Why tax reforms fail to meet their objective

Shri Pranay Marfatia, Chairman of All India Federation of Tax Practitioners, Western Zone, Shri N. M. Ranka, President, of the Federation, Shri K. Shivaram, Deputy President Shri M. K. Chaturvedi, Vice President, ITAT, esteemed personalities on the dais, ladies and gentlemen. I feel honoured and privileged for having been invited to inaugurate the 12th National Convention in this great commercial city of Mumbai, particularly when such Conventions and Seminars are held when Budget Preparation is in the offing and particularly when as of date, there is throughout the country, great enthusiastic response to the Report of the Task Force on Direct & Indirect Taxes.

TAX EVOLUTION TO ECONOMIC REVOLUTION:

The topic from “Tax Evolution to Economic Revolution” is intricate. Economic Revolution is the goal, whereas Tax Evolution is one of the means to achieve that goal. I am not a certified Economist. However, as a citizen of this country, I would like India to be known as a secure Nation. As a citizen, I am concerned with GDP growth. We must discover ways and means to achieve GDP growth at the rate of 8% p.a. Too many young peoples’ future and too many poor peoples’ hopes rest on this achivement.

According to Professor Learner, restrictive or expansionary policies should be undertaken, depending on unused productive capacity and not on the basis of fiscal deficits or surplus. I often wonder why our policies are not based on Unused Productive Capacity. Our country has a surplus of $ 65 billion in foreign exchange reserves, foodgrains, manpower and industrial capacity. However, we have failed to exploit these surpluses.

MAJOR DRAWBACKS IN THE ECONOMY:

Endemic delays of our judicial system

According to Dr. Jalan, RBI Governor, one of the impediments to the GDP growth of 8% is delays of our judicial system. These delays adversely affect mobility of capital for which the entire economy has to pay the price.

A recent survey of 1,800 companies under liquidation shows that 59% of the cases took more than 10 years. In other words, capital was frozen for 10 years. However, we have to pay a very heavy price for such delays. If, for 20 years, resources, including land, machinery and workers get locked up, then the economy as a whole becomes less competitive and it results in increased cost of capital and interest rates for every one, including the Government. As a result, all of us have to pay the price for this delay and inefficiency.

Inefficiency of investments: Fiscal consolidation is the key

Our country is capable of achieving growth rate of 8% GDP, provided we improve our work culture. In this connection, the Government needs the support from the people. We need labour reforms, competition and we need to bring in more Foreign Direct Investment. To achieve 8% growth, the investment rate should increase to 33% of GDP and in order to increase the investment rate, we need to increase domestic savings to 30% of GDP. Lastly, we need to reduce the Total Fiscal Deficit to 4% of GDP.

Poor expenditure management

Over the last couple of years, the Tax proposals show that the real problem faced by the economy is not answered. Taxes are heavily imposed on fixed income-earners while no effective steps are taken to curb Government expenditure. To give an example of how a rupee was spent by GOI during fiscal year ending 31st March, 2001, it may be noted that:

RECEIPTS
RUPEES IN CRORES

Total Receipt Rs. 2,81,000 cr.
Transfer to States Rs. 72,000 cr.
Balance with GOI Rs. 2,09,000 cr.

EXPENDITURE
RUPEES IN CRORES

Interest Rs. 1,00,000 cr.
Defence Rs. 50,000 cr.
Subsidy Rs. 23,000 cr.
Pension Rs. 16,000 cr.
Total Non-Plan Expenditure Rs. 1,98,000 cr.
Balance with GOI Rs. 12,000 cr.

From the above balance, it is clear that 69% of the tax revenue goes for interest payment.

As on 1st November, 2002, the total indebtedness of State of Maharashtra was Rs. 72,000 cr. Therefore, expenditure management is the solution which can be achieved if the Government has political will and co-operation from people. Expenditure management can bring about tax revolution. This year, revenue expenditure of GOI has increased by 16% against Budget estimate of 11% + capital expenditure is 3% against estimated 11%.

Moreover, we need to inculcate the concept of financial accountability. If Rs. 72,000 crores are transferred to the State, then this State must account for it.

Therefore, I am of the view that the tax proposals recommended by Dr. Kelkar Committee, though relevant, may remain cosmetic unless the root cause, viz. excessive Government expenditure, is tackled.

Political will:

Political will is one of the key factors required for growth of economy. Be it concerning taxation of agricultural income, labour reforms or disinvestment to the tune of Rs. 80,000 crs. recommended by the Xth Plan.

