Tax policy in the time of demonetisation

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The income tax department is hyperactive now. The Budget will be watched for corporate tax rates and capital gains

Arun Jaitley will be presenting a very unique Budget in the aftermath of demonetisation which struck the economy like a bolt from the blue. All are agreed, including the President, that demonetisation will slow down GDP growth.

The Prime Minister has sought shelter for his move in the recommendations of the Justice Wanchoo Committee of 1971. He has cited American authorities such as James Henry of Mckenzie, Kenneth Rogoff and Larry Summers of Harvard in support. He thinks that the measure was delayed by 40 years.

Demonetisation effects

What started off as a measure to ward off fake notes used in funding terrorism, corruption and hoarding black money has now ended up with a call for cashless transactions in the aftermath of the long unending queues before banks and ATMs putting the common man to hardship for withdrawing his own money. It is easy to talk about cashless transactions.

In our country, the vast majority is not even used to banks leave alone debit cards. The beneficiaries of the call for cashless transactions will be mobile phone operators.

Minimum income scheme: Apart from fall in GDP growth, demonetisation has also led to expectations that the Budget may announce Universal Minimum Income Scheme under which every Jan Dhan account holder will get ₹1,000 per month for twelve months, resulting in an outgo of ₹3 lakh crore for the exchequer. That may very well justify the hardship borne by the common man.

Searches and seizures: The Income Tax Department is on a go. Searches and seizures are taking place left, right and centre. It did not require demonetisation to resort to large scale searches and seizures. Revenue gathered from searches and seizures will crystallise after a long time when litigation is over. In the meantime, government is announcing one amnesty after another. We had the Income Declaration Scheme, which ended on September 2016 and then came the Taxation Laws Second Amendment Act 2016, providing an amnesty for old currency now demonetised.

Undisclosed income in the form of cash or deposits in banks will be taxed at 30 per cent with a surcharge of 33 per cent of the tax and penalty of 10 per cent besides deposit of 25 per cent of the undisclosed income in Pradhan Mantri “Garib Kalyan Scheme” 2016 with a lock in period of four years. Non declaration of undisclosed cash or deposit in accounts under the scheme will mean a tax levy of 77.25 per cent.

Amnesty schemes: Amnesty schemes have never been popular with the cognoscenti. Scofflaws figure that they can wait until the next amnesty is announced. The Indonesian Amnesty Scheme has been more successful than India’s but opponents took the Government to court, arguing that amnesty amounted to legalised money laundering.

Budget options

Corporate tax: Government is committed to reducing the corporate tax rates. All the world over there is an aversion for levy of corporation tax. Professor Diego Zuluaga of the Institute of Financial Services, Institute of Economic Affairs, London, points out that about half of the cost of corporate tax is borne by employees in the form of lower wages because of reduced invested capital. The burden falls on shareholders, workers and consumers in varying proportions.

The Confederation of Indian Industry has called for reducing the Corporate Tax Rate to 18 per cent including all surcharges and cess along with removal of all tax incentives and concessions. It has noted that there are 32 incentives applicable on corporate profits before calculating tax which has resulted in an effective tax rate of just 19.8 per cent. Corporate tax rates need reduction because we are in a competitive environment where all countries are resorting to unhealthy tax competition to attract foreign direct and portfolio investment.

A new phenomenon considered harmful by the OECD relates to the concept of Base Erosion and Profit Sharing under which multinationals have the option to shift their profits to jurisdictions which levy minimum taxes. Barring US, most counties across the world have steeply reduced corporate tax rates.

There is the threat after India amended the tax treaties with Singapore, Mauritius and Cyprus, that FPIs may face capital gains tax and therefore may shift base to jurisdictions like France, Spain and Netherlands. from April 2017. The General Anti Avoidance Rules will start kicking in and investors in India will have to show substance or real presence.

Tax GDP ratio: Of the 3.8 per cent of India’s population of 130 crore, barely one quarter crossed the tax threshold; 0.1 per cent declare incomes of more than ten lakhs. Our tax to GDP ratio is just 10.8 per cent. This is well below the OECD average of more than a third.

There is call for a relook at the capital gains tax structure with suggestions for abolition of the special treatment for long term capital gains or at least follow the method suggested in the Direct Taxes Code of 2009. The way we tax dividends is most unsatisfactory. It favours the rich. A better solution will be to exempt dividends in the hands of the small shareholders and levy tax at the appropriate rate for those with larger dividends.

The proposed GST has raised hopes that the tax-GDP ratio will go up because of plugging of loopholes and better data entry in the system.

But States are insisting that tobacco, petroleum products and alcohol should be kept out of GST. Parthsarathy Shome fears that it will take 50 per cent of the GDP out of the GST and that will call for higher levy of GST.

The scope of of ideas thrown open by demonetisation only shows we are going to witness a most fascinating budget when it is presented in Parliament.

Ramanujam is a former chief commissioner of income tax; Sangeetha is an advocate

Published on January 12, 2017
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