Reforms to Income Tax Laws

The government has announced its intent to review the IT Act. To fundamentally resolve the source of these disputes requires that the contentious sections of the Act be carefully redrafted, and tax structure simplified.

What is Taxation?

• Taxation is not just a vehicle for raising state revenue. It can also be critically important for economic and political development.
• In recent times, India has introduced some far-reaching reforms to increase compliance (like Goods and Services Tax (GST), reduction in corporate tax rate and phasing out of exemptions etc.) and to reduce tax evasion (like Place of Effective Management, Black Money Act etc.).

Income Tax Structure in India:

• Between assessment years 2019-20 and 2022-23, the number of taxpayers increased from 89.8 to 93.7 million.
• Budget 2024-25 has further reduced the tax rate for incomes below Rs 12 lakh, which will impact more than 80 per cent of individual returns and 51 per cent of the gross income filed in returns.
• Only 6.08 cr individuals pay taxes (~4.9%) much below the desired level of 23%.
• In India, only 15.5% of net national income is reported.
• Overall, Tax-to-GDP ratio (at 17.82% in FY 2017-18) still remains below that of emerging economies (~21%) and much below OECD average (~34%).

Reasons behind low Tax-to-GDP ratio in India:

• Low tax base:
• Income Tax: In India, the exemption threshold of income tax has been consistently raised, much rapidly than underlying income growth. This implies that relatively well off people are subsidized at the cost of services which could be provided to poor with the forgone money.
• Corporate Tax: Before the recently unveiled tax-cuts, India was branded as a high-tax destination with corporate tax rate over 30%.
• Moreover, a complex system of exemptions, tax cuts, preferential tax rates, deferral of tax liabilities etc. has led to large tax collection expenditure and a significant amount of revenue foregone.
• Tax Evasion: Tax evasion and corruption undermines the legitimacy of the State. It creates a belief among the citizens that the public resources are being wasted, reducing the willingness to pay.
• A state that over-emphasizes or prioritizes redistribution over delivery of services ends up having middle class 'exit from the state' i.e. people start avoid paying taxes, start associating state with inefficiencies, promote using private hospitals or sending children to private schools etc. This will reduce the demand of services from state, further eroding its legitimacy to earn taxes.
• Multiplicity of exemptions and exclusions further increase the complexity of the tax structure and acts as a disincentive for tax-compliant society, as in case of GST.
• Weak Tax Administration: is considered a key barrier to effective and fair tax collection in the country.
• Tax administration and tax compliance is weak due to lack of technical expertise and financial resources, as well as due to corruption.
• Tax administrative capacity at sub-national and local government levels (e.g. user charges, property tax etc.) is particularly wanting.
• Structural Issues: Several structural factors have impinged upon India’s tax revenue performance such as: o large share of agriculture (historically untaxed sector) & service sector (lightly taxed sector).

Need for Tax Reforms:

Various committees, to consolidate the direct taxes, were constituted by the government like Raja Chelliah Committee (early 1990s), Vijay Kelkar Committee (2002), and the Easwar Panel.

• Recently, with the constitution of Arbind Modi Committee on Income Tax Reforms and Akhilesh Ranjan Panel on formulating a new Direct Tax Code (DTC), Government seems to be moving firmly in the direction of Direct Tax reform.
• Direct Taxes Code (DTC) aims to revise, consolidate and simplify the structure of direct tax laws (like the Income tax Act, 1961; Wealth Tax Act, 1957) in India into a single legislation.

Measures taken by the Government

• Increasing Tax Compliance
• CBDT launched ‘E- Sahyog’ portal to facilitate online filing of the returns;
• Project Saksham was launched by CBIC to help in implementation of Goods and Services Tax (GST) and in extension of Indian Customs Single Window Interface for Facilitating Trade (SWIFT)
• Extending the scope of Tax Collected at Source (TCS): E.g. 1% TCS is charged on luxury items (cars > 10 lakh/ cash payment > 2 lakh) collected by seller. o Push towards digitalization and formalization will increase expansion of tax net.
• Anti-Tax Avoidance Measures:
• Advanced Pricing Agreements (APAs): APA is an agreement between a taxpayer and tax authority determining the transfer pricing methodology for pricing the tax payer’s international transactions for future years.
• GAAR (General Anti-Avoidance Rules), effective from April 1st, 2017, is a set of rules which helps the revenue authorities to decide:
  • whether a particular transaction has commercial substance or not
  • tax liability associated with a genuine transaction.