The inequities in India’s tax system2 min read . Updated: 25 Dec 2019, 12:18 AM IST
Small firms end up being taxed much more than big ones because of a complex tax structure
Mumbai/New Delhi: Almost every year, we hear complaints about India’s high corporate tax rates from corporate lobby groups in the run-up to the budget. This year has been no exception.
While India’s statutory corporate tax rate at 34.6%, for taxable income exceeding Rs10 crore, is indeed among the highest in the world, the effective tax rate which Indian firms actually pay is lower at 28%. The effective tax rate is lower than in some of India’s emerging market peers such as Mexico and Brazil.
The gulf between the statutory rate and the effective tax rate is largely because of a complex tax system involving a slew of exemptions. The lack of a simple and clear tax system largely benefits the largest firms which pay the lowest taxes.
Firms with profits less than Rs1 crore end up facing a tax rate slightly above 30% while firms with profits above Rs500 crore face a lower tax rate of 26%, data released by the finance ministry as part of its budget documents show.
The effective tax rate also varies widely across industries. The automobiles sector, which has been among the biggest generators of factory jobs over the past decade, faces an effective tax rate of 30%. In contrast, capital-intensive sectors such as power and petroleum face much lower effective tax rates.
The Indian tax system in general is loaded in favour of capital-intensive industries. Consider exemptions on account of accelerated depreciations, for instance. These exemptions, allowing for greater deductions in the earlier years of an asset and used to minimize taxable income, account for the lion’s share of revenues foregone because of corporate tax exemptions.
Designed to encourage capital investments, these exemptions implicitly subsidize labour-saving technologies in a country with a huge demographic and jobs challenge.
It is not just the corporate tax system which suffers from distortions and inequities. Personal income tax rules also tend to implicitly subsidize the relatively richer sections of the society. Incentives for small savings schemes are typically cornered by big savers belonging to the higher income tax brackets, the 2015-16 Economic Survey found. Yet, subsequent attempts to reduce such subsidies in the 2016 budget attracted a backlash, forcing the government to back-track.
While corporate tax exemptions as a share of gross domestic product (GDP) have been declining over the past few years even as the effective tax rate has been rising, the share of personal tax exemptions as a share of GDP has been rising. From 0.3% of GDP in fiscal 2014, personal tax exemptions have risen to an estimated 0.5% of GDP in the current fiscal year.
The complexities and ambiguities in the tax structure also give rise to endless litigation, with the amount locked up in such litigation rising with each passing year.
The inequities, ambiguities, and distortions in India’s tax structure have not gone unnoticed, and successive finance ministers have made the right noises about simplifying the tax structure. Yet, such declarations have not been matched with decisive action.
Two decades after a “new direct tax code bill" found mention in the 1997 budget speech, and nearly nine years after the first direct tax code draft bill was released, we are still deliberating how our direct tax structure should look, with another committee set up to look into the issue.
This is the second part of a two-part data series on India’s tax system. The first part examined whether India is an outlier in terms of its tax-GDP ratio.