Image source: https://www.deccanherald.com/opinion/panorama/after-nearly-four-years-gst-is-still-a-work-in-progress-959381.html

This article has been written by Abdullah Mustaqueem, pursuing a Certificate Course in Advance Corporate Taxation from LawSikho.

Introduction

In order to carry out the necessary functions as the development of public institutions, infrastructure, and other welfare activities including the implementation of welfare schemes the government needs funds that are being collected in the form of taxes from its citizens. Although the term “tax” is not defined in the Income Tax Act, 1961 but Section 4(1) of Chapter II defines the “Basis of Charge” which explains where and when the tax is to be levied. If we delve into history we will come to know how ancient this concept of tax is and how embedded roots it has in our country.

The present-day tax system has been in force in one form or the other since ancient times. If we delve into the past we can find references in Manusmriti and Arthashastra to various types of taxes that were levied in ancient India. Accordingly, taxes were levied but they were not arbitrary in nature. There was a fair share in the tax collected be it farmers, traders, artisans, and other people of the society. Manusmriti clearly depicts the existence of a well-planned taxation system in India where taxes were paid in the form of gold coins, cattle, raw material, and also by rendering personal service. 

The word “tax ” originated from the word “taxation” meaning estimate. It was levied on either the sale or purchase of goods and was collected in a disorganized manner. About 2000 years ago it was Augustus Caesar who passed a decree stating that the tax should be levied throughout the world. In Germany and throughout the Roman Empire taxes were levied on the basis of sales, turnover, purchase, and sometimes on the stock of crops as well. The basic idea behind the imposition of these taxes was to meet the expenditure on the huge army of the Roman Empire and the administrative expenditure as well which later on turned out to be a way to fund the modern-day government to meet its various expenditures including development, defense, social welfare, etc. Every country has a proper taxation process in order to make the process of tax payment more efficient So that not only there is an ease in payment of taxes but also the tax base increases. Let us examine the Indian taxation system in detail and its importance in our country.

The tax system in India

The Indian taxation system is both progressive and proportional in nature, progressive in the sense that as the Income increases the rate of tax charged as per the slab also increases and It is proportional in the sense that tax levied upon is in the proportion to the amount on which it is being levied. Although tax is levied according to the Seventh Schedule of the constitution which contains all the lists ie. Union List, State List, and Concurrent List but tax is not a part of only one list of the three, it depends upon the type of tax and on whom it is being levied. As Article 265 of the Indian Constitution says No tax shall be levied or collected except by authority of law.

Types of taxes in India

Basically, there are two types of taxes levied in India direct and Indirect, From the introduction of GST in 2017, there has been a significant change in the Indirect taxation system of India which has also Impacted the direct tax system by Increasing the Income-tax base in the country.

  • Direct taxes:  As the name suggests the tax levied directly on the Income of a person or an Organisation is a direct tax that can be broadly categorized into Income tax for Individuals and Corporate tax for corporates and organizations. Although there a several taxes in the form of a direct tax but these two taxes cover the majority portion of tax levied. The revenue collected in the form of direct tax is done by the central government it forms a major portion of revenue for the government.
  • Indirect taxes: Tax that is not levied directly on the Income rather on the products or services purchased is the indirect tax. Which Includes taxes imposed on the goods or services sold to the consumer. One of the most important tax reform that India has done in the sphere of Indirect tax is the introduction of GST that is the “Goods and services tax” which has not only changed the way indirect tax is being levied but has also inculcated almost all the indirect taxes under one head. It has also solved one of the most controversial issues of “double taxation” among the different states. Although indirect taxes are submerged under the head “GST” there are several other taxes as well like customs duty, excise duty, and the dividend distribution tax.

Importance of taxes

After understanding the structure and type of taxes levied in India now let us review the importance of taxes in India.

Importance of direct taxes

Direct taxes display the importance of taxes by reducing income equalities with its progressive tax structure. Citizens are taxed in proportion to their economic circumstances, thereby encouraging social and economical equality. Taxes play an important role in reducing the glaring income Inequalities by imposing or levying tax progressively on the incomes of the citizens which not only reduces the income inequality but also encourages social and economical equality among the citizens of India. 

