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The Indian tax system needs a complete overhaul
April, 07th 2015

Indian taxpayers have a litany of woes to relate about the tax system, ranging from arbitrary tax demands and high-handed behaviour, to complex and vaguely worded tax laws. Firms have also been complaining about rising instances of ‘tax terrorism’ which have rendered the country unfriendly to business. It was in this backdrop that the Tax Administration Reforms Commission (TARC), headed by Parthasarathi Shome, was constituted in August 2013. The committee had suggested far-reaching changes for a customer-focussed tax regime in India. S Mahalingam, a member of the Commission and former CFO of Tata Consultancy Services, spoke at length to Business Line on the impactful report. Excerpts from the interview:

One of the fundamental changes suggested in the report is the abolition of post of Revenue Secretary. You recommend that the powers be vested with the CBDT and CBEC. Why?

The Revenue Secretary usually comes from the civil services and thus brings with him little experience or familiarity with tax laws and administration, particularly international practices, which are increasingly central to tax policy. Yet he finally signs off on all the key policy decisions of the department. Usually, he tends to focus on the administrative aspects, rather than modernising the tax system. To oversee the tax administration, we have instead suggested a Governing Council to oversee the two Boards, with representatives from the industry as well.

Our interactions showed that there is phenomenal capability within the tax department on policy formulation. Good policy cannot be formulated without analysis and experience. This cannot come about if you rotate officers arbitrarily every three years. Tax officers must be allowed to develop specialisation in their respective fields. There is a need for augmenting their decisions with data. So we are not just against generalists at the Revenue Secretary level, we are against them at all levels.

The report strongly criticises aggressive revenue forecasts made in the annual budget, which are often missed. It notes it is the unachievable targets set for tax officers that often results in ‘tax terrorism’. How can this be addressed?

When you formulate policies that affect so many taxpayers, they need to be backed by rigorous analysis of data. But such analysis seems to be completely absent in India. No impact assessment is carried out before changing tax laws. Nor is there any assessment of costs or benefits after the change is implemented. This is a key reason why the tax system completely lacks customer focus.

Take the simple case of tax projections which are made each year in the budget. They are often unrealistic. Yet this becomes the target which percolates down the department. In March, the department holds back refunds due to taxpayers or calls them up asking for higher advance tax payments. This is quite a flawed approach to tax collections. Yes, you may be meeting the number, but at the expense of taxpayer interests.

Tax projections need to be backed by analysis. If you are assuming a certain tax buoyancy based on a certain GDP growth, it is necessary to go back into the components of that GDP growth to see if the projections are realistic. If it is agriculture which is contributing to growth in a specific year, that will not lead to tax buoyancy. But today, such projections are made without really using the rich data that is available with the tax department because there is no systematic data warehousing, data mining or people who can ask the right questions. Therefore, tax projections end up looking like simple excel sheet forecasts, backed by no real data.

While India has just 20 people engaged in analytics in the tax department, the UK has 400. There is a great need for capacity building in this area. We have advocated a Tax Council to help in formulation of tax policy and related legislation, to be headed by the government’s Chief Economic Advisor.

We have suggested the setting up of a knowledge, analysis and intelligence centre which can help in forecasting, data analytics and research.

TARC has recommended a merger of the CBEC and CBDT functions, especially for large taxpayers. Given that one deals with transactions and another with income, what are the synergies between the two?

The separation of the CBDT from the CBEC is essentially an artificial distinction. Combining the two can lead to generation of rich sectoral data which can be used to formulate better tax policies. Globally, most countries have unified their direct and indirect tax regimes, so that they can be treated holistically as ‘business’ taxes.

Sharing information on businesses can lead to higher tax collections. It will ensure people don’t make arbitrage out of information asymmetry. We found that a GST pilot project in Maharashtra which put together the CBDT and CBEC databases to generate comprehensive profiles, helped collect ?500 crore of VAT from traders who evaded it.

India’s low tax base has been a long-standing problem. Why is it that initiatives like tracking high-value transactions or insisting on PAN cards for more transactions have not worked?

True. Take direct taxes, for instance. While direct tax collections have increased by over 700 per cent in the last ten years, the number of taxpayers has only increased by 35 per cent. The taxpayers in the lowest income slab of upto ?5 lakh make up 98.3 per cent of the total taxpayers. They contribute only 10 per cent of the tax revenues. This suggests that the tax base is extremely narrow.

This has to do with systematic data capture and monitoring. To give a simplistic example, if I am running an organisation like TCS, which has 3.5 lakh employees, I need to know three things. How many employees have attended office today? How many are productive? And how many are getting billed? If I don’t know these basic things, the organisation cannot function effectively.

The tax department needs a similar framework. If there is a high value transaction taking place, that should lead to the right questions on who were the parties involved, what was the value and what were the taxes paid. The TARC did a simplistic analysis to say it is possible to increase the tax base to 6 crore from the present 3.5 crore. But this is not easy. You need a holistic system-driven approach to drive the expansion in tax base.

