Challenge in corporate tax

IT WAS always known that the fate of the Kelkar task force recommendations on tax reform would be decided by the political acceptability of its proposals on direct taxes. This has become apparent after finalisation of the two reports on direct and indirect taxes. True, there have been some protests by industries which will be affected by implementation of the proposals on indirect taxes, notably by the textile and small-scale industries about the panel's recommendations on excise duties. However, these are minor voices of complaint compared to the volley of protests that greeted the publication of the consultation paper on direct taxes a couple of months ago.

Now that the final report on direct taxes has been released, what are the chances that the entire package of tax reform will be implemented by Jaswant Singh when he presents the Union budget for 2003-04 next month? There has been an element of moderation of the earlier proposals on personal income tax. Senior citizens will start paying tax at a higher level of income, interest payments on housing loans will enjoy tax exemption up to a ceiling and some allowance has been made for preferential treatment of contributions to retirement schemes. But if one were to go by the initial reaction of the Bharatiya Janata Party these are not adequate concessions for the party's traditional supporters among the urban salaried and self-employed. Yet, it is not the BJP's views on the taxation of household savings or for that matter the criticism by the likes of Om Prakash Chautala of the proposal to tax agricultural income which will decide the fate of the Kelkar proposals.

The unspoken story of the controversy that has swirled round the Kelkar committees is that the proposal which will have by far the biggest fallout is the one on corporate taxes. It is not the removal of most exemptions on personal income taxes or the streamlining of excise and customs duties which will shake up the tax economy. It is instead the twin suggestions of a lowering of the corporate tax rate on domestic companies to 30 per cent, the removal of exemptions, a lowering of the depreciation rate to 15 per cent and in general an alignment of book profits with the profits reported for payment of taxes which will together have the biggest impact on tax revenue. At one stroke, many of India's highly profitable companies which have substantially succeeded in avoiding payment of corporate tax will find the existing legal loop-holes closed to them. For this very reason, one can expect a tremendous amount of lobbying to prevent the Finance Minister from implementing the suggestions on corporate taxes. If the Kelkar proposals on direct taxes are one package, rejection of the recommendations on corporate taxes will mean the others too will be scrapped. And if the direct tax proposals are given short shrift, so too the panel's package on indirect taxes.

The proposal to lower the corporate tax rate from 36.75 per cent to 30 per cent, alongside the removal of most exemptions on salaried income, has been seen by some as a "pro-rich" proposal by the Kelkar panel. While there can be some questions about the implications for equity of some of the recommendations (the suggestion to abolish dividend tax is the most obvious one), the proposal on corporate taxes is certainly not one of them. Indeed, it can even be argued that the task force has dared to take on some of the biggest and most powerful entities in the corporate sector. Can it be allowed to succeed?

Statistics reported in the consultation paper and amplified in the final report reveal the scale of the problem in corporate taxes. In 1999-2000, the tax rate, according to law, was 38.5 per cent but among a sample of 3,777 profit-making companies the effective rate paid was just 21.7 per cent of profits. In 2000-01, the statutory rate was 39.55 per cent, but the effective levy among 2,585 companies was 21.9 per cent. And, more recently, in 2001-02 in a smaller sample of 1,275 non-banking companies the tax paid worked out to an average of 21.75 per cent when the corporate tax rate was supposed to be 36.75 per cent. Companies which have been astute in taking advantage of the legal exemptions and loopholes have clearly been able to avoid paying corporate tax to the full extent. An illustrative exercise of the Kelkar task force on direct taxes indicates that implementation of the recommendations (lowering the tax rate to 30 per cent but correspondingly removing most exemptions) would raise revenue from non-banking companies by as much as 34 per cent. The Rs. 40,000 crores that the Government has budgeted to collect from this sector in 2002-03 would instead fetch as much as Rs. 53,600 crores. This is hardly a "pro-rich" recommendation by the Kelkar panel.

One cannot expect corporates to silently accept such a recommendation on streamlining taxes on company profits. So far, the outcry against the personal income tax proposals contained in the consultation paper — which in effect was an attack on the larger Kelkar package — has allowed the companies with an interest in killing the recommendations on corporate taxes to remain silent. But as it gets closer to the time to take a final decision on overhauling the tax rates and structure, one can be sure that all the powers of persuasion and pressure will be brought to bear on the Government to not implement what is a radical tax proposal. The arguments will be the familiar ones — that such a decision will affect corporate profitability, have a negative impact on investment, will stifle potential global competitors among Indian companies and place Indian companies at an even greater disadvantage vis-a-vis their competitors. But it is reasonable to ask if profits built on (legal) tax avoidance should be protected and if a moderate (perhaps even low) tax rate of 30 per cent in a transparent tax regime will not provide a stronger foundation for the Indian corporate sector. The debate about the Kelkar proposals has been muddied by the accusations and counter-accusations on personal income taxes and concessions for savings. The stakes are much greater in corporate taxes.

Tailpiece: One feature of the task force reports which must be universally welcomed is the information they have made public and in the process demolished some shibboleths. One such is the relative size of the tax burden borne by the salaried and non-salaried. From the data in the reports, it turns out that one weapon in the so-called Indian tax rebellion has been forged partly in myth. The tax records show that of the 27 million Indians who are expected to file income tax returns this year, 16 million, or close to 60 per cent, are from the non-salaried (self-employed) groups. The self-employed now account for 51 per cent of total income tax collections. This suggests that it may not be true that it is the salaried who are bearing a disproportionate burden of income tax. A fuller picture reveals that while among the salaried, those earning between Rs 1 and 3 lakhs a year contribute to 58 per cent of tax collections from this group, the payment by the non-salaried is top heavy. More than a third of the 16 million non-salaried who file their returns report incomes of less than Rs. 60,000 a year and pay almost no income tax, while the creme de la creme among the non-salaried (those reporting incomes of more than Rs. 5 lakhs a year) account for 53 per cent of tax revenue from this group.

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