Direct taxes also help in curbing inflation as they have control over the money supply in the market. Moreover, when it comes to direct taxes people are aware of how much tax will be levied in the respective financial year.

Importance of indirect taxes

Indirect taxes are levied at a uniform rate irrespective of who is availing the services or buying the products, moreover they form a major portion of revenue for the state governments. They provide easy access to collect from point of sale by the seller from the consumer directly. One major role which indirect taxes play is strengthening the Federal Structure of the government across India which means through indirect taxes the state government has its own source of revenue and it is not dependable on the central government thereby it is independent to take its decisions hence upholding the basic Structure of Indian Constitution. 

One of the most important functions that are played by the indirect tax system is increasing the tax base and collection as people who otherwise are not paying tax to have to pay it in the form of Indirect tax.

The structure of taxation in India in comparison with other countries

India

Indian taxation structure is divided into 3 tiers where tax is levied by Central Government, State Government, and Local Authorities. The various acts through which the tax is levied in India derive their authority from the Constitution itself where Article 265 provides that “No Tax Should be levied without the authority of Law”, therefore, following this provisions which is the Law of the Land that is the “Constitution of India” every legislation passed by the parliament derives its power to levy taxes through constitution itself.

USA

The Governments of both the local level and state are independent of each other in the United States of America. So the taxes are levied by both local and state governments which include income tax, property tax, sales tax, gifts tax, etc. The USA has adopted a progressive taxation system under which taxes are levied on the income earned by the individual in proportion to which they are earning although the majority of revenue is collected in the form of direct taxes while the remaining is in the form of Indirect taxes.

UK

Taxation in the United Kingdom is simple and easy to understand with high administrative efficiency. In the United Kingdom, the taxation system is very efficient due to the administrative machinery which not only makes it more effective but also makes it simple and easy to understand. Whereas taxes are levied by both central government and local government which includes income tax, VAT, corporate tax, fuel duty, business rates, council tax, street parking charges, etc. Apart from the taxes collected by the local governments it also receives grants from the central government as well.

South Africa

The mode of collection of taxes in South Africa is a bit distinct when compared to that of India where there are three levels through which tax is being levied on the Central Government, State government, and Local bodies. While in South Africa tax is levied at two levels that is by central and state government. Also, there is an authority that collects revenue on behalf of the state government in Africa that is the South Africa revenue Service (SARS). The types of taxes include income tax, corporate tax, vat, and fuel duty are collected by the Central Government whereas local governments collect municipal rates and funds from the central government.

Mexico

Mexico has also adopted a progressive taxation regime like that of India where taxes are levied in proportion to the income earned. There are several types of taxes levied in Mexico which include income tax, corporate tax, alternative minimum tax, capital gains tax, etc. Although the treatment of capital gains tax is distinct from that of India.

China

China has an impact of socialism on its tax structure. Which reflects socialism as a major principle in the Macroeconomic policy of the country. Since the reforms of 1994 china structure its taxation system by dividing taxes into 26 categories which can be divided into 8 major heads; turnover taxes, income taxes, resource taxes, taxes for a special purpose, property taxes, behavioral taxes, agricultural taxes, and customs duties.

Tax to GDP ratio

The tax to GDP ratio is calculated by dividing the revenue collected in the form of tax from the GDP of the country. It indicates not only the country’s development but also the relation between the development of the country and the tax collected in the form of revenue. Tax and GDP are directly proportional to each other therefore when there is an increase in the GDP there is also an increase in the tax collection (an increased GDP indicates that there has been an increase in overall development in the country and hence an increase per capita income). By looking at the abovementioned graph we can very well decipher that India is having the lowest tax to GDP ratio amongst all the developing and developed nations, in fact, its ratio is less than the world average. This low tax to GDP ratio might be due to the following reasons; tax evasion, low per capita income, etc.