Need to increase foreign direct investment into India:

In the context of global uncertainty, India’s growth rate of 8% will attract attention provided we create like conditions. We can achieve the target of $ 15 billion, provided we improve our bureaucracy, eliminate political uncertainty and introduce infrastructural reforms. Recently, when Jack Welsh (CEO of General Electrics) came to India to inaugurate a function, the power supply went off six times. This should not happen. Lastly, we need to give tax incentives to companies like Intel. Recently, Israel provided tax incentives to Intel to the tune of $ 600 million in order to prevent Intel from shifting to Ireland. According to International Agencies, we are understating FDI numbers by 75%. If so, someone should get the record straight. We should encourage firms in Business Process Outsourcing, which is doing very well.

TAX REFORMS:

One of the methods of achieving economic revolution is to improve tax to GDP ratio, without making the tax system confiscatory. It is here that the role of seminars and conventions come into play because they suggest ways of achieving a rational tax structure which is fair and equitable.

One of the items on the Agenda of this Convention is the Task Force proposals on Direct Taxes constituted by the Ministry of Finance, Department of Revenue under the Chairmanship of Dr. V. L. Kelkar.

At the outset, I am sure that in the next two days, the Technical Committees would deliberate on these proposals.

The purpose of my referring to the drawbacks in the economy and particularly poor expenditure management on the part of the Government is to highlight an important point viz. that these Tax proposals, both concerning Direct and Indirect Taxes, though relevant, would stand defeated if the Government fails to control its expenditure. Good governance and proper expenditure management should constitute the basis for achieving economic revolution. The proposals made by the Task Force would be rendered cosmetic unless emergent steps are taken to control Government expenditure. The proposals of the Task Force have recommended elimination of tax incentives, deductions and exemptions for various reasons, one such reason being that these exemptions create distortion in the tax structure. However, the biggest distortion is caused by mounting Government expenditure. My apprehension is that we are not treating the economy as a whole. We are not treating the patient as a whole. We need to take simultaneous steps to curtail Government expenditure and tax reforms should go hand-in-hand with such curtailment because only then the reforms could succeed. Further, tax incentives in a developing economy, have a role to play. Countries like Korea, Israel, Ireland and China have benefited by tax incentives. Let us not go by examples of developed economies. In India, the benefit of tax incentives is wiped out by Government expenditure.

It is for this reason that I have relied upon the data for the fiscal year ending 31st March, 2001. It is for this reason that I have referred to the growing indebtedness of State of Maharashtra as on 1st November, 2002. This is in order to show that unless we curtail the Government expenditure, the proposals made by the Task Force would be rendered meaningless. We need to keep the entire picture before us.

