Cut in tax rates for MSMEs may stunt their growth: OECD general secy

In a Q&A, OECD's Angel Gurria lauds note ban, says benefits like lower graft will be seen gradually

The Organisation for Economic Cooperation and Development (OECD) recently came out with economic survey of India, 2017, saying demonetisation will have long term benefits. OECD general secretary Angel Gurria tells Subhayan Chakraborty that some of the benefits such as formalisation of the economy are already apparent, while some others such as lower corruption etc would be visible gradually.

Edited excerpts:

The OECD Economic Survey of India says that demonetisation will have long term beneficial impact. When will these benefits start accruing? 
 

We have been very clear that demonetisation may have caused some short-term pain in the end of 2016 and early 2017, but we are also optimistic that there will be important long-term gains. Some of the benefits -- in terms of increasing formalisation of payment -- are already apparent in the growth in the use of digital payment systems and filing of digital tax returns.  The medium-to-longer-term benefits, including lower corruption, better tax compliance and financial deepening, should come about gradually in the coming years.  

The report suggested reduction in corporate tax rate to 25 per cent from 30 per cent. The Budget reduced the rate but only for firms having annual turnover of up to Rs 50 crore. Does this meet your prescription?

This is a significant first step, since the measure will benefit up to 96 per cent of Indian enterprises, according to the government’s own estimates. We support the government’s plan to extend the lower tax rate to all companies, while reducing the wide range of exemptions and deductions now in place, and would push for swift implementation Having lower rates reserved for smaller companies could be an incentive to stay small and not grow, which is obviously not the intended goal of the reform.  

The Budget has taken a clue from OECD transfer pricing norms and introduced the concept of secondary revisions. Do you think that meets the OECD norms?

Secondary adjustments are useful in order to align the economic benefit of the transaction with the arm's length outcomes. Under the OECD Transfer Pricing Guidelines, secondary adjustments are allowed and the new proposals in the Indian Finance Bill 2017, seem to be in line with that approach. It’s also important to ensure, however, that those secondary adjustments don't themselves create new instances of double taxation!

The government will introduce a General Anti-Avoidance Rule (GAAR) from the next financial year, at the same time the Base Erosion and Profit Shifting norms developed by the OECD come into effect. Do you think GAAR will help in implementing BEPS norms in India?

General anti-avoidance rules can play an important role in strengthening the integrity of a tax system.  While not included as one of the 15 Action Items nor a substitute for implementing the BEPS measures, a GAAR can provide support to the BEPS recommendations, notably by preventing taxpayers from entering into artificial arrangements that lack economic substance and have the effect of undermining policies designed to prevent BEPS.  India has been involved with a number of OECD and related fora in recent years that have considered in detail how to develop and implement effective GAAR provisions. Of course, ensuring a good level of tax certainty should also be a key objective.

The Survey discusses labour reforms in India. Is it possible given vehement resistance by trade unions? 

While unions may oppose some elements of labour reform, it is important to emphasise that creating more formal jobs for the majority of unrepresented workers in the informal/unorganised sector is important for everyone. The current approach of having the states undertake critical reforms can produce results. Rajasthan has been particularly ambitious as concerns labour reform. It has reformed the Apprenticeship Act and involved industry representatives more closely in designing training programmes to create better employment opportunities for young people. To promote job creation, Rajasthan has also raised the threshold above which a company needs prior permission from the government to adjust its workforce.  Labour reforms should aim to reduce the current cumbersome and costly restrictions that increase with the size of companies, favour capital-intensive investments and keep many jobs in the less-productive informal sector, without job protection or social benefits. More flexible work arrangements would help create more quality jobs for the 90 per cent of workers currently in often low-productivity informal jobs. Assessing the impact of states’ labour reforms on the creation and quality of jobs would help inform the policy debate. 

The Survey also suggested creation of an inheritance tax. But what is the relevance of the tax when wealth tax is done away with? 

Wealth in India is highly concentrated in the hands of a very small minority. Taxing wealth, either annually (wealth tax) or when it is inherited, would help increase the redistributive impact of the tax system, and raise additional revenue to fund social infrastructure. Wealth taxes and inheritance taxes are different instruments. Inheritance taxes generate fewer distortions than annual wealth taxes: because they are only levied at the end of a person’s life, they do not discourage retirement savings or wealth-generating economic activity. Inheritance tax is more difficult for taxpayers to plan against or to game, and less costly to administer. Taxing wealth transfers at death increases equality of opportunity by reducing the inter-generational persistence of relative wealth positions. Overall, very few OECD countries have a wealth tax, while many have inheritance taxes.

OECD has recommended that India should strengthen public bank balance sheets by recapitalising them and promoting bank consolidation. The government will recapitalise banks to the tune of Rs 70,000 crore in the four years that will end in 2018-19. Is this amount enough? Do you think the case for consolidation is there in India beyond SBI?

It is important to reduce the level of non-performing loans, which are hovering around 9 per cent of gross advances. Non-performing loans reduce opportunities for new credit and keep resources in firms that are no longer viable. This calls for a comprehensive approach between the banks, the borrowers and the owners of the banks. The bad loans should be recognised at the bank level, which is already being done. The companies should be restructured and the bad loans disposed of - either sold or written down. Banks could then be recapitalised with private and public participation. The exact amounts needed are hard to estimate. It is important to act sooner than later, as the costs of inaction are lost opportunities that continue accumulating.   

The OECD has also suggested bringing the government ownership stake below 51 per cent in PSU banks. But many say India avoided financial meltdown largely because of government shareholding pattern in PSU banks. Do you agree?

Ownership as such is not key – it is the governance of banks that is most important. There is no magic in the 51% number, but allowing the private sector share to rise above 49% would allow banks to be recapitalised without overburdening the budget. It would also be likely to bring new dynamic owners to the board and improve decision making, while preserving state interests in these banks