Mukesh Butani: It's a case of tax rates vs tax compliance

BUDGET ANALYSIS/DIRECT TAX

The Finance Minister's budget speech acknowledged the strides made in fiscal consolidation during 2007-08. Economic Survey data for 2007-08, released on Thursday, reveals tax-to-GDP ratio has scaled up quite significantly over the last couple of years in a row. Direct tax collections alone have shown about 40 per cent increase for two consecutive years, a phenomenon perhaps witnessed for the first time in the last several decades. The recent buoyancy in direct tax collections not only eased the pressure on North Block to meet the annual fiscal targets, but has also buoyed expectations of tax rate cuts for both corporate and individual tax payers in the country.

Referring to budget deficit statistics, the FM in his budget speech expressed contentment over meeting targets for reduction in fiscal deficit (1 per cent of GDP) and revenue deficit (0.5 per cent of GDP) and promised elimination of revenue deficits by 2008-09. However, the budget proposals did not come out with any initiative to foster tax-to-GDP ratio. Undoubtedly, the rise in tax-to-GDP ratio to over 12 per cent is commendable, but we are yet to arrive at a consistent view on India's tax-to-GDP ratio data.

On the direct tax front, buoyed by the handsome growth in direct tax collections over the last couple of years, the industry was expecting a reduction in tax rates for the corporate tax payer; without mincing any words, Mr P Chidambaram expressed that the buoyancy in tax collection did not present a vehement case for any reduction. However, the FM did not disappoint completely as he apparently chose to trade the expected corporate tax cut with excise duty reduction.

At the same time, without loosing sight of the forthcoming general elections and with a view to appease the middle class electorate, the finance minister offered the much awaited relief to individual tax payers by significantly increasing the minimum exemption limit and raising the income slabs liable to maximum marginal rate of tax. In my budget wishlist, this change was overdue since the last budget gave it a skip.

In a measure to curb volatility in the secondary market, the tax rate for short term capital gains was increased to 15 per cent. The increased tax rate on short tem gains may hurt FIIs, if treaty protection were to be withdrawn in future. To simplify administration of securities transaction tax (STT), it is proposed to treat STT as tax deductible expenditure. Also, to encourage derivative trading, measures have been proposed to simplify the levy in case of exercise and non-exercise of options. The levy of the Banking Cash Transaction Tax is proposed to be abolished with effect from April 1, 2009, and rightly so!

To rationalize levy of Dividend Distribution Tax on domestic companies and to mitigate double taxation of dividend income, it has been proposed to allow set off of the dividend received from a subsidiary company against dividend distributed by the parent company. Though, this change does not seem at par with erstwhile section 80M which exempted every subsequent layer of dividend distribution. In another significant change proposed, abolition of TDS on listed corporate debt instruments would catalyze the development of debt market in the country.

Moving to sectoral tax exemptions, a five year tax holiday has been extended to 2/3/4 star hotels and hospitals to be constructed in specified districts /cities; a move intended to boost the growth of social infrastructure in the country. Also, though the industry will cheer the survival of tax holiday for SEZ developer and units, the sunset on 10A/10B tax holiday will hurt IT/ITES units.

While, weighted deduction of business expenditures to promote research and development activities would be welcomed by the industry with open arms, introduction of "Commodities Transaction Tax" on commodities option and futures trading would need clarity.

While the Economic Survey and the budget speech made a mention of climate change and importance of green fuels usage, no concrete fiscal incentives were announced in the budget to give a fillip to this sector.

The FM, though expressing contentment over the recent buoyancy in direct tax collections; clearly sounded concern over the unfinished agenda of improving tax administration and compliance levels. The ramp-up of revenue collections can be attributed to three key factors "" widening tax base, increase in tax rates and lastly, improved tax compliance coupled with efficient tax administration. Among types of taxes, self-assessment tax and tax deducted/collected at source grew over 50 per cent, indicating improved tax administration and better tax compliance levels.

Undisputedly, voluntary tax compliance has increased over the last decade, partly due to efficient tax administration and partly due to increased cost of tax evasion. However, increase in voluntary tax compliance thus far has been only meagre (3-5 per cent) and any let-off at this stage must be viewed with lot of skepticism.

I am really surprised by the conspicuous absence of any mention/announcement on the new Income Tax Code. The new Income tax Code would have gone a long way in enhancement of tax administration and compliance levels. To me personally, Budget 2008 is overall a balanced budget to propel the growth in manufacturing sector, at the same time not losing momentum on corporate tax collections and the interest of common man. Overall, good balancing act between larger economic objectives and political wishlist of UPA coalition. Well done, PC!

Mukesh Butani, Partner, BMR and Associates