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Tax Simplification and Rationalisation
Context:
The Indian government has set up a committee, led by V.K. Gupta, Chief Commissioner of Income Tax, to review and update the Income Tax Act.
More on News:
- The aim is to simplify and rationalise the Act without altering its fundamental structure.
- This move is significant as the Income Tax Act of 1961 has undergone thousands of amendments over the past six decades, yet it remains outdated in many ways.
- With the evolving economic landscape, especially due to the rise of digital commerce and globalised trade, there is an urgent need for tax laws to reflect modern realities.
Committee’s Mandate:
- The committee’s mandate primarily focuses on simplifying the language of the Income Tax Act and ensuring it aligns with contemporary business needs.
- Once a new law is enacted, making further amendments becomes challenging, so the current revision could be pivotal in shaping a modern tax framework.
- Key areas of focus include provisions related to mergers and acquisitions (M&As), dispute resolution, and taxation of salaried individuals, among others.
What is Tax Rationalisation and Simplification?
- Tax Rationalisation: It refers to the process of restructuring tax policies to make them more efficient, equitable, and aligned with economic goals.
- This often involves lowering tax rates while broadening the tax base, reducing loopholes, and ensuring fairness across different sectors.
- For example, India’s corporate tax rate was reduced to 25% in recent years, a significant departure from the excessively high 97% marginal rate seen in the 1970s.
- Tax Simplification: It involves making tax laws easier to understand and comply with.
- A prime example in India is the Goods and Services Tax (GST), which replaced a complex web of indirect taxes with a unified system.
- Similarly, the current review of the Income Tax Act aims to simplify provisions that have become too complicated due to numerous amendments over the years.
Importance of Tax Rationalisation and Simplification:
- Streamlining Tax Rates: The primary objective of tax rationalisation is not merely to increase revenue but to simplify the existing tax structure.
- In the context of GST, this involves reducing the number of tax slabs and addressing issues such as the inverted duty structure, where input tax rates exceed output rates, which can hinder cash flow for various industries.
- Reducing Litigation and Compliance Costs: A simplified tax structure can significantly decrease litigation related to tax classifications and compliance costs for businesses.
- For instance, proposals to combine certain GST slabs aim to alleviate the administrative burden on manufacturers and service providers1.
- Encouraging Compliance: Simplified tax codes tend to encourage higher compliance rates among taxpayers.
- Recent data indicates that over 72% of taxpayers opted for a new, simpler income tax regime in 2023-24, reflecting a growing preference for transparency and ease of understanding in tax obligations.
- Enhanced Predictability: A simplified tax system provides greater predictability for taxpayers, allowing them to plan their finances more effectively.
- Equity in Taxation: Simplification efforts also focus on achieving horizontal and vertical equity in taxation.
- Administrative Efficiency: Streamlining the tax framework can enhance the efficiency of tax administration.
- This includes reducing the complexity of determining tax liabilities and improving compliance through technology-driven processes.
- Support for Economic Growth: By creating a more business-friendly atmosphere through rationalised tax policies, the government aims to bolster domestic manufacturing and attract foreign investments, ultimately contributing to sustainable economic growth.
Challenges:
- Complex M&A Provisions: Current laws do not adequately address modern business practices like mergers and acquisitions.
- For example, only manufacturing companies can set off losses during mergers, while service companies are excluded.
- Unfair Tax Deductibility Rules: In strategic acquisitions, the tax-deductibility of interest on borrowed money is capped unfairly at 20% of dividends, which often does not align with the actual costs incurred.
- Dispute Resolution: India’s tax dispute resolution mechanism is slow and cumbersome.
- Alternative dispute resolution methods and advanced ruling systems need urgent reform to prevent tax disputes from dragging on for years.
- Salaried Individuals: The standard deduction for salaried individuals, currently ₹50,000, is too low and does not account for the real expenses incurred by high-income earners.
- Employee Stock Ownership Plans (ESOPs): The current taxation framework for ESOPs, where taxes are levied when options are exercised, does not consider the fact that there is no actual monetisation at that stage.
Way Forward:
- Update M&A Tax Provisions: Tax laws must be modernised to allow losses from mergers across all sectors, not just manufacturing.
- Enhance Dispute Resolution Mechanisms: This could include reviving the advanced ruling system, making it accessible to more businesses, and ensuring that cases are resolved within a few months.
- Revise Salary Taxation Rules: Increasing the standard deduction for salaried individuals and revising how ESOPs are taxed will make the system more equitable.
- Rationalise TDS Provisions: The burden on tax deductors must be reduced, and the rates and compliance requirements for tax deducted at source (TDS) should be simplified.