Why is there a continuing disconnect between what the government says and what the tax department does? For instance, this government did make an assurance that it would not act on retrospective tax amendment. Yet Cairn India has been slapped with a retrospective tax demand.

Retrospective tax demands are undesirable. But this can only be explained by the pressure to generate revenues. There is a genuine need to fund India’s welfare and infrastructure programs. And if the fiscal deficit targets are not met, and borrowings get out of hand, you are essentially mortgaging the future to fund the present. But to generate revenues, leakages have to be plugged systematically and you need to plan how you will meet your revenue targets. To give a reassurance on ‘no retrospective taxation’ when alternative revenue sources haven’t been found, is not realistic.

This is why there is a need to think through revenue targets more carefully. To cite one instance, transfer pricing officers in India are given tax targets! Now, a transfer pricing officer is meant to basically avoid evasion and clarify rules on transfer pricing, by deciding where the value addition in a business is happening. Once you give him a target to meet, he is bound to take the most extreme position.

So if you simply take last year’s revenues and increase it by X percentage, it is not an appropriate way to set revenue targets. This leads to unhealthy practices, litigation and when the Court rules against you, you again resort to another spurious amendment.

The report flags the problem of infructuous tax demands, stating that the Indian tax department has one of the worst recovery records in the world. Why does this happen?

Indian tax laws tend to be loosely drafted and open to interpretation. This is because you don’t have specialists drafting the law. Moreover, tax changes are often done in a hurry with little or no analysis or impact assessment. That is why it is critical that the tax department acquires the specialisation to draft the law. Specialisation will help the department win more cases too. Currently, the tax department also often loses out, not because their case is per se weak, but because the assessee can often hire specialist lawyers who fight the case for years. Whereas, departmental lawyers keep changing and the tax officer who is familiar with the case may be transferred too. The dispute resolution mechanism needs to improve too; the department must engage with the assessee before the issue is taken to the Courts.

Corruption is an often cited complaint with the department. Would curbing the discretionary powers to the assessing officer help?

There is bound to be some discretion. But if your administrative systems are working very well, it is possible to reduce the face-to-face meetings between tax officers and taxpayers. This can reduce corruption. Systematic handling of them through dispute resolution centres can also reduce opportunities for corrupt practices. Ultimately it is very difficult to discourage a person who wants to be corrupt, but you can reduce the number of avenues and enhance systemic interventions.

When talking of corruption, the role of vigilance also has to come under scrutiny. For instance, we met an honest officer whose career was ruined for 15 years, because of charges that were never proved. The investigation just goes on and on and the file never gets closed. Corruption cannot be brought down by vigilance alone, you need analytics too.

Why has the simplification and rationalisation of the tax structure come to a halt in recent years? Instead of fewer slabs and exemptions, we seem to be adding on more slabs, more surcharges, cesses and more complexity.

If we had a large tax base, a simpler system can be administered. But we don’t, so revenue pressures force the government to tap as many sources as possible. What we need is impact analysis. After any new tax is imposed, if we had an evaluation of the impact on revenues vis-à-vis compliance costs to the taxpayer, we would be able to eliminate taxes that don’t work. But because there is no such assessment, taxes that have no business to exist continue for years, even as new taxes get added. This is what the Tax Council can look at. It can bring in the business perspective that is essential to evaluate such measures.

TARC’s report is an unusually detailed and comprehensive report. But usually, there is a tendency to cherry-pick recommendations from such reports and implement them partially. What would be your comment on this?

If you want to get rid of tax terrorism, you have to fundamentally transform India’s tax administration. You cannot do it through incremental changes. To cite an example, to reduce disputes, you cannot simply create more posts of full-time commissioners in the department. You need to analyse why disputes arise, create dispute resolution mechanisms and frame the laws in a more water-tight manner. If you do not approach it in that fashion, you cannot succeed.

The importance of the people aspects, brought out in the report, cannot be over emphasised. Our interactions showed that the tax department has completely lost its spirit. It needs to be restored. As one senior officer told me: “If you are mistreated by your employer, how will you deal fairly with the taxpayer?” To me, that did seem to have the ring of truth. Tax officers need to be better equipped through training, empowered by their boards and given the ability to build expertise and specialisation.

Finally, you need to get out of this system of setting unhealthy revenue targets which are not based on reality. To do this, you need effective ICT use and powerful analytics. On collections, you should not be wasting your resources going after people who are already compliant. You need to go after people who are sitting on the fence.

What we have suggested is a complete systemic overhaul of the tax administration. Mere tinkering will not be enough. We have not stopped with recommending changes alone. We have also outlined the manner in which you can bring about the change. We have outlined the need for immediate action and created timelines for achievement of different objectives. We also travelled across India to talk to tax department officials to get their feedback to the report.

This is a unique report, in my view, because of the coming together of people with exceptional experience and expertise. Dr Shome has brought in extraordinary perspective in terms of his own rich experience in tax administration and laws, as well the practices around the world that we can adopt in India. The report is also practical because of the active participation of two former chairmen, and two former members of CBEC and CBDT, apart from representatives like myself and MR Diwakar from the private sector.

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