NCERT Summary: Stock Markets in India- 4 | Indian Economy for UPSC CSE PDF Download

Tax Reforms in India
Since the beginning of the last decade as a part of the economic reforms programme, the taxation system in the country has been subjected to consistent and comprehensive reform. The need for the tax reforms arises from the fact that

• tax resources must maximised
• international competitiveness must be imparted to the Indian economy
• transaction costs must be reduced -
• the high-cost nature of Indian economy needs to be corrected so that
• compliance increases
• equity improves
• investment flows

On the direct tax front, the reforms are the following:

• Reduction and rationalization of rates- there are only three rates of income tax today with the highest rate at 30%
• Simplification of procedures
• Strengthening of administration
• Widening of the tax base to include more tax payers in the tax net
• Exemptions are gradually being withdrawn'
• MAT was introduced for the 'zero
• tax' companies
• The Direct Tax Code of 2010 is meant to replace the outdated Income Tax Code of 1961.

Indirect Taxes

• Reduction in the peak tariff rates-10% is the peak customs duty today which was more than a 90% reduction since 1991.
• The number of slabs has come down drastically
• There is a progressive change from specific duty to advalorem tax
• VAT is introduced
• GST is being rolled out by 2011
• Extension of service tax to more than 1.00 items at 10% rate

Tax expenditure
Tax expenditure refers to revenue forgone as a result of exemptions and concessions (personal, corporate, indirect tax). It was introduced for the first time in 2006-07 Union Budget. The revenue foregone due to tax incentives in 2010-11 is estimated at Rs 5,60,276 crore. Such exemptions have been justified for promoting balanced regional growth, dispersal of industries, neutralisation of disadvantages on account of location, and incentives to priority sectors, including infrastructure. These should be subject to a sunset clause, as tax exemptions often create pressure groups for their perpetuation. While some may be justified as they enhance investment and generate more taxes for the government, others are not. Such exemptions and concessions can distort resource allocation and stunt productivity. They also result in a multiplicity of rates, legal complexities, classification disputes, litigation etc. If these exemptions are rationalized, they can help the government spend more on social and infrastructure and help reduce the fiscal deficit.

G-20 and Bank Tax
Group of 20 saw the European countries like Germany and France propose a ban tax on their transactions so that fund could be mobilised in order to bail out future bank failures. The idea is to avoid taxing ordinary people. India along with Brazil and other countries opposed it on the following grounds

• Regulation is the remedy
• Banks can pay the tax and not shed their reckless behavior
• It may in fact induce them to be more reckless as there is a ready fund available and bailout is guaranteed.
• India has a well regulated banking system and so did not suffer the same fate as the banks in developed economies. The problems of the advanced countries should not be imposed on others
• banks, as private entities, would simply push the added costs onto consumers.

Tax Havens
A tax haven is a country or territory where certain taxes are levied at a low rate or not at all. Individuals and/or corporate entities can find it attractive to move themselves to areas with reduced or nil taxation levels. This creates a situation of tax competition among governments. Different jurisdictions tend to be havens for different types of taxes, and for different categories of people and/or companies. For example, income tax, wealth tax or corporate tax etc. The important features of a tax haven arte:

• nil or nominal taxes;
• lack of effective exchange of tax information with foreign tax authorities, that is, personal finance information is not shared with other countries
• no requirement for a substantive local presence; and
• self-promotion as an offshore financial center.

Switzerland, Singapore, the Cayman Islands, Monaco, Luxembourg and Hong Kong are among 45 territories blacklisted by the Organisation for Economic Co-operation and Development and threatened with punitive financial retaliation for their banking secrecy.

Tax Incidence
It shows the entity on whom tax us imposed. It is different from the tax burden as shown below, if government increases tax on petrol, oil companies may absorb it, if competition is intense or they may pass it on to private motorists. Tax incidence here refers is on companies and the burden may be on the consumer.

Tax Burden
It means those who actually pay taxes from whom tax is collected. Depending on the market forces involved, a tax can be absorbed by the seller or by the buyer (in the form of higher prices), or by a third party like sellers' employees in the form of lower wages.

Tax Base
The value of goods, services and incomes on which tax is imposed. When economists speak of the tax base being broadened, they mean a wider range of goods, services, income, etc. has been made subject to a tax. In the case of income tax, the tax base is taxable income. Some kinds of income are excluded from the definition of taxable income, such as savings. For sales tax, the tax base is the value/volume of items that are subject to tax; essential goods, for example, are not part of the tax base.

