Finance Minister P. Chidambarams statement that the Direct Taxes Code requires a fresh look perhaps reflects the Governments acknowledgement that the proposed tax code has created uncertainties and disincentives that are not conducive to economic growth. This is not to say that the steep fall in economic growth has been wholly on account of the tax policy.
However, the proposals in the DTC and the changes made to the tax law in the recent past are, arguably, not insignificant contributors to the current environment of falling consumption, savings, investments and capital formation.
The DTC seeks to make far-reaching changes on certain basic concepts such as the meaning of income, persons liable to tax, and the scope and basis of taxation. Apart from unsettling prevailing tax positions, the changes create new uncertainties that will likely increase the tax burden.
A significant rise in the Effective Tax Rate is not only a disincentive to grow and earn but also adversely affects competitiveness and, in turn, earnings. Likewise, it affects new investments, capital formation as also the ability to raise capital and attract talent. Relevance of MAT
Some provisions in the DTC may be in direct conflict with economic objectives. To illustrate, imposition of MAT (Minimum Alternate Tax) and elimination of MAT credit would reduce competitiveness by increasing the ETR due to double taxation.
There is perhaps no need for MAT anymore as most incentives, except those for the infrastructure sector, have been withdrawn, thereby ending the regime of liberal tax incentives that created a mismatch between tax and book profit.
Also, provisions such as the General Anti-Avoidance Rules (GAAR), Controlled Foreign Company (CFC), and the modified scheme of capital gain taxation could deter private capital formation, reduce savings and divert investments from capital markets. A comprehensive study of such provisions is needed to determine their economic impact.
Certain fundamental questions need to be answered first such as, whether GAAR would deter abusive tax arrangements or also adversely affect investments; whether CFC regulation would deter profit retention outside India or outbound investments themselves, even as regulations have been liberalised to make Indian companies globally competitive. Wooing foreign investment
Fiscal incentives and a liberal regulatory regime are, in many respects, important policy tools of a government when competing with other countries to attract potential investors. International studies have shown that incentives along with general economic and framework conditions are important in determining the size and quality of investment flows.
Tax incentives can compensate for deficiencies prevalent in a developing economy such as ours, and are often seen as effective policy tools for achieving economic and social objectives. Hence, deterrents in the tax code must not be so excessive, in form or administration, as to render businesses uncompetitive.
Moreover, investors value transparency, simplicity, stability and certainty in the application of tax law and tax administration as equally as, if not more than special tax incentives. Assessing the impact
The objective of a tax code should not only be the efficient collection of tax revenue but also formulating the Governments tax policy. The evaluation process should be two-fold: Impact on taxpayer and revenue; and economic impact, that is, competitiveness, savings, investments and private capital formation. This is an effective cost/benefit analysis of the change. Also, the change should only achieve what it is meant to and no more.
In the current economic scenario where private capital domestic and foreign is expected to fuel high growth, the quest for higher tax collections must not create an adverse economic impact.
Heavy taxation of productive income is detrimental to private capital formation.
Excessive taxation is not a sustainable solution to budget problems. Also, other jurisdictions should be kept in mind when setting the tax law, as taxes raised to an uncompetitive level can render businesses uncompetitive too.
When taking a fresh look at DTC, a broad-based committee, similar to the recently appointed expert group for GAAR, could bring the needed objectivity to the development of a fiscal legislation that is crucial to the Governments reform process.