ASSIGNMENT

OF

MACROECONOMICS (ECO561) BASED ON

TAXATION SYSTEM IN INDIA

SUBMITTED TO Ms. POOJA KANSRA

SUBMITTED BY DEVENDRA OJHA MBA (HONS.) RQ1101A14

Taxation system in India

EVOLUTION OF INDIAN TAX SYSTEM Tax policy in India has evolved as an important component of fiscal policy that played a central role in the planned development strategy. In particular, tax policy was the principal instrument for transferring private savings to public consumption and investment. Tax policy was also used to encourage savings and investment, reduce inequalities of income and wealth, foster balanced regional development, encourage small-scale industries on the assumption that they are employment intensive, and influence the volume and direction of economic activities in the country. INTRODUCTION India has a well developed tax structure with a three-tier federal structure, comprising the union government, the state government and the urban/rural local bodies. The power to levy taxes and duties is distributed among the three tiers of governments, in accordance with the provision of the Indian constitution. In last 10-15 years, Indian taxation system has undergone tremendous reforms. The tax rates have been rationalized and tax laws have been simplified resulting in better compliance, ease of tax payment and better enforcement. The process of rationalization of tax administration is ongoing in India. Since April 01, 2005, most of the State Governments in India have replaced sales tax with VAT. Taxes Levied by Central Government: 1. Direct Taxes Direct tax is a tax which is directly charged on the tax payer. It is taken care by the Central Board of Direct taxes (CBDT).it is a division of department of revenue under Ministry of finance. It is governed by revenue act 1963.

(a) Tax on Corporate Income Companies residents in India are taxed on their worldwide income arising from all sources in accordance with the provisions of the Income Tax Act. Non-resident corporations are essentially taxed on the income earned from a business connection in India or from other Indian sources. Domestic corporations are subject to tax at a basic rate of 35% and a 2.5% surcharge. Foreign corporations have a basic tax rate of 40% and a 2.5% surcharge. In addition, an education cess at the rate of 2% on the tax payable is also charged. Corporate are subject to wealth tax at the rate of 1%, if the net wealth exceeds Rs.1.5 million. (b) Capital Gains Tax Tax is payable on capital gains on sale of assets. Long-term Capital Gains Tax is charged if Capital assets are held for more than three years. In case of shares, securities listed on a recognized stock exchange in India, units of specified mutual funds, the period for holding is one year. Long-term capital gains are taxed at a basic rate of 20%. However, long-term capital gains from sale of equity shares or units of mutual funds are exempt from tax. Short-term capital gains are taxed at the normal corporate income tax rates. Short-term capital gains arising on the transfer of equity shares or units of mutual funds are taxed at a rate of 10%. (c) Personal Income Tax Personal income tax is levied by Central Government and is administered by Central Board of Direct taxes under Ministry of Finance in accordance with the provisions of the Income Tax Act. The rates for personal income tax are as follows:-

Income tax slabs 2011-2012 for General tax payers

Income tax slab (in Rs.) Tax

0 to 1,80,000 1,80,001 to 5,00,000 5,00,001 to 8,00,000 Above 8,00,000

No tax 10% 20% 30%

Income tax slabs 2011-2012 for Women

Income tax slab (in Rs.) Tax

0 to 1,90,000 1,90,001 to 5,00,000 5,00,001 to 8,00,000 Above 8,00,000

No tax 10% 20% 30%

Income tax slabs 2011-2012 for Senior citizen (Aged 60 years but less than 80 years)
Income tax slab (in Rs.) Tax

0 to 2,50,000 2,50,001 to 5,00,000 5,00,001 to 8,00,000 Above 8,00,000

No tax 10% 20% 30%

Income tax slabs 2011-2012 for Very Senior citizen (Above 80 years)
Income tax slab (in Rs.) 0 to 5,00,000 5,00,001 to 8,00,000 Above 8,00,000 Tax 0% 20% 30%

