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Special provisions of the Income Tax law: Are all incomes created equal?
June, 08th 2018

The ongoing work of the expert committee to come up with a tax law is a once-in-a-generation opportunity to correct systemic ills.

The ongoing work of the expert committee to come up with a tax law is a once-in-a-generation opportunity to correct systemic ills. Since ‘simplification’ is a key objective of this exercise, it may be useful to briefly examine some of the reasons why our current system is the way it is, and what can be done to make it simpler. There are, of course, several aspects to a ‘simplification’ exercise, but there is one specific area which requires more attention.

Over the decades, there has been considerable slicing and dicing of our tax base, because of the Centre differentiating between various types of incomes, and (to a slightly lesser extent) between various types of taxpayers. Some element of classification is, of course, an inherent feature of income tax. For instance, the levy of tax at a higher rate on the income of the rich, and a lower rate on the income of the poor is a normal feature of tax regimes worldwide. But, when we look at our income tax law today, it may appear that our fondness for legislation by segregation has gone too far.

To start with, let us take the case of interest income earned by foreign companies from India. There are separate regimes and tax rates that apply to the interest on rupee loans, foreign currency loans, non-convertible debentures and masala bonds. The capital gain provisions, again, are in disarray, with the recent removal of the exemption for listed securities making matters much more complicated. Income from patents has its own tax rate and regime, as do income from carbon credits and the online advertising income of non-residents.

There is a separate presumptive tax regime for businesses that ply, hire or lease goods carriages, and another one for persons engaged in the legal, medical, architectural, accountancy and engineering professions. There are also separate presumptive regimes for small retailers, foreign shipping companies, non-residents engaged in the oil and gas business, those who operate aircrafts, and those involved in the installation and commissioning of power plants.

Sportsmen, sports associations, life insurance companies, and newly set up manufacturing companies also have their own special provisions. Dividends are subject to a special dividend distribution tax, and share buybacks to a buyback tax. We also have a securities transaction tax and a commodities transaction tax within the overall direct tax framework. The list can go on.

Each of these provisions was brought in for a specific purpose, and one cannot really find fault with them on an individual level. But, in the larger scheme of things, the proliferation of these regimes raises some important questions that need to be considered as we overhaul our tax regime.

Historically, our tax regime was riddled with numerous exemption provisions that added to the complexity of the law and contributed to a narrow tax base. Recognising the distortion-creating effects of such provisions, most exemptions have either been phased out or are in the process of being phased out. But, at a conceptual level, many of these special regimes are similar to, and can have the

same destabilising effect as, exemptions. Should we not therefore be equally concerned with their impact on our tax base? In the case of indirect taxes, the rationale behind taxing different goods at different rates is understandable, and even here, most experts believe that there should be a convergence of GST rates in the long term.

In income tax, barring some limited exceptions (such as capital gains and incomes of non-residents taxed on a gross basis), is there a rational basis for taxing different kinds of incomes at different rates and under different computation rules? Will this not make tax returns complicated, compliance costly and ‘planning’ lucrative?

For a tax regime to be truly ‘simple’ and for it to contribute to an improved business climate, the law needs to be detailed and sophisticated. (This may sound counter-intuitive, but a lot of the complexity in our law today arises not because the law is too detailed, but because it is insufficiently so. As a result, many important aspects are not addressed by the law at all, which lead to uncertainty and litigation).

Special provisions add to the bulk of the income-tax law, but, they do not make it simple or sophisticated. Instead, they undermine the basic structure of the law by diluting a comprehensive and (once) coherent law into several disjointed and unrelated chapters, each with its own levy and computational challenges.

As we look for ways to reform our tax system, we should consider moving away from an excessive reliance on ad hoc special regimes, and instead, focus on strengthening and detailing out the basic structure of a single income tax. Such an approach will go a long way in modernising and simplifying our tax code.

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