To my mind, these proposals need to be deferred or at least implemented in stages for the following reasons. Firstly, the speed with which these proposals have been made is totally unjustifiable. It does not take into account consequences of elimination of exemptions. For example, the Task Force has recommended elimination of exemptions and tax holidays under sections 10A and 10B of the Income-tax Act on the ground that these exemptions create distortions to the tax structure. As stated hereinabove, the Task Force does not take into account the entire economy. In his recent book, Dr. Jalan, Governor of RBI has commented that India’s record in honouring financial contracts is poor. It is important to bear in mind that tax holidays were given to EOU and Software Export Companies initially for ten years. Contracts were entered into on the basis of exemption. If exemptions are withdrawn, then it would be impossible to honour financial contracts. Similarly, one of the proposals made by the Task Force is to remove rebates on capital investments as one of the means to tackle the problem of increased non-performing assets of banks and financial institutions running into Rs. 1,10,000 crores on the ground that these rebates are often misused. The various JPC Reports from 1992 show irregularities in banking transactions on account of collusion between bank officials and constituents. It is important to bear in mind that Banks pay only 6% interest on fixed deposit, but they charge 10% on housing loan. In other free economies, banks work on spreads of not more than 2%. In India it is 4%. This is because we have to pay for inefficiency of the banks, the overheads and lastly, because we underwrite banks non-performing assets. No doubt, the Securitization and Reconstruction of Financial Assets Act is a step in the right direction, but it needs to be implemented properly. Otherwise, I am afraid that the situation will not improve and the consequence would be that rebates on capital investment under the Income-tax Act, which have an important role to play, would be hastily eliminated without reduction of Problems Loans. Moreover, the triad of adequate liquidity in the system, a benign inflation rate and lack of credit demand can encourage companies to dictate terms to lenders. It is for this reason that I am of the view that these Tax proposals need to be deferred or spreadover. One of the criticism levelled by bank officials is against the Judicial process. The complaint has been that banks are not in a position to recover the loans expeditiously. However, this criticism is not fully justified. The manner in which loans are sanctioned needs to be investigated. In several cases, proper Valuation Reports are not called for while sanctioning the loans. My apprehension is that unless all proper measures are taken, mere Tax proposals would not help the economy and a stage might come where we may be compelled to bring back some of the eliminated incentives. Further, in the age of globalization, foreign direct investment plays an important role. The Tax proposal has made certain suggestions on the basis of the economic situation prevailing in highly developed countries. That may not be appropriate to our conditions. It is for this reason that I gave the example of tax incentives offered by Israel to Intel, amounting to $ 600 million in order to prevent that company from shifting to Ireland. Therefore, in the present state of our economy and with World recession, I am of the view that these proposals need to be deferred. Further, this country is facing drought this year. This year, on account of drought, we anticipate expenditure of Rs. 5,000 crores. This is one more reason for deferring implementation of these Tax proposals. Further, the data collected by International agencies show that we are understating foreign direct investment numbers by 75%. That our software exports and business process outsourcing are to the tune of $ 10 billion [See Report of NASCOM]. If these figures are correct, then I do not agree with the Task Force, which has recommended elimination of tax incentives to exporters under section 80HHC etc. Of course, this data needs to be checked, but if this data is correct, then the proposal for elimination of section 80HHC is not warranted. It is for this reason that I have stated that these proposals are drafted hastily. Lastly, some of these fiscal incentives have social value. For example, section 80DDB of the Income-tax Act provides for deduction to people suffering from AIDS. These incentives cannot be withdrawn. Similarly, removal of deduction from house property income on account of interest payments on borrowed capital may not be a correct decision in the Indian context as in India, differential interest rates on housing loans at 9.5% p.a. is higher than those prevailing in developed countries. I am fully aware that these incentives have an element of subsidy in-built, but as stated herein above, we have to go by the Indian context as the said incentive gives impetus to steel, cement and housing sectors. It is true that the Government is trying its best to bring down the interest burden. However, unless we step out of political economy, it would not be possible to achieve economic revolution. The Government must down-size its Jumbo cabinets. The Government should take steps to enlighten the public on economic issues because without co-operation from the people it would not be possible to achieve economic revolution. Further, I am not in favour of repeal of Chapter XIVB because block assessment proceedings provide for short-term goal of maximizing the revenue and looking to the recession in the economy today, I am of the view that Chapter XIVB of the Income-tax Act should be continued. The Task Force has also suggested restriction of depreciation allowance under section 32 of the Income-tax Act to the amounts charged to Profit & Loss Account as per Companies Act. However, this may require amendments to sections 205, 350 and Schedule XIV of the Companies Act, which enable companies to charge depreciation in a manner it likes in respect of assets not mentioned in the Schedule. Therefore, I once again repeat that before implementing the proposals of the Task Force, an in-depth examination be carried out. The Technical Committee should consider all these aspects in the next two days. Similarly, it would not be advisable to repeal section 36(1)(iii) of the Income-tax Act as the proposed elimination of interest on capital borrowed for business can fall under section 37 of the Income-tax Act.

In this Seminar/Convention I would request the Technical Committees, if possible to consider tax reforms on following subjects:
(i) Tax Competition.

(ii) Transfer Pricing Regulation

(iii) E-Commerce Taxation

(iv) Tax Treatise

(v) International Taxation, and

(vi) Corporate Restructuring

CONCLUSION

I recommend strongly that for the next 10 years, India should pursue only One-Point Programme viz. Economic Development. Our country is rich in resources. However, we fritter away those resources by going into non-issues.

It is the duty of every Indian – Professional, business entrepreneur, workmen – to perform his/her duty keeping in mind the economic development of the country. Every bandh, protest, stone-throwing incident, damaging public utility services during strike causes economic loss to the country. Every stone thrown during the cricket match discourages foreign investment. Every wrong advise given by the Tax Professionals have economic consequences. It is the duty of the Tax Professionals not to encourage tax evasion in the garb of tax planning. There is a very thin line between legitimate tax litigation and illegitimate tax evasion. Your Federation has prescribed a Code of Conduct in which they have laid down the duties of tax lawyers to their clients, to their opponents and to the Court. I recommend one more clause – “Duty to the Country”.