Can India Afford $97 Billion Tax Breaks?

Did you know that India gave away tax breaks or exemptions worth Rs 533,582 crore ($97 billion) or nearly 67% of tax collections in 2011-12.

That’s according to the Statement of Revenue Foregone, a part of the Union Budget documents presented for the first time in the 2006-07 Union Budget, and a regular practice ever since.

This is not to say all such breaks are good or bad, merely to highlight what the specifics are and for those who want to ask; what specifically can we afford and not?

Govindraj Ethiraj, Editor, IndiaSpend, spoke to Mohandas Pai, chairman, Manipal Global Foundation, Uday Ved, Senior Tax Partner, KPMG and Anupam Gupta, chartered accountant and columnist, IndiaSpend, on the intricacies of exemptions and more…

Govind: Let me get a quick background on what this means from Uday.

Uday: See, there is Rs 533,582 crore ($97 billion) when it comes to tax giveaways. Now, we are not saying that this is bad, but what does this figure mean?

This means that the Government has given certain tax exemptions to corporates and individuals. There may be reasons for doing that… the trade- off is whether exemptions should be given or the fiscal deficit should be balanced. Of course, exemptions have been given for the right reasons in the past. There are various kinds of exemptions, we can talk about it. Whether it is good or bad, one is to see again…

Govind: Right, and there are some very interesting figures there. It has been found that as companies get bigger, they pay less tax.

Uday: I think it is from the effective tax rate perspective because there are certain exemptions in terms of capital investments or accelerated depreciation, if you invest in assets. This year's budget made an announcement, introducing the investment allowance bank. If you invest 100 crores plus in capital assets, you will get an additional depreciation of 15%. So, it’s a cash flow issue that effectively reduces the tax, which possibly smaller companies cannot afford.

Govind: So, it pays to be big. Let’s ask Mohan next. So, Mohan how do you see this whole issue of revenue forgone?

Mohan: The Government has given the report (statement of revenue forgone) as part of the budget, which I think is being done for the last 6 years. When you look at excise duty on page 33, the defined revenue forgone and the difference between the duties that would be payable but for the exemption notification and the actual duty paid in terms of asset notification. It is important to understand definitions.

For crude oil, the given away revenue is 57,752 crores. Now, in the case of crude oil, the govt has said the duty on crude oil has come down because the crude oil prices are higher and people should not pay duty on that and claiming that from the govt as subsidy. We cannot take it as revenue forgone.

For example, diamond and gold is greater than 61,000 crores. Now, diamond and gold are imported in India primarily for exports, there is no local consumption for diamonds at least and for gold there is only a nominal duty. Now as the govt policies, the rates have to be less, then the lesser rate is the standard rate. So, you cannot say because I issued the exemption notification, I did not amend the schedule in the law and bring it down to the exemption notification and like move it up and down, the difference is revenue forgone. Revenue forgone should be defined as revenue accrued but for a benefit given to some identified persons. Now, when everybody gets the benefit, you can take it as revenue forgone, it’s the standard rate.

For example, if the govt today says the tax rate should be 40%, but issues a notification saying the highest income tax rate is 30%, then 30% is the rate. Or we can say the difference between 30 and 40%, I've lost as revenue because 30% is the rate.

So, first of all, I think this figure of Rs 533,582 crore is totally wrong. You must go through the excise figures, the custom figures, the direct taxes and we should take only those figures as revenue forgone where everybody cannot take the benefit, only a few specified people can take the benefit because it’s given to a few and the figure will be less. I think we should be very clear with definitions because this is very misleading. It is telling the people of the country a wrong story by putting the corporate sector in a bad light.

Govind: Mohan, as you pointed it out yourself, the govt has been doing it for the last 6 years. Why has the govt being doing it for the last 6 years?

Mohan: The govt puts this figure out for whatever reason it has because globally there is only one rate. Globally, there is a rate in the law, and that’s the rate that applies. In India, they follow a funny practice of having a rate and issuing an exemption notification for everybody. But in law, exemption notification was to be used by the govt to give benefits to a few and not everybody. If everybody gets the benefit, the entire country gets the benefits and there is no benefit to just a few. It cannot be revenue forgone. That’s the point I am trying to make.

For example, Amartya Sen has gone on record to say, the govt gives away 61,000 crores for gold and jewellery, it is a non-profitable asset, why are you taking it away? But we have 30 billion dollar export industry for diamonds. Now, the diamond industry exports will disappear. So, we need to be very careful with these figures. So, Rs 533,582 crore is not something the govt has lost, the figure is much, much smaller.

Govind: The logical next question is: what are the areas you feel the govt should actually be allowing revenue forgone as opposed to the general description which you are disagreeing with. Uday, so assuming that we can agree and now start splitting it up, what would those areas be? How do you distinguish between what’s good what’s bad.