(d) Tax Incentives Government of India provides tax incentives for: Corporate profit Accelerated depreciation allowance Deductibility of certain expenses subject to certain conditions. These tax incentives are, subject to specified conditions, available for new investment in Infrastructure, Power distribution, certain telecom services, Undertakings developing or operating industrial parks or special economic zones, Production or refining of mineral oil, Companies carrying on R&D, Developing housing projects, Undertakings in certain hill states, Handling of food grains, Food processing, Rural hospitals etc

2. Indirect Taxes (a) Excise Duty Manufacture of goods in India attracts Excise Duty under the Central Excise act 1944 and the Central Excise Tariff Act 1985. Herein, the term Manufacture means bringing into existence a new article having a distinct name, character, use and marketability and includes packing, labelling etc. Most of the products attract excise duties at the rate of 16%. Some products also attract special excise duty/and an additional duty of excise at the rate of 8% above the 16% excise duty. 2% education cess is also applicable on the aggregate of the duties of excise. Excise duty is based on the maximum retail price in some cases. (b) Customs Duty The levy and the rate of customs duty in India are governed by the Customs Act 1962 and the Customs Tariff Act 1975. Imported goods in India attract basic customs duty, additional customs duty and education cess. The rates of basic customs duty are specified under the Tariff Act. The peak rate of basic customs duty has been reduced to 15% for industrial goods. Customs duties in India are administrated by Central Board of Excise and Customs under Ministry of Finance. (c) Service Tax Service tax is levied at the rate of 10% (plus 2% education cess) on certain identified taxable services provided in India by specified service providers. Service tax on taxable services rendered in India are exempt, if payment for such services is received in convertible foreign exchange in India and the same is not repatriated outside India. (d) Securities Transaction Tax Transactions in equity shares, derivatives and units of equity-oriented funds entered in a recognized stock exchange attract Securities. Transaction Tax at the following rate: Delivery base transactions in equity shares or buyer and seller each units of an equity-oriented fund - 0.075% Sale of units of an equity-oriented fund to the seller mutual fund - 0.15% Non delivery base transactions in the above - 0.015% Derivatives (futures and options) seller - 0.01%

Taxes Levied by State Governments (a) Sales Tax/VAT Sales tax is levied on the sale of movable goods. Most of the Indian States have replaced Sales tax with a new Value Added Tax (VAT) from April 01, 2005. VAT is imposed on goods only and not services and it has replaced sales tax. Other indirect taxes such as excise duty, service tax etc., are not replaced by VAT. VAT is implemented at the State level by State Governments. VAT is applied on each stage of sale with a mechanism of credit for the input VAT paid. There are four slabs of VAT: 0% for essential commodities 1% on bullion and precious stones 4% on industrial inputs and capital goods and items of mass consumption All other items 12.5% Petroleum products, tobacco, liquor etc., attract higher VAT rates that vary from State to State (b) Stamp duty Stamp duty is a tax that is levied on documents. Historically, this included the majority of legal documents such as cheques, receipts, military commissions, marriage licences and land transactions. A physical stamp (a revenue stamp) had to be attached to or impressed upon the document to denote that stamp duty had been paid before the document was legally effective. (c) State excise (d) Land revenue (e) Duty on entertainment (f) Tax on profession and callings Taxes Levied by local bodies (a) Tax on properties (b) Octroi (c) Tax on markets (d) User charges for utilities like water supply, drainage etc

ANALYSIS OF THE TRENDS AND ECONOMIC IMPACT OF THE TAX SYSTEM.

The analysis shows that despite initiating systematic reforms, the revenue productivity of the tax system has not shown appreciable increase and the decline the tax ratio due to reduction in customs duty could not be compensated by internal indirect taxes. The trends in tax revenue in India show four distinct phases.

In the first, there was a steady increase in the tax-GDP ratio from 6.3 per cent in 1950-51 to 16.1 per cent in 1987-88. In the initial years of planning, increase in tax ratio was necessitated by the need to finance large public sector plans. Thus, the tax ratio increased from a mere 6.3 per cent in 1950-51 to 10.4 per cent in 1970-71 and further to 13.8 per cent in 1980-81. The increase continued until it peaked to 16.1 per cent in 1987- 88. The buoyancy of the tax in later years of the phase was fuelled by the economy attaining a higher growth path and progressive substitution of quantitative restrictions with tariffs following initial attempts at liberalisation in the late 1980s.

