The case for simpler tax laws

The idea of a new Direct Tax code (DTC) has been in the works since 2009. Almost after eight years of pursuit, the idea was given a burial by the finance minister in his Budget speech in February 2017. The idea got a fresh lease of life within a span of six months, when a task force was constituted in November 2017 to give its recommendations on the current tax regime and how to align it with the needs of a dynamic and fast-growing economy.

The task force was directed to give its recommendations keeping in mind aspects such as the tax system prevalent in various other countries, international best practices, and the existing tax provisions vis-à-vis the current economic needs of the country. While the objective is to update the tax laws to meet the needs of the current business environment, this would also be a good opportunity to revisit some of the existing provisions of the Income-tax Act, 1961, especially those that have outlived their purpose and require reconsideration.

One such provision is section 43B, which was introduced by the Finance Act 1983. Under this provision any sum payable by way of tax, duty, cess or fees under any law for the time being in force and any sum payable by an employer as contribution to any provident fund or gratuity fund or any other fund for the welfare of employees is allowed only on actual payment, despite the taxpayer following the accrual basis of accounting. Expenses such as bonus, commission or leave encashment payable to employees, interest on any loan or borrowing from a public/state financial institution or a scheduled bank, are also covered under this provision.

Similarly, the Income-tax Act also has provisions wherein deduction for expenses is disallowed if the tax deduction at source (TDS) has not been done in accordance with the relevant provisions. Whether an expense is subject to TDS or not is a matter of interpretation in many cases, with divergent views being taken by the taxpayer and the tax department. Finality in such matters is reached only at the higher appellate levels and after considerable time lag.  

Meanwhile, the taxpayer is denied deduction for genuine business expenses which have indisputably been incurred. Moreover, it is pertinent to note that the taxpayer is only performing this function on behalf of, and for the benefit of the tax authorities. There is no direct or indirect benefit to the taxpayer for either deducting or non-deducting the taxes. In fact, an onerous obligation is cast on the taxpayer to carry out tax withholding. 

Ancillary laws and the Income-tax Act have specific provisions which levy interest, fine or penalty for various kinds of non-compliance under the laws. These laws also contain stringent provisions for prosecution. From the government's perspective, the interest and penal provisions under the laws ensure compensation for any delay or shortfall in deposit of taxes, duties, provident fund or other dues. The penalty and prosecution provisions can be a viable deterrent to ensure that taxpayers meet the compliances under various laws.

Also, the development of e-compliance platforms and the tremendous advancement in digitisation facilitates swifter detection of non-compliance and enforcement of penal/prosecution provisions under various laws. Thus, there is a strong case for removal of consequential disallowance in the Income-tax Act, as it casts a dual burden on the taxpayer and also results in unnecessary litigation.

Another set of provisions that merits a second look is the framework for computing depreciation on assets. The Income-tax Act recognises the written down value (WDV) method for depreciating assets. Assets are grouped under sub-heads such as “tangible assets” and “intangible assets”, called “block of assets”. Depreciation is charged on the block of assets rather than the individual asset and WDV needs to be worked out throughout the existence of the block. In contrast, under the Companies Act 2013, depreciation is calculated on individual assets by considering the useful life of the asset, its cost and the residual value. 

This creates a divergence in the quantum of depreciation claimed under the tax law and that computed in the books of account for financial reporting purposes, despite the fact that the asset can (or should) depreciate only at one rate. Thus, the most appropriate rate should be followed for the purpose of determining book profits and for tax purposes as well.

There has been considerable dispute and litigation related to depreciation under the tax laws.  A significant proportion of such disputes could be addressed by following a single set of principles for both tax and book depreciation purposes.

Similarly, provisions under tax laws related to Minimum Alternate Tax (MAT) have also resulted in ambiguity and litigation. MAT was introduced to address cases where despite showing high profits in their books of account and paying substantial dividends, taxpayers paid marginal or no tax. The computation mechanism requires various adjustments to arrive at the “book profits” on which MAT is calculated. The DTC will provide a good opportunity to simplify the provisions related to MAT. The distributable surplus as certified by the auditors can be relied upon to levy MAT, instead of subjecting such book profits to further adjustments.

The new Tax Code has opened a window for the government to evaluate these provisions and work towards keeping the tax laws simple. The four principles or canons of taxation laid out by Adam Smith — the principles of equality, certainty, convenience and economy — are still considered as the cornerstone of sound public finance and the new Tax Code is just the right opportunity for the government to make good its promise of bringing in a taxpayer-friendly environment and improving the ease of doing business in India.    

The writer is national leader, tax - Grant Thornton India LLP. Rajashree Sarna contributed to this article

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