Dealing with parallel economy

DIRECT TAX

For the past several decades, we have been plagued by the menace of parallel economy. The baptism of unaccounted wealth as part of the parallel economy requires debate since in geometric terms parallel lines do not meet, whereas unaccounted wealth and income traverses with practically all sectors of our life. No wonder, it flourishes in our system.

Consecutive surveys have revealed that the growth of parallel economy is not in the primary or secondary sector, but dominant in the services sector given that agricultural income is not taxed. Since the proportionate share of services sector is continually expanding, it is a worrisome trend to the policy makers in general and citizens in particular.

Tax evasion, misuse and flouting of fiscal laws and regulations, retention of proceeds in offshore bank accounts, property transactions and anti-social activities such as smuggling and drug trafficking can be identified as major factors supporting the parallel economy in our country.

The policy makers, with a view to combat such syndrome, have from time to time announced plethora of reforms in the area of tax, licensing regime, capital market transactions and exchange controls.

Historically, amnesty schemes have been introduced with the twin objective of raising revenues and breaking through the so-called parallel economy. Most of these schemes have given an opportunity to erring taxpayers to disclose income and wealth with suitable amnesty from penal consequences and prosecution. Despite wide usage, such schemes remain controversial since there is a growing perception amongst experts that they entice tax evaders by incentivising them to pay lower rates of tax "" simple interest with penalty waiver and immunity from prosecution.

The flip side being, honest taxpayers are discouraged to continue meeting compliance requirements.

Several Voluntary Disclosure of Income Schemes (VDIS) have been announced in the post-independence era. Besides the most recent VDIS of 1997, all earlier schemes have met with disastrous results. VDIS 1997 resulted in disclosure of Rs 33000 crore (estimated at 2.3 per cent of GDP at current market price) and tax collection of over Rs 10100 crore (estimated at 0.7 per cent of GDP at current market prices). Given the fact that the 1997 scheme allowed disclosure of income for the previous 8-10 years, the disclosure figures represents a drop in the ocean. Most conservatives would agree that given the current level of GDP, the unaccounted money in the economy would assume enormous proportions.

It is therefore for the legislature to debate upon the benefits and pitfalls of a new avatar of amnesty scheme. Would such a scheme add insult to injury by providing soft landing to tax evaders who would fork out 30 per cent tax and simple penal interest?

The constitutional validity of amnesty schemes has been a matter of debate before the Supreme Court. Though successive schemes have passed the test of constitutional validity on the grounds that it is not "palpably discriminatory to honest tax payers," it lacks confidence and support of citizens at large.

Assurance given by the government to the Supreme Court that the 1997 amnesty scheme was the last one, lost its relevance in 1998 when Finance Minister Yashwant Sinha announced 'Kar Vivad Samadhan'. The 1998 scheme essentially allowed taxpayers to arrive at a compromise with the revenue authorities in situations where litigation was pending.

Very few taxpayers came forward. Given the quantum of open cases with judicial and quasi-judicial authorities, such a scheme, if appropriately introduced and seamlessly executed, shall go a long way in reducing pendency in various courts.

Taking a cue from amnesty schemes being implemented by various governments, the HM Revenue & Customs (HMRC) of the UK has been toying with an idea of introducing a partial amnesty for tax evaders who have offshore bank accounts.

The draft scheme shall cap penalties at one-tenth of the tax evaded and is designed to encourage individuals to disclose their offshore holdings.

A landmark court ruling, which forced Barclays bank to hand over records of its customers with offshore accounts has been the leading light in this direction. The scheme will be timed with legal enforcement on high street banks to divulge information on client's with offshore accounts.

Tax Reforms Committee: The Wanchoo Committee in its report way back in early 1970s made valuable suggestions for checking tax evasion, including mechanism for setting up Settlement Commission to resolve disputes amicably, taxing agricultural income and introduction of search, seizure and survey operations. I doubt if the government has a time frame in mind to tax agricultural income. The operation and effectiveness of Settlement Commission has to be judged from the number of cases it has been able to resolve. The Wanchoo Committee suggested radical changes such as compulsory levy of penalty in cases of proven concealment.

Dr Kelkar's task force suggested tightening of search and seizure provisions, besides favouring imposition of full penal consequences in case of detection of concealment.

Legislative changes in the past few years to curb tax evasion epitomise the transition of policy makers' approach from amnesty schemes to tax reforms. Notable among them are taxation of gifts from unrelated persons, rigorous imprisonment for wilful falsification of books of accounts, introduction of Banking Cash Transaction Tax, and furnishing of Annual information Reports (AIR).

In summary, despite efforts to contain the growth of parallel economy, the problem continues to plague us and arrest our growth levels. A significant contribution has been the slow-paced implementation of tax reforms suggested by expert committees, lackadaisical and indifferent attitude of administrators, red tape and inefficient administration. Amnesties pose an alluring temptation for governments to tap unaccounted money; though over the years surveys have shown that they encourage proliferation of the same.

e-mail: mukesh.butani@yahoo.com

(The author is a Partner with BMR & Associates and these are his personal views)