The second phase started with the economic recession following the severe draught of 1987 and was marked by stagnancy in revenues until 1992-93. However, triggered by the pay revision of government employees, expenditureGDP ratio increased significantly after 1988-89 and this caused serious fiscal imbalances leading to the unprecedented economic crisis in 1991. The subsequent adoption of stabilisation of structural adjustment program led to sharp reduction in import duties.

Thus, in the third phase, the tax ratio declined from 15.8 per cent in 1991-92 to the lowest level of 13.4 per cent in 1997-98 and fluctuated around 13-14 per

cent until 2001-02 even as the deficits continued to be high. Thus, tax GDP ratio increased by over one percentage point in the tax ratio to 15.2 per cent in 2003-04 (revised estimates for the Centre and budget estimates for the states).

Interestingly, the trends in tax ratios of direct and indirect taxes follow different paths. In the case of the former, the tax ratio remained virtually stagnant throughout the forty year period from 1950 to 1990 at a little over 2 per cent of GDP. Thereafter, coinciding with the reforms marked by significant reduction in the tax rates and simplification of the tax structure, the direct taxes increased sharply to over 4 per cent in 2003-04 and expected to be at about 4.5 per cent in 2004-05. In contrast, much of the increase in the tax ratio during the first 40 years of planned development in India came from indirect taxes, which as a proportion of GDP increased by over three times from 4 per cent in 1950-51 to 13.5 per cent in 1991-92. However, in the subsequent period, it declined to about 10.6 per cent before recovering to a little over 11 per cent. The decline in the tax ratio in recent years was mainly due to lower buoyancy of indirect taxes. Interestingly, fluctuations in the tax ratio are seen mainly at the central level. Central revenues constitute about 60 per cent of the total tax revenues and therefore, fluctuations in central tax ratio impacts significantly on the aggregate tax ratio. The tax ratios at both central and state levels increased sharply during the period from 1950-51 to 1985-86. Thereafter, the tax ratio at the state level was stagnant at about 5.5 per cent until 2001-02 and then increased marginally to 6 per cent in 2003-04. In contrast, the central tax ratio continued to increase and peaked in 1987-88 to remain at that level until the fiscal crisis of 1991-92. In subsequent years, there was a sharp decline until 2001-02 followed by recovery to the pre-1991 level in 2004-05 (revised estimates). Within the central level, the share of direct taxes increased from 20 per cent in 1990-91 to over 43 per cent in 2004-05. As mentioned earlier, the increase in the tax ratio until the end of the 1980s was due to indirect taxes, but in subsequent years increase in direct taxes arrested the sharp decline indirect taxes.

FATAL FLAWS IN OUR TAX LAWS There are three main objectives of any budget - to modify the existing tax system, to achieve specific economic and social objectives, and to balance receipts and expenditure while making provisions for the government's deficit. Unfortunately, every budget in our country seems to pursue a single-minded agenda of raising the tax rates without any concern for the manufacturing and service sectors. The manufacturing sector in India has been rendered uncompetitive on account of poor infrastructure, erratic power supply and a horrendous taxation system.

Very often, our tax system makes it viable for a product to be imported from low-cost manufacturing hubs such as China. Similarly, the manner in which service tax is being levied will soon ensure that our services sector is also crippled. There are seven fatal flaws which have now become a permanent part of our tax laws and the future looks very grim unless these are rectified.

Absence of impact assessment: There is no assessment of the impact of a new levy on a particular sector or the industry in general - who will be affected, how easy it will be to collect the tax, or whether the levy is equitable and fair. This year's budget, for instance, seeks to levy service tax on health care. All "hospitals with 25 or more beds that have the facility of central airconditioning" will be brought under the service tax net. Every hospital with 25 beds is bound to have an operation theatre and therefore will have central airconditioning in some part of the building. In fact, one way to avoid the tax is to install window air-conditioners and escape the levy.

Services in government hospitals are in a dismal state and the vast majority of the population is forced to go to private hospitals. Levying service tax on such a sector is reprehensible. The state has failed to provide basic health care and the least it can do is to avoid making it even more expensive.

