BUDGET AND TAXATION
BUDGET AND TAXATION
To prepare for INDIAN ECONOMY for any competitive exam, aspirants have to know about Budget and Taxation. It gives an idea of all the important topics for the IAS Exam and the Economy syllabus (GS-II). Important Budget and Taxation terms are important from Economy perspectives in the UPSC exam. IAS aspirants should thoroughly understand their meaning and application, as questions can be asked from this static portion of the IAS Syllabus in both the UPSC Prelims and the UPSC Mains exams
In this article, you will read about the meaning of Fiscal Policy, its meaning, types, Objectives, importance etc and other aspects related to Budget and Taxation.
- Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.
- Using fiscal policy, Govt influences the savings, investment and consumption in an economy, to accomplish certain national goals such as income redistribution, socio-economic welfare, economic development and inclusive growth.
- It is the sister strategy to monetary policy through which a central bank influences a nation’s money supply.
- Fiscal policy is result of several component policies or mix of policy instruments. These include, policy on taxation, subsidy, welfare expenditure, etc; investment or disinvestment strategies; and debt or surplus management.
- Full Employment
- Economic Growth
- Price stability
Fiscal policy is based on the theories of British economist John Maynard Keynes (Keynesian economics). This theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending.
|Types of fiscal policy|
- Types of fiscal policy
- Neutral Fiscal Policy
- Contractionary Fiscal policy
- Expansionary Fiscal Policy
|Neutral Fiscal Policy||Policy implies a balanced budget where Govt. spending is equal to the Tax revenue. It further means that government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity|
|Contractionary (restrictive) Fiscal policy||Policy involves raising taxes or cutting govt spending, so that Govt spending is less than Tax revenue. It cuts up on the aggregate demand and to reduce the inflationary pressures in the economy|
Expansionary Fiscal Policy
|Policy is generally used for giving stimulus to the economy. i.e. to speed up the rate of GDP growth or during a recession when growth in national income is not sufficient enough to maintain the present standards of living. A tax cut and/or an increase in government spending would be implemented to stimulate economic growth and lower unemployment rates. This is not a sustainable policy, as it leads to budget deficits and thus, should be used with caution.|
|Objectives of fiscal policy|
- Full Employment – through rural employment programmes like MGNREGA and various similar employment schemes.
- To Fight Inflation – Higher Income tax will reduces disposable income which will result into curbing demand. To fight deflation, we need to reduce direct and indirect taxes to boost demand.
- To Boost Economic Growth – Provide income tax benefits on household savings in LIC/Mutual Fund etc. this will ensure new investible capital to industries which will help in factory expansion, jobs, GDP growth.
- Inclusive Growth – Higher taxes on rich could enable use of taxed money for health, education, women, poverty removal programs.
- To Boost Regionally Balanced Growth – Give tax benefits to industrialists for setting up factories in North East, Left-wing Extremism (LWE) & other backward areas.
Exchange Rate Stability – Give tax benefits to exporters to boost exports; while impose higher taxes on imported items to reduce imports which will help containing Current Account Deficit (CAD).
|Importance of fiscal policy in India|
- In a country like India, fiscal policy plays a key role in elevating the rate of capital formation both in the public and private sectors.
- Through taxation, the fiscal policy helps to mobilise a considerable amount of resources for financing its numerous projects.
- Fiscal policy also helps in providing stimulus to elevate the savings rate.
- The fiscal policy gives adequate incentives to the private sector to expand its activities.
- Fiscal policy aims to minimise the imbalance in the dispersal of income and wealth.
|A. Budget (Annual Financial Statement) – Art. 112|
- Budget is an annual financial statement (Art. 112) containing estimated revenues and expenditures for the next financial year.
- Budget is the primary tool used by Govt to implement its fiscal policy.
- Budget comes from a French word ‘bougette’ which means a leather bag / suitcase.
- Union Finance Minister would keep the documents in it, & present them to the parliament.
- While the term ‘budget’ is not given in our constitution, but for each financial year, the Govt. is required to present Annual Financial Statement containing receipt and expenditure of last year (and projections for the next year).
- Finance Minister Nirmala Sitharaman (in 2019) ended this colonial practice by presenting the budget in a traditional four-fold red cloth ledger.
|Art. 266(1) – Consolidated Fund Of India||Incoming taxes, loans raised, loans recovered. Withdrawal need Parliament Permission (except for Charged Expenditure like Judges’ salaries).|
|Art. 267 – Contingency Fund of India||Unforeseen events INR500 cr by Finance Secretary on behalf of President. Parliament approval is “subsequently” obtained, after expenditure. Money refilled from CFI.|
|Art. 266(2) – Public Accounts Of India||
|Q. The authorization for the withdrawal of funds from the Consolidated Fund of India must come from______(CSE-2011)
|Objectives of govt. budget|
- Resource allocation in the best interest of society and the country.
- Allocating resources optimally for public welfare.
- Uplift downtrodden sections of the society by reducing poverty levels and creating gainful employment.
- Creating programmes for citizens so that they get basic need such as food, shelter, health, education etc.
- Union budget takes steps to control inflation, deflation and economic fluctuations thus ensuring economic stability in the country.
- Union budget makes sure that there is fair distribution of income through taxes and subsidies.
- Union budget of any nation is crucial as it has widespread implications on the country’s economic stability and general life as such.
|Financial Year (FY)|
|1867||British Indian Govt. started financial year 1st April to 31st March to align with their home country’s financial year.|
|Constitution has not specified any months for FY but we continued the British legacy.|
|2016-17||Finance ministry had setup Shankar Acharya Committee to assess whether we should change FY (like Jan-Dec or Rabi-Kharif Cropping seasons). So we can get better estimation of tax collection and expenditure.|
|2017||All states not in favor because accounting practices need to be changed. Its challenges outweighed the benefits. So, Govt not implementing.|
|Three Documents related to Budget|
|Annual Financial Statement (AFS) Article 112
The finance bill and appropriation bill are considered money bills. Rajya Sabha approval is necessary, at maximum they can discuss it for 14 days and give suggestions to Lok Sabha for amendments, but it’s not binding on the Lok Sabha to accept Rajya Sabha’s suggestions. Whether a given bill is money bill or not, Lok Sabha’s decision is final and it cannot be enquired by any Court (Art.122).
|Q. What will follow if a Money Bill is substantially amended by Rajya Sabha? (CSE-2013)
|Q. Find correct statement(s): (CSE-2015)
Six stages of passing of Budget
The budget goes through the following six stages in the Parliament:
- Presentation of budget
- General Discussion
- Scrutiny by departmental committee
- On demands for grants, cut motions, guillotine
- Passing of Appropriation Bill
- Passing of Finance Bill
- Vote on account is the process by which an incumbent obtains votes from Parliament to spend money on various items for a part of the year.
- The Constitution does not mandate any specific date for presentation of the Budget, but it is presented to the Lok Sabha on such day as the President directs.
Vote on Account
Before 2017, it was presented in the last working day of Feb. Then it will pass through aforementioned six stages upto May month.
- But in between, on 31st March, the financial year will be over so previous year’s Appropriation Act’s validity will be over.
- Then government cannot withdraw money from the consolidated fund of India even for the routine expenditure like staff salary, administrative bills etc.
- So, to avoid such crisis, government will put a motion for vote on account.
