In the current discourse about black money, let us not lose sight of the honest taxpayer in India, whose good intentions are severely tested every year by procedural obstacles. Among the worst is getting certification for taxes already paid through deduction at source.
A total of 34 million income tax returns were filed in 2009-10, by Report 26 of 2010-11 of the Comptroller and Auditor General (CAG). The same source also reports 96 million PAN card holders, although it is not clear if this number nets out duplicate cards. Whatever, there clearly remains a huge distance between the number of filers, and the universe of those with taxable potential.
Tax withholding at source from income tax payable is universally endorsed as the key structural corrective for filing failure. Tax deducted at source (TDS) signals to the tax authority the existence of an income recipient with taxable potential. It also achieves another very important purpose, which is to yield revenue to government as and when incomes are earned, thus evening out the revenue flow over the year.
TDS signalling can be achieved even through a system of final withholding, whereby tax is withheld at the lowest slab rate, and is not refundable. This system does not encourage the recipient to file for refunds due, if any, but a good information network will register the existence of a taxpayer with additional taxes potentially due, by virtue of the low rate of withholding, and give the tax authority a basis on which to follow up if no return is filed.
In India, we have provisional withholding, whereby refunds on TDS (along with other advance payments) can be claimed. This carries a greater incentive to file a return, and is fair to deductees whose income falls below the taxable threshold. TDS on salary is unlikely to be refundable, since the deduction is calibrated to the marginal rate payable on each slab. So refundability arises largely in respect of non-salary payments like interest. And TDS on interest is where all the problems arise, for taxpayers and deductors alike.
Banks are expected to pay TDS on interest due every quarter. So if there is a fixed deposit (FD) with interest cumulated every quarter, TDS is deducted from gross interest, and the net amount cumulated for the next quarter. So far, the procedure is understandable, although deductees do not actually receive any income. They are only deemed to have received income by virtue of the quarterly cumulation of the FD. But let that pass.
There is further complexity. Suppose there is an FD maturing on September 18, which is then renewed for a further period of, say, one year. The bank records the gross income payable on the new FD for the 12 remaining days in the quarter ending on September 30, and pays TDS on that, then carries the net interest forward into the next quarter. This violates the principle of quarterly cumulation. And it adds further to the workload of bank staff. If the bank overestimates TDS due by error, it cumulates its way into the gross interest payable in subsequent quarters.
Unlike a monthly salary statement from which salary earners receive full information on tax deducted each month, information on TDS from bank interest is not conveyed to FD holders every quarter. The TDS certificate is issued only after the conclusion of the financial year. Furthermore, the burden of extracting this certificate lies on the deductee. After much effort, the aspiring filer can expect to wave it triumphantly only by the middle of June. There is further harassment involved for those individuals wanting to file electronically, if TDS is not electronically uploaded.
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The TDS rate itself can change in the course of the year, without any information to deductees. For example, up to September 2009, TDS was deducted at 10.3 per cent, inclusive of cesses. Then it was changed to a flat 10 per cent. Fortunately, this kind of mid-year change should not happen anymore with the new Direct Tax Code, which prescribes TDS rates in its Third Schedule.
Annual Reports of the finance ministry provide only an aggregate figure of gross TDS collected, with no breakdowns. Annual CAG reports did provide separate figures for TDS from corporate and non-corporate taxpayers up to report CA 21 of 2009, which covered 2007-08, but not thereafter. From that last report, TDS is relatively insignificant for corporate taxpayers, but accounts for over half of gross collections from non-corporates (mostly individuals). Clearly, for individual taxpayers, taking credit for TDS paid is an important part of their tax-filing exercise.
Category-wise details of TDS by source are available only in aggregate across individual and corporate taxpayers, even in that last report for 2007-08. Interest accounted for roughly 20 per cent of gross TDS collections. Refunds amounted to 40 per cent of gross TDS (this last figure is still provided in subsequent reports, and seems to have come down in 2008-09 to 30 per cent).
Refunds are not specific with respect to income category, but clearly interest income is more susceptible than salary. The numbers, even at the reduced refund rate, suggest that TDS from interest income prompts the deductee to file only when a refund is due.
If this is true, TDS is not playing its signalling role in the manner it is meant to. Clearly, the TDS mechanism itself needs to be rationalised for this to happen. One immediate simplification possible is for banks to pay TDS only when interest payments actually fall due, as happens for cumulative taxable bonds. This would get rid of calculations for quarterly interest, and for interest on pieces of quarters. The reduced work load on bank staff should free them to take on the burden of providing TDS certification more readily. In that case, more deductees might willingly come forward to file a return, even when no refund is due.
The author is the honorary visiting professor, Indian Statistical Institute, Delhi