India's New Direct Tax Code:Panacea or Deus Ex Machina?

India’s New Direct Tax Code: Panacea or Deus Ex Machina?


Direct taxes, throughout independent India’s 62 plus years, have generally yielded less than the cost of the administrative apparatus created and sustained to collect them. One of the reasons for this is the ease with which any but the employee classes working in the “formal” sector can underpay or dodge them.

The other reason is the sheer impracticality of assessing liability against perquisites and indirect income. Departmental instructions are drafted as clearly as mud, and made infinitely worse by confused amendments year after year.

The Government has made little headway on expanding the tax payers’ base. The direct tax payers are, in fact, a miniscule number of a few lakh in a population of over a billion. And corporations would rather plough back would-be profits into expansion than pay taxes.

As things stand, if it weren’t for the multiple layers of indirect taxes, duties and excises on raw materials, intermediate goods/services, as well as on finished products/services; it would be difficult to carry on. This massive taxation, combined with borrowing from institutional sources, both domestic and international; and massive deficit financing keeps the engines running.

The Government of India would be hard pressed to support itself, let alone its various development programmes and other obligations, without recourse to its various Deus ex machina that keep it trundling forward.

In the context of reform, direct taxes need to be reasonable and comparable with other large economies to encourage compliance, discourage tax exiles and flight of capital. The Government also needs to eschew hidden whammies. Similarly, indirect taxes should not be so onerous so as to cripple competitiveness, particularly in a rapidly globalising India.

Most FMs, cleaving to discretion being the better part of valour, have given direct tax reform a miss. However, Mr. P. Chidambaram, our once and many times FM, took the bull by the horns during his last tenure and drafted a code on direct taxes to replace the Income Tax Act of 1961.

Coda are generally associated with big time reform. They have traditionally been major dictates that consolidate, harmonise, unify and systematise clusters of laws, written and unwritten, forging them together with custom, tradition and political vision. The term has been applied throughout history to mark milestones in the evolution of law-making and, more importantly, the very serious business of nation-building.

Thus, we encounter the ancient and famous Codex Hammurabi from 1790 BC. Hammurabi changed the face of criminal law and justice in ancient Babylon with this code which nevertheless was simple enough to come down to us carved onto a single stone.

Napoleon Bonaparte laid down his path-breaking Civil Code in 1804, after the fall of the Bourbons; after the French Revolution and its blast of liberté, égalité, fraternité. The Code Napoleon was a unification and modernisation of civil law based on older,
largely royalist French and Roman predecessors. It abolished the privileges of birth and laid out property laws, opening the door to modern democracy. The Code was thought to be so good that it remains the basic template for civil law in most of Europe to this day.

The question before us then is what can free India’s first declaration in the form of a code hope to accomplish? And the answer: unless shorn of its sleight- of- hand, old wine in new bottles provisions, very little indeed!

It continues, for instance, to exempt the 60% or so of the population engaged in agriculture. It is ironic perhaps that all tax revenues of centuries past, in British and Mughal India, was either tribute, indemnity or spoils from vassal/vanquished states; or land revenue extracted from toiling peasants through their overlords.

And even written in clear, succinct and simple language, it nevertheless seeks to conceal more than it reveals. For example, it is true that corporate taxation has been reduced to 25% from 30%, but MAT has been reworked to accrue better returns than it is getting at present to make up the shortfall.

Also, an ostensibly reduced Wealth Tax, dramatically down from 1% on a low threshold of just Rs. 30 lakhs to 0.25% per annum is proposed to be made applicable on all Wealth greater than Rs. 50 crores. Except that “Wealth” will now include shares and other financial instruments and thus tax even promoter shareholdings in companies on a recurring basis year after year! How this retrograde intention is meant to help corporate India grow into sizes that can help it compete on the global stage is beyond comprehension.

The individual taxpayer is pleased at first at the contemplation of tax slabs made much broader. Proposals such as a modest 10% rate of tax for income up to 10 lakhs, 20% for up to 25 lakhs and 30% for all income beyond this figure are most encouraging.

But, all perquisites of individual tax payers including medical expenses will be taxed at the applicable slab rates and this includes the perks of government servants. This will be very hard to calculate equitably. For instance, try to imagine the perquisite value of a government allotted “quarter” versus a commercially leased flat and you will intuit the new can of worms coming up.
Besides, one of several flies in the ointment is again in the treatment of capital gains which would be taxed at the applicable slab rates and include all financial instruments including equity, fixed deposits and mutual fund earnings.

How is this expected to encourage the equity cult, or indeed saving, one does not know. Traders and active investors responding to a bull market will be taxed on profits at their slab rate, though curiously, passive recipients of dividends will continue to receive them free of taxes.

There will be no distinction between short and long term capital gains. This also means anybody who sells a property after the code comes into force will probably pay 30% in taxes instead of the 20% he used to pay after “indexation”.

The most worrying part is that this back-loaded code is being promoted as a panacea for future tax administration, when, unless it is shorn of its retrograde provisions, it is no more than yet another deus ex machina, an expedient bolt from the blue that seeks to solve a problem of revenue generation, rather than prescribing a lasting cure to low direct tax compliance.

(1,049 words)

15th August 2009
Gautam Mukherjee


Published as "Reforming direct taxes" in Leader slot on Op-Ed Page of The Pioneer on Tuesday, August 18th, 2009. Also appeared online at www.dailypioneer.com and is archived there under Columnists.