Arbind Modi panel proposed 15% corporation tax rate; is that even viable?

The panel projected a boost in compliance and taxing multinationals on a par with domestic companies

A governmental panel headed by former central tax body member Arbind Modi had, in a report that was junked, recommended a lowering of the corporation tax rate from 25-30 per cent to 15 per cent. Though it was not accepted by the then finance minister Arun Jaitley, the report had several bold moves that, if implemented, would change the grammar of direct taxes in India.

But one question that arises is, were these bold proposals really viable in the current Indian context? How did the report justify the proposals?

The report primarily depended on a crucial procedural aspect, and a jump in reporting of corporate incomes resulting in enhanced tax compliance. This, in turn, would have boosted corporation tax revenue. The report recommended forgoing a large chunk of revenue accruing from personal income-tax collections by liberalising the slab structure, and rationalising provisions related to exemptions and savings.

The report proposed to ensure that all companies doing business in India paid tax at a lower rate by eliminating the scope for balance sheet management.

The new panel under Akhilesh Ranjan, current member of the Central Board of Direct Taxes (CBDT), is to submit its report to the present finance minister, Nirmala Sitharaman, by August 16.

The journey so far

The history of direct tax reform in India has not been as illustrative as that of indirect taxes. The universe of indirect taxes started with customs and excise, and expanded further over years, with the addition of MODVAT, then state and central value-added or sales taxes, and then service tax. These were all later succeeded by the goods and services tax (GST).

The structure of direct taxes, on the other hand, has remained nearly the same for decades, with tinkering of slabs and rates, in consonance with growth in the economy and incomes. The system still relies on a law made in 1961, though it has seen more than 2,000 amendments to date. Since economic liberalisation until demonetisation, the Union government took professional help from four committees to simplify India’s income-tax laws.

Whether or not the current panel under Ranjan would keep these recommendations intact is still under the wraps, but the justification behind the “interim” proposals is worth understanding.

New source rule, low-rate-high-compliance model

A surprising (and relieving) assertion that the report made was that the proposed corporation tax rate cut to 15 per cent from 25 per cent (for most companies) would not result in any revenue loss. Rather, it went ahead and said that if all recommended reforms were “bundled together”, corporation taxes would earn the government nearly 15 per cent more revenue than business as usual.

Taking the tax collection data for assessment year (AY) 2017-18 as a use case, the Arbind Modi report said that two things would give a boost of Rs 65,000 crore from corporation taxes.

The first major gain in tax revenue from companies comes from a change in definitions — modification in the “source rule” of taxation — and using the cash accounting method. 

Changing the source rule would mean that all incomes/profits earned in India would be liable to tax, irrespective of the nature of the company. Even a multinational or a US-based technology behemoth like Google would be liable to pay corporation tax in India for all the business activities performed in this country.

This would increase the “scope” of corporate income, the report said.

Cash accounting method means that taxes would be paid on incomes/profits actually accumulated in accounts of the companies, and not books of accounts. The latter involves discretion on the part of the taxpayer on disclosing the nature of income. This would treat all income/profit/dividends, whether capital or revenue, equity or debt, in the same way, rationalising corporate incomes and taxes, the report proposed.

At a reduced corporation tax rate, this would result in a revenue gain of Rs 38,000 crore in AY17-18, according to the report.

In doing this, the report proposed revoking the current taxation system based on transfer pricing. This would “eliminate the scope for base erosion and profit shifting (BEPS) on account of ambiguity in law, fragmented jurisdiction or transfer pricing”, the report noted.

Secondly, the report based the bump in corporate tax collection after the rate cut partially on improved reporting of incomes and tax compliance as well.

“One per cent (percentage point) reduction in corporation tax rate will induce an increase of 0.8 per cent in reporting of corporate income,” the report said, based on its calculations. This would add another Rs 28,000 crore in AY17-18 corporation tax revenue bucket.

These two measures in totality would give a boost of Rs 65,000 crore to the government (hypothetically in AY17-18).

Bounties to middle class, but with caveats

On personal income-tax front, the report proposed a more liberalised slab structure, and the government would forgo a massive Rs 40,000 crore purely on account of this alone.

The preferred model proposed no income tax up to Rs 6 lakh of income, and removal of tax-based incentives such as those on mediclaim and house rent allowance (HRA). Investments in provident funds or equity-linked savings schemes were capped at Rs 150,000, with caps on individual instruments as well.

For instance, it capped non-taxable contribution to national pension scheme (NPS) to an employee contribution of 10 per cent and employer contribution of 10 per cent (20 per cent in total). A sum of Rs 50,000 would be exempt for contribution towards any kind of provident fund, inclusive of employer contribution. Investment of Rs 25,000 in lieu of life insurance and up to Rs 48,000 per year for education of children were proposed to be exempt at the time of contribution by the Arbind Modi report.

This, the report noted, would give individuals the option to save in government-supported/designed instruments like provident funds, with a caveat that their withdrawals would be taxed.

The report proposes the abolition of dividend distribution tax (DDT) and securities transaction tax (STT). On DDT and long-term capital gains (LTCG) tax, it proposed these should now be levied on individuals which earned dividends or capital gains.

In AY17-18, companies paid out dividends to the tune of Rs 2.4 trillion to shareholders, of which nearly Rs 1 trillion was paid to the central or state governments. Shifting taxation to the individual will mean a Rs 21,000-crore revenue loss to the tax department, the report said. Adjusting for revenue gain of Rs 5,000 crore on account of a new tax on profits made by branches of a company, the total revenue loss due to abolition of DDT would cost the tax department Rs 16,000 crore.

On capital gains, individuals would be resultantly taxed at a higher tax rate than before, if the recommendation of the Modi report were to be accepted. As LTCG are generally derived more by the richer sections of the society, the income-tax incidence of, say, 30 per cent would bring in more revenue than the 10 per cent incidence of LTCG in its current avatar.

While this will result in a gain of Rs 15,000 crore to the Centre, a revenue loss due to abolition of STT of Rs 9,000 crore would result in a net gain of Rs 6,000 crore.

It remains to be seen whether the final report keeps these bold provisions or resorts to a reform with incremental changes.