Time is taken for the compliances

 

It is the time taken by the taxpayers to prepare all the compliances and pay taxes which includes the majority of taxes that are Income tax, value-added tax, sales tax, and labor tax. As we can see the time taken to prepare all the compliances and pay the taxes is again high as compared to the other countries which very much indicates how complex the Indian taxation structure is and this needs to be worked upon. This not only reduces the burden of current business entities but will also attract new businesses which will enhance the growth of India in the future.

Tax rate

The rate at which tax is levied in India is quite high as compared to other nations only China surpasses India in that. But instead of having a high tax to GDP ratio on the contrary India has one of the lowest ratios which more or less explains the effectiveness of taxation in India. There should be a significant change in the taxation policy and administration in order to make India’s taxation system more effective. 

Tax payments

When we observe the above-given graph we can see that there is a significant difference in the tax payments in India as compared to the other nations in fact the payments made in India are far more than the world average which very much explains the lacunae in the Indian taxation system. Where there are a large number of taxes but they are not effective so instead of having a large number of taxes we should club the taxes under major heads which would not only reduce the time involved in the compliances but would also increase the effectiveness of taxes. Recent reforms like the introduction of GST is a positive step towards making the Indian taxation system more effective and robust.

Contribution of revenue in government expenditure

In India, the contribution of tax in government expenditure is fairly less as compared to the other nations where it goes up to 90 in case of UK. While when we compare it with the world’s average it’s even below that which reveals the true picture of the effectiveness of the Indian taxation system. From the above graph, we can also conclude that India has to rely on non-tax revenues that are foreign borrowings which might have adverse consequences on the economy.

Administration of taxes

Since we are discussing how efficient the tax system is in India and when we look into the details of it we get to know about two concepts; cost of tax collection and compliance cost. When we observe the above graph we can see that the ratio between the tax cost incurred to the tax collected is very low when it comes to India which pretty much explains how high the administration cost is. In the case of India due to all the complex compliances, we need to employ an expert to file our taxes which increases the cost of filing taxes. In such a scenario we need to bring some necessary changes to the existing tax system of our country to make it more user-friendly and less complex. 

Budget 2021 – new reforms

Since we are discussing reforms, The budget of 2021 has made some significant ones including the reduction in the corporate tax rate from a whopping 30 percent to 22 percent for the existing businesses, and from 25 percent to 15 percent for the new manufacturing firms which are established after 1st of October 2019 provided that they commence their operations before March 31, 2023. These reforms have been introduced to boost the growth and make India look a good option in terms of attracting new investment, especially in the manufacturing sector.

This reform, in particular, would not only make India a more attractive destination for the foreign firms engaged in manufacturing businesses But would also increase the employment opportunities for the people of India. It would also increase the profitability which means that now the companies would have surplus money in their hands, which they can use to expand the existing businesses or rather invest in new ventures. This latest tax cut is expected to give  India a more competitive advantage on the global stage.

Conclusion

From the above discussion, we can see that there is a need to bring reforms to the existing tax structure of India. Not only the progressivity of tax but also the tax to GDP ratio which is far below than the other nations. In terms of the tax rates in personal income and corporate tax, we found that India already has moderate rates and graduated slabs. We have discovered that India now has a moderate tax rate when it comes to both corporate or Income tax and there is no further reason to lower the tax rate but the administrative expenses are a major concern which not only increases the cost of the collection but also the time involved in doing all the compliances. Since there are a lot of exemptions and deductions offered to the taxpayer due to which India loses a large part of its revenue collection. This accounts for about 8 to 9 percent of the existing GDP and due to this liberalized structure we lose a large portion of tax but the more concerning part is that most of the deductions and exemptions are availed by the privileged sections, therefore, there is a need to change the existing system. So that the privileged class does not exploit in the name of deductions and exemptions and we lose the revenue which was to be collected by them. We need to reassess the existing taxation system and policies for the underprivileged sections of the population and bring changes according to it. In terms of reforming the existing taxation structure in India, we need to consider the taxation structures across the globe. As we are well aware of the fact that the cost of compliances in India is far more than most of the nations of the world. We need to reduce the compliance cost and in order to do that we can adopt a structure of administration adopted by the UK government, it would not only reduce the cost of tax collection but would also reduce the time involved in doing so.


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