- Here, parliament (practically Lok Sabha) will allow the govt to spend some money from the CFI, till the (next) Appropriation Act for next financial year is passed.
- Vote on Account is generally granted for two months for an amount equivalent to one-sixth of the total budget estimation.
|Relevance of vote on account|
Vote on Account is no longer necessary because –
- No constitutional compulsion to put budget on a specific date. So, from 2017, present Govt. began tabling the budget on the first working day of February.
- All the six stages are completed by the last week of March.
- Appropriation bill gets passed and signed by President before completion of 31st March. So they did not require vote on account in 2017, 2018.
- In 2019’s Interim Budget, they demanded vote on account because they planned to place full- budget after general elections.
- Our constitution does not define or require interim budget.
- But, during election year it’s considered immoral and unethical for such Govt. to make drastic changes through budget like “1.5 x times MSP to farmer”.
- So, while they will present a budget in the regular fashion i.e. 3 documents (AFS, Finance Bill, Appropriation Bill) & 6 Stages of Passing. But it not have grand populist announcements – e.g. loan waiver.
- Similar to the Regular General Budget, an Interim budget is valid for the whole financial year, however in between if new government is formed they may present another budget to change the provisions, these budgets are called Interim Budgets, and were presented in
|2004 – by Yashwant Sinha|
|2009 – by Pranab Mukherji|
|2014 – by Chidambaram|
|2019 – Piyush Goyal|
|FM Nirmala S. presented (Full) General Budget in 17th Lok Sabha.|
|Theme for budget 2020|
- Aspirational India
- Economic Development for all
- Caring India
- It is a document prepared by the Chief Economic Adviser (CEA) in the finance ministry.
|ES – Vol – 1||ES – Vol – 2|
|Shows prospects & suggestions for the future years.||Shows annual data of past year.
There is no constitutional obligation to prepare or present it. But usually, it is tabled in the parliament a day before the Union Budget.
|2019-Feb||No economic survey was presented|
|2019-July||presented before the (Full) General Budget|
|2014||Interim Budget without Economic Survey Feb-2014, then (General) Budget with Economic Survey July-2014.|
While Budget is labelled after next financial year (e.g. 2020-21), the Economic survey is labelled after previous Financial Year. e.g. The survey tabled on Feb-2018 is labelled as “Economic Survey 2017-18”.
Since 2014-15, Adopted Two Volume Systems similar to the “IMF’s World Economic Outlook”.
Vol-1 = future suggestions
Vol-2 = Past data.
Chief Economic Advisor
- Falls under Department of Economic affairs, Ministry of Finance.
- Usual tenure 3 years, reappointment possible, but not a constitutional or statutory body.
- CEA has control over Indian Economic Service (IES)
- Notable CEAs in Past:
- Manmohan Singh,
- Raghuram Rajan,
- Arvind Subramanian (2014-18).
- 2018-Dec: Krishnamurthy
- Venkata Subramanian became the new CEA.
Finance Ministry and its dept.
|Dept of Economic Affairs|
- DEA is responsible for the fiscal policy, Preparation and presentation of Union budget including the Railway component of budget.
- Also Budget for Union Territories without legislature, budget for States under president rule.
- DEA announces the Interest rates of small saving schemes.
- DEA assigns infrastructure status to a particular sector.
|Organizations related to dept of economic affairs|
|Constitutional Body||Finance Commission (Art. 280)|
|Statutory Body||Board for Industrial and Financial Reconstruction (BIFR) – abolished after the coming of another statutory body- Insolvency and Bankruptcy Board of India (IBBI) under Corporate Affairs Ministry.|
|Chief Economic Advisor||CEA that we have covered in above section.|
|Financial Stability and Development Council (FSDC)||FSDC is neither Constitutional nor statutory body. FM is chairman. Members include the chiefs of all financial regulatory bodies- such as RBI, SEBI, IRDAI etc. and the chief of IBBI- Insolvency and Bankruptcy Board of India.|
|PSU||Security Printing and Minting Corporation of India Ltd. (SPMCIL). Registered under the Companies Act responsible for printing currency notes, coins, commemorative coins, cheques, postage stamps, non-judicial stamps, passports/visa and other travel documents etc.|
- Which one of the following is responsible for the preparation and presentation of Union Budget to the Parliament? (CSE-2010)
- Department of Revenue
- Department of Economic Affairs
- Department of Financial Services
- Department of Expenditure
|Dept of expenditure|
- Here the Controller General of Account (CGA) prepares the estimate of how much money will have to be spent from the consolidated fund of India.
- It also deals with Pay Commission reports, Pension Accounting office.
|Dept of revenue|
Looks after the taxation matters using bodies:
|Statutory Bodies (Quasi-judicial bodies)||· Central Board of Direct Taxes (CBDT) under the ambit of Department of Income Tax
· Central Board of Indirect Taxes and Customs (CBIC). Before- 2018, March, it was known as Central Board of Excise and Customs (CBEC). After GST was introduced, excise duty was replaced by central GST, because excise was levied by the central govt. It implements GST from 1st July 2017, under the 101st Constitutional Amendment Act, 2016.
· Various Tribunals and appellate bodies related to taxation.
|Attached / Subordinate bodies
|· Enforcement Directorate
· Central Economic Intelligence Bureau(CEIB)
· Central Bureau of Narcotics
· Financial Intelligence Unit
|Goods and Service Tax Network (GSTN) is a non-profit company. Originally its 51% shareholding was with HDFC, ICICI etc. In 2018 Government decided to make it 100% owned by Union & State Governments.|
|Q. Find correct Statement(s): (CSE-2015)
|Dept of financial services|
- Various schemes for Financial Inclusion, PSB supervision and recapitalization, Public Sector Financial Intermediaries, including their regulators (Except EPFO, ESIC etc.)
- Employee Provident Fund Organisation (EPFO) and Employees State Insurance Corporation (ESIC)
|Organizations under/related to DFS|
|Bank Board Bureau||Neither Constitutional / statutory. Setup through gazette notification for selection of top officials (MD, CEO, Chairman and full-time Directors) for PSBs, LIC and other public sector financial institutions. Actual appointment done by Finance ministry Department of Financial Services → DFS appoints.|
|PSU||National Credit Guarantee Trustee Company (NCGTC): For providing credit guarantee for Mudra Loans and Stand up India, loans related to education and skill development.|
|Dept of investment and public asset management (DIPAM)|
- Department of Investment and Public Asset Management (DIPAM) looks after Disinvestment of CPSE.
The highest official in each of above 5 departments is called ‘Secretary’ (usually an IAS), and among those 5 secretaries, the senior-most is designated as the Finance Secretary, who signs ₹ 1 note.