Tax rate
It indicates how much tax is due from each source. Some tax systems have high rates but have a narrow base allowing generous deduction of business expenses. Other tax systems have a wide base with few exemptions and lower rates.

Tax Shelters
Any technique which allows one to legally reduce or avoid tax liabilities. It is a way in which the taxpayer can invest his income in a particular kind of investment that gives tax concessions. Difference between tax avoidance and tax evasion: There are provisions in the law that allow one to save and invest in a manner that leads to reduction in taxable income, if these provisions are used for the benefit, it is called tax avoidance. It is lawful to take all available tax deductions. Tax evasion, on the other hand, is a punishable offence. Tax evasion typically involves failing to report income, or improperly claiming deductions that are not authorized.

Hidden taxes
Hidden taxes are taxes that are concealed in the price of articles that one buys. Hidden taxes are also referred to as implicit taxes. The most well-known form of the hidden tax is the indirect tax. Examples of hidden taxes are import duties.

Differentiate between Proportional, progressive and regressive tax?
An important feature of tax systems is whether they are proportional tax (the tax as a percentage of income is constant over all income levels), progressive tax (the tax as a percentage of income rises as income rises), or regressive tax (the tax as a percentage of income falls as income rises). Progressive taxes reduce the tax incidence on people with smaller incomes, as they shift the incidence disproportionately to those with higher incomes.

Ad Valorem
A Latin term meaning "according to worth," referring to taxes levied on the basis of value. Taxes on real estate and personal property are ad valorem. Luxury goods are taxed higher even if they weigh the same or number the same as ordinary goods. Compound duties are a combination of value and other factors based on which tax is imposed.

Excise Duty
Excise duty is a tax on manufacture and is levied on the manufacture of goods within the country.

Customs Duty
When goods are imported or exported, customs duty is imposed and collected by the Union Government. Peak customs duty today is 10%. 

Negative Income Tax
Subsidy is a negative income tax. It is a taxation system where income subsidies are given to persons or families that are below the poverty line. The government will send financial aid to a person who files an income tax return reporting an income below a certain level.

Octroi
Entry 52 of the State List, VII Schedule, which specifies tax on the entry of goods into a local area is the octroi. Octroi has been a main source of revenue for most of the urban local bodies in India. It is criticized for the fact that it is an obsolete method of tax collection and involves stoppage of vehicles at the check posts outside the city limits, thereby obstructing a free flow of vehicular traffic; waste of business hours; loss of fuel etc.

Tax Buoyancy
It refers to the percentage change in tax revenue with the growth of national income. That is growth based increase in tax collections.

Tax Elasticity
Tax elasticity is defined as the percentage change in tax revenue in response to the change in tax rate and the extension of coverage. Buoyancy, on the other hand is the response to economic growth when the base increases but there is no change in the rate.

Tax Stability
It means no frequent changes and continuity of policy in a predictable and transparent manner. Although revenue from different taxes varies from year to year, revenue stability is desirable because it makes it easier for a government to build a credible spending and borrowing plan for the year ahead. Taxes whose revenue is relatively stable contribute to overall revenue stability. Market players also can plan better.

Pigovian Tax
The Pigovian tax is imposed on bodies that have a negative externality. For example, pollution. Externality means impact of one person's actions on the well being of an outsider (bystander or third party). For example, the seller and consumer of cigarettes together will harm the third person with pollution. Example of negative externality is exhaust fumes from automobiles. Positive externality refers to a good effect on the third party. For example, restoration of historic buildings, research into new technologies. Carbon tax is one example in the context of the need to discourage fossil fuels and encourage renewable sources due to climate change threat.

Tobin Tax?
James Tobin, economist, proposed a worldwide tax on all foreign exchange transactions- when foreign capital enters a country and when it leaves. The aim is to check speculative flows. Long term investment — generally FDI, will not suffer as it does not invest for speculative (short term ) reasons like FIIs.

Tobin Justified the tax on two Grounds
First, it would reduce exchange rate volatility and improve macroeconomic performance. Second, the tax could bring in revenue to support for development efforts or exchange rate stabilization. The defining characteristic of a Tobin tax is that the tax is levied twice- once when one acquires foreign exchange, and again when one sells the foreign exchange. The south east Asian currency crisis (1997) is attributed to the 'dynamics of hot money' (portfolio investments or FII flows). Tobin tax can be imposed only if all the countries accept the proposition. Otherwise, FIIs can go to countries where the tax is not imposed.

