Budget 2003-04
The finance minister seems to have ignored most of Kelkar's tax proposals in order to gain popular appeal
Its a Budget with a difference this time. Despite acknowledging the work done by the task force headed by Vijay Kelkar on tax reforms as "sound", finance minister Jaswant Singh seems to have decided to ignore most recommendations made by it. Kelkar's main suggestions were to do away with all exemptions, reduce the rate of corporate tax, expand the service tax net and bring the level of service tax on par with that of the manufacturing sector eventually.
He also advocated rationalising of duty structures, simplification of tax procedures and strengthening of the tax administration. Experts agree that Kelkar's recommendations were built on pure economic logic and a tax regime based on those principles would only have improved tax compliance and efficiency in the long run. But the finance minister has disregarded most of Kelkar's proposals, especially the ones which are sensitive even if they were radical, to please the public ahead of the elections.
Some areas where there was no dispute and a clear consensus emerged -- like the introduction of VAT, rationalising excise and customs duty structure and the procedural simplifications -- the Budget has effected the recommendations of the task force. Politically sensitive areas like subsidy rationalisations have been dealt with in a modest way. And in this process, the finance minister appears to have compromised on efficacy and economic rationale, say experts.
It is only obvious that corporates and individual tax payers are delighted with the finance minister's charitable Budget. A key recommendation by Kelkar which would have had a far reaching impact on corporates was to do away with all exemptions. Kelkar's point was that in the plethora of exemptions and concessions given under the Indian tax system, there is a huge difference between corporate tax rates and what the companies actually end up paying as tax. As outlined in the final report by the task force, in 1999-2000, the effective tax rate of a sample of 3777 companies was 21.7 per cent as against the statutory rate of 38.5 per cent.
Similarly in 2000-2001, the effective tax rate of a sample of 2585 companies was 21.9 per cent as against the statutory rate of 39.55 per cent. Again, the financial results of 1334 profit-making companies for the fiscal year 2001-2002 indicated an effective tax rate of 21.75 per cent for 1275 non-banks. For the 59 banks in the set, however, the effective tax paid was higher at 35.01 per cent.
"The erosion of the tax base is evidenced by the divergence between the statutory corporate tax rate and the effective tax rate and we are of the strong view that divergence between taxable income and book profit undermines corporate governance," stated Kelkar's report. Indeed, it is this anomaly that Kelkar had wanted to correct.
Kelkar's philosophy was to redesign corporate tax so as to align taxable income and book profits with corporate profits bearing the full burden of corporate tax. "This is possible only by eliminating the various tax incentives/preferences as well as rationalising various other allowances which are inconsistent with accounting practices," stated the report.
As a compensation for taking away exemptions, Kelkar had recommended a cut in the corporate tax rate to 30 per cent for resident corporates and 35 per cent for foreign companies from the current rate of 35 per cent and 40 per cent respectively. The surcharge was to be eliminated completely.
Under Kelkar's suggestions for corporate taxes the number of tax paying companies would have increased dramatically and they would have been left with lesser ways to evade tax. But the finance minister has refrained from biting the bullet and has kept all the exemptions intact. In his Budget speech, Jaswant Sinha said: "We cannot ignore the commitments made, or wish them away." This is despite the fact that the minister acknowledged that: "For a modern, forward-looking and in the long run, revenue beneficial taxation system, the proposals that have been mooted may be the most appropriate!"
As exemptions have been left unchanged, the minister has kept corporate tax rates untouched and altered only the surcharge. Even here, the finance minister has not eliminated the surcharge entirely. For corporates, the surcharge has been halved from 5 per cent to 2.5 per cent; for individuals with taxable income of less than Rs 8.5 lakh it has been eliminated completely, and for individuals with income more than that level the surcharge has been doubled from 5 per cent to 10 per cent.
Another point that the finance minister has ignored to keep the corporates happy is to keep standard depreciation rates untouched for plant and machinery. "It is good idea to keep the depreciation rates where they are, given the high rate of change in technology and low capital formation" says Ketan Dalal, partner RSM & Co. The task force had recommended that the rate of depreciation on general plant and machinery be reduced to 15 per cent from 25 per cent and the rates for other blocks of assets also be similarly reviewed. The idea was to align tax depreciation with book depreciation under the Companies Act 1956.
