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Presumptive taxation scheme
July, 18th 2009

A Budget proposal that has created a lot of attention, interest and excitement among the small businesses is the presumptive taxation scheme. The Finance Bill, 2009, seeks to extend the scheme to all businesses with gross receipts not exceeding Rs 40 lakh; at present, the presumptive scheme is available to three businesses, viz. civil construction, retail trade and transporters.

Presumptive income taxation is employed primarily in economies where hard-to-tax taxpayers are the majority of the population, and administrative resources are scarce, observes Mr T. G. Suresh, a Chennai-based Chartered Accountant, specialising in direct taxes. In developing countries, where most taxpayers lack the financial transparency that allows for effective taxation by the Government, presumptive taxation may still be the most appropriate method of tax administration for specific groups of taxpayers, he adds, during a recent interaction with Business Line.

Mr Suresh reminds that while most tax laws are written as if tax is assessed on well-defined measures of income, in well-documented and transparent accounting records, the reality is that most taxpayers do not possess the administrative resources to maintain accurate books or navigate complex tax codes.

Excerpts from the interview.

At present the retail traders are required to offer only 5 per cent of the turnover as their income; what is the rationale of bringing them to the 8 per cent level?

I really dont find any rationale in bringing them under Section 44AD. On the contrary, with corporates entering retail in a big way, the retail traders margins would be under severe pressure, and hence a status quo or reduction could be contemplated.

Is there any alternative mechanism that the Government can consider?

The Government can consider introducing a tax amount in the range of Rs 7,500 to Rs 10,000, may be in two instalments. A similar scheme was introduced for retail traders by Mr Manmohan Singh when he was the Finance Minister; a small amount of Rs 1,400 was levied as tax. However, the scheme was discontinued on account of poor patronage. Now, with an extensive media coverage, and effective public campaign through print, electronic and Internet platforms, the scheme can be made successful. A small exemption ceiling in the lines of service tax, say up to Rs 10,00,000, may also be considered to benefit the small business people.

How does the tax administration generally go about detecting cases of misuse, such as bigger enterprises taking shelter under the presumptive taxation scheme?

Use of presumptive income taxes is often disputed on the grounds that it may cause erosion of the standard tax base, which may occur if large firms take shelter under the presumptive scheme.

Tax administration can always send notice under Section 143(2) to ascertain whether the gross receipts exceed Rs 40 lakh. Even under the proposed scheme, the Department is entitled to do so, to prevent the misuse of the scheme by the bigger enterprises.

As a chartered accountant, who aims at proper record-keeping and maintaining of books of account, do you view presumptive taxation schemes as retrograde?

It is generally an acceptable methodology, globally, to use presumptive income for bringing more people under the tax net. Small enterprises, especially the individually-owned, lack the resources to keep organised records of their economic activity. Examples are the neighbourhood grocery stores, fast-food kiosks, street vendors, small service enterprises and other such economic agents, who account for a large part of the informal sector.

These businesses are often family-operated and have very low profit margins. They are called informal because, for the most part, they do not exist as firms nor file tax returns even if they are required to do so by law.

While many such enterprises would undoubtedly fail to pay taxes anyway, the burden of tax compliance is very often a strong disincentive for those who are inclined to comply with the tax requirements. At the same time, the tax administration has very limited audit and enforcement resources. The risks of tax evasion under these circumstances are low enough that many small enterprises opt not to file a tax return.

It is important to note that these are in part taxpayers who might be willing to file, even with a low risk of penalty, if the compliance costs were lower; but they just lack the resources to meet the usual accounting standards that the law asks for.

Any solution to this problem must start with an effort to reduce the compliance costs for the prospective taxpayer. Its first objective should be to increase the number of tax returns filed.

Just increasing the number of tax returns will allow the tax administration to get better information on tax filers, regardless of the actual revenue collection. This should lower the cost of future enforcement, and eventually lead to lower expected return to evasion efforts.

Hence presumptive taxation should not be viewed a retrograde; on the contrary, it is a welcome move.

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