A simplified tax code could bring all-round benefits to the economy
Jaimini Bhagwati / Apr 15, 2011, 00:59 IST
On March 23, 2011, UK Chancellor of the Exchequer George Osborne made a fleeting reference to the Indian tax code in his Budget speech. Embarking on reducing UK corporate taxes from the current level of 28 per cent to 23 per cent by 2014-15 and simplifying its tax structure, Osborne remarked that “our tax code has become so complex that it recently overtook India to become the longest in the world”. Separately, on April 9, 2011, The Washington Post reported that the ambassadors of the US, UK, European Union and four other countries had recently written a joint letter to India’s finance minister stating that “we have received feedback from many foreign investors that the growing unpredictability in India’s tax policies creates unquantifiable risks in investment planning”. Irrespective of whether these comments were warranted or not, it is revealing that India is viewed as having a complicated and unpredictable tax framework. This article provides a broad overview of India’s tax rates and policies, and implications for investment in India.
Table I lists the corporate and indirect tax rates in G20 countries and the global average in 2010.
In the period 2005 to 2010, corporate taxes have come down steadily for Organisation for Economic Co-operation and Development (OECD) countries in response to competitive pressures to attract investment. In contrast, indirect taxes have not been reduced. In the last five years, the global average for corporate taxes has decreased from 27.9 per cent to 25 per cent and the OECD average from 28.3 per cent to 25.9 per cent. In the same period, India’s corporate tax rates has remained around 34 per cent. The global average for indirect taxes has changed marginally from 15.9 per cent to 15.6 per cent and the OECD average has actually risen from 17.8 per cent to 18.3 per cent.
(I) Corporate and Indirect Tax Rates in 2010(%)
Name of
country
Corporate
tax rate
Indirect
tax rate
1
Argentina
35.00
21.00
2
Australia
30.00
10.00
3
Brazil
34.00
19.00
4
Canada
31.00
5.00
5
China
25.00
17.00
6
European Union
23.03
20.44
7
France
33.33
19.60
8
Germany
29.41
19.00
9
India
33.99
12.50
10
Indonesia
25.00
10.00
11
Italy
31.40
20.00
12
Japan
40.69
5.00
13
Korea, Republic of
24.20
10.00
14
Mexico
30.00
16.00
15
Russia
20.00
18.00
16
Saudi Arabia
20.00
0.00
17
South Africa
34.55
14.00
18
Turkey
20.00
18.00
19
UK
28.00
17.50
20
USA
40.00
0.00
Global average
24.99
15.61
Source: KPMG Corporate and Indirect Tax Survey 2010
(II) tax rates in india
Domestic
company
Foreign
company
Corporate tax
33.99%
42.02%
Minimum alternate tax
20%
19.44%
Dividend distribution tax
16.23%
15.76%
Source: KPMG
Every tax jurisdiction provides a bewildering array of conditional tax reductions or exemptions. Therefore, it would be simplistic to come to any conclusion from the numbers in Table I about the tax rates that are applied in practice to domestic/foreign companies/nationals. It can be seen from Table I that at a base level, corporate and indirect taxes in India are not particularly high compared to the rest of the world. However, India suffers by comparison with other countries where tax codes are easier to interpret and if there are disputes about tax claims, legal remedies are more speedily available. Table II shows that the Indian corporate tax rate is higher for foreign companies and the minimum alternate tax and dividend distribution tax are marginally lower.
Corporations and individuals scout around the globe to reduce tax incidence. For instance, GE’s central tax department has several thousand employees and is deemed to be an independent profit centre. Although it would be counterproductive for India to engage in a competitive lowering of corporate taxes, differences in tax rates between domestic and foreign companies are unnecessarily discriminatory.
In a specific on-going tax dispute in India, Vodafone is contesting the tax department’s claim of $2.5 billion on its $11.2 billion 2007 acquisition of Hutchison’s stake in Hutchison-Essar. International newspapers have repeatedly highlighted this case as symptomatic of the unpredictability of Indian tax laws. However, it appears that despite the Double Taxation Avoidance Agreement (DTAA) with Mauritius, this tax claim is justified. Consequently, India needs better public outreach efforts to counter allegations of arbitrary and retroactive tax claims as in the Vodafone case.
Among other objectives, the proposed Direct Tax Code (DTC) is intended to limit tax exemptions, broaden the tax base and make the application of the tax code simpler and, thus, reduce litigation between government and taxpayers. It is to be expected that affected entities will object if DTC raises their applicable tax rates. However, there should be longer-term positive consequences of a simpler tax code including an increase in foreign direct investment (FDI). The climate for FDI into India needs every possible encouragement since the numbers have been bleak. For instance, in the ten months from April 2010 to January 2011, FDI amounted to $17.1 billion, a decrease of 25 per cent compared to $22.9 billion for the same period in the previous fiscal year.
The other significant pending tax reform is the Goods and Services Tax (GST). The GST will club together all service, excise and sales taxes. Stamp and registration duties also need to be standardised across states. State governments have been supportive and the proposed legislation includes a GST Council to be headed by the Union finance minister and state finance ministers as members. The general sense is that preparatory work on DTC is ahead of GST. Hence public advocacy efforts for GST need to be increased. Although April 2012 has been indicated as the start date for DTC and GST, there are doubts whether it would be possible to adhere to this time frame.
To summarise, simplification of India’s tax codes including stamp and other duties has to be an end objective by itself and the introduction of DTC and GST should not be delayed by protracted discussions. Reasonable people can and do differ on how best to design tax policies to achieve optimal outcomes on a variety of socially desirable objectives. However, the trade-off in terms of foregone growth and employment caused by delays in domestic and foreign investments, which stem from the complexities and interpretational ambiguities of our tax codes, can be expensive. Let us get on with the required simplifications through DTC and GST within fiscal 2012-13, which would also help to widen the tax base and reduce volatility in tax collections.
The following quotes from "We, the Nation: The Lost Decades" by Nani A. Palkhivala may be of interest to the readers of this article. "The general public are (sic: should be is) not aware that the greatest single factor responsible for the paucity of foreign investment in India is the insensate instability of our laws, specially tax laws, and the total absence of honour and good faith on the part of the government."? "The Finance Act, 1986, shamelessly discontinued investment allowance without the three years' notice which was mandatory under the law, by the simple expedient of omitting the statutory words which required three years' notice." The latest is the withdrawal of the exemptions, by the Finance Act, 2011, to SEZ-companies from Minimum Alternate Tax and Dividend Distribution Tax.
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