In his February 2015 Budget speech, Arun Jaitley earned much praise for declaring that the government would, over a period of three years, phase out various tax exemptions for the corporate sector and at the same time bring down the corporate tax rate to 25 percent from the prevailing 30 percent. Of course, it did earn him brickbats from those who focussed only on the reduction in tax rates and conveniently airbrushed what he said about this being accompanied by a withdrawal of exemptions.
Two years on, are the critics right? Has Jaitley focussed more on reducing rates than on withdrawing exemptions?
Those who feel corporate tax exemptions are also subsidies, will say Jaitley has done more of the former. They will quote the rise and rise of revenue foregone due to exemptions. Revenue foregone in the case of corporate tax rose from Rs 76,858 crore in 2015-16 to Rs 83,492 in 2016-17. In the case of indirect taxes (customs and excise), revenue foregone increased from Rs 1,48,442 crore to Rs 1,54,822 crore over the same period. (The revenue foregone on account of personal income tax is also a sizeable sum, but does not attract the criticism that corporate tax and indirect tax exemptions do).
But what of the charge that Jaitley is not doing enough on withdrawing exemptions?
That Jaitley was not just making an empty promise was evident when, in November 2015, the finance ministry unveiled a roadmap for withdrawal of exemptions.
According to this report, profit-linked, investment-linked and area-based tax deductions were to be phased out for both corporate and non-corporate tax payers, the sunset date of existing exemptions were not to be extended, where there was no terminal date, a sunset date of 31 March 2017 was to be set for claim of benefit and no weighted deduction was to be allowed after 1 April 2017.
Budget 2016-17 kick-started the process. Several deductions were reduced and sunset dates put for others along with reductions in tax rates for some categories of businesses – new manufacturing companies set up after March 2016 were given the option of being taxed at 25 percent provided they did not claim any exemption and companies with turnover less than Rs 5 crore got a 1 percent reduction. However, some new exemptions were given to start-ups, with certain conditions.
This year, admittedly, Jaitley has not moved forward on withdrawing exemptions even as he reduced corporate tax rates.
But let’s look at who has got this benefit: the small and medium enterprises sector. Income tax for companies with an annual turnover of up to Rs 50 crore has been brought down to 25 percent. A big chunk of this lot was paying an effective tax rate of 30.26 percent, while the large companies (turnover above Rs 500 crore) paid an effective tax rate of 25.9 percent. So Jaitley has in a way done the tax equivalent of social levelling. Large companies have not got any tax relief this year.
Was pressing the pause button on withdrawal of exemptions warranted? Let’s not forget that taking the axe to exemptions this year would not have been a good idea, considering the slowdown the economy is going through. At the same time, the business group most adversely affected by demonetisation – the small and medium enterprises – have got substantial relief.
What of the way forward?
There’s no getting away from the fact that tax exemptions have to go. They are a drain on the exchequer and they also are the main source of disputes, especially on corporate tax. Amounts under dispute in the case of corporate tax saw a 32 percent increase between 2014-15 and 2015-16. This clearly has to end. How the withdrawals are sequenced and calibrated is the key.
An abrupt withdrawal of exemptions already given and being enjoyed is not an option. The business models of companies, which would have factored that in, will go for a toss. If a company had started operations in 2013 on the basis of a ten-year tax holiday, would it be fair to say the tax break will end in 2019? So the finance ministry will have to continue with putting in sunset clauses where there are none and resisting lobbying to extend the life of those that are nearing an end. To that extent, withdrawal of tax concessions will be a gradual affair.
Equally important is to do a cost-benefit analysis of existing exemptions and, if they are not found to be serving the purpose, work with industry to phase them out as quickly as possible. When special economic zones (SEZ) have not really taken off in the way they were expected to, is there any point in continuing with deduction of profits of companies engaged in developing them? The revenue lost on this account was Rs 2,118 crore in 2016-17.
The temptation to give tax sops to encourage new sectors or entrepreneurship also has to be resisted. Last year, Jaitley gave tax sops to start-ups – 100 percent deduction of profits for three out of five years, no tax on capital gains with certain conditions. This year, the deduction of profits has been relaxed to three out of seven years and the conditions relating to no tax on capital gains has also been eased.
As Sunil Sinha, principal economist, India Ratings, points out, putting too many ifs and buts to tax concessions makes them cumbersome to administer and also give more scope for disputes. Perhaps the government can start with doing away with conditions, as a precursor to doing away with exemptions.
The problem of exemptions in indirect taxes will be more or less taken care of with the coming of the goods and services tax regime. But what of direct taxes? Sinha makes a pithy point when notes that while this government has been tom-tomming its GST push, there is hardly any talk about a direct tax code; that seems to have been buried with the United Progressive Alliance government. A simple and straightforward direct tax code with minimum exemptions (if any, at all) would go a long way to ending disputes and reducing revenue loss. Will Jaitley make a start on this in the coming year?