imports of goods and services on which such a levy would have applied is ₹5,31,759 crore. At 12 per cent, the government would have netted ₹63,811 crore on its net deficit on trade in both goods and services in 2017-18.

This amount would be sufficient to forego the levy of taxes on dividend distribution, dis-allowance of CSR expenses, securities transaction tax, estate duty, wealth tax, fringe benefits tax and banking transaction tax.

Without such an equalising levy, the burden on the direct tax payers would keep rising along with the increase in our trade or current account deficit and bizarre ways of levying taxes on residents would continue. An equalising levy would also help partially improve the cost competitiveness of Indian industry.

The writer is author of ‘Making Growth Happen in India’.

Published on November 04, 2019

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