Taxation System in India | SSC CGL Tier 2 - Study Material, Online Tests, Previous Year PDF Download

Definition of Taxation

A tax is a legal fee or financial charge levied by the government on an individual or an organization. This Tax is used is collected as revenue for public works done by the government like – health infrastructure, education infrastructure, transport services like Metro, buses, etc.

Taxation imposes a financial obligation on its citizens or residents. The Central and State government plays a significant role in determining the taxes in India. To streamline the process of taxation and ensure transparency in the country, the state and central governments have undertaken various policy reforms over the last few years. One such change was the Goods and Services Tax (GST) related to the delivery of goods and services in the country.

Objectives behind Taxation

The primary goal of taxation is to finance government expenditures, yet taxation policies also encompass non-revenue objectives. These objectives include:

1. Economic development: Taxation serves as a means of mobilizing resources for economic development. By leveraging tax revenues, the government aims to boost both public and private investment. Strategic tax planning can enhance the ratio of savings to national income, contributing to economic growth.

2. Income redistribution: Taxation is utilized to reduce inequalities in the distribution of income and wealth, aiming for a more equitable society.

3. Employment promotion: Lowering the tax rate becomes crucial for achieving the goal of full employment. This leads to an increase in disposable income, subsequently driving up demand for goods and services. The resulting heightened demand stimulates investment, fostering income and employment growth through the multiplier effect.

4. Price stability: Taxation proves effective in controlling inflation by adjusting rates. Raising direct taxes can control private spending, alleviating pressure on the commodity market. Conversely, indirect taxes on commodities may contribute to inflation. High commodity prices discourage consumption while encouraging saving. Conversely, reducing taxes during deflation can have the opposite effect.

Types of Taxes

In India, taxes can be categorized into two main types:

• Direct Tax:

  • Imposed directly on taxpayers and mandated to be paid directly to the government.
  • Examples include Income tax, applicable to individual or corporate earnings/profits.
  • The tax amount varies based on government-prescribed Income tax slabs, subject to periodic revisions. Generally, higher income levels incur higher tax payments.

• Indirect Tax:

  • Levied not on income, profit, or revenue but on goods and services consumed by the taxpayer.
  • Unlike direct taxes, indirect taxes can be shifted from one individual to another.
  • Previously, various indirect taxes such as service tax, sales tax, value-added tax (VAT), central excise duty, and customs duty were imposed on taxpayers. However, the implementation of the Goods and Services Tax (GST) regime from July 1, 2017, replaced all previous forms of indirect taxes on goods and services, streamlining taxation under a unified system governed by both state and central governments.

Major taxation related reforms introduced in recent times

• Indirect taxes reforms: The integration of State and Central indirect taxes in the GST led to the abolition of entry tax and the Central Sales Tax (CST). This has had important spillover effects on the economy. The abolition of the entry tax has reduced trip times on the major road corridors leading to cost benefits for the manufacturers. GST stands for Goods and Services Tax. It is an Indirect tax which introduced to replace a host of other Indirect taxes such as VAT service tax, purchase tax, excise duty, and so on. GST levied on the supply of certain goods and services in India. It is one tax that is applicable all over India.
• Reduction in the corporate tax rate for all existing domestic companies: In order to promote growth and investment, the Government has brought in a historic tax reform through the Taxation Laws (Amendment) Ordinance 2019 which provided a concessional tax regime of 22% for all existing domestic companies from FY 2019-20 if they do not avail any specified exemption or incentive. Further, such companies have also been exempted from payment of Minimum Alternate Tax (MAT).
• The incentive for new manufacturing domestic companies: In order to attract investment in the manufacturing sector, the Taxation Laws (Amendment) Ordinance 2019 has drastically reduced the tax rate to 15% for new manufacturing domestic companies if such company does not avail any specified exemption or incentive. These companies have also been exempted from payment of Minimum Alternate Tax (MAT).
• Reduction in MAT rate: In order to provide relief to the companies which continue to avail exemption/deduction and pay tax under MAT, the rate of MAT has also been reduced from 18.5% to 15%.
• Exemption from income-tax to individuals earning income up to Rs. 5 lakh and increase in standard deduction: Further, to provide complete relief from payment of income-tax to individuals earning taxable income up to Rs. 5 lakh, the Finance Act, 2019 exempted an individual taxpayer with taxable income up to Rs. 5 lakh by providing 100% tax rebate. Also, to provide relief to the salaried taxpayers, the Finance Act, 2019 enhanced the standard deduction from Rs. 40,000 to Rs. 50,000.

