India’s taxing times

Over the last two decades, India’s tax administration has undergone extensive and much-needed modification and modernisation; changes that still continue today. Whereas such reforms have resulted in the simplification of many aspects of the fiscal legislation, there still remain several areas where further attention is needed.

The Indian tax reforms were initiated in the late 1980s with several key reforms. Most prominent amongst these included the moderation of rates of taxation, the discontinuation of several artificial disallowances, and the confinement of wealth tax to non-productive assets.

Furthermore, a tax holiday for the infrastructure sector was mooted, specific provision on treaty override was enacted in the statute, and special concessional tax treatment was considered in the cases of foreign institutional investors, overseas financial organisations and investors in global depository receipts.

These provisions, coupled with the opening up of the Indian market to foreign investments in 1991, helped boost economic activity to unprecedented levels. Today, the reform process still continues, but not with the same momentum as was seen in the early days.

Before the reforms
Prior to the beginning of the economic reforms, tax rates were high to the point of being almost punitive. There were no incentives for productive efforts or for reinvestments, a situation that led to reckless expenditure for the sole purpose of gaining tax relief, for example indiscriminate investment in capital goods. Furthermore, such disorganised fiscal policy led to a thriving parallel underground economy, which in turn encouraged a certain degree of socio∞economic debasement.

Recent reforms
In recent years there have been several significant changes to the tax administration. One of the main complaints by practitioners such as Bansi S. Mehta is the length of time taken by the tax office in responding to requests for clarification on specific issues of taxation. In many cases the tax board office can be at best unhelpful, and at worst adversarial.

In response to such confrontations, businesses and advisors have increasingly turned to the high court to request an assessment of individual situations, and this threat of litigation has prompted a noticeable curtailment in the response times by the tax office.

The creation of the position of ombudsman, with the aim of assisting tax payers with their minor grievances, has further improved the process. For example, previously, it was not uncommon for the tax department to sit on tax refunds for many months, but with the intervention of the ombudsman, the tax office has been more forthcoming is settling claims.

Presumptive taxation
Another reform that has had a beneficial impact on many Indian companies is that of presumptive taxation. This is available as a substitute to the elaborate computation process. Using presumptive taxation, a fixed percentage, or amount, is applied to the turnover or the unit number of assets. For example, for a non-resident supplier or service provider in the field of oil exploration, a fixed 10 percent presumptive rate is applied to the gross receipts. Similarly, in the case of small transport operators, a fixed sum of INR3500 per vehicle per month gives the amount of taxable income.

Although India’s double-taxation treaty with several countries provide for total exemption of shipping profits for non-resident shipping enterprises engaged in international traffic, presumptive taxation applies to other cases whereby 7.5 percent of the gross freight is regarded as taxable income of the non-resident shipping company.

Once the presumptive tax regime is available and invoked, normal computation (which is the bane of India’s tax litigation) is dispensed with. In some fields of presumptive taxation the taxpayer is given the option to opt out of this tax, in which case the taxable subject matter would be computed without invoking presumptive taxation, for example, in the field of small transport operators and small retailers.

In line with international practice, shipping companies in India are also now subject to a form of presumptive taxation, based on the tonnage of each ship comprised in the fleet.

Currently, presumptive taxation is available to companies in the following sectors: small civil contractors, small retailers, small transport operators, non∞resident service providers in the oil exploration field, foreign shipping companies touching India for inbound or outbound freight, and foreign airlines. Although for taxation this is still not fully operational, there is still a proposal before the government to apply a presumptive taxation regime to the diamond and jewellery trade also. 

The presumptive taxation regime owes its origin and thriving existence to the complexity of tax provisions for computing taxable income, and experience shows that, to the extent that it is considered by the Indian parliament, the tax litigation is minimised.

Ongoing issues: Interpretation
In spite of such reforms, some issues still remain. Whereas legislative changes have tried to tackle fundamental problems, the resulting difficulties in the interpretation of the law have clouded the waters. Undoubtedly the new laws have public interest at heart, but their sheer volume and differing interpretations of them have led to confrontations with the tax department.

The inefficiencies of the tax office
A great deal has been done in terms of the simplification of existing administration, however over-staffed tax offices still manage to find ways of keeping themselves busy by following Parkinson’s law; work expands to fill up available time.

Whereas several changes are underway to increase working efficiency – most notably the continued roll-out of automated systems in tax offices – tax administration for the time being remains largely a manual process, and as such is subject to human failings. And although many see the replacement of man by machine, from a human standpoint, as being a sad development, the reality is that machines have been proved incapable of one particular human attribute; being lazy!

In spite of its understandable unpopularity, there needs to be a continued and concerted effort to trim manpower, and redeploy resources to other more needful areas of public administration. On the flip side of the coin, however, there also seems to be a dearth of in key positions of responsibility. The most critical area for reform is the need to instill experienced people in areas of the administration that call for an exercise of sound judgment and the ability to adopt a stance on key issues.

A move towards outsourcing would also serve to improve the efficiency of the tax administration, as in this case the work can be assigned to bodies who regulate and monitor their members more closely.

Foreign investors
The potential for foreign investment in India is huge, and could bring prosperity both for the investor and the Indian market itself. However, there is a great deal of uncertainty surrounding the status of foreign investors in the eyes of tax legislation.

A foreign investor in India can be categorised in one of two ways; either as Foreign Direct Investor or as a Market Operator, and there are significant tax implications to be considered with both of these classifications. An example of a market operator is a private equity fund, whose investment in businesses has the potential to create billions of dollars of revenues for the Indian economy.

However, the tax regime is often confused by the operations of private equity funds, meaning that the group is liable for taxation as a market operator rather than an investor. In which circumstances, private equity would not be a viable business proposition in India.

Presently, the majority of private equity funds choose to bypass the situation by structuring their vehicles as Mauritian entities, although this can be cumbersome and in some cases discourages private equity investment. Since the potential for private equity investment in India is huge, the government needs to simplify the tax legislation to encourage private equity funds to enter the country.

Looking forward
For many years now, past and present political parties have promised to introduce a single, simple, unified tax code, although when in power, this has become less of a priority. The current government, formed of alliances between a number of parties, is no exception, and has been forced to put the individual priorities of splinter alliances to the forefront, at the expense of any wholesale tax changes.

Although extensive lobbying (by the chamber of commerce, professional societies and not least by the press) serves to maintain pressure on the government, since the current administration has just six months of power remaining, it seems unlikely that any meaningful changes will be made in such a short period of time.

As low rates of taxation have expanded tax revenues, the simplification of tax laws and procedures could further enhance revenue coffers. Since India depends heavily on inward capital flows, a simplified approach of friendliness would go a long way. Furthermore, bilateral tax treaties need to be carried into effect in a manner that demonstrates the spirit in which they were intended, not in a manner that shows suspicion or distrust.

For India to pose an attractive market for investments, there are several key items that need to be addressed. Firstly, it is imperative that there is established a stable tax regime with low rates, in order to combat the flight into parallel economy. Secondly, there needs to be a responsive administration, properly framed and instructed to administer the tax regime without taking an adversarial role.

Finally, there is a need for an extended period of fiscal consistency, during which no major upheavals to the regime are made. In other words the Indian market is crying out for a realistic, stable, friendly and sensitive approach to tax assessment and its collection.