Uday: I would actually put it in parts. Mohan was saying, one is the indirect taxes and the two large ones are customs duty and excise duty, which I think account for some 44% and 37% out of Rs 533,582 crore. The significant chunk would be these two. You have a reduced rate by issue of notification to promote certain industries. When it comes to corporate taxes, I would clearly say that it’s one area the tax has possibly foregone as far as govt is concerned. That’s about 12-12.5% of the total. If you look at that, the one large industry of the maximum beneficiary of this is the IT and BPO industry… whether it is tax exemption or whether you are in STP or the export- oriented units or you are in SEZ. STP did not pick up at that time. The last 15 years has been going on with Kelkar Committee and Raja Chelliah Committee and now the Shome Committee recently. Once you have a sunset close now, STPI, EOUS are concerned, that exemption has been taken away for the last two years. So, one exemption which still remains is the SEZs. What that entails is when a corporate tax/grade is 30%, if you are in SEZ, you don't pay tax. You have a minimum alternate tax, so the tax gets reduced from 30 to 20. If you are in SEZ and whether it has really played its part or no. That’s the million dollar question which should be asked.

Govind: And I'm sure a lot of other people would argue against that. Particularly this has not happened in the last 5 years to this extent. So Mohan, let’s come back to the issue of corporate tax and corporate exemption. Uday also feels it’s an area that may need a closer look. Small companies actually pay more tax and large companies pay less tax. So, the study shows that companies with PBT of 1 crore have an effective tax rate of 26% and large companies whose PBT is 500 crores have an effective tax rate of 21%. So, what this seems to suggest is that the bigger you are the easier it is for you.

Mohan: Govind, first let me contradict what Uday said because Uday is not going by data. The statement says, 68,000 crores is the revenue forgone for corporate tax. It’s just that it is 12,000 crores out of 68,000 crores is only like 16%. It is not a large amount. The largest amount is about accelerated depreciation of 37,831 crores out of 68,000 crores. So, I say it should be given to everybody. If everybody gets it, there is no benefit and no tax foregone. That’s the point I'm trying to make.

Govind, it’s very important for us to define what is tax forgone. I would define it as when the general rate is applicable to everybody and some few people get an exemption. For example, in excise duty, there are exemptions. For Himachal Pradesh & Kashmir, you don't pay excise duty, the rest of the country, you pay excise duty. Now, that is tax foregone. If it applies to everybody, it is not tax foregone.

SEZ can be in any part of the country, anybody can do it. It is for them to locate, so if I put is as tax foregone and put it down here, it is totally misleading. So, please understand, we have to define things very carefully.

I think we can do away with accelerated depreciation and reduce the tax rate by 3-4%. say 30% to 27% , that would be much better.

Now, having said this, let me answer the second question, big companies happen to be more capital intensive unless they happen to be in the service sector. So, if you look at the tax rate of banks, it’s very close to the marginal tax rate. So, for bigger companies which are in manufacturing which are asset-based have accelerated depreciation, their tax paid is less than the marginal rate. That’s why big companies get more benefits than small companies.

Govind: Uday has a point. Go ahead.

Uday: I would put accelerated depreciation a little differently because that is given for certain kind of assets and investments made and now investment allowance has been introduced back again. It says if you invest more than 100 crores, it’s a lesser amount you are investing when there is capital spend and infrastructure. So accelerated depreciation is putting it a little differently.

SEZ, what Mohan said, can be set up everywhere. Again, the objective behind the revenue forgone was to say if the govt had not given the exemption, I could have used this money for something else. May be that is what the govt is trying to project. But certainly the revenue forgone objective is very different.

Govind: Mohan, let’s come back to the tax exemption rather the tax differential between small companies and large companies. Optically, this sounds unfair. We can keep depreciation and the small edge aside. Why is that big companies get away with paying less tax.

Mohan: Most of the tax exemptions are based upon assets and since big companies have large assets, they get a tax break. Let’s say an exemption is based upon employment. Let’s say, the exemption is equal to 3 times the quantity contributed to provident fund and ESI. That means the smaller companies that are less capital intensive and more employee intensive will get bigger benefits. So, the country has been giving capital incentives rather than employment incentives.

I object to that because I think the biggest issue is to give incentives for employment and not capital… So that point is something the govt must take into account… and since larger companies are capital-intensive they have a bigger tax break. Like you say, we are democratic.

Anupam: My only question would be how do you balance incentives versus fiscal balance considering the current situation. How much can we afford to give out versus the spending that we have to do? I’m assuming you can’t withdraw these concessions straight away because some of them are generating revenue for the government… so, how do we find the balance? And how much of it is political vs the actual balance sheet on the fiscal front?

Mohan: Let me answer that by saying, I don’t believe that Rs 533,000 crore is the amount of revenue that the government has lost because of giving exemptions. I think the figure is closer to 1 lakh crore rupees at best. This is my estimate… that 1 lakh crores, at best, is about 10% of the total tax collections in India. Out of 1 lakh crores, may be 20-30 thousand crores you can positively do away with. So, I don’t think this is leading to something which is hurting the government.