Types of budgets
|Revenue Versus Capital Budget|
|Revenue budget||Capital Budget|
|It is associated with the income and expenditure that are of temporary in nature (1 year or less), and/or do not result into creation of permanent / capital / physical / financial assets.||Capital budget is associated with the income and expenditure that are of long term nature and/or results into creation of permanent / capital /financial assets, such as land, buildings, machinery, equipment, shares, bonds, G- sec.|
|Taxation, revenue from selling goods and services, interest payment on previous loans, salaries, pension, subsidies and other non- developmental expenditure.||Borrowings, disinvestment, and expenditure on assets creation.
|Q. Which of the following is/are included in the capital budget of the Government of India? (Asked in CSE-2016)
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
|General Budget Vs Railway Budget|
|Background||Acworth Committee (In 1920-21) recommends separate Railway Budget. This practice continued even after Independence, first the railway minister would present the Railway budget in parliament, and after a few days finance minister will present General Budget.|
|NITI Aayog’s Bibek Debroy committee recommends its abolition because:-
|o No constitutional requirement
o During coalition government, Rail budget was used for populism, cheap fares which eroded the profitability of Railways.
o During the British time, railway revenue used to be quite large compared to other sources of revenue, but after independence, Railway revenue is quite small compared to overall General budget- So it does not deserve a special presentation.
|Therefore, Govt merged Railway budget with General budget from 2017.|
|Plan Vs Non-Plan Expenditure Budget|
This budgeting is a method of classifying the expenditure side of budget.
|Plan (expenditure) budget||Non-Plan (Expenditure) Budget|
Since Budget-2017, incumbent govt stopped the practice of displaying the plan and non-plan expenditure separately because-
- No such constitutional requirement
- Government had dissolved the planning commission in 2014-15
- 12th Five Year Plan (2012-17) was ending in 2017 anyways.
|Balanced, Surplus and Deficit Budget|
|Balanced Budget||A government Budget is assumed to be balanced if the expected expenditure is equal to the anticipated receipts for a fiscal year.|
|A Budget is said to be surplus when the expected revenues surpass the estimated expenditure for a particular business year. Here, the Budget becomes surplus, when taxes imposed, are higher than the expenses.|
|Deficit Budget||A Budget is in deficit if the expenditure surpasses the revenue for a designated year.|
|Traditional / Line-item Budgeting
|· In this type, simply calculating the income and expenditure without measuring the underlying benefit or performance
· For instance, Allot INR 100000 to buy a new computers in government department
|· Calculating the income and expenditure tied with underlying benefit or performance
· Allot INR 50,000 to buy a new computer with target that it should result in 30% the faster clearance of RTI-applications compared to pen and paper based office system.
· Such budgeting helps measuring cost : benefit and efficiency.
|Zero based budgeting
|· In a traditional budgeting, the approach is “automatic and incremental” e.g. “Last year we allotted INR 100000 crore to educational schemes, so this year we should allot 55,000 crores, lest the opposition parties create controversy.”
· Whereas in Zero Based Budgeting the budget is viewed as a fresh exercise from zero base. So, each department has to justify its budget demands to finance ministry. E.g. if last year ₹ 50,000 crores given to education schemes but still 60% of class 5 kids cannot read class 2 books, then we will delete / modify that scheme.
|Gender based budgeting
|· This system was started from Budget-2005.
· It is not a separate budget but rather within the general budget, Finance Ministry will put a separate expenditure document showing women specific schemes, targets, and commitments– in two parts:
1. Part A – Women Specific Schemes, i.e. which have 100% allocation meant for women. E.g. Nai Roshni scheme (Minority Affairs Ministry) for leadership development in Minority Women.
· Part B – Pro Women Schemes, i.e. atleast 30% allocation meant for women. E.g. Samagra Shiksha (Min of HRD) for pre-nursey to Class12 both boys & girls covered.
|Sunset Budgeting||· In a traditional budgeting, once a scheme is launched it runs perpetually, even after regime change e.g. MNREGA, Mid-day Meal.
· In a zero based budgeting, schemes are reviewed every year and then they may get discontinued or continued (with or without modifications).
· In Sunset Budgeting, scheme are announced with deadline. e.g. MEITY to give MDR subsidy for a period of two years starting from 1/1/2018. Thus, this scheme will self-destruct after deadline just like the sun will set after the sunset time.
|Tribal Sub-Plan & SCSP|
From 1970s, Govt required individual ministries to earmark funds for SC/ST within their overall funds, under the titles:
|Scheduled Castes Sub-Plan (SCSP)||Social Justice Ministry monitors via e-utthaan.gov.in|
Tribal Sub plan (TSP)
|Ministry of Tribal Affairs monitors via stcmis.gov.in.
Although not required by the Constitution, but Govt. also tables separate documents showing
1) allocation for children
2) allocation for North Eastern Areas.
|Lapsable Funds à March Rush|
Appropriation act allows the govt to spend funds from consolidated fund of India for a period of one year (ending in 31st March).
- If any allotted funds remain unutilised, then by the ‘Rule of Law’, they must be returned (govt. will have to again seek Parliament approval for the next financial year using next appropriation bill).
- This led to rush in March among the Govt organisations to spend money lest they have to return it back.
2017-18: Finance ministry issued directive that in “In the fourth quarter (Jan to March) and in the March-Month, Govt organizations shall not spend more than “specified%” of funds”. This helps controlling the March Rush.
|Non Lapsable Funds à No March Rush|
- The money in such fund will not lapse on 31st March, so it can be used in future without getting another approval from parliament.
- g. Nirbhaya Fund under Department of Economic Affairs for safety of women related projects.
- Because the fund is non lapsable, Departments become sluggish in utilising it. Budget 2013 started Nirbhaya fund in the aftermath of Gangrape (2012) at Delhi. The successive budgets kept adding of corpus into it. By 2018:, the fund was about INR 3000 crore but not even 50% utilized for any women safety activities.
- 2018: Defence ministry demands “non-lapsable defence modernization fund”, but Finance ministry rejected for similar same reason. (money will remain unspent.)
|Taxation in India|
- Tax is the money paid by the taxpayers to the government. Tax is compulsory payment and not voluntary payment or donation made by the taxpayers.
- It is compulsory as it is extracted by the government through legislation. If taxpayers fails to pay the taxes or evade taxes, it is punishable by law.
- The tax system in India is mainly a three tier system which is based between the Central, State Governments and the local government organizations (such as Municipality and Panchayats).
- Thus, Taxes in India are levied by –
- Central Government
- State Government
- Local authorities such as panchayats and Municipalities
|Distribution of Taxation Power|
Article 246 (schedule VII) of the Indian Constitution, distributes legislative powers including taxation, between the Parliament and the State Legislature.
Schedule VII provides for the three lists:
|List – I
|It provides for areas on which only parliament is competent to make laws|
|List – II
|It provides for areas on which only parliament is competent to make laws|
|List – III
|the areas on which both the Parliament and the State Legislature can make laws upon concurrently|
|Art 248 mentions that the residual powers of Legislation are vested in the Parliament. It means that Parliament has exclusive power to make any law with respect to any matter not enumerated in list II and III. Such power shall include the power of making any law imposing a tax not mentioned in either of those lists.|
NOTE – Separate heads of taxation are provided under List- I & List – II of Seventh Schedule of the Constitution. However, there is no head of taxation in the Concurrent List (It means that Union and the States have no concurrent power of taxation)
The 73rd and 74th constitutional amendment act have provisions to levy taxes by panchayats and Municipalities respectively. A State may by law authorise a Panchayat (or Municipality) to levy, collect and appropriate taxes, duties, tolls etc.
- Types of Tax
- Direct tax
- Indirect tax
|Direct tax is imposed directly on the taxpayer. Also, it is paid directly to the government by the person on which it is imposed. Direct tax cannot be shifted by the taxpayer to someone else.
Thus, in case of Direct tax, the incidence of tax, and impact of tax is on the same person.