MAT
Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the Income Tax Act, but the profit and loss account of the company is prepared as per provisions of the Companies Act. There were large number of companies who show book profits as per their profit and loss account (according to the Companies Act) but do not pay any tax by showing no taxable income as per provisions of the Income Tax act. Although the companies show book profits and may even declare dividends to the shareholders, they do not pay any income tax. These companies are popularly known as Zero Tax companies. In order to bring such companies under the income tax act net, MAT was introduced in 1996. They are required to pay MAT at 18.5% (2011-12). Book profit is Profit which is notional made but not yet realized through a transaction, such a stock which has risen in value but is still being held. It is also called unrealized gain or unrealized profit or paper gain or paper profit.

Presumptive Tax
Presumptive Tax the Estimated Income Method of assessment for certain categories of businesses is prevalent in several countries. Presumptive taxation involves the use of indirect means to ascertain tax liability, which differ from the usual rules based on the taxpayer's accounts. The term presumptive is used to indicate that there is a legal presumption that the taxpayer's income is no less than the amount resulting from application of the indirect method. The reason for the presumptive tax is that in a number of businesses the assesses do not maintain books of accounts or the books of accounts maintained are irregular and incomplete. It was introduced in India in the early nineties for traders but was withdrawn as the success rate was low.

Laffer Curve
Developed by Arthur Laffer, this curve shows the relationship between tax rates and tax revenue collected by governments. The Laffer curve has been debated in the country since 1997-1998 Budget reduced rates and slabs in the income tax regime in the country.

Inverted Duty Structure
Higher import duty on the raw materials than on the finished product are called inverted duty structure .It puts the domestic manufacturers at, a disadvantage making them uncompetitive. For instance, compact fluorescent lamps (CFLs), where the import duty on raw materials for manufacturing CFLs is 9.7 per cent more than on finished bulbs. This skewed duty structure makes domestic CFL manufacturers uncompetitive.

Dividend Distribution tax
Companies giving dividend have to pay tax on the amount distributed as dividend.

Withholding tax
It means withholding of tax from certain payments including interest, salaries paid to employees professional fee, payments to contractors etc. It is the same as TDS.

Capital Gains Tax
It is the tax on the gains made from buying and selling assets like land, shares etc. If the gain is made in the assets held for over three year (one year for shares), it is called long term capital gain and taxed. For shares, there is no long term capital gains tax. For short term capital gains (less than one year), it is 15% for shares.

Wealth Tax
When income accumulates into wealth, it gets taxed after a point. Wealth tax is levied only in respect of specified non-productive assets such as residential houses, urban land, jewellery, bullion, motor cars etc.

Securities Transaction Tax
Introduced in the Union Budget 20042005, it is a tax on the value of all the transactions of purchase of securities that take place in a recognised stock exchange of India. It is meant to make up revenue loss from the abolition of long term capital gains tax.

Transfer Pricing
Transfer pricing involves charging for goods supplied to the subsidiary. The international norm in this regard is the 'arms length principle' which means that when two related parties deal in goods and services, pricing must be done objectively and commercially. If the principle is not followed, it means losses for the government. For example, an MNC has a subsidiary in India and elsewhere. The corporate tax rates are high in India. Therefore, the price of goods sold by the MNC to the two subsidiaries in the two countries is shown differently higher in India and less in the other country. In that case, Indian subsidiary shows less profit or more losses and tax liability (corporate tax) is less. Thus, transfer pricing is generally done in a way as to show high profit in countries where the corporate tax rate is low and low profits/losses where the rate is high. Therefore, transfer pricing norms existing today need to be rationalise the tax revenues that are due to the government are not eroded. Tax evasion and money laundering has to be checked by tightening the transfer pricing regime.

Rupee Comes Like This
The major pan of the government's revenue comes from borrowings. Consequently, the biggest chunk of expenditure is on interest payments. Out of every rupee that enters the government's coffers, 29 paise is from borrowings and other debt, with corporation tax contributing 22 paise and income tax another 12 paise. Of the remaining, customs and excise duties account for 10 paise each, with another 10 paise coming from non-tax revenue. Service taxes amount to six paise, while nondebt capital receipts contribute one paise.