The Government is committed to providing a hassle-free direct tax environment with moderate tax rates and ease of compliance to the taxpayers and also to stimulate growth by reforming the direct taxes system. Some of the recent steps taken in this direction, apart from those discussed above, are as under:

• Personal Income Tax –In order to reform Personal Income Tax, the Finance Act, 2020 has provided an option to individuals and co-operatives for paying income tax at concessional rates if they do not avail of specified exemption and incentive.
• Abolition of Dividend Distribution Tax (DDT) – In order to increase the attractiveness of the Indian Equity Market and to provide relief to a large class of investors in whose case dividend income is taxable at the rate lower than the rate of DDT, the Finance Act, 2020 removed the Dividend Distribution Tax under which the companies are not required to pay DDT with effect from 01.04.2020. The dividend income shall be taxed only in the hands of the recipients at their applicable rate.
• Vivad se Vishwas – In the current times, a large number of disputes related to direct taxes are pending at various levels of adjudication from Commissioner (Appeals) level to Supreme Court. These tax disputes consume a large part of resources both on the part of the Government as well as taxpayers and also deprive the Government of the timely collection of revenue. With these facts in mind, an urgent need was felt to provide for the resolution of pending tax disputes which will not only benefit the Government by generating timely revenue but also the taxpayers as it will bring down mounting litigation costs and efforts can be better utilized for expanding business activities. Direct Tax Vivad se Vishwas Act, 2020 was enacted on 17th March 2020 under which the declarations for settling disputes are currently being filed.
• Faceless E-assessment Scheme – The E-assessment Scheme, 2019 has been notified on 12th September 2019 which provides for a new scheme for making assessments by eliminating the interface between the Assessing Officer and the assessee, optimizing the use of resources through functional specialization, and introducing the team-based assessment.
• Faceless appeals –In order to take the reforms to the next level and to eliminate human interface, the Finance Act, 2020 empowered the Central Government to notify the Faceless Appeal Scheme in the appellate function of the department between the appellant and the Commissioner of Income-tax (Appeals).
• Document Identification Number (DIN) – In order to bring efficiency and transparency in the functioning of the Income Tax Department, every communication of the Department whether it is related to assessment, appeals, investigation, penalty, and rectification, among other things, issued from 1st October 2019 onwards are mandatorily having a computer-generated unique document identification number (DIN).
• Pre-filling of Income-tax Returns – In order to make tax compliance more convenient, pre-filled Income Tax Returns (ITR) have been provided to individual taxpayers. The ITR form now contains pre-filled details of certain incomes such as salary income. The scope of information for pre-filling is being continuously expanded by pre-filling more transactions in the ITR.
• Encouraging digital transactions – In order to facilitate the digitalization of the economy and reduce unaccounted transactions, various measures have been taken which include reduction in the rate of presumptive profit on digital turnover, removal of MDR charges on prescribed modes of transactions, reducing the threshold for cash transactions, prohibition of certain cash transactions, etc.
• Simplification of compliance norms for Start-ups – Start-ups have been provided a hassle-free tax environment which includes simplification of the assessment procedure, exemptions from Angel-tax, the constitution of dedicated start-up cells, etc.
• Relaxation in the norms for Prosecution: The threshold for launching prosecution has been substantially increased. A system of the collegium of senior officers for sanction of prosecution has been introduced. The norms for compounding have also been relaxed.
• Raising of monetary limit for filing of appeal – To effectively reduce taxpayer grievances/ litigation and help the Income Tax Department focus on litigation involving complex legal issues and high tax effects, the monetary thresholds for filing of departmental appeals have been raised from Rs. 20 lakh to Rs. 50 lakh for appeal before ITAT, from Rs. 50 lakh to Rs. 1 crore for appeal before the High Court and from Rs. 1 crore to Rs. 2 crores for appeal before the Supreme Court.