Examples of Direct Tax – Income tax, Corporate tax etc.
|An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). An indirect tax is one that can be shifted by the taxpayer to someone else.
Thus in case of Indirect tax, the incidence of tax and impact of tax do not lie on the same person.
|Direct tax||Indirect tax|
|Incidence and impact of tax fall on the same person.||Incidence and Impact of tax fall on two different persons.|
|It is levied on the income. E.g. – Income tax, Corporate tax etc||It is levied on goods and services. E.g.- GST etc
|It is progressive in nature- higher taxes are levied on persons earning higher income
|It is regressive in nature i.e. all persons (rich and poor) will bear the same taxes on goods and services, irrespective of their capability to pay.|
- Types of taxes acc. to fairness
|A tax that takes the same percentage of income from all income groups
For example – if the Government decides to have a single slab in Income tax rate (let us assume 30%). Then the percentage of income paid in taxes will be same for the low income group, middle income group and high income group.
|A tax that takes a larger percentage of income from high-income groups than from low-income groups.
For example – Income Tax rate India. (tax rate goes up as income level rises). Rich people pay a larger portion of their income as tax in comparison to poor people.
| A tax that takes a larger percentage of income from low-income groups than from high-income groups.
E.g. An indirect tax on soya oil (suppose – 18%). Lower income group pay high proportion of their income as tax while buying it in comparison to higher income group.
|Distribution of Taxation Power|
- Canon of Equality – Tax should be equal and proportionate to income. Rich people should pay more taxes than poor.
- Canon of Certainty – Dates, slabs, percentages should be definite and told in advance. Randomly govt should not demand “any%” tax to build statue, temple or mosque.
- Canon of Convenience – taxpayer should not be made wait for a mile long queue & fill-up 50 pages worth tax forms.
- Canon of Economy – to collect INR1000 crore tax, govt shouldn’t be spending INR9900 crores in salaries of tax officials.
|Direct Tax||Union govt||State govt|
-Minimum Alternate Tax (MAT)
-Capital Gains Tax (CGT)
-Dividend Distribution Tax (DDT) (Abolish)
|-Agriculture Income tax
-Professional Tax (Constitutional ceiling of max ₹2500 per year)
|On assets transactions
|-Securities Transaction Tax
-Commodities Transaction Tax
-Wealth Tax (Abolished)
-Banking Cash Transaction Tax (Abolished)
-Estate Duty (Abolished)
-Stamp or Registration duty
-Property tax in urban areas
|-Hotel Receipt Tax (Abolished)
-Gift Tax (Abolished)
-Fringe Benefit Tax (Abolished)
i.e. When the
employer give benefits to employee apart from salary.
|Union Budget-2020: (Expected collection) Corporation Tax > Income tax > STT|
- Income Tax
- Corporate Tax
- Minimum Alternative Tax (MAT)
- Dividend Distribution Tax (DDT)
- Capital Gains Tax (CGT)
- Securities and Transaction tax/Commodities Transaction Tax
- Wealth Tax
- Estate Duty
- Fringe Benefit tax (FBT)
|Union Tax, Cess And Surcharge|
|Union Tax||Computed on taxable income, profit, transaction.
Union tax goes to Consolidated Fund of India.
Later divided between Union and states as per the finance commission formula. (except if IGST: divided on GST Council’s formula.)
|Surcharge||Computed on Tax amount. So, it is a ‘tax on tax’. This amount will also go to CFI. It is not shared with States using Finance Commission Formula.
Usually cess does not have any clear objective in ‘prefix’ so it may be used for any purpose.
Exception is 10% Social Welfare Surcharge on the custom duty on imported goods. This will specifically use for social welfare schemes of the union.
|A cess is a tax on tax, levied by the govt. for a specific purpose. It is levied on the tax payable and not on the taxable income.
In a sense, for the taxpayer, it is equivalent to a surcharge on tax.
A cess can be levied on both direct and indirect taxes. Clear objective is mentioned. Proceeds of the cess cannot be spent on any other kind of govt. expenditure. E.g. the proceeds from the education cess cannot be used for cleaning the environment and vice versa
To meet specific socio-economic goals, a cess is preferred over a tax because it is relatively easier to introduce, modify, and abolish.
Computed on [(Tax) + (Surcharge, if any)]
Recent examples of cess are:
Infrastructure cess on motor vehicles, Clean environment cess, Krishi Kalyan cess (for the improvement of agriculture and welfare of farmers), education cess.
By default, cess goes to CFI→ from there, to a specific fund in Public Accounts e.g. Central Road Safety Fund etc.
Cess is not shared with States using Finance Commission Formula. (Although some of the cess money will invisibly go to states as a part of scheme implementation e.g. Pradhan Mantri Fasal Bima Premium share, etc.)
GST Compensation Cess is shared with States, as per GST formula.
Also known as Corporate Income Tax (CIT), levied on Company’s profit, under the Income-tax Act, 1961.
|Additional tax benefits to companies producing solar power, electric batteries, computer server, laptop etc. in any part of India. Companies operating from GIFT-city-IFSC given 100% exemption from Corporation Tax for 10 years.|
|Budget-2020||Tax holiday for developers of affordable housing extended till 31 march 2021.
– If a Sovereign Wealth Fund invests in Indian infrastructure projects → Tax holiday for them. E.g. Abu Dhabi Investment Authority
|Revision of corporate tax in sept 2019|
|Existing Indian companies
|25-30% depending on turnover + 0-12% surcharge depending on profit + 4% health, Edu cess||22% tax + 10% surcharge on (tax) + 4% cess (on tax + surcharge)
|New Indian manuf. company registered from 1/10/2019.
Budget-2020: new Indian electricity companies also eligible in this
|–||15 % + surcharge & cess as given above
|Foreign Company’s profit from India||40% + surcharge + cess
|Zero profit companies||18.5% MAT
Corporation tax for foreign company’s profit from India is highest among emerging economies.
|Corporation Tax on Start-ups:|
|Startup is a company not older than 10 years and not having turnover more than 100 cr. Govt helps them through Startup India Scheme.|
|Startup can claim 100% deduction on its profits, for 3 years out of the first 10 years of incorporation. (as such they get tax benefits under Startup India scheme, but new budget fine-tuned those technical definitions further.)|
|Start-ups generally use Employee Stock Option Plan (ESOP) to attract talented employees. But ESOP was subjected to various direct taxes → New budget gave some technical reliefs to them|
|Corporation Tax Cut on Cooperative Societies:|
|30% + surcharge + cess||22% + 10% surcharge + 4% Cess|
|Equalisation Levy / Google Tax|
- Equalization Levy (Direct Tax) was introduced in India in 2016, with the intention of taxing the digital transactionse. the income accruing to foreign e-commerce companies from India.
- It is aimed at taxing business to business transactions.
- If a foreign company makes profit in India, they have to pay 40% Corporation Tax.
- If an Indian businessman purchases digital advertisement slots in google-ad sense or facebook then those (foreign) e-ad companies are making profit. But earlier, they did not pay tax on that profit, claiming their business activity (of displaying digital-ads) is done outside India on global servers.
- Budget-2016 imposed 6% tax on such income of foreign technology companies.
