There are many facets to the context of Budget 2010-11. Let us look at the factors that would inevitably be on the top of finance minister Pranab Mukherjees mind when it comes to direct taxes: The tax collection trend is now marked by a temperate phase after the stupendous growth of four years up to 2007-08; increasing share of direct taxes in the Centres gross tax receipts; the shift from profit-linked to investment-linked incentives that was initiated in the last Budget; the draft Direct Taxes Code that proposes significant policy changes; and above all, the question of equitable taxation.
Direct tax collections this year would be some Rs 10,000-15,000 crore or so above the Budget estimate of Rs 3.7 lakh crore, yet shy of the tax departments internally revised figure of Rs 4 lakh crore. This would be a good 10-11% increase over the previous year, which is definitely not something to be scoffed at in a crisis year.
Of course, the collections this year would pale in comparison to the spectacular growth figures of the four years up to 2007-08 during which the direct tax revenue tripled thanks to the combined effect of three factors in the following order: sturdy expansion of the economy, increased compliance achieved through moderate tax rates and improved efficiency of tax administration. (Collections in 07-08 were Rs 3.1 lakh crore, up 37% over the previous year, but the growth declined to just 8% in 2008-09 as the latter half of the year saw the worst effect of the global economic crisis on India Inc and personal income tax payers).
Recent years saw a steady increase in the share of direct taxes in the Central governments gross tax revenue from 41% in 2003-04 to 56% in 08-09. In the last Budget, the finance minister Pranab Mukherjee obliquely referred to this trend and said it reflected a sharp improvement in the equity of the countrys tax system. The general belief is that direct taxes are more equitable than indirect taxes as the former allows, up to a certain extent, gradation of tax rates in line with income progress. Indirect taxes are mostly neutral to the earning capacity of the taxpayer, although it also does have some scope for differentiation like higher excise on big cars.
But precious little has been done in successive Budgets to correct the prevalent system where the effective tax rate (ETR) on large companies is much lower than that on smaller firms. While the statutory rate is 33.99%, the ETR for companies with profit before tax (PBT) of greater than Rs 500 crore is 21.85%. While the average ETR is 22.24%, it is 24.04% for companies with PBT up to Rs 1 crore and 22.46% for firms with PBT of Rs 1-10 crore.
It is obvious that tax incentives go mostly to bigger firms. This stunts economic expansion. It is unlikely the newly engineered shift from the profit-linked to investment-linked incentives would automatically address the inequity, even as it would encourage capital formation in the economy. In fact, it could even exacerbate the situation, unless the government makes a deliberate effort to reduce the tax burden of smaller firms and institutes a mechanism for preventing the misuse of such comparative benefit.
Another often glossed over fact is that public sector companies pay a larger proportion of their profits as tax (ETR of 25.69%) than private companies (ETR of 21.28%). So, contrary to popular belief, private sector entails much larger tax expenditure for the government. There are also patent differences between companies belonging to different sectors of the economy when it comes to their tax burden.
This, however, results from well-articulated policy preferences rather than subterfuge. Technology companies have a lower tax burden with ETR of 14-16% (thanks to Section 10A and 10B tax holidays). Infrastructure companies too have generally reduced their tax liability in recent years thanks to sundry incentives. However, manufacturing firms, especially FMCG companies and most service-sector firms have higher ETRs of 25-30%.
The rate of tax on corporate income in India is fairly moderate and comparable to that of developed economies. It may be noted that many developed countries hiked corporate tax rates as the economic recession undermined government finances. The UK for instance hiked the highest rate for taxing corporate income to 50%. China is the only major country that has cut the corporate tax rate (to 25%) recently. So, with the fisc under strain and the DTC that proposes a revamp of the tax regime likely to be in place in a year or so, there isnt a case for reducing the statutory rate in this years Budget. Whenever a rate cut comes, there should be concomitant removal of various exemptions and other concessions. The DTC proposes a reduction in corporate tax rate to 25% but contingent on cleansing of the exemptions slate.
Coming to certain specific expectations, there is a demand for removal of the surcharge on corporate income so as to align corporate tax rate with (the highest) personal income tax rate. (The 10% surcharge on PIT was removed in last Budget). Another question is if the tax holiday for software export units would be extended again, for one more year, or till the DTC is introduced. This tax holiday, extended for a year in last Budget, is due to expire on March 31, 2010.
Would the finance minister change the way dividends are taxed? The classical way to tax dividends at the hands of the shareholders. India and South Africa are among countries where dividends are taxed at the firm level. Since the DDT rate (15%) is half the highest PIT rate (30%), promoters of highly profit-making companies and institutional shareholders are envied for their windfall gains. The policymakers cite a reduction in the administration load for the current manner of DDT levy. One proposal is to shift to the global practice of taxing dividends at the hands of the shareholders and introduce an exemption threshold of 25,000-50,000 a year as dividend income to lessen the burden on small shareholders.
There is an ongoing debate on whether short-term capital gains from listed securities should be treated at par with business income and taxed accordingly. (Short term capital gains are taxed at 15%). Such a measure could help enhance revenue, but the finance minister has the option to wait till the introduction of DTC, which proposes to tax all capital gains at par with business income.
The DTC proposal to levy minimum alternate tax (MAT) on gross assets is widely opposed, as it would be a huge burden on asset-heavy companies. But the fact remains that over 90% of the registered companies in India dont pay tax as they dont declare profits. A sizeable section of these companies are sitting on large assets. The hike in MAT rate to 15% in the last Budget was aimed at enhancing equity and the strategy seems to have worked. As far as PIT is concerned, the Budget is expected to largely maintain the status quo, as the DDT proposes a major revamp that would bring 90% of the taxpayers at 10% tax rate, but along with the removal of HRA benefits and a system of taxing retirement benefits on withdrawal.
The sturdy economic recovery is what the revenue department has pinned its hopes on, when it says the last three months of the fiscal would see a rather dramatic rise in direct tax collections, so as to touch the Rs 4 lakh crore mark. However, there are certain factors that belie this notion. For instance, the new dispute resolution scheme introduced last year prevents the assessing officers (AOs) from slapping demand notices on foreign taxpayers till the dispute resolution panel reviews the draft order and gives its opinion in nine months. This, of course, will reduce litigation and enhance revenue by bringing more certainty to AOs demands, but could adversely affect revenue this year.