Tax corporate revenues rather than profits

Thanks to the Government’s relentless anti-corruption drive after demonetisation, over five lakh new taxpayers have been added to the rolls, and tax collections have risen. In August, the finance ministry said that a total of 2.8 crore IT returns were filed, a new record, representing an increase of nearly 25 per cent over the 2016-17 tax year.

Still, these numbers mean that 95 per cent of adult Indians do not pay income tax. This is one reason why it represents only about 13 per cent of the Government’s revenues. But there’s a bigger reason for this. We let corporations spend crores of otherwise productive hours each year devising ingenious ways to legally pay the smallest tax possible. Tax strategies even dictate corporate behaviour — such as where and when to invest. The country’s best minds in the accounting and law firms are dedicated not to innovation, product development or logistics but to exploit tax loopholes.

At the heart of this problem is a basic flaw: we define income incorrectly and indiscriminately. The definition of income for a salaried employee is the top line on a payslip, the total earned during a tax year. Sure, there are a few approved deductions for some savings, mortgage interest and pensions but the general idea is that a salaried employee pays taxes on nearly every rupee earned.

For a corporation, however, we define income as its bottom line. We allow companies to not only deduct the cost of materials and direct labour from their revenues but every imaginable expense, including those that are normally required for operations such as the cost of indirect labour, rent, utilities, travel expenses, information technology, advertising and legal.

Corporations benefit from roads, bridges and ports, and are served by various government ministries. Logic dictates that companies should pay for these services regardless of whether they make a profit or not. The cost of consuming government services should be treated as no different from various other operational costs such as rent, employee compensation or utility bill. Paying taxes to the government ought to be a cost of doing business.

Today, a company that is a heavy user of government services pays no taxes if it reports a loss. Worse, the company is able to carry over its losses to future years to further lower its tax bill. Imagine if salaried individuals were permitted to deduct all expenses of running their households and pay a tax on the income that is left. Not only would this be absurd; the Government’s already low tax collections would plummet even further.

Corporate income should simply be redefined as a company’s gross revenue, a number that is easy to obtain and not subject to debate. Public companies report their revenues to SEBI. For private companies, it is simple to compute the top line revenue from the new GST system. Once a company’s gross revenue number is known, our tax laws should be changed to simply require companies to pay a flat tax on revenue. The tax itself could be very small, as little as 3 per cent of total revenue. Such a tax would eliminate the need for corporate tax departments, tax lawyers, lobbyists and special interest agencies all in one simple stroke.

A tax on revenue would also rid us of an important source of corruption. And it would control aggressive CBDT officials who make “exaggerated” tax demands so that tax collection targets may be met a point made in the recent audit report by the CAG. The report also pointed to persistent and pervasive irregularities in calculating income and corporate taxes. With a flat tax on revenue, this problem would go away as well.

“Gross Receipts” taxes are simple, effective, transparent, fair and efficient. Both South Africa and Ireland assess a small “Turnover Tax” on all businesses. A tax on corporate revenue is imposed in several US states as well.

The finance ministry said in November that a task force would be created to study improvements to tax legislation. This committee should recommend replacing the corporate income tax by a small flat tax on corporate revenue. Doing so would further simplify our tax infrastructure now that the GST regime is firmly in place.

The writer is MD of education consultancy Rao Advisors LLC