- Officially called “Equalisation Levy”, not part of “Income Tax” or “Corporation Tax” under the Income Tax Act 1961, but a separate levy altogether imposed by the Finance Bill 2016.
- Foreign Company cannot escape it saying we are protected under the Double Taxation Avoidance Agreement (DTAA) in our home country.
|Q. With reference to India’s decision to levy an equalization tax of 6% on online advertisement services offered by non-resident entities, which of the following statements is/are correct? (CSE-2018)
Significant Economic Presence (SEP): Concepts basically means if a foreign company is making money from Indians through digital ads / streaming services (e.g. NETFLIX videos from overseas servers) then the company has ‘SEP’ in India, therefore, Indian govt has powers to tax it.
‘Tax challenges of digitisation’ – OECD has used a phrase to denote above type of problems where digital services type MNC companies are avoiding taxes.
GAFA Tax – France has implemented tax on large technology companies called Google Apple Facebook Amazon from 1st Jan 2019.
|Minimum Alternate Tax (MAT)|
- Some industrial houses use tax-deduction-exemptions-depreciations and accounting tricks to become “Zero Profit Companies” & escape paying Corporation Tax.
- Budget-1996 introduced 5% MAT on book profit using a different type of formula.
|Budget 2018||If such company is in GIFT city IFSC, then for them MAT only 9%.|
|September 2019||The government reduced the MAT tax rate from 18.5 per cent to 15 per cent.|
AMT (Alternative Minimum Tax): Concept similar to MAT but for Non-Corporate assesses e.g. Individual or Hindu Undivided Family (HUF) or Cooperative Society who are earning more than INR “x” lakh but not paying direct tax. Both MAT and AMT subjected to the surcharge and cess.
|Dividend Distribution Tax (DDT)|
- FM Chidambaram in 1997 started to levy DDT on a shareholder’s dividend income.
- In reality, company (source) will cut that much income portion from shareholders’ dividend, and directly deposit that particular amount to the govt, as DDT.
- Shareholder did not have to pay Income tax on it.
DDT Rate à 15% + cess + surcharge = 20.56% on dividend paid.
|Budget-2019||Companies in GIFT-city-IFSC given some exemptions from DDT.|
|Budget-2020||Abolished DDT. But, dividend will be taxable in the hands of shareholder (i.e. he will pay income tax on it)|
|Previously even lower middle-class shareholder’s around 20% dividend was cut in the name of DDT.
But now he may have to pay barely 0-5% income tax on income from dividend.
Thus, Shareholders get to keep more money for spending → shopping spree → demand, production, economic growth.
Foreign investors will be attracted to invest in Indian companies’ shares.
- Profit making companies sometimes repurchase their own shares back from shareholders.
- Impact – These many shares are eliminated from company’s liability side.
- Benefit to company – No need to pay dividend on these shares in future.
|Budget 2013||Government ordered unlisted companies to pay “20% Buy back tax” they buy back their own shares from the market|
|Budget-2019||Made this applicable on listed companies as well.|
|Capital Gains Tax (CGT)|
- When an owner makes profit by selling his capital assets such as non-agro-land, property, jewellery, paintings, vehicles, machinery, patents, trademarks, shares, bonds & other securities- then he has to pay CGT.
- Depending on how long did the owner keep that asset before selling it, he will pay:
- Either short capital gains tax (LCGT) or
- Long capital gains tax (SCGT)
- In practice, the buyer will deduct that much amount from the payment to seller, and deposit to the govt.
To avoid CGT, some people form shell companies abroad & do transactions from there to avoid paying taxes to India.
|Earlier Listed companies Shares, Mutual Funds Units etc. were exempt from LCGT. But, since large amount of money is invested here and owners make good profits by selling them, so govt decided to apply the Long Term Capital Gains Tax system on them at 10%.|
|If Startup entrepreneurs unable to secure capital from investors → they sometimes have to sell their house arrange money for starting business. So, Govt. had exempted their house-selling-profit from CGT. This scheme extended it till 31 march 2021.
– Companies operating from GIFT-city-IFSC given some exemptions from CGT.
|Q. In which of the following circumstances may ‘capital gains’ arise? (CSE-12)
|Income Tax On Individuals|
- James Wilson (financial member of the Council of India, founder of the Economist magazine and Standard Chartered Bank) introduced income tax in India on 24 July 1860 to compensate the British losses during 1857’s Sepoy mutiny.
- Suppose the gross income of an Indian Resident (age less than 60) is INR 9 lakhs.
- Out of this gross income, first we have to subtract the tax-deductions and tax- exemptions like income from agriculture, investments made in Provident Fund, NPS, LIC, Medical Insurance etc (upto a certain limit), house rent allowance (HRA), repayment of home/education loan, money donated in eligible charitable funds etc
- After subtracting such things, suppose taxable Income is: INR 5,50,000/-
- From this amount, Salaried individuals get standard deduction of INR50000. (Previously, it was INR40000 but Interim-Budget-2019 raised it to INR50000).
- Hence, INR5,50,000 – 50,000 = ₹5 lakh is the taxable income.
|Additional tax deduction given:
· if took loans to buy electric vehicle
· if someone is taking home loan for the first time.
|New slabs for Income Tax in Budget-2020|
If we give up exemptions and deductions such as :
- Salaried employees’ standard deduction, HRA, Leave Travel Concession (LTA)
- Section 80C deduction (e.g. investments made in LIC/NPS etc upto ₹1.5 lakh per year) Etc.
- Then you can opt to pay with new (reduced) income tax slabs viz.
|Taxable Income (per annum)||New slab, if you give up deduction & exemptions)||Old slabs, if u don’t give up
|Upto ₹2.5 lakh
|Nil / 0%
|Nil / 0%
|>₹2.5 lakh-₹5 lakh
(meaning from 2,50,001 to 5,00,000)
|5% (But 12500 rebate so in reality ₹0)
|5% (But 12500 rebate so in reality ₹0)
|>₹5 lakh to ₹7.5 lakh||10 %||20%
|>₹7.5 lakh to ₹10 lakh||15%|
|>₹10 lakh to ₹12.5 lakh||20%||30%|
|>₹12.5 lakh to ₹15 lakh||25%|
|Surcharge & cess applicable?||Yes||Yes|
|E.g. An employee with annual salary ₹15lakhs will pay total Income Tax||₹1.95 lakh**
|**It is left to individual’s discretion whether he wants to stay in old / new system. But if all people opted for the new slabs then Govt will hypothetically get ₹40,000 crore less (compared to old system). Technically, it’s called “Revenue forgone”|
Reduction in Income tax paid will increase disposable income with people → shopping spree and increase in expenditure → rising in demand → production, economic growth etc.
Shopping spree and increase disposable income with people will increase indirect tax collection e.g. Mobiles (18% GST).
|Direct Tax Code (DTC) Task Force (2017-2019)|
- Finance Ministry in 2017, setup DTC taskforce under CBDT member Arbind Modi.
- Taskforce had noted IRS officer, Chartered Accountant, Tax Lawyer, Corporate Consultant etc. Chief Economic Advisor Krishnamurthy Subramanian was also a member of this taskforce
- Report was submitted in Aug 2019 to the Finance Ministry.
- While Govt is yet to release this report in public domain, but according to journalists, it contains following suggestions:
- Replace the Income Tax Act 1961 with a simpler Direct Tax Code.
- Reduce the corporation tax further.
