GST has brought in a structural change in the indirect tax system in India. Continuous improvements in the structure, IT, administration and review systems in the GST through the GST Council will certainly improve the current construct and lift the economy up in the years ahead.
What is needed now is a similar reform on the direct tax front. It is time to revamp the Income Tax Act 1944.
Over time, cosmetic changes, complications, poor tax administration and a complex law have crept in.
What is needed is a simple, easy-to-understand but effective direct tax law. A few key areas need focus: clarity is required as to whether income tax is on gross income or net income. In other words, is the objective of income tax to tax gross income or income after savings, investment and consumption.
The tax base needs to be widened. Only 1.5% of our 130 crore people pay Income Tax and only 30,000 people earn more than ₹1 crore per annum. A good 90% of taxpayers contribute to only 23% of tax revenue. A large-scale exclusion of the population in paying income tax is seen. Predictably, the tax base has shrunk from 2.7 crore in FY’03 to 2 crore in FY’17.
While salaried employees in the formal sector dutifully pay income tax, there is large-scale evasion from informal sector, traders etc. This needs plugging.
Reduce rates, remove exemptions
High rates are a recipe for low tax compliance.
A lower rate for lower incomes and high rates for higher incomes will ensure better balance.
The threshold for income tax needs to be revised periodically to counter the effects of inflation.
A plethora of exemptions and deductions, adding to litigation on these, needs to be removed.
For individuals, there should be simple formula for net income taxation. Assuming gross income from all sources is ₹100, allow 35% for savings, 32.5% of the remaining for consumption. As a result, only ₹32.5 of the gross income should be taxable.
For corporates, the calculation is as follows. For ₹100 of profit before tax, add book depreciation of 10%. Limit 35% for investments in assets for future business growth. Hence income chargeable to tax is ₹71.5
For individuals, those earning below ₹5 lakh need not be taxed. Those between this floor and ₹10 lakh should be taxed at 5%, while income between ₹10 lakh and ₹1 crore should be taxed at 10%.
The next slab till ₹10 crore should see 15% tax. Anything above that would be taxed at 20%.
For corporates, rate should be 10% up to ₹100 crore of chargeable income and 15% between that floor and ₹500 crore. The next slab up to ₹1,000 crore should be taxed 20%. Those above ₹1,000 crore should be taxed at 25%.
Once audited accounts are as per accounting standards, tax authorities should not have any discretion to review the basis of accounting. This will ensure avoidance of unnecessary legal disputes.
Remove Anomalies
Several anomalies have crept into the current direct tax system. These include dividend distribution tax, MAT, surcharges / cess and interest rate arbitrage between delayed refunds and tax payments. Further, as net income is taxed once, any gift, wealth or estate passing on to others from the taxed net Income should not be taxed again.
An estimated 3.9 lakh cases are pending before several appeal forums. If laws are made simple, litigation will be reduced. Online assessments should be encouraged. A differential tax for cash transactions may be considered, to discourage offline modes of payment. Further, processes in assessment of tax, and for appeals thereafter, should be simplified. Setting a time limit for assessments, appeals and hearings / passing of orders should be specified and enforced.
