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India's Tax Reforms Fall Short of Expectations
By Naresh Minocha
Feb 06, 2020

Naresh Minocha, a veteran journalist, specializes in governance, polity, macro-economic issues, telecom, energy, chemicals and agriculture. He has been working as Consulting Editor with since 2004. He writes and speaks with authority on any issue he picks up. In-depth research is his passion. In his over 37-years journalistic career, he has worked in different capacities for both Indian and foreign media organizations. He continues to enjoy endless, learning journey that he started during his university days in the seventies. He believes his quest to be a ‘Know-All' is boundless.

HOW to avoid messing up reforms & check slowing down a booming economy? If an international study on this issue is written, Indian taxation reforms would figure in it prominently. And evidence on this count especially on the big-bang goods and service tax (GST) keeps piling up.

A case in point is Indian Railways, the largest departmental enterprise. It is now struggling to replace more than 410 existing contracts with new ones (novation) to achieve tax efficiency with help of its GST consultant. Corporates of all sizes from different sectors are grappling with one GST issue or the other.

Another case in point is cautionary insight on GST & other taxes reforms issued by 15th Finance Commission (FC). It is a constitutional body constituted every five years to recommend distribution of divisible taxes between the Central and State (provincial) governments. Factor in too the Central Government's Budget for financial year 2020-21 that has, among other thing, hinted at fresh tinkering with GST rates.

Before elaborating on GST flux & resulting uncertainty, consider the fact that the outcome of all taxation reforms since 1991 is nothing to crow about if the tax revenue is measured as a percentage of gross domestic product (GDP). FC has pointed out that combined tax revenue of central and state governments has largely stagnated at 17.5% of the GDP since the early 1990s. This level is "far below India's estimated tax capacity", it says. "In contrast to India, tax revenue has been rising in other emerging markets".

FC has suggested that "the driver of tax reforms must be broadening of the base and streamlining the rates, with parallel steps to increase the capacity and expertise of the tax administration at all tiers of government".

FC is expected to elaborate of prioritization and sequencing of taxation & fiscal reforms in its 2nd and final report expected to be submitted in October 2020. Under Modi Government that came to power in May 2014, taxation reforms have been mixed bag of initiatives -mostly not well conceived and badly executed.

Take the case of direct tax code (DTC), which has been mooted first time in the mid-eighties. The previous UPA regime introduced DTC bill in Lower House of Parliament in 2010. After much debate, public comments and revisions, it was not enacted into a law. The Bill lapsed with dissolution of Lower House in May 2014. Modi Government saw no merit in reviving DTC as stated by late Arun Jaitley in March 2015 when he was Finance Minister.

In November 2017, the Government constituted a Task Force (TF) to draft a new direct tax law keeping in view, among other issues, the best international practices. TF gave its report in August 2019. Without making it public for seeking comments of stakeholders, the Government unveiled corporate tax cuts in September 2019. In the Budget presented on 1st February 2020, the Finance Minister Nirmala Sitharaman avoided uttering name DTC in her two-hour & 43 minutes speech. She didn't mention about TF's recommendations. DTC, that should integrate all direct tax laws & taxes, is nowhere in sight.

No wonder then that FC has observed: "There is also need to move towards the implementation of the Direct Tax Code by bringing all the direct taxes under a single code, removing exemptions, broad-basing the slabs, streamlining the rates and unifying compliance procedures. Parallel steps to increase the capacity and expertise of the tax administration at all tiers of government are long overdue".

The Budget, no doubt, provides for a slew of tax incentives for foreign investors. These include 100% tax exemption to all format of income from investments made in infrastructure & other specified sectors by sovereign wealth funds of foreign governments before 31st March 2024 & 1% percent reduction in withholding tax to 4% on interest earned on listed bonds. The Budget also proposed scrapping of dividend distribution tax (DDT) to benefit companies especially foreign ones. This has been levied on dividend declared by companies since 1996. Dividend would now be taxed in the hands of recipients as was the case prior to 1996.

The Budget has created an alternative stream of personal income tax (PIT) rates, thereby complicating tax structure. Such ‘either this or that' approach is similar to the one unveiled while offering lower corporate tax (CT) rates subject to tax payer foregoing existing exemptions.

If PIT assesses forgoes 70 tax exemptions, then they can exercise option to pay taxes at lower rates. Income Tax Act has over 100 exemptions & deductions (Es & Ds). The Finance Minister intends to review the remaining Es & Ds in coming years.

Two parallel tax structures in CT & PIT domains are thus set to increase the cost of compliance & oversight. The Government has not announced when the existing streams that are intertwined with exemptions would be withdrawn.

The Government, however, believes it has reformed taxes well. As put by Mrs Sitharaman "the direct taxes are now the lowest, simplest, and smoothest".

She added: "continuing the tax reform is an ongoing challenge and we propose to pursue them with full vigour".

The limitation of the CT incentives is that they would yield benefit in terms of higher economic growth and higher tax revenue over the medium & long-term. Moreover, the direct tax incentives announced in the budget would lead to significant revenue forgo.

Can the Government afford to go on forgoing tax revenue when it needs it urgently to arrest declining in growth of GDP?

The Government has perhaps assessed this issue internally. Hence its move to recover direct taxes under litigation through a compromise scheme .

Under this, Government would waive interest and penalty on disputed tax amount if it is paid by 31st March 2020. Disputed CT & PIT aggregate to Rs 802621 crore (Rs 8026.21 billion).

A similar scheme for recovery of disputed indirect taxes was announced last year. Finance Minister stated that the scheme led to settlement of more than 1,89,000 cases. She didn't disclose tax realized through this scheme.

