Off Season Tax Cuts

The finance minister said that the budget is not the only medium to announce concessions. Very few expected that he will choose off the parliament to announce wide tax cuts which bring joy to the public. Although the wider consequences are good there are hidden troubles. Especially EET (Exempt exempt tax) for the senior citizens who withdraw their pension fund sounds sad. The saving rate hiked from Rs.1 lakh to Rs.3 lakh sounds good but investment in mutual funds, post offices, fixed deposits and insurance are not allowed. Mr.F.M where can we invest this saving?

The Times of India writes (14 August 2009)


The promise of a modern direct tax code is that lower taxes and simpler rules ensure compliance and more revenue. Its provisions should avoid
complicated clauses, sub-clauses and caveats. Tax rates should factor in earning profiles. Also, successful tax rationalisation involves weeding out unnecessary exemptions and bad taxes. The draft of a radically new direct taxes code unveiled by the government scores in all these areas. And it should engender less litigation than the 1961 law, a jungle of rules expressed in inaccessible bureaucratese.

The tax authorities' definition of 'high income' has remained out of touch with India's post-reforms economic realities in terms of the middle class's changing face, transformed income levels and cost of living. Recognising this, the draft code substantially reduces individual and corporate income tax liability. But there's a case for a higher cut-off for tax application than the proposed Rs 1.6 lakh annual income. Reducing the corporate tax rate brings it in line with rates in many major economies. There will be heartburn over removal of exemptions, including home loan tax breaks. The draft code's larger premise, however, is unexceptionable. Not persisting with incentives for pre-selected economic activities, it seeks to put more money in people's hands to be spent or invested on the basis of choice rather than nudging.

Enhancing the tax deduction ceiling on savings is pocket-friendly. But feelgood may be offset by the exempt, exempt, tax (EET) regime extended to all approved social security investments. True, this addresses the anomaly of EET applying only to the New Pension Scheme. But it's debatable if withdrawals should be taxed, given the precariousness of our social security structures. Some investments as in provident fund are mandatory. So people would effectively be taxed on forced savings. If EET does kick in, all social security savings should be a matter of choice. Also, more thought needs to be given to ensuring the economic security of senior citizens.

The minimum alternate tax is to apply to assets, not book profits. This obligation is in line with international practices. But the 2 per cent tax rate seems excessive and could negatively impact loss-making companies and capital-intensive businesses. As for taxing foreign firms, should bilateral tax treaties be overturned, it can have a bearing on foreign capital. While foreign companies should be taxed like any other business, taxmen shouldn't appear to change rules agreed upon mutually. Overall, the draft code is welcome, more so when taken along with the goods and services tax (GST) that's to kick in by 2010. GST is work-in-progress and the new income tax code has a 2011 deadline. Should these dates be kept, India's direct and indirect tax system will soon be revolutionised. Here's hoping for a smooth road to implementation.

GST should be put in

There are price variations and duping on the products. Customers are troubled over many golmals by the shopkeepers. Their basic excuse is the tax varies from state to state. The proposed GST will remove this anomaly and increase the national integration of the people and reduce their pain.

Pratik Jain, Executive Director of KPMG writes in The Economic Times (21 July 2009)

When the finance minister reaffirmed implementation of GST from April 2010 in his budget speech, not many were convinced. However, in his
post-budget interactions with industry associations the following day, the minister indicated that the deadline of April 2010 is indeed realistic and the country may adopt a ‘partial’ GST regime in case some of the states do not to come on-board by that time.

Now, this is the first time that the government has talked about partial GST, much like state VAT, when most of the states implemented from April 1, 2005, while few came along the way later. Obviously, this has created a bit of confusion and there are several unanswered questions.

The first obvious issue is what would be the form of partial implementation. Does it imply that while Central GST
would be implemented uniformly in all states, the state GST would only be implemented in select states? The other alternative could be that even Central GST is not implemented in states which are not ready for the big move on 1 April 2010. The first scenario seems more fungible, as partial implementation of Central GST could lead to nightmares. Therefore, it is reasonable to assume that even in a partial GST scenario; the Central GST would be implemented in its entirety.

The issues and anomalies likely to result from piecemeal implementation are numerous. These include seamless flow of state tax credits on inter-state transactions, rate mismatches between GST and non-GST states resulting in diversion of trade, levy of state GST on services, etc.

Though the last major indirect tax reform i.e. VAT was also implemented in phases over a period of 2 years, it may not be prudent to rely merely on success of VAT and presume that phased implementation of GST would also yield similar results. There are fundamental differences between the two levies, with partial GST having much wider ramifications as compared to partial VAT regime.

For instance, VAT is purely a state subject and does not impact transactions involving multiple states. Therefore, transactions between VAT and non-VAT states (such as inter-state sales/ stock transfers) did not warrant any special treatment. Such transactions continued to be governed by the Central Sales Tax (CST) laws, which applied uniformly across all states, and was collected by the state of origin.

However, under GST, since CST is likely to be phased-out and replaced with some sort of destination based tax, a special taxing scheme would need to be devised for transactions between GST and non-GST states. For instance, when goods are sold from the GST to a non-GST state, then how will it be taxed? GST state can not tax it (assuming origin based CST is abolished by then).

Similarly, non-GST state can not tax it as the destination based taxation under the GST regime would not be applicable to them. Then, are we saying that under partial GST, we will continue with CST in some form?
Under GST, the states would also be given the right to levy and collect state GST on select services. While articulating the ‘place of supply rules’ for ascertaining the relevant state that would levy state GST itself would be a difficult task (given the international experience), drafting these rules with exceptions for non-GST states would be even more difficult.



For instance, if a taxable service is consumed in a non-GST state, the state would have no power to levy service tax/state GST on the supply. Will this not give an unfair advantage of the consumers of a non-GST state over the GST state? Or will the Centre perhaps levy Central GST on such transactions at a higher rate in the non-GST state, and then pass on a part of proceeds to the state? If the view is that under partial GST, the states will not be levying tax on services, then would that be a real GST?

Currently, a mean rate of 16% (8% Central GST and 8% state GST) is being talked about. However, in a non-GST state, the rates could be different, as currently on most products standard VAT rate is 12.5%. If these states do not align their rates with the state GST rate in the neighbouring state, then there would definitely be diversion of trade, removal of which is one of the primary objectives of GST.

Then there would be several procedural and administrative issues as well. For instance, the taxpayers with operations spread over GST and non-GST states would need to have two sets of internal processes, IT infrastructure, invoicing mechanism, etc. Fixation of MRP for products sold in different geographies would also be a challenge in light of the variations in tax rates, credit mechanism, etc.

To conclude, it may not be absolutely reasonable to tread the path of a major reform by taking the first step back instead of forward. While such a bold move may be warranted in exceptional circumstances, many would argue that there is nothing egregious about the existing tax regime that would make the 2010 deadline sacrosanct.

After all, we have been operating in this regime for past several decades, and have still managed to be one of the fastest growing economies in the world. Therefore, before taking a final call on the transition date for GST, one would hope that the implementing agencies would have taken into account all ramifications and the alternatives available.