Another such example is the levy of service tax on commercial coaching centres. Once again, the teaching standards in our schools and colleges force parents to opt for extra tuition for their wards. It is equally unfair to levy service tax on such activity.

Excessive taxation: India continues to be the most heavily taxed country in the world if all direct and indirect levies are taken into account. The increasing trend of multiple levies of VAT and service tax on the industry has exacerbated the woes of the taxpayer.

Total uncertainty: The uncertainty of our tax laws makes long- or even medium -term planning virtually impossible. For example, excise duty was to be levied on branded jewellery in 2005. Detailed representations were made to the finance ministry pointing to the impracticability of such a levy and the proposal was dropped. Inexplicably, the item will now be taxed. The special economic zones, or SEZs, are also victims of such uncertainty and no unit in any SEZ knows exactly what its tax liability is for the next 12 months.

Complexity: It is ironical that every finance minister swears by simplification and rationalisation, and does just the opposite. The classic example is the new Direct Taxes Code, which is more complex and irrational than the Income Tax Act of 1961. Service tax, with its new set of rules framed in 2011, has now crossed the stage of complexity to become totally incomprehensible.

Absence of execution: In 1789, Thomas Jefferson, one of the founding fathers of the US Constitution and third President of the republic, stated that the execution of laws is more important than the making of them. However, in India, the failure to implement laws continues to be the single largest weakness of the tax system. This year's budget now makes prosecution possible for any

service tax violation. But several prosecution provisions in the income tax, central excise and customs laws are virtually defunct as no prosecution is ever initiated. In the last 20 years, there are not even 10 cases where major offenders have been punished for any tax offence.

Rampant injustice in tax administration: The unfortunate reality of the central and state taxation is that those with money, muscle or political power are least concerned about obeying any tax laws. The organised sector is repeatedly harassed with frivolous show cause notices and absurdly high-pitched demands. To file an appeal, the assesses has to first deposit 30 to 50 per cent of the demand. If the appeal is allowed, the next nightmare is getting the refund. No attempt has been made to check the all-pervasive corruption in the tax departments.

Scant respect for the Constitution: The federal structure of our Constitution has allocated and distributed areas of taxation between the Centre and states. However, the practice of levying service tax on activities already subject to state sales tax continues unchecked as it is always possible to argue that a particular activity, although amounting to a sale, has also a service element and therefore can be taxed. The most shocking example is the levy of service tax on hire purchase and leasing transactions that are liable to pay sales tax. Similarly, the sale of packaged software, which is liable to VAT, is also subject to service tax.

CONCLUSION The foregoing analysis shows that there has been significant progress in tax reforms particularly in tax administration in recent years that has helped in the recovery of tax-GDP ratio close to the levels that prevailed prior to significant reduction in customs. This, however, is only the beginning, and considerable distance in reforming the tax system is yet to be covered. In other words, the tax system reform including reform in administration is a continuous exercise for improving the revenue productivity, minimise distortions and improve equity. It is important to note that the reforms should be undertaken at central, state as well as local levels. A major objective should be to minimise distortions and compliance cost. Broadening the base of both central and state taxes and keeping the tax structures simple within the administrative capacity of the governments is an important international lesson that has to be taken note of in calibrating further reforms. Phasing out small scale industry exemptions, minimising exemptions and concession to industries in the services sector, minimising discretion and selectivity in tax policy and administration are all important not only for the soundness of the tax system but to enhance its acceptability and credibility. If our manufacturing and service sectors are to be competitive, these seven fundamental flaws have to be eliminated. We can easily attain a 10 per cent growth in GDP if there is a proper tax system in place.

REFERENCES

http://businesstoday.intoday.in/story/arvind-p.-datar-on-budget2011/1/13951.html http://220.227.161.86/16791tsibf.pdf http://www.indianembassy.org/taxation-system-in-india.php India (2001a) Report of the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan, Planning Commission, Government of India, May. http://planningcommission.nic.in/aboutus/committee/wrkgrp/tptarpt.pdf http://finmin.nic.in/reports/IPFStat201011.pdf