We expect Budget 2010 to lay down the roadmap for achieving a 10% Gross Domestic Product growth rate while containing inflation and the burgeoning fiscal deficit. This appears to be an impossible trilogy given that increased government spending and tax benefits are likely to be key growth drivers which would make inflation and fiscal deficit controls onerous tasks. Balancing these would be the most important task for the finance minister on Budget Day.
This article focuses on the revenue proposals expected from Budget 2010.
There has been an engaging debate on the rollback of the stimulus in the wake of the recovery. Opinions vary on both the timing and extent of the rollback.
One school of thought argues that a withdrawal of the stimulus is imperative to contain rising inflation, while an opposing thought is that this would nip the economic recovery in the bud. Let us split the stimulus into fiscal and monetary measures.
The Reserve Bank of India's decision to begin a rollback of the monetary measures augurs well for inflation control. Fiscal measures were meant to reduce production costs for both consumer and capital goods and thereby stimulate consumption and investment demand. Withdrawing these measures is likely to result in cost-induced inflationary pressure, especially if increased taxes are passed on to consumers.
Needless to say, the likely impact on growth will only spoil the party. Also, with the much awaited Goods and Services Tax likely to be unveiled in April 2011, any increase in the excise duty or service tax would only be short term. However, measures such as exemptions to exporters should be selectively withdrawn given the strong recovery in exports.
Revenue proposals on indirect taxes need to focus on widening the tax base to augment revenues. Area-specific excise duty exemptions have outlived their purpose and are best withdrawn. A single rate structure for excise duty would pave the way for the GST rollout and also augment revenues. While the service tax net has been expanded over the years to include a large number of services, certain significant exceptions such as doctors are yet to be included.
Also, the scope of certain taxable services must be expanded to widen the net. An important focus of the budget must also be on plugging the procedural loopholes.
The direct tax proposals are to be seen in the light of two important developments the introduction of the Direct Tax Code bill and the growth of direct tax collections by 8.5% despite the economic slump. Budget 2010 is significant as it will bridge the gap between the current tax structure and the propositions made by the new bill.
This promises that there would be considerable relief for tax payers, encompassing the reshuffling of slabs, reduced rates, increased deduction limits and so on. The budget should take sizable steps towards a more liberal and tax-payer friendly regime.
Hence, besides the rate of levy, a critical look at some other provisions is vital. The effective introduction of the much-hyped Limited Liability Partnership has been marred because of the ambiguity in spelling out taxation laws in the case of conversion from a company to an LLP. Otherwise, ambiguity prevails as the tax code is not completely synchronized with the LLP memorandum.
Another grey area is the Minimum Alternate Tax for companies. A complete shift in the basis of the levy of MAT puts in question its applicability and relevance. Search and seizure provisions have been at the dynamic end for a long time.
Amendments from a block assessment to the assessment under section 153A have failed to achieve the fine balance between increased collections and reduced litigation. Budget 2010 should lay the pathway for the law going forward.
While tax exemptions have acted as investment catalysts for a long time, many of these have outlived their purpose. For a region to experience sustainable long-term growth, the economics of investing there must exist beyond just tax benefits.
Withdrawing these exemptions would ensure a simplified structure and equity for all regions, in addition to an expanded tax net. Sector-specific exemptions linked to investments as opposed to income, such as tax holidays for development of social infrastructure like hospitals, schools in rural areas, would be a more effective stimulant.
Divestment claims importance in light of the increased fiscal deficit and public debts. The government sees it as a means to soothe its current fiscal stress.
However, the tall order of raising 25,000 crore rupees annually puts pressure on the government for the selection and modus for divestment. Given the current market volatility and the low key response to the government's share sale, the possibility of divesting stakes through strategic partners must be considered in the budget.
The long term objective of the budget's tax proposals would be to provide ease of tax compliance to ensure ease of business and to expand the net of taxpayers in India. Steps taken towards simplifying tax compliance have had a positive impact on direct tax revenues, which contributed about 56% of the total tax revenue in 2008-09 as compared to 41% in 2003-04.
However, procedural issues continue to remain the proverbial "thorn in the flesh" and reforms on this front would go a long way toward making India a business-friendly destination. Simplifying withholding tax norms, export refund claim procedures and tax audit requirements would be some of the steps expected in this direction.
The current tax administration is also burdened by longstanding disputes and litigation. The 4-tier appellate system coupled with ad hoc administrative discretion adds to the number of outstanding cases. The introduction of a National Tax Tribunal seems a possible way forward and must be kept on a fast track to ensure the speedy disposal of tax disputes, as well as serve as a way of releasing our already-stretched higher judiciary.
The most significant part of the rationalization would be the reorganization of tax treaties. While some critics argue that this would impact foreign investment, the crux of the investment rationale is strong economic fundamentals; tax exemptions are only the icing on the cake. Re-negotiating treaties would plug tax leakages and also reduce money laundering practices.