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Taxman's welfare
October, 28th 2006
The so-called welfare law in Customs and Central Excise that denies refunds to taxpayers encourages corruption, and needs to be abolished.
Now that India is ranked first in the list of corrupt countries enumerated in Transparency Internationals Bribe Payers Index 2006, it is time we scrap some laws that promote corruption. Domestic corruption is also related to its international aspect, and in that respect, one such law that promotes corruption and needs to be abolished is the Customs and Central Excises so-called welfare law for denying refunds.
According to this law, if the refund claimed by the taxpayer is granted but the amount paid by the him as revenue has not been passed on to the consumer, the amount will not be refunded to him, but will go to the Welfare Fund. In reality, this supposedly socialist law has created havoc in the tax administration. The door for refund gets practically blocked for ever. The department just doesnt like to provide refunds in the name of unjust enrichment. I know of cases where companies have been denied refund even after having won in the Tribunal on merit; the department having gone to high court and losing there; the assistant collector denying refund on practically no grounds, although there is a proper certification by only one government undertaking which bought the goods; and the Collector Appeal remanding the case back to the assistant collector and the matter still remaining with him for long enough to call the refund system a black hole. Once the taxpayers know that they cannot get the refund in any case, however much they prove that they have passed on the duty, because nothing is accepted as a proof, they find it compelling to settle the issue right in the beginning, instead of fighting for refunds for 10 years. The departmental officers are covered nicely by the directive of the finance minister to raise more and more revenue to reach the target.
Under the welfare law, if a manufacturer (or importer) pays, say, 40 per cent duty but holds that 25 per cent is the correct rate, he pays the duty and files a refund claim. In the meanwhile, he may add the higher burden of duty to his cost of production, which he may recover from the consumer. But if he doesnt and then gets back the refund of the 15 per cent duty, then that receipt becomes his windfall gain, unless he proves that the burden has been passed on to the consumers. This law was made in 1991 by amending Section 11 and Section 27 of the Customs Act. And the practice from 1878 was given a go by.
The Supreme Court upheld the constitutionality of the law in the case of Mafatlal Industries vs UOI(1). Whether the law was a rational one is different from saying it was a legal one. Indeed, the law cannot be justified on economic grounds for a number of reasons:
lThe law assumes that a firm is always able to sell its products above or equal to its costs (including the duty paid). Had this been true, there would not have been so many companies making losses and going to the Board for Industrial and Financial Reconstruction (BIFR). Take SAIL, for instance. At one point, it was losing more than Rs 1,000 crore a year. Can one say that the burden of duty of excise and customs had been passed on by it when it sold goods far below the cost?
  • Price has no direct correlation with cost all the time. It is determined by market forces, depending upon whether it is a competitive, monopolistic, oligopolistic or monopsonistic situation. Often products are sold at a much higher profit, and some times, at a loss, without even recovering the cost.
    So adding the higher tax to cost does not mean that the tax burden has been passed on or vice versa. In fact, the dissenting judge in the Mafatlal case has called the doctrine of passing on the burden quite absurd.
  • When a firm makes a loss rather than making profit, as in the case of so many that end up before the BIFR, the government does not come forward to subsidise its due impoverishment, but it comes heavily on undue enrichment. So it is a one-way treatment.
  • For communists, profit is a bad word. But if an economy has to grow, as India does, companies need to earn profits. Profit is the engine of growth. If a firm makes profit, it can take chances with innovation. It is said that only a car with strong brakes can speed up. Only the enormous profit of Motorola could enable it lose millions of dollars in experimenting with the Iridium project.
  • This subject has become highly litigated. Immunerable cases are being fought at different levels. Some issues are even pending with the Constitutional Bench of the Supreme Court, since the judgements by several benches differed.
    The law of barring unjust enrichment may be constitutional, but it is not economically sound. The Gold Control Act was constitutional, but it was found to be economically redundant and was scrapped in late 1980s. Now the time has come to scrap this one, too. The Kelkar committee report in 2002 recommended substantial modification to this law. Before that, the Shome committee in May, 2001 recommended that the provision to deny refunds to the manufacturer by the tax administration should be removed, and the law appropriately amended (2).
    It is about time we abolish this retrograde law.

    (1) - 1997(89) ELT 247 SC (2) - Report of the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan, May 2001, Government of India

    Sukumar Mukhopadhyay

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