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Corporate tax rates must be brought down to 25%

Part 1: 16% excise is a regressive policy

Mukesh Butani

Vijay Kelkar is drawing applause and, in equal measure, criticism for the paradigm shift in fiscal reforms proposed in the report released by the task force under his chairmanship.

This is not different from the reactions to any radical reform pronouncement and Kelkar should take it with a pinch of salt.

The recommendations of the task force are bold, seeking to free the tax policy from vested interests, and it prescribes an across-the-board simplification and taxpayer services as a means to compliance.

In its 94-page report, the task force has outlined a path to reform the tax administration by addressing aspects such as accountability, infrastructure, human resources management, computerisation and operational issues such as collection of information, verification of tax returns, refunds, and taxpayer identification.

On the policy front, it has reworked the tax rates and slabs for personal taxes, tax treatment of savings, education and medical expenses, charities and corporate incentives.

While the prescriptions of the task force are welcome and its efforts commendable, a re-look is necessary on some issues.

The task force has been biased against all exemptions and deductions, some of which may have an economic and social rationale in an evolving economy like ours.

For example, the task force has recommended the removal of deductions from (owner-occupied) house property income on account of interest payments on borrowed capital.

It has relied on precedents in various developed economies where mortgage interest is not a deductible expense against house property income.

What needs recognition is the differential interest rates on housing loans, which, at 9.5-10 per cent per annum in India, are significantly higher than in many of the developed economies, and hence for reasons of parity, they justify a deduction in the Indian context.

Further, this incentive gives an impetus to the housing sector by giving fiscal incentives for constructing/purchasing house property, and has an indirect growth impact on various other core sectors such as steel and cement.

The personal income tax rates have been redesigned, the maximum marginal rate being applicable for an income level of over Rs 400,000.

This belies international precedents that the report has considered in making its recommendations.

The maximum marginal income tax rate is triggered at significantly high income levels in most economies. Accordingly, this level should be raised to at least Rs 10 lakh (Rs 1 million) in India.

The task force recommends the removal of almost all exemptions, deductions, rebates, and allowances for corporates.

In the same vein, it recommends the lowering of the corporate tax rate to 30 per cent, thereby achieving simplification and offsetting any cause for litigation.

In the process, the effective tax cost to corporates rises to 30 per cent (when the effective tax rate, as recognised by the task force in its report, in the existing regime was 21.9 per cent in 2000-01 against the statutory rate of 39.55 per cent), significantly higher than the effective tax rate in the exemption regime.

As equity requires that the reduction should be commensurate to neutralise the withdrawal of the exemptions, my take will be for at least a 10-percentage-point reduction in the corporate tax rate to 25 per cent.

The task force, with all its progressive intent and principles, has been ambitious. This is highlighted by its recommendations on taxation of agricultural income.

Though there is significant merit in such a move, this will generate significant political heat, and will require strong government will, at both the central and the states' levels, to carry it through.

An interesting and welcome recommendation is the identification of the issues in taxation of non-residents, a growing fraternity, especially in view of the significant emphasis that the successive governments have been placing on foreign investment as a facilitator of growth in India.

The task force recognised that the issues related to non-resident taxation were complex and required a detailed analysis for reform and had recommended setting up a working group to examine it.

Foreign investors will be closely following the developments in this area since the tax administration has been identified as one of the roadblocks to foreign direct investment.

(The author is national director, global tax advisory services, Ernst & Young - India)

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