- Tax rates for domestic and foreign companies should be same. This will encourage ease of doing business in India.
- Give additional tax relief for the start up companies.
- Increase the number of tax slabs from present three (5%, 20%, 30%) to four (10%, 20%, 30% and 35% for super-rich earning INR 2 crore and above).
- Abolish Dividend Distribution Tax (DDT). [done in Budget-2020]
- Setup Litigation Management Unit (LMU) to look after the tax related court cases in an efficient manner.
|FINANCIAL TRANSACTION TAXES (FTT)|
|Tobin Tax (Robinhood Tax)|
- Nobel recipient American economist James Tobin proposed (1970s) a small tax every time currency is converted into another currency (e.g. from Dollar to Rupee and vice versa).
- Such tax will discourage short term speculative investment and flight of capital from one country to another.
- Tobin tax helps stabilizing the global economy and currency exchange rates.
- In India, foreign currency conversions are subjected to (previously Service Tax) & now GST
|Securities Transaction Tax (STT)|
- SST is levied on the sale and purchase of shares, ETF-units, derivatives and other securities at stock-exchanges.
- It’s rate (0.001%-2%) varies as per the nature of the securities.
Budget-2019 relaxed certain STT norms on Option contracts.
|Commodities Transaction Tax (CTT)|
- CTT is levied on non-agricultural commodities traded at Commodities-Exchanges. (Rate about 0.01%).
|Capital Gains Tax||Applicable when share (or any capital asset) is “sold at profit” by its previous owner.|
|Securities Transaction Tax||Applicable on the selling price of share (or other types of securities). Irrespective of whether seller is making profit or loss.|
|Dividend Distribution Tax||Applicable on the dividend which is given by company to a shareholders. And Budget-2020 abolished this tax|
|DIRECT TAXES: MISC. CONCEPTS|
|Hindu Undivided Family (HUF)|
- A Hindu, Buddhists, Jains, or Sikhs family members can come together, pool their assets and form an HUF under the Income Tax Act.
- HUF is taxed separately from its members, & helps saving taxes due to certain provisions/loopholes of Income Tax Act.
- Salaried employees can easily compute their taxable income from their annual salary, & pay income tax.
- Companies hire full time Chartered Accountants to compute their taxable income and pay Corporation tax.
- But self-employed freelance consultants and professionals such as lawyers, doctors, fashion designers etc. face difficulty in keeping such account books. So, for them Income Tax Act has Presumptive Taxation System i.e. their ‘income/profit’ is computed as “x%” of their gross receipts, and on that amount they have to pay income tax (depending on slabs) + applicable cess and surcharges, if any.
|Budget-2017||To encourage less-cash-economy, 2017 budget had given benefits in this presumptive taxation calculation formula, If the entrepreneur received payments in cashless format – NEFT, RTGS, Cheque, Card etc.|
- New financial year starts from 1st April 2019 and ends on 31st March 2020.
- Rational à If everyone paid all of their direct taxes at 11:59PM on 31st March 2020, then govt. will face money-shortage for the whole year till 31st March midnight comes.
- Advance Tax mechanism requires people to pay their Income tax and Corporation tax in advance-instalments on quarterly basis, if their annual tax liability is INR 10,000 or more.
|Tax Deduction at source (TDS)|
- Suppose a college pays ₹10,000 to a freelance visiting faculty or a bank/NBFC/post- office pays ₹10,000 as interest to a depositor, then how to ensure that payment- recipient (visiting faculty) reports his income to the tax authorities, otherwise he could avoid paying taxes.
- Hence, Income Tax Act requires such organizations to deduct a portion of the payment at source and deposit it to IT-dept along with PAN card number of the recipient.
- Then, payment-recipient will be forced to file his tax return, to unlock his TDS amount.
- On one side, TDS helps fighting tax evasion but on the other side, TDS also creates hardship for lower middle-class persons, because part of their payment is cut in advance.
Tax Collected at Source i.e. collected by receiver or payee or seller. e.g. Jeweller selling jewellery would collect TCS and pay to the IT department. Tax payee will have to file tax-return to unlock this amount.
Budget-2020: Authorized Forex dealers will have to cut 5% TCS while converting Indian Rupee into foreign currency. Similar norms on foreign tour operators.
|Meaning||TDS implies the amount deducted from the recipient’s income in the form of Tax||TCS refer to an amount accumulated by the seller or company as tax.|
|Imposition||Specified expenses crosses the prescribed||Sale of specified items is made.|
|Responsible person||Deducted by payer or buyer||Deducted by payee or seller|
|Occurrence||Crediting the account of the payee or during payment, whichever is earlier.||Debiting the account of the buyer or during receipt, whichever is earlier|
- A person is eligible to receive income tax refund from IT-dept if he has paid more tax to the govt than his actual tax liability.
- In above case, Income Tax Department will refund money along with interest.
- Similarly, GST refund can be claimed by an entrepreneur from GSTN web portal.
|MERITS OF DIRECT TAX|
- Progressive Tax – related to ability to pay principle. So an important tool to reduce inequalities of income and wealth.
- Elasticity – A direct tax can be varied according to the needs of the government as well as according to the changes in the income of the people. For example – if the income of the people rises, the government may increase the direct tax and vice versa.
- Certainty – A person liable to pay direct tax knows with certainty how much he has to pay and when he has to pay
- Equity – It is generally progressive (based on ability to pay principle). Through it rich people can be made to pay more taxes than poor. Similarly, in case of necessity, low income group people can be given relaxation and the super-rich can be made to pay more. Thus, an important tool to reduce income inequalities.
- Important tool in Fiscal policy of the government. For example – In case of high inflation, the government may increase the direct tax rate to reduce money in the hands of people so as to bring down the consumer demand. Similarly, to boost demand and improve employment, the government can reduce rates of direct tax.
- Can reduce volatility in International currency exchange rates by imposing Tobin Tax.
Tobin tax is a tax on all spot conversions of one currency into another. The initial concept of the tax put a penalty on short-term financial ventures into another currency. Rather than the consumers paying a tax, the Tobin tax would be paid by market players as a method for controlling the stability of a country’s currency.
|DEMERITS OF DIRECT TAX|
- Tax Evasion – People try to evade direct taxes by using different means (such as submitting false returns, etc). Thus it is also prone to excessive litigation. For example – Govt has come out with Direct Tax Vivad se Vishwas Bill 2020, to provide for a mechanism for resolution of pending tax disputes related to income tax and corporation taxes
- Disincentive to work – Direct tax may be disincentive to work. In case of high direct tax rate, a large part of the income earned will be given to the government in the form of taxation. Thus It may disincentive people to work hard. It may reduce people’s willingness to work. Further, high direct tax may act as hurdle to Foreign Direct Investment to the country.
- Sectoral Imbalance – Certain sectors such as corporate sector is heavily taxed. Whereas, agriculture sector is tax free. Even rich farmers are exempted from personal income tax.
- Narrow base because large staff will be required if we try to collect Income taxes even from poor people.
- Externalities not counted – Academic Books Company vs Film star promoting cigars (30% Tax on both)
- Hardship not counted: Working Carpenter (5%) vs sleeping landlord (5%)
- Prone to litigation & loopholes, tax evasion, avoidance.
- An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer).
