A Regime Of Fear

To reform tax policy, government must think about it more clearly.

Written by Ajay Shah | Updated: November 3, 2015 4:20 am
Income tax, Tax, gst, gst rates In most mature countries, financial activities by non-residents are not taxed.

Tax reform is one of the highest priorities in India today. The finance ministry has set up the Justice Easwar committee to reduce conflict in this area. While this is a step in the right direction, the problem runs deeper. We require a rethinking of tax policy, legal drafting, and organisational structures. Reforms must be more ambitious, and the policy work needs to be adequately resourced.

Legal risk associated with taxation and arbitrary actions of the tax authorities have created a climate of fear. The first area of work is thinking clearly about tax policy. If our foundations are confused, the private sector cannot anticipate future actions and decisions taken by the tax authorities could be internally contradictory. For example, in most mature countries, financial activities by non-residents are not taxed. We think differently, but recoil at the harmful consequences of taxing non-residents. This has resulted in a messy stalemate, where attempts to tax non-residents are held back by “exemptions”. After the crisis over minimum alternate tax (MAT) on foreign portfolio investors (FPIs) had subsided, it was reported the income tax authorities were trying to establish whether FPIs have permanent establishments in India in order to open a new battlefront. This cat-and-mouse game is the result of a mistake at the core of tax policy. Similar concerns bedevil the taxation of firms. We have one of the highest corporate tax rates. To reduce the damage, we have an array of exemptions. This has created complexity, unpredictability and legal risks. The first pillar of reform is sound economic thinking on tax policy.

The second pillar concerns drafting of income tax law. Poor drafting has set the stage for chronic battles between the income tax department and citizens. Legal risk is embedded in a law when words and phrases such as “reasonable”, “public interest”, “opinion” or “believe” are used. These could mean almost anything depending on the reader. A modern, well-drafted law would not use such words and phrases. The present income tax law uses “reasonable” 59 times, “public interest” 14 times, “opinion” 76 times, and “believe” 27 times. Section 147 authorises an assessing officer to reopen assessments if there’s “reason to believe” there has been evasion.

Another element of archaic drafting that plagues the Income Tax Act is the use of “provisos” that create exceptions to the general principle. The phrase “provided that” occurs 450 times. So, the law is founded on faulty tax policy. Exceptions were introduced to mitigate its adverse consequences. And this has been done shabbily.

The third pillar is rethinking the foundations of public administration. The strategy in modern states has been to place tax policy and the drafting of the finance bill in their equivalent of the department of economic affairs. But tax administration should be kept at arm’s length from the finance ministry. The tax administration should not have a say in tax policy. This reduces politicisation and ensures policy is not distorted in ways attractive to administrators.

A recent study showed tax authorities win only 23 per cent cases before the judiciary. An important source of the problem is the present system of targets. To set targets better, statutory tax-base surveys need to be carried out. For example, today, tax officers are given an aggregate target, such as Rs 20 crore. In a modern tax regime, a tax officer would get an aggregate target, along with several sub-targets: Say, Rs 5 crore from persons earning below Rs 20 lakh a year, Rs 5 crore from persons earning Rs 20-50 lakh, and so on.

A procedural tax administration law, distinct from the Finance Act, is required.

This should specify the organisation of legislative, executive and quasi-judicial functions in tax administration. This would have many similarities with the clarification on the working of financial agencies in the Indian Financial Code (IFC).

Justice Easwar and his team have been given a first deadline of three months, and a total time of a year. A permanent technical team is required to think about tax policy, draft high-quality legislation, continually refine the law based on experience and feedback, etc. For comparison, it’ estimated that 15,000 man-days went into the drafting of the IFC by a team of over 150 people.

The writer is professor, NIPFP, Delhi

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  1. N
    Nov 4, 2015 at 11:37 am
    Expressing opinion against government policies does not mean that he is speaking against India. Only government and administration do not consute India. It is republic and people living there are part of it.
  2. A
    Anil Maheshwari
    Nov 4, 2015 at 11:05 am
    Barring unscrupulous elements, everyone suffers the tax terrorism. Why should one refrain from speaking just for the sake of the lofty ideals of nationalism? The only and one need is transparency in the digital age and grievances readdressal machinery in the right earnest besides making efforts to change the mindset of the taxation officers who consider every tax payer dishonest.
  3. A
    Anil Maheshwari
    Nov 3, 2015 at 12:58 pm
    The w exercise of tax reforms is an eyewash. None is seriously interested in curbing the tax terrorism, unleashed by the IT Department, bureaucrats, Chartered Accountants and practising senior lawyers in the high courts and the apex court. The simplification of the IT act means a seatback to the vested interests. Lo! even in the new group one is a practising High Court advocate and another is the former chief justice of a high court. What good one can expect from the vested interests. No wonder, the young entrepreneurs prefer to set up offices abroad in Singapore, the USA etc. to escape from the unbridled tyranny of the IT Department.
  4. A
    Nov 3, 2015 at 9:03 pm
    Correction: Tax pracioners, chartered accountants and tax officials are the major nexus who make obstacles for a transparent reforms in this sector. From income to indirect taxes there are so many paperwork related rules and procedures for complicated nuisances. To simplify rules and reform this sector, expert committee must be consuted without the above groups.
  5. A
    Nov 3, 2015 at 9:02 pm
    Tax pracioners, chartered accountants and tax official are the major nexus who make obstacles for a transparent reforms in this sector. From income to indirect taxes there are so many paperwork related rules and procedures. To simplify rules and reform this sector, expert committee must be consuted without the above groups.
  6. S
    Nov 3, 2015 at 10:49 am
    Thinking of a new way to suck blood money / hafta!
  7. V
    Nov 3, 2015 at 7:33 pm
    When Tax Lawyers double up as Finance ministers, expecting tax reforms is a pipe-dream. This Justice Easwaran committee is going to meet the same fate. Only talk no action. More complicated laws, so more power for Chartered Accountants and Tax lawyers and the IT department. Set up a business in India at your own peril, especially if you are a small guy who has no resources to fight tax authorities.
  8. S
    Nov 3, 2015 at 7:14 pm
    What unbridled tyranny of the Income Tax Department has been suffered by Mr. Anil Maheshwari himself? One should avoid speaking against India and India's tax policies. Mr Anil himself should clarify what needs to be done?
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