Hidden tax subsidies

It is well known that the effective rate of corporate taxation is far below the announced rate of 35 per cent (plus applicable surcharges). Companies pay a lower effective rate because they are able to take advantage of several exemptions allowed them under the Income Tax Act. Just how much do these exemptions cost the government in terms of revenue losses?

A study by the Business Standard Research Bureau (BSRB), reported in Tuesday's edition of the paper, provides some estimates. Even though they are based on a sample of companies and hence, do not reflect the overall magnitude of the losses, they are quite striking.

For a sample of over 700 companies, the taxes actually provided for were over Rs 14,000 crore less than what they would have been if the announced rate had applied.

The benefit of tax exemptions worked out to 32 per cent of notional tax dues. This means an effective tax rate of about 26 per cent for the sample, which might be taken as a fair reflection of the corporate sector as a whole.

Further, the BSRB study reveals the essentially discriminatory nature of the exemptions. There are huge differences in the effective tax rate across sectors. Companies in the automobile sector pay close to the average, clocking in at around 24 per cent.

However, shipping pays only 4 per cent, textiles 13 per cent, and software, whose profits are still shielded by the exemption on export earnings, also 13 per cent.

One of the major recommendations of the Task Force on Direct Taxes, chaired by Vijay Kelkar, was the complete elimination of tax exemptions. The previous government chose not to act on this recommendation in its last full Budget.

The new government has given indications of being favourably inclined towards the task force's report. Thursday's Budget speech will indicate the extent of acceptance. In the light of the numbers revealed by the study, the finance minister would do well to take the issue forward, if not in this Budget, then certainly in the next one, barely eight months away.

There are two major issues at stake. One is the magnitude of economic benefits that these exemptions have actually provided. Have the macroeconomic and sectoral objectives that motivated the exemptions been realised to any reasonable degree? The macro-level industrial performance numbers certainly don't suggest this. Industry's share of GDP has been essentially stagnant over the last several years.

The second is the question of equity. Companies have been arguing that they are taxed at a higher rate than individuals. This may be nominally true, but in practice, as these numbers show, the opposite is the case.

There would be a case for equalising the rates for corporation tax with the highest income tax slab if the tax exemptions are withdrawn, as suggested by the Kelkar task force. As it happens, this would also make it possible to give industry what it has been asking for: the abolition of the minimum alternate tax.