- In the indirect taxes, tax incidence and tax impact does not fall on the same person. E.g. Customs Duty on import and export, Excise duty on manufacturing of goods, Service tax on services, Sales Tax, Value Added Tax (VAT), and Goods and Services tax (GST).
- Indirect taxes fall under the Ambit of Finance Ministry, Central Board of Excise and Customs (CBEC)
- Budget-2018 renamed it as Central Board of Indirect Taxes and Customs (CBIC)
|Source of Indirect tax revenues for the Union||Source of Indirect tax revenue for the states|
|· Customs Duty
· Central Excise Duty
· Central Sales tax
· Service Tax
|· Sales Tax
· Excise duty on alcoholic liquors
· Taxes on luxuries, entertainments, amusements, betting and gambling
· Electricity Tax
· Entry Tax
|Note – With the implementation of GST, Several of the above taxes has been subsumed in it. We will be coming out a separate article on GST.|
Tax incidence à It is on the person from whom govt collects the tax. (e.g. shopkeeper)
Tax impact à It is on the person who finally bears the tax & cannot pass its burden on further. (e.g. Consumer)
- Types of indirect taxes
- Ad- Valorem tax
- Specific Tax per unit
|Ad- Valorem tax
|Taxes based on the value of something. E.g. 35% Customs Duty on import of Tropicana juice. So, if juice priced at ₹100 imported, then ₹35 as tax.
Easier to administer.
|Specific Tax per unit
|Tax based on quantity of items. E.g. ₹ 260 Excise duty on production of every 1000 cigarettes of 65-70mm length. Here we are taxing them irrespective of their manufacturing price or selling price.
Difficult to administer, leads to inspector-raj & litigation. But, if slight increase in this tax, then greater burden passed on to the consumer so it helps reducing harmful consumption.
- Pigouvian tax is the one used/imposed in order to diminish the negative fallouts of externalities. For instance, it is generally imposed on high polluting industries which not only causes harm to environment but poses health risks to the people living nearby.
- An externality is a positive or negative consequence of an economic activity experienced by unrelated third parties. E.g. Cement company, whereas unrelated third parties (local community, flora and fauna) are harmed by cement company’s air-pollution.
- English economist Arthur C. Pigou proposed taxing the companies that create such negative externalities. E.g. polluting industries, cigarettes (passive smoking), alcohol (social disharmony).
- India has high level of indirect taxes on petroleum, tobacco and alcoholic products.
- Prior to GST, we had “Clean environment cess” on Rs 400 per tonne of coal.
|Cascading Effect Of Indirect Taxes|
If a government levies 10% indirect tax every time an item is sold, then buyer will have to pay tax on tax. This ‘cascading effect’ of indirect taxes raises the price of final product.
|Case||Price||10%tax on price||Total|
|Retailer bought from wholesaler||₹100
|Retailor sold to customer with ₹10 profit||₹120
- In case of cascading effect, both buyer and seller will prefer to do transaction without bills, to entirely avoid tax liability and so the cascading effect . this will result into decrease in Govt.’s revenue collection, increase in Fiscal deficit and rise in black money.
- Solution – This problem can be solved, if govt gives some type of cashback, reward points or input tax credit (ITC) to the sellers, on the indirect taxes they have already paid in previous stage.
- To claim such input tax credit, the sellers will have to show the bills and invoices for each stage. Self-policing could reduce black money.
|MERITS OF INDIRECT TAX|
- Wider Coverage and Broad Based – The effect of Indirect taxes are felt by more or less all the people in the society. It has to be paid (both by rich and poor) when they purchase tax imposed commodities. (In case of direct taxes, low income group may not be required to pay taxes)
- Sin Tax/Consumption Control– It can be used as a tool to discourage consumption of undesirable goods. For e.g. By Imposing taxes on luxury goods and making them more expensive, the government can divert resources from these sectors to sectors producing necessary goods.
- Convenience– Govt imposes indirect taxes on manufacturers. However, they are finally paid by consumers. They are convenient in the sense that tax payers (consumers) pay taxes in small amounts. Also they are convenient to government as they collect these taxes in lumpsum from the manufacturers.
- Elastic– It is elastic in nature. Since it has wider coverage, so any small increase in tax will bring in large revenue.
|DE-MERITS OF INDIRECT TAX|
- Regressive in Nature – Not equitable in nature. The rich and the poor have to pay the same rate of indirect taxes on commodities of mass consumption. This may further increase income disparities among the rich and the poor. They impose a heavier burden on the poor.
- Uncertain– Indirect taxes are often rather uncertain. Taxes on commodities with elastic demand are particularly uncertain, since quantity demanded will greatly affect as prices go up due to the imposition of tax.
- As Indirect Taxes increases the prices of the commodity, they are considered as Inflationary.
- High level of corruption, evasion, cascading effect if input credit is not given e.g. erstwhile sales tax system.
- Indirect taxes increase → product becomes expensive → reduction in demand so uncertainty involved in how much rupee will Government actually earn from taxation.
- This tax is hidden in the price. Customers do not always feel the pinch of paying indirect tax so it promotes less civic consciousness than direct taxes.
- It is a tax levied when a consumer buys a good or service. It is meant to be a single, comprehensive tax that will subsume all the other smaller indirect taxes on consumption like service tax, etc
- It is a single tax on the supply of goods and services, right from the manufacturer to the end consumer.
- This is how it is done in most developed countries. More than 160 countries have implemented this system of taxation.
|Why we need GST regime?|
Pre-GST indirect taxation regime in India was marred by –
- Poor compliance rate à leads to less revenue realisation due to tax avoidance, lack of technical intervention and dismal database management.
Compliance is an externally imposed constraint to follow social or organizational or legal norms.
- Narrow taxation base
- Multiplicity of taxes results into confusion and complexity. This also increases operational and compliance cost.
- Lack of single market and single tax hinders ease of doing business in india
- High human interface in taxation system à harassment, license and inspector raj and high level of corruption.
- Pre-GST indirect taxation system had cascading effect à results into multiple layers of taxation, inflation and economic in inequality.
- Lack of quantifiable and verifiable taxation data pertaining to poor integration and database management.
- Lack of use of technology à poor assessment and compliance rate. More vulnerable to frauds, fake claims etc.
- Lack of cooperative federalism in fiscal regime à envisaged in GST in terms of GST Council.
- Lack of uniformity in returns, refunds, registrations and procedures for registration of taxpayers,
- Uncertainty in system of classification of goods and services, refunds and taxation rates.
|Cascading effect of indirect taxes|
Meaning – Cascading effect is when there is tax on tax levied on a product at every step of the sale. The tax is levied on a value which includes tax paid by the previous buyer, thus, making the end consumer pay “tax on already paid tax.”
If a government levies 10% indirect tax every time an item is sold, then buyer will have to pay tax on tax. This ‘cascading effect’ of indirect taxes raises the price of final product. Observe:
|Case||Price||10% tax on price||Total|
|Retailer bought from wholesaler||₹100
|Retailer sold to consumer with ₹10 profit||₹120||₹12||₹132|
|Breakdown – 132 = 100 (price of original product)+10 (tax paid by retailer to wholesaler)+10 (as retailer’s profit margin)+11 (tax paid by customer to buy from retailer) + 1#
· 1# à this one rupee is 10% of 10 (tax paid by retailer to wholesaler). So, it’s “Tax On Tax paid at previous stage” / cascading effect of tax on the end-customer.