The bigger thing which is leading to tax payments being less is, there is a report by Credit Suisse, which says only 50% of the economy is in the formal sector. 50% of the economy is the place from where we capture the taxes. The balance 50% is not taxed at all because the informal sector is not prone to taxes. And India has one of the largest percentages of informal sectors compared to total GDP… comparable with sub-Saharan Africa. Please understand what it means. It is a very primitive system. And that is the reason for the tax base to be less.

You asked another question; that India has one of the lowest tax-to-GDPs, and that is wrong because India’s tax-to-GDP is 18% because you must also include state taxes. And if 50% of the economy is outside because it is informal, it amounts to 36% of tax-to-GDP whereas America is 25%.

Okay, so add up state and centre, and you’ll have a different figure. Uday, are you also in consonance with this figure? 1 lakh crore is really what is exemption in the true sense. And that is nowhere near the 533,000 crore that we started with.

Uday: Yeah, I think the way you look at it, I would actually concur with what Mohan is saying about the actual exemption that is being given because the differential rates vis-à-vis the different class of tax payers is what is important. Now for the first time for individuals, you have the reverse scenario where you’re going to tax the rich by adding 10% surcharge. So I think that clearly is a welcome step from that perspective.

But as far as indirect taxes are concerned, which would be about 80% plus right, which as is if it is given to every single industry then I think that is possibly not a tax foregone because I think that is given anywhere.

Mohan, a very specific question. There is a tax exemption on gold and there is a tax exemption on diamond. Now diamonds, your argument is well taken that you’re really adding value because you’re importing raw material and exporting the finished product and therefore it doesn’t make sense to tax the raw material. But gold is something that is more of a consumption item in India, right? You’re not importing gold as a raw material for re-export. So why should gold get that kind of exception?

Mohan: I think the exemption figure is wrong because gold is now taxed something like 6-8%.Chidambaram increased it to 6-8%. See, in case of gold, please understand, if you tax gold higher, there will be smuggling. Haji Mastan & Kareem Lala and the gold smuggling gang started it. So, you can’t tax it at 30% or 40% . You see, they say that revenue foregone for gold and diamonds is something like 65,000 crores… assume that it is 50:50, i.e. Rs 30,000 crore. Gold imports are something like $60bn. $60 bn, at let’s say Rs 50/dollar, is 3 lakh crores. 10% is the revenue foregone. So, if you tax gold, at 15%, 5-6% plus what is revenue foregone, there’ll be smuggling, there’ll be no gold imports. So I think you’ve got to be very careful when you look at the numbers. I don’t think they are giving any special privileges to gold.

People are investing in gold primarily because they don’t have confidence in the government and inflation is very high.

It requires a different policy response to bring down people’s fascination with gold.

So, we’re coming to the end of this discussion. Let me get a quick wrap up from both of you. Uday, so we started with Rs 533,852 crore, we arrived at a figure of 1 lakh crore. How does this issue get addressed? The common man feels like the government is giving away exemptions to the rich, it may be companies, it may be large companies, they may be publicly held, but the perception is that it is money given away to the rich. And that’s really what I think the Amartya Sen argument is. And the other is the real argument which is how do we dissect this in a manner which we can actually start trimming a few of these heads?

Uday: As I said, corporate tax and individual tax would be the two large accounts where I think there is clearly in terms of accelerate depreciation that you said or investment allowance that you said, to an extent, I would say that I think SEZ is actually a part of it. Mohan disagrees with that, but I would possibly believe that SEZ is part of that. But clearly indirect taxes are not one.. in fact, the lower rates that India has actually agreed to lower indirect taxes, particularly import duty, as a part of the WTO, which has been agreed to over the years, in fact it has agreed to keep the basic at 10% and we are still higher than that as of today.

So you’re saying, don’t look at it inward, but look at it outward, look at our tariffs in contrast with other countries, and then if you really want to , revisit the customs structure, we’re really not giving away that much. Okay, that’s the Uday Ved view…Mohan, what’s your call? One is the real numbers which we have debated to some extent and the other is the optics. How do we manage the optics then?

Mohan: No, my thing is, first you must have proper data, you must tell the department to give the current data before going into this issue because you’re misleading the Parliament, you’re misleading the public, because no one really goes into the definition but people balance the figure of Rs 533,582 crore and you’re also guilty …

Point number two is you are seeing that from 2003-04 till today, tax collection on the income tax and corporate tax has gone up from 103,000 crore to 550,000 crore, which is a tremendous increase because of data mining and automation of the entire function. I think if the government automates the entire process of tax collection for indirect taxes, there could be a 5-6% increase in taxes and tax evasion could come down.

Point 3, we must bring more of the informal sector into the tax net and GST, and that will enhance taxes. So, I think running an efficient tax administration is the best way and then look at each of the tax breaks that have been given for area exemptions and something else and the misuse and if necessary, put it away… so, ultimately you end up with 8-10% of tax exemption being given away and that is perfectly fine. So, I mean that’s what we need to do to make sure that the tax exemptions do not look too big..

Govind: Thank you Mohan and Uday for joining us and giving us useful insights on whether or not the government is foregoing revenue and to what extent should taxes be exempt… that’s, of course, a debate that will continue…