T N Pandey: Progression in corporate tax not advisable

TAXING MATTERS

As the time for Budget approaches, suggestions from various quarters start pouring in at the Union Ministry of Finance.

One suggestion that is made almost every year is about introducing progression in the assessment of corporations.

The proposals are generally two fold: Corporations should have tax brackets like individuals and those with incomes up to say Rs 2.5 lakh could be taxed at a flat rate of 15 to 20 per cent (without surcharge).

Those with incomes above Rs 2.5 lakh could be taxed at prevalent rate of tax.

The justifications given for this demand are:

The categorisation would increase the number of companies and, consequently, the employment level in the country.

Large companies are in a position to take full advantage of the fiscal incentives, including the depreciation allowance, provided by the government but the smaller companies are unable to do so.

As a result, the effective tax rate in their cases is higher vis-a-vis bigger ones.

Before examining the proposal, it is necessary to give the historical background of corporate taxation. Under the 1886 Income-Tax Act, tax on corporate profits was levied at a flat rate.

It was replaced by a slab system in 1916 and the rates were raised. Then, a super-tax was levied in 1917 in addition to the income-tax. Incomes above Rs 50,000 was subjected to the super-tax.

The same position continued under the 1922 Act.

When the 1922 Act was amended in 1939, the exemption limit for super-tax was withdrawn and the super-tax was made payable at a flat rate on the whole of the company's profit.

At present too, the companies are taxed at flat rates of tax without any basic exemption.

Thus, for the past so many years, companies are paying tax at a flat rate. Since AY 1993-94, firms are also taxed as separate entities at the rates applicable to companies.

The present position is that both firms and companies are taxed at the rate of 35 per cent, with surcharge wherever applicable, and if a change in the method of taxation of companies is made, similar change will have to be extended to the firms too.

Issues have been raised on whether there should be threshold exemption limit for the companies too.

The Taxation Enquiry Committee of 1924-25 (popularly referred to as Todhunter Committee) recommended the abolition of exemption limit for corporation tax on the ground that "small companies derive relatively as much advantage as large ones from the privilege of incorporation and the amount of profit made by a company bears no necessary relation to the wealth and poverty of its shareholders".

The Economic Administration Reforms Commission, headed by late L K Jha, in its report has also said that there is no need for progression in the matter of company taxation.

It said: "It is generally agreed that the principles of progression cannot be applied to the taxation of companies because they are not natural persons and the income of a company cannot be taken to reflect the relative ability to pay of its shareholders. Moreover, if a higher rate of tax is levied on larger profits, greater inequity will be meted out to the smaller shareholders of the more successful or larger companies. In any case, an attempt would be made to split up companies to lighten the tax burden. Hence, progression with reference to size of income cannot be introduced into the corporate tax system."

Before raising the demand for lower taxation of smaller companies or introducing progression in company taxation, it is necessary to make empirical studies to find out whether the smaller companies are indeed not getting the full advantage of tax incentives and concessions and whether a change in the existing pattern would generate more employment and if so, to what extent.

In other words, is there any justification to change the system of taxation being followed for many years when experts have repeatedly voted against the proposal? Chambers of commerce and others, who are in favour of this proposal, should show some studies and then come up with a more convincing proposal in this regard.

If accepted, one possible outcome of the proposal could be mushrooming of small companies in the country. Bigger trading, service and other companies not involved in large- scale manufacturing and production activities, would prefer to split into smaller units to avail of lower rates of tax at the threshold levels.

This would lead to fragmentation of existing companies and work against economies of scale in many cases.

With the increase in the number of companies, the work at different levels viz. Registrar of Companies' Offices, income tax offices, etc., would increase with no ostensible benefits. Revenue would obviously fall and there would be a tendency to find ways and means to avoid tax through the formation of smaller companies.

Further, the repercussions of the change would be on the taxation of firms also where it may be difficult to deny similar benefit.

Taking into account the various aspects mentioned earlier, it could be said that the existing system is working very well and hence, no change in the same seems necessary.