Expansion of scope of TDS/TCS – For widening the tax base, several new transactions were brought into the ambit of Tax Deduction at Source (TDS) and Tax Collection at Source (TCS). These transactions include huge cash withdrawals, foreign remittances, purchases of a luxury cars, e-commerce participants, sales of goods, acquisition of immovable property, etc.

Trend of tax collection in India

• The tax-to-GDP ratio denotes the proportion of tax collected relative to the national gross domestic product (GDP). According to the 2016 Economic Survey, India's tax-to-GDP ratio stands at 16.6 percent, significantly lower than the average of 21 percent in emerging market economies and the 34 percent average in OECD nations.

• In India, there is one direct taxpayer for every 16 voters, highlighting a relatively small segment of the population actively contributing to direct taxes. Notably, only 1% of India's total population is involved in paying income tax.

• The direct to indirect tax ratio in India is approximately 35:65, a notable departure from the trend in most OECD economies. In contrast, the majority of OECD nations maintain a ratio of 67:33, favoring a higher proportion of direct taxes over indirect ones.

Issues associated with Taxation System in India

• “Generous” government policy
• Tax exemption raj that benefited the richer private sector.
• India has a relatively large informal/unorganized sector, and tax evasion is more rampant in the informal sector compare to the organized sector.
• Low per capita income, high poverty, keeps tax collections low.
• Out of 25 crore households in India, 15 crores belong to the agricultural sector which is exempted from taxes.
• A parallel economy of unaccounted incomes and expenditures exists which goes untaxed.
• India has one of the highest numbers of disputes between tax administration and taxpayers, with the lowest proportion of recovery of tax arrears.
• The actual number of people who pay tax is lower because of those who report zero tax liabilities.

Recommendations made to address issues associated with Taxation System in India

• Scrutinize exemptions like transfer pricing, base erosion, and profit shifting (BEPS), among others.
• Advocate for the broadening of the individual taxpayers’ base, as recommended by the Economic Survey.
• Implement the suggestions of the Tax Administration Reform Commission (TARC) to amalgamate CBDT and CBEC.
• Utilize tools such as PAN and enact simplified laws to enhance tax buoyancy.
• Foster an attitudinal change among citizens, emphasizing a sense of duty towards the nation.
• Harness the benefits of Information and Communication Technology (ICT) systems.
• Establish an effective dispute settlement mechanism.
• Formulate a specialized task force to monitor economic activities predominantly settled in cash, thereby bringing the parallel economy under the tax net.
• Monitor jewelry stores to identify individuals acquiring gold without paying taxes.
• Undertake political initiatives to integrate India’s informal sector into the formal sector, promoting a level playing field and increasing overall wealth.
• Consider reducing tax rates, given India's high global tax rates, to prevent tax evasion.
• Emphasize expanding the tax base rather than deepening it.
• Explore the simplification of direct tax laws, as proposed by the Justice Easwar committee. The Economic Survey suggests that building fiscal capacity is essential for India's sustained growth in per capita income.
• Contemplate the possibility of taxing the farm sector, as suggested by the Economic Survey.

Conclusion

Renowned economist Joseph Stiglitz suggests that an ideal tax system would involve progressive income taxes, supplemented by indirect taxation, property taxes, and capital taxes. These components enhance the overall progressivity of the tax system while mitigating potential distortions. India should strive towards realizing this optimal tax structure.