T N Pandey: For a perfect Finance Act

Major tax changes need not be routed through finance bills

The finance ministry is in the process of finalising proposals for Budget 2005, inter-alia, on issues relating to direct taxes. Elaborate changes are expected in the Income Tax Act with a view to reform it. The finance minister, while presenting last year's Budget, said, "I am a votary of tax reforms, but it would be unwise on my part to attempt to do tax reforms in a hurried or piecemeal manner.

Seven months from now, there will be an occasion to visit the subject of tax reform."

Obviously, the reference to the seven-month period was the Budget-making exercise for 2005.

In view of the repeated statements from the prime minister and the finance minister regarding tax reforms, a number of changes in tax laws are expected in the coming Budget.

The Finance Bill may be loaded with numerous changes concerning the Income Tax law about which the taxpayers have no clue, what with the Budget-making process being confidential.

On February 28, the country will be clamped with one-sided changes in such laws, which would then become fate accompli for the taxpayers.

The issue is whether fundamental and widespread changes in tax laws should be made through annual Finance Acts.

A look at various Finance Acts in the past six or seven years shows that several changes in the IT Act and Wealth Tax have been carried out in a hurried manner, which contained numerous errors that had to be corrected later.

In the process, the laws became more complicated. The extent of changes made can be seen from the chart above.

It is clear that changes in the IT Act, made through annual Finance Acts, are contrary to the purpose for which these Acts are meant. Through annual Finance Acts, a number of far-reaching changes, for instance, those relating to reorganisation and restructuring of companies (Finance Bill, 1999); a new law relating to taxation of perquisites and tax holiday for core sectors of infrastructure (Finance Bill, 2001); abolition of dividend tax; and many such amendments have been made.

Schemes like voluntary disclosure scheme and Kar vivad samadhan scheme, which were announced through Finance Bills, created lot of legal and other issues for which elaborate clarifications had to be issued by the Central Board for Direct taxes and chief commissioners of Income Tax.

Hurried legislation in the past resulted in many mistakes, which have been admitted by finance ministers.

The fact that the provisions introduced through Finance Acts lacked clarity and were not well thought out has been accepted in the finance ministers' Budget speeches and in the explanatory memoranda.

That there were no concerted thoughts and discussions concerning major proposals and the Finance Bills were rushed is possible not only at the government's level, but also at the level of the taxpayers, trade associations, chambers, professional bodies and so on because:

The exercises related to Finance Bills are time-bound since the Budget is to be presented to the Parliament on a pre-fixed date "" generally on February 28 "" each year;

Budget exercises are carried out under secrecy and officers of the finance ministry are made "out of bounds" for public "" no discussions can be had with them during the Budget-making;

Hence, some serious thinking in the context of bringing changes in tax laws is necessary. These changes (amendments) should be divided into two categories: (i) Amendments of a technical nature and (ii) amendments that are of a strategic nature or require policy decisions.

A technical amendment is a change in the tax law that reflects no substantial re-examination of the tax policy.

So, the existing tax structure is not changed but the wording of particular provisions is altered so as to implement better the underlying policy of the provisions.

A technical amendment may be necessary because the original law opened an unintended loophole; a judicial or administrative interpretation of the law has given an undesirable result; the original law is unintentionally harsh on a particular taxpayer or group of taxpayers; a change in the procedure for reporting information is desired; the law contains a drafting error; and changes have short-term impacts.

Only such changes should be introduced through annual Finance Acts.

The second category of changes, which, for convenience, may be referred to as "special changes" could be when the government wants to make a strategic change in the existing Act; meet emerging situations caused by external factors like globalisation and liberalisation by providing tax benefits to encourage reorganisation or restructuring of corporate sectors; introduce provisions that deviate from the generally accepted notions of tax equity; proposals that lead to sacrifice of tax revenue to achieve a non-tax objective like development of backward areas, infrastructure facilities and so on.

There could be many such areas.

If practical tax reforms are desired, major and fundamental changes in tax laws should be made only through the Income Tax Amendment Acts. The proposals contained in such Acts can be widely discussed, considered by Parliamentary committees, discussed in the Parliament and only then should the changes be incorporated in tax laws.

Finance acts should be used only for making changes that are of a technical nature. If this procedure is followed, there would be no need to "roll back" the changes announced through the finance bills, as has been done in the past.