In The Interest Of Equity

Inflation adjustment. While giving up the scheme of indexing the cost of acquisition of the asset transferred, it has been argued that the consumer price index, on the basis of which the inflation adjustment is made, is deficient in the sense that it does not represent an accretion of real economic power of a house owner. This, in my view, is an incorrect view of the nature of and rationale for indexation. Inflation adjustment is to be made for the erosion in the purchasing power of the money value of the asset and not for "accretion" of economic power embedded in the asset. Inflation indexation should be applied to all taxpayers in the country applying the same scale... Any gain over... the general price index is a real gain of economic power and when this is realised in cash, it should be taxable.

 

Differential treatment. The proposed scheme, in effect, allows use of different scales of compensation for inflation for differently appreciating assets. Where an asset is held for nine years and the cost is more than 60 per cent of sale price, there is no inflation adjustment at all. On the other hand, where an asset is held for nine years and the cost is a mere 10 per cent of sale price, compensation for inflation works out to five times the cost, much higher than what the society has suffered on an average. Simplicity is sought to be achieved at an unacceptable price in the form of iniquity.

Financial assets. An innovative concept of block of financial assets has been suggested for computing capital gain on transfer of financial assets. It has been stated that the main advantage of the innovative scheme... is that it will do away with the detailed exercise an investor has to undertake for finding the cost of acquisition of financial assets. But such an objective is unlikely to be achieved... For determining the value of the block, one has to keep as much detailed records as at present...

Export incentives

Deviation from accounting profit. The proposal for deduction from the gross total income on the basis of a flat percentage of the foreign exchange brought into India would deviate the deduction from the actual income earned from export related activities. Percentages... have been fixed on an ad hoc basis. By adopting a simple percentage for allowing export incentives, some assessees would stand to benefit and others may stand to lose. Where the actual profit is less than the amount of deduction arrived at on the basis of the percentage of foreign exchange, tax on domestic income would again become attractive... The proper course is to link the incentive to actual profit from export computed on the basis of audited accounts. Hundred per cent deduction is allowed for new undertakings under Section 80-IA at present. As an additional measure, the assessees may be required to maintain separate books of accounts for the export business.

Distributed profit tax

Arbitrage opportunity. With a view to encouraging small investors to take the mutual fund route for entering the capital market, the group has suggested that there would be a 10 per cent tax on the profits distributed by a mutual fund to unit holders. Mutual funds do not pay tax and, therefore, profits distributed by them stand on a different footing from dividend distributed by companies. While small investors, whose income is not taxable, will see their earnings get eroded, big investors would exploit the arbitrage opportunity and book profit, otherwise taxable at a higher rate, at a lower rate.

It is well known that companies park surplus funds in Units Scheme-64 and Units Scheme-95 of UTI. A company paying tax at (proposed) 35 per cent would benefit by diverting its entire reserves to these units, now yielding about 16 per cent return per annum. With 10 per cent tax at source, the yield would be 14.4 per cent tax free. The company would borrow for its business and pay tax deductible interest. Unless the interest payable is above 22 per cent the company would stand to gain. The prime lending rate charged by banks is around 16 per cent and the gap will be open for exploitation. Smart treasury managers would seize this arbitrage opportunity. Another example: An assessee has capital gain taxable at (proposed) 35 per cent. To reduce the tax burden, he would buy US-64 units cum-dividend and sell ex-dividend generating a matching capital loss. By this, he [c]ould convert the capital gain taxable at 35 per cent to dividend from UTI taxable at 10 per cent. Schedular treatment of income throws up such opportunity to be exploited by the taxpayers when the income getting preferential treatment cannot be quarantined.

Assessment of search cases

Anomalies overlooked. The group did not have occasion to go through each of the provisions of the chapter containing special procedure for assessment of search cases. It has recommended retention of the provision without any change. A close reading would show that the new procedure for assessment of search cases, introduced by Finance Act 1995, has many legal problems. The scheme has gaps as well as overlappings with the normal procedure. Some of the provisions are highly iniquitous. The recent ordinance has not removed the defects. Rather, it has accentuated the features which make it look like an amnesty scheme. If an assessee is searched, he can get away with disclosing the income and paying tax at the rate of 60 per cent within 45 days of getting the notice after the search...

Presumptive income

Needless exercise. The presumptive income scheme for professionals only presumes expenditure as a percentage of gross receipts and does not address the real problem, which is under reporting of receipts... In my view, as verification of expenditure is not much of a problem for the Department, there is no need to presume expenditure on the basis of a percentage of gross receipts.

Waiver of penalty

Wrong signal. With the objective of containing litigation, the group has suggested that penalty should be waived if the assessee pays tax within the prescribed period, in respect of the addition to the returned income made in the assessment. In my view, it is highly improper to provide such a promise in the law. It would send a wrong signal, encouraging people to take a chance and under-declare taxable income, especially when everybody knows that not more than 3 per cent of the returns will ever be scrutinised. Assessees found to have concealed income in the scrutiny proceedings will get away lightly by paying tax and interest on the concealed income after the assessment.

Conclusion

Any task for simplification of tax laws must have a rational basis. Simplification through schedular treatment of any particular type of income often opens up arbitrage opportunities. Eliminating differentials across sources of income involves moving from schedular to global income tax. As far as possible, the tax base should equal net accounting profits. Dominated by considerations of ease of collection based on income and rate of tax have been suggested by the group in the circumstances stated above. The schemes are iniquitous and do not integrate well with broadly based tax... Making tax changes without giving adequate consideration to equity would undermine the credibility of the tax regime.