One of the most forward-looking proposals in the last Union Budget, for 2015-16, was the plan to reduce the headline corporation tax rate by five percentage points in a phased manner while ending the various exemptions that permit companies to pay less than the headline tax rate. This was planned to simplify the tax regime, broaden the tax net, and reduce distortions in the system. In general, the thrust towards reducing tax exemption-based regimes is welcome. What is worrisome, however, is that there seems to be a slate of proposals that act in the opposite direction, to in fact increase the number of tax exemptions - all apparently for the best of reasons, but dangerous nonetheless.
One such proposal came in from the committee appointed by the Securities and Exchange Board of India, or Sebi, to look into the venture capital scene in India. The committee, headed by N R Narayana Murthy, has suggested several tax breaks for venture capital that it says will help grow the alternative investment ecosystem in India. For example, services to raise funds from overseas investment are proposed to be exempted from service tax. Meanwhile, it has been proposed by the pension regulator that the upcoming Union Budget, to be presented in five weeks, exempt withdrawals from the National Pension Scheme, or NPS, from taxation, and subject it to an exempt-exempt-exempt (EEE) regime, as opposed to an exempt-exempt-tax (EET) regime. The Seventh Central Pay Commission has also recommended that "withdrawals under the NPS should be tax-exempt to place NPS on a par with other pension schemes". Currently the employee provident fund (EPF) is EEE, while the NPS is EET, and there are worries that this leads to a skewed playing field. But levelling the playing field should ideally mean that all schemes become EET, not EEE.
Read our full coverage on Union Budget 2016
There are too many programmes on the anvil that create new claims on the state. The new farm insurance scheme suggests raising the Centre's commitment to filling any gap between premiums and claims. There is a concern here that must be addressed: this would reduce the insurance companies' incentives to administer the scheme properly. Worse, this might encourage insurance companies to discard their own system of scrutiny of cases claiming insurance benefits without any fear of any losses. Indeed, tax exemptions are part and parcel of various recent government thrusts. For example, solar energy is to be provided exemptions - although, worldwide, tax exemptions on renewable energy have often backfired. If solar energy is truly to become a sustainable backbone for the Indian energy economy, then why subsidise it? If solar energy is genuinely getting competitive on tariffs, as many who back renewable energy claim, then why not expose it to a straightforward tax regime? Even the government's manufacturing policy attempts to involve some protection from taxes. The Make in India website proudly lists various "incentives under the Income Tax Act", including heavier weighted deductions for research and development, and additional deductions for hiring new workers.
The government must recognise that an exemption regime is dangerous. It twists entrepreneurs and investors into seeking out tax benefits rather than good and productive ideas. It distorts the economy. Even if considered important as protection for growing industries, it has been found they become impossible to withdraw. Instead of an exemption regime, Indian entrepreneurship and investments will get a boost if there is a stable and straightforward tax regime where no effort is put into tax arbitrage. This should underlie the drafting of the Union Budget.