Similarly, the task force's suggestion to allow carry-forward of business losses indefinitely has also been thrown out of the window. This would have been beneficial for companies which are in high-risk businesses, have a long gestation period, or those which have unstable and volatile income streams. Notably, companies engaged in the telecom and steel business would have benefited from this move since many companies in these sectors have huge accumulated losses.
For banks, Kelkar's task force had recommended that the provision for bad debt be made an allowable deduction. As per the expense rule in the Income Tax Act, any provision is an allowable deduction if it is a statutory obligation. In case of banks and financial institutions, even though they have to make provisions for NPAs to comply with Reserve Bank of India (RBI) regulations, for tax purposes this statutory obligation is disregarded. If full deduction was allowed for NPA provisioning, it would have meant huge tax savings for banks.
But given that the tax collection from banks would have been down by 35 per cent because of this move, the finance minister decided not to dole out this benefit to banks. "Moreover, since he had already packed goodies for the banking sector by hiking the FDI limit, and by creating liquidity in their books by buying back high-yielding government bonds, may be another sweetener for banks would have been less of a priority," said a banker.
What's more intriguing is that, quite contrary to what the task force recommended, the Budget proposed to increase the exemptions given to individuals. Kelkar has suggested that standard deduction, and exemptions, including Section 88 and 80L benefits, be done away with while raising the minimum amount taxable to Rs 1 lakh.
In sharp contrast, the budget hiked the level of standard deduction and increase the items eligible for tax rebate. For instance, the tax rebate offered for children's educational expenses is an addition to the list of items eligible for Section 88 benefits. Similarly, there is additional deduction available for the physically handicapped and senior citizens. Says A N Shanbhag, a Mumbai-based tax consultant, "Kelkar's tax proposal of hiking the threshold limit for individual income and eliminating exemptions was definitely a superior alternative. But the finance minister has not gone ahead with it only to please people in the short-run. Actually, Kelkar's suggestions would have worked out beneficial for all in the long run. "
But most ordinary people, including the experts, are happy that the finance minister has not taken away the sops given for housing. "Given that the measure is for a social cause and has macro-economic implications for the economy, the finance minister has done the right thing by keeping the tax incentive for housing," says RSM's Dalal.
Even in areas like dividend tax and long-term capital gains tax, the finance minister has not really gone the whole hog to help the capital markets. Kelkar had recommended the removal of dividend tax and long-term capital gains tax on listed equity.
Kelkar's logic was that corporate profits get taxed at the company level, and hence, it didn't make sense to tax it again at the hands of investors. The Budget has conceded part of the argument and made the dividends tax-free in the hands of investors.
But it has only shifted the incidence of tax from investors to the company. While the move will be beneficial to investors in the top income tax bracket (since dividend distribution tax is only 12.5 per cent compared to 30 per cent personal income tax rate in the top bracket), it will ease compliance. But the issue of double taxation remains unresolved.And the move defies the spirit and economic logic by levying a dividend distribution tax on the company, say experts.
Similarly, in case of long-term capital gains tax, the Budget has abolished long-term capital gains tax on shares acquired on or after March 1, 2003. The finance minister has said that the proposal will be re-examined next year.
Not surprisingly, the stock market has been disappointed. Based on Kelkar's recommendations the market was expecting the Budget to abolish long-term capital gains tax altogether. Some experts, however, point out that the removal of this tax is only to give a boost to the equity markets and hence, it is only appropriate to render this concession for shares purchased henceforth.
The introduction of Value Added Tax and rationalisation of excise duty and the reduction in customs duty structure are welcome moves. So is the hike in services tax. "These moves were more or less inevitable, and hence it is not surprising that the finance minister went ahead with the proposals," says Sachin Menon, partner, Ernst and Young. But overall, the Budget has attempted little in terms of setting a trend for building a tax regime based on pure economic efficiency and easy compliance.
