Direct Taxes: The Death Of (Some) Taxes

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[The direct tax regime in the past few decades has been transformed: in tax rates, approach, and towards taxing real income. The Task Force on Implementation of the Fiscal Responsibility and Budget Management (FRBM) Act (the Kelkar Committee) advocated a revenue-driven strategy for achieving FRBM targets. It&rsquo;s working: in 2006-07, the tax to GDP ratio was 10.8 per cent, from 9.8 per cent of GDP in 2004-05. This growth is evident across the board. The proportion of direct taxes to total revenue has gone up from 19 per cent in 1991 to approximately 48 per cent in 2007-08. Corporate tax has risen sharply over the years: from 9.3 per cent in 1991 to 30.1 per cent in 2006-07; but personal income tax, also 9.3 per cent in 1991, has gone up to just 17.5 per cent in 2006-07. How have tax rates fared? For firms, they have gone down, but only marginally; the reduction in the base line rate from 35 per cent to 30 per cent has been offset by surcharges and cess, making the effective tax rate to 34 per cent. But tax rates have to be viewed holistically. For years, there were a variety of such disallowances &mdash; such as for sales promotion and entertainment expenses &mdash; that have been removed; though some of them have returned in the form of a fringe benefit tax, justifiably mooted to tax collective benefits enjoyed by employees. But that soon expanded into including items which had nothing to do with employees, let alone collective benefits envisaged by them. Depreciation rates were increased at some point of time and then reduced. The last reduction was in Budget 2005, wherein depreciation rate of general plant and machinery had been reduced to 15 per cent from 25 per cent. Several allowances, deductions and exemptions were permitted at various points in time &mdash; from development rebate to investment allowance (aimed at incentivising investments in new plant and machinery) to a plethora of others for setting up new units in backward areas. There have been sectoral exemptions, export related exemptions, deductions for computer and film software, hotels, and many others. Some exemptions continue; the rest have a sunset clause, like the exemption for units in software technology parks and 100 per cent export-oriented units. The one major exemption &mdash; a controversial one &mdash; is that for units in an SEZ. Personal tax is also being rationalised. Although the overall tax burden has been reduced by an increase in the basic exemption limit and changes in slabs, for higher income brackets the 10 per cent surcharge has a neutralising effect. There has been relief by reduction of rates for annual income levels of Rs 2,50,000, but only marginal reductions for higher income slabs. Savings are now more sensibly taxed, allowing deductions instead of rebates, and providing a composite limit (Rs 1 lakh) for all personal savings. The elimination of a few more exemptions (on withdrawal from life insurance, provident funds, etc.) faces implementation challenges, given the absence of social security. The withholding tax has been strengthened by introducing electronic tax deduction at source. Long-term capital gains on sale of equity shares has been exempted; tax rates for short-term capital gains is now 10 per cent, but with the introduction of securities transaction tax. The trend of reducing tax rates and removing exemptions has broadly continued over many years. But given the very dynamic and volatile environment, it may not be possible to adhere to this inflexibly. No one could have predicted the appreciation of the rupee and the significant drop in dollar earnings; already, the clamour for reinstating export related exemptions and deductions has begun. The next week will unfold the government&rsquo;s thinking at a very crucial juncture in India&rsquo;s economy. The author is the Executive Director at PricewaterhouseCoopers (Businessworld Issue 25 Feb-3 Mar 2008)