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India Inc's effective tax compliance rate rises to 26% in 2007-08
June, 23rd 2008

 If increasing subsidy bill is giving headache to P Chidambaram, he has found succour in higher direct tax collections. Direct tax receipts from companies and personal income have reportedly, increased 71.3% (ET June 19) in the first two months of the current year compared to the same period last year.

This may be too early to predict the collections for the full year, but if one goes by past records the finance minister has every reason to be optimistic. After all, rationalisation of tax structure has been giving good dividends. Despite a fall in tax rate, collections of corporate tax have increased steadily.

An ET survey of 200 large companies finds that their aggregate tax provisions have increased 28.3% in 2007-08 over the previous year.

The bigger question, however, is: Does a rise in tax collections automatically imply success of the restructuring process of corporate taxation? After all, higher tax collections last year could be the result of higher profits. As demand picked up following improvement in macro fundamentals, India Inc witnessed an all-round prosperity.

The unit price realisation rose sharply, inflating net margins and by extension increased corporate tax provisions too. So far so good. But what is significant is that the tax collection in 2007-08 has increased at a higher rate than that of the pre-tax profit. The aggregate collections have increased 28.3% in 2007-08 over 2006-07 as against 26.8% rise in pre-tax profit during the same period.

This has raised the effective compliance rate, that is, tax as percentage of pre-tax profit, from 25.6% in 2006-07 to about 26% in 2007-08. A 0.4 percentage point rise in compliance rate may not look very impressive, but it shows a positive trend, especially since pre-tax profit itself has increased at a very high rate.

Take the case of Indian Oil Corporation, the fourth biggest tax payer in the list. Following sharp rise in crude prices it has witnessed a decline in pre-tax profits in 2007-08, but its tax provisions have increased raising the effective tax compliance rate from 28.5% in 2006-07 to 30.9% last year.

And if the tax compliance rate of Steel Authority of India (Sail), the biggest tax payer in the list has remained same at 34.3% in both the years, what is important is that it has provided for much higher taxes in 2007-08. Sail earned a record pre-tax profit of Rs 11,471 crore in 2007-08 following sharp rise in steel prices and as a result, even at the same compliance rate the actual collections were substantially more than that of the previous year.

As such, at 34.3% Sails tax compliance rate was way ahead of 26% for the sample companies as a whole. But not Sail alone, the steel companies in general seems to have higher compliance rate compared to India Inc. Nine steel companies in the list together have provided for 32.1% of their pre-tax profits towards taxes in 2007-08 as compared to 26% of India Inc.

At the individual level, as many as 110 companies in the list provided for 30% or more of their pre-tax profits towards taxes in 2007-08 as compared to 98 in the previous year. The tax rate world-over has declined consistently during the last decade. The rate has declined in India too.

It may come down further in the coming years, but what is important is that the adherence of the tax compliance rate must be ensured so that a rise in corporate margin automatically raises collections.

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