Define Cess
The term cess is generally used to mean a tax. It is an additional levy on a tax. It is different from surcharge as the latter is general while the former is specific. Collections from the latter can be used for any purpose while cess collections can be used for designated ends only- education cess etc.

Direct Taxes Code Bill, 2010
The direct taxation of the income of individuals companies and other entities is governed by the Income Tax Act, 1961. The Direct Taxes Code seeks to consolidate the law relating to direct taxes. The Bill will replace the Income Tax Act, 1961, and the Wealth Tax Act, 1957. The Bill widens tax slabs, and lowers corporate tax rates. It removes a number of exemptions and grandfathers some others.

The Bill replaces the Income Tax Act, 1961 and the Wealth Tax Act, 1957. The Bill widens income tax slabs for individuals' income between Rs 2 lakh to Rs 5 lakh will be taxed at 10%, between Rs 5 lakh and Rs 10 lakh at 20%, and that over Rs 10 lakh at 30%. Companies will be taxed at 30% of business income. Foreign companies shall pay an additional branch profits tax of 15%, Non profit organisations are taxed at 15%. The Bill removes several tax deductions currently allowed for companies, but retains most deductions current available to individuals. The Bill removes the distinction between short term and long term capital gains for all assets except securities listed on stock exchanges. The wealth tax exemption Limit is increased from Rs 15 lakh to Rs 1 crore. The Bill introduces General Anti Avoidance Rules to allow tax authorities to classify any arrangement as one entered into for evading taxes. MAT is at 20% of book profits

Key Issues and Analysis
A Draft Direct Taxes Code, 2009 that was published for public feedback had the intent of simplifying tax legislation and widening the tax base. The Bill reverses some of the provisions of that Draft Code. Tax exemptions for individuals have been retained while most exemptions for corporates removed. The tax rates for individuals have been lowered. The taxes paid by corporates will form a greater part of the government's revenue than earlier.

The Bill may increase the burden of compliance in two ways. There are no guidelines to indicate in what situations the General Anti Avoidance Rules will be implemented. Additionally, the Bill requires income from different units of the same business to compute their tax liability separately. The Bill retains the Dividend Distribution Tax and the Security Transaction Tax. These taxes are levied at a uniform rate irrespective of the amount of income or profit, and go against the principle of progressive taxation of individuals. The Bill seeks to tax foreign companies if their place of effective management' is in India at any time of the year. It is unclear-as to what would constitute effective management of a foreign company in India.

Bill makes a number of broad changes to the way income is taxed under the Income Tax Act, 1961, These include:

• Personal income — Widening of income tax slabs and the removal of some exemptions;
• Business and corporate income — Removal or grandfathering (phasing out) of most exemptions.
• Tax administration — Wider powers to prevent tax evasion, and an increase in certain penalties.
• Tax Administration and Appellate Authorities
• Under the Act, the apex authority for tax administration is the Central Board of Direct Taxes (CBDT).
• The Bill introduces a general antiavoidance rule. (GAAR), which aims to plug loopholes in the law which help tax payers reduce their tax liability. The Commissioner of Income Tax can declare any arrangement by a tax payer as 'impermissible', if in his judgement, its main purpose was to have obtained a tax benefit.

India-Mauritius Tax Treaty
India and Mauritius have a double taxation avoidance treaty (DTAA) under which companies of one country investing in the other country are not taxed. It is well-intentioned but is being abused. India has been seeking to tax capital gains on companies making profit in India. Mauritius has agreed to negotiate and revise the existing Double Taxation Avoidance Agreement (DTAA) with India.

More than 40% of total foreign investments to India originate from Mauritius. Authorities here suspect most these investments are nothing but treaty shopping to avoid paying tax. Capital gains is exempted from tax in Mauritius, and under the DTAA, a Mauritian company cannot be taxed in India. The government has en under pressure to act against tax havens, especially after the civil society slammed it for its failure to tackle the issue of black money and tax evasion. India has been insisting on taxing all gains made by a Mauritian company here. India has DTAAs with 79 countries and is in the process of negotiating more such agreements to broaden the information sharing mechanism. To give more teeth to its tax laws and bring tax evaders to book, the Government has devised a Tax Information Exchange Agreement (TIEA) which is being negotiated with 22 identified tax havens. The finance ministry has been negotiating fresh tax treaties with countries with which has no such arrangement and revising existing treaties where liberal clauses are replaced with more stringent reporting mechanism to avoid any round tripping.