These compromise schemes might be construed as incentive for others tax defaulters to enter into litigation to delay payment of taxes. They can very well use litigated tax amount as interest-free working capital till announcement of fresh settlement scheme. It is here pertinent to note that total CT and PIT arrears not under dispute but not realized is Rs 138471 crore (Rs 1384.71 billion) crore.

If tax arrears and tax disputes are taken as yardstick for success of tax reforms, then rise in unpaid taxes puts a big question mark on efficacy of reforms. The rise in tax frauds especially in GST and customs shows that there is something fundamentally wrong with tax reforms.

Before Modi Government came to power, the previous regime had done lot of spadework on tackling black money (BM). The current government chose BM as fulcrum to expand tax base and to enhance tax revenue. It enacted Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015. This brought in trickle of income stashed abroad.

This was followed by demonetization in November 2016 to target cash hidden within the country. It did lead to enrolment of new assesses as they came, deposited sacks of cash in banks and filed income tax returns.

Demonetization, however, hurt economic growth badly, thereby impacting both inflow of direct and indirect taxes. It led to failure of many businesses, thereby accentuating loan defaults. Informal or unorganized economy got GST as the 2 nd shock. It knocked at the core of their business operations - cash transactions end to end.

Launched in July 2017 by integrating several central & state taxes, GST is still a work in progress. It is governed by a statutory body GST council comprising Finance Ministers of Centre and States. It is managed through GST network (GSTN).

Hailed as driver of economic efficiency & integration, this one nation, one tax has suffered numerous problems and is subject to frequent changes in GST rates and regulations. Stakeholders are still exploring how to make the best of new tax regime with all realizing that it has increased the cost of compliance with GST rules.

The Railways belatedly realized that it can achieve tax efficiency by changing the contracts for implementation of projects financed with resources raised by its wholly owned company - Indian Railway Finance Corporation's (IRFC). It raises debt from the domestic and overseas capital markets. The railway lines, rolling stock and other assets developed with IRFC funds are categorized as extra budgetary resources-institutional finance (EBR-IF) projects

For these projects, IRFC has so far been treated as undisclosed principal, owner of projects. The Railways Ministry acts as IRFC's agent. The Railways awarded contracts, oversaw their execution till the completion. This was followed by leasing of projects/assets by IRFC to the Railways.

In mid-December 2019, Railways decided to remodel such contracts by making IRFC as disclosed principal, that is, the owner of projects. It would henceforth by buyer of equipment and services from the contractors.

Under this arrangement, contractors would issue all tax invoices to IRFC. It would henceforth avail of GST input tax credit, which is refund of tax paid of inputs used in projects.

To implement this format of contracts, IRFC obtained GST Identification Number (GSTNIN) in 26 States & Union Territories where it has or is financing rail projects. This contract model was to be effective from 1 st January 2020. This roll-out date was deferred to 1 st February 2020 as several zonal railways expressed difficulties in changeover to the new arrangement.

Under the arrangement, contracts with suppliers have to reworked to show direct transactions between IRFC and contractors in the documents. Suppliers would issue two identical payment invoices to IRFC and the Railways. The latter, acting purely as agent, would make payment on behalf of the former.

This date has again been shifted to 1 st March as Railways Board has not yet approved the draft novation agreement.

As for corporates' woes, there is a near unanimity among companies that GST has increased the administrative cost of compliance due to requirement for registration and form filing.

Impact of GST varies from sector to sector. Take the case of ReNew Power Private Limited. In its offering circular issued last month to prospective foreign subscribers of its bonds called senior notes, ReNew says: "there would be disruptions and likely loss of revenue in the short run because of the transition. Cost will reduce for manufacturers, though it will increase for the services sector".

It says that GST led to an increase in tax rates on equipment used in wind and solar energy projects, including material increases in the tax rates on components of solar power generating systems such as modules and cables, and on services such as civil and general works and evacuation costs.

Another company, Adani Transmission Limited, has similarly told international investors that "GST regime is at a nascent stage and the law relating to GST is undergoing frequent amendments. Such changes in law and rate clarifications may impact the Issuer's (its) operations, profitability and cash flows".

In her budget speech, Mrs Sitharaman mentioned steps being taken to reform GST system. She said GSTC is deliberating a new GST rate structure to address issues like inverted duty structure (IDS).

IDS is characterised by higher import duty on inputs/intermediates and lower duty on final product, thereby making manufacturing uncompetitive.

She also stated that revenue authorities are using deep data analytics and artificial intelligence tools for "crackdown on GST input tax credit refund, and other frauds and to identify all those who are trying to game the system".

According to FC, "GST is a critical component of the divisible pool and represents a fundamental shift in revenue federalism. The implementation of GST has thrown up multiple challenges: large shortfalls in collection vis-a-vis the original forecasts, high degree of volatility in collections, accumulation of large integrated GST (IGST) credit, continuing dependence of most States (twenty-one of twenty-nine in 2018-19) on compensation from the Union Government to make up for the shortfall from the assured 14 per cent growth in GST revenues, glitches in the operation of GSTN in general and invoice and input tax matching, delays in refunds and serious cases of frauds in particular. The implementation of GST continues to be work in progress, and it still needs many systemic and structure improvements to expand is scope, stabilise its operations and finally deliver its stated objectives. We need also to consider structural implications for low consumption States".

FC has noted that GST receipts are running short of the target by nearly Rs 100,000 crore (Rs 1000 billion).

The shortfall led to liquidity crunch at the Central Government. It has thus been delaying payment of compensation to States for any shortfall in State GST from assumed 14% annual rise in tax receipts for period of five years. GST receipts of most States have been below this assumed, annual rise.

As put by FC, "The short-term transitional difficulties in implementing these structural reforms can create a pessimistic view on the medium-term prospects of economic growth and revenue collections".

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