· Then, both buyer and seller will prefer to do transaction without bills, to entirely avoid tax liability and its cascading effect. The result will be decrease in Govt.’s revenue collection, rise in Fiscal deficit, rising black money among others.
|Objectives of GST|
- To establish the highest standards of co-operative federation in the functioning of the Council.
- Evolving by a process of wider consultation, a GST structure, which is information technology driven and user friendly.
- The Council is to be guided by the need for a harmonised structure of GST and the development of a harmonised national market for goods and services.
|Evolution of GST in India|
|2004||Vijay Kelkar Task Force on Fiscal Responsibility and Budget Management (FRBM) recommends GST.|
|2006||In Budget speech, P. Chidambaram announces the launch of GST from 2010|
|2011||UPA government introduces 115th Amendment Bill 2011 to implement GST but it lapsed with the dissolution of 15th Lok Sabha.|
|2014-16||Modi govt. introduces 122nd Constitutional Amendment Bill 2014 in 16th Lok Sabha. Since GST aimed to change federal financial relations, so under Art.368, this constitutional bill required:
· Lok Sabha and Rajya Sabha each: 50 % majority of the total membership, and 2/3rd majority of all members present and voting.
· State Vidhan Sabha: approval by majority of state assemblies (i.e. 15Vidhan-Sabhas of India at that time)
Ultimately, it was passed & became 101st Constitutional Amendment Act, 2016
- 102nd amendment 2018àConstitutional status to National Commission for Backward Class
- 103rd amendment 2019à Economically Weaker Sections Quota
- 104th amendment 2020àAnglo Indian reservation removed in LS & Vidhan sabha, but SC/ST continued till January 25, 2030
Provisions Of 101st Constitutional Amendment Act, 2016
|States given power to tax goods and services. (previously, they couldn’t tax services.)
But only Union will have the power to tax inter-state supply of goods and services in the form of “IGST”
|IGST (on inter-state trade) will be distributed between Union and states, as per the formula by the GST Council|
|270||CGST (New indirect tax of the union, which has replaced excise duty and service tax). CGST will be distributed between union and state govt. as per the formula set by finance commission.|
|279A||President of India to appoint a constitutional body, “GST Council” headed by Finance Minister.|
|366||Alcoholic liquor for human consumption is kept out of GST. (i.e. State govt continue to levy State Excise on its production and State VAT on its sale.)|
|Union representatives (2)||States’ representatives (total 31)|
|– Finance Minister as the Chairman
– Union Minister of State for finance or revenue.
|– Each state government (including UT with legislature: J&K, Delhi & Puducherry) can nominate one minister to GST council- it may be their minister of finance or Dy.CM or any other minister as per their wish.
– One of them will be selected as the Vice- Chairman of GST council.
|Voting power – 1/3 rd||Voting power – 2/3 rd|
|NOTE – If all members do not unanimously agree over a proposal then it will be put for voting. However in such case, minimum 3/4 votes required to pass the proposal.|
|QUORUM– Council Meetings to proceed only with quorum of 50% of total membership.|
Functions of GST Council
The GST Council shall make recommendations to the Union and the States on-
- The taxes, cesses and surcharges levied by the Union, the States and the local bodies which may be subsumed in the goods and services tax;
- The goods and services that may be subjected to, or exempted from the tax;
- Model GST Laws, principles of levy, apportionment of GST levied on supplies in the course of inter-State trade or commerce under Art. 269A and the principles that govern the place of supply;
- The threshold limit of turnover below which goods and services may be exempted from goods and services tax;
- The rates including floor rates with bands of goods and services tax;
- Any special rate or rates for a specified period, to raise additional resources during any natural calamity or disaster;
- Special provision with respect to the States of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand;
- Any other matter relating to the GST, as the Council may decide.
- Compensation to the states for their revenue loss in switching from VAT to GST regime (through Cess mechanism):
- Dispute settlement between Union vs state(s), state(s) vs state(s).
|A. Parliament has passed following laws:|
|1. Central Goods &Services Tax Act (CGST)
2. Integrated Goods &Services Tax Act (IGST)
3. Union Territory Goods & Services Tax Act (UTGST)
4. Finance Act 2020 amends UTGST Act to update list of UTs:
a) (new) Ladakh without legislature.
b) (merged) 1) Dadra and Nagar Haveli + 2) Daman and Diu àtreated as single UT (because Govt merged them in 2019).
5. Goods and Services Tax (Compensation to States) Amendment Act. Parliament originally passed them in 2017, later amended in 2018 As per the recommendations of the GST Council.
|B. State Legislatures have passed State Goods and Service Tax Acts. (SGST)|
|C. Jammu & Kashmir passed SGST Act on 8th July 2017 then only GST system became effective there as well. Jammu And Kashmir Reorganisation Act, 2019 has not abolished this SGST act. Present status is:
– SGST applicable on J&K (UT with Legislature)
– UTGST on Ladakh (UT without Legislature)
|GST MODEL IN INDIA|
Dual system of GST model, to protect the autonomy of states
- CGST- levied by Central.
- SGST- levied by State.
- IGST- levied by Central, in case interstate trade.
Three Models of GST
- Central GST
GST to be levied by the centre
- State GST
GST to be levied by the state
- Dual GST
GST to be levied by the centre and states
|CENTRE’S INDIRECT TAXES SUBSUMED IN CGST|
|Indirect Tax of Union||Whether replaced by CGST?|
|For import-export: Basic Customs Duty, cess / surcharge on it.||Customs Duty is not replaced with GST. It is separate from GST-regime. So, imported goods are subjected to Custom Duty + IGST.
Previously, imported goods were subjected to Customs Duty + education cess but Budget 2018 replaced it with Customs Duty + 10% Social Welfare Surcharge.
Budget-2020à 5% Health Cess on imported medical devices for building hospitals.
|On imports: Special Additional Customs Duty (SAD), Countervailing Duty (CVD)||They are not ‘replaced’ with CGST, but simply abolished.
|Central Sales Tax (CST
|CST was the Union tax levied on sale of items in inter- state trade, and it was assigned to the ‘Origin state’. It’s replaced with IGST (CGST + SGST)|
|On providing services: Service tax and Krishi Kalyan Cess and Swatchh Bharat Cess
|Completely replaced by CGST. These previous cess / surcharge are deleted.
|On manufacturing of goods: Excise duty and various Cess / surcharges on it
|Completely replaced by CGST (except 5 hydrocarbon fuels: petrol, diesel etc.)
– Excise on manufacturing medicinal & toiletry preparations containing alcohol (e.g. Cough syrups, deodorants and perfumes) also replaced by CGST.
– Alcoholic Liquor for human consumption- falls in States’ purview so Union Excise / CGST not applicable on it.
|Excise duty on Tobacco products
|It’s replaced with 14% CGST. Further, Union also levies + GST Compensation Cess + National Calamity Contingency Duty(NCCD) on them.
Because 101st Constitutional Amendment allows Union to tax tobacco products separately.
NCCD money goes to Public Account → National Disaster Response Fund set up under Disaster Management Act, 2005.
Budget-2020: increase National Calamity Contingent Duty on Cigarettes and other tobacco products
|Excise duty on production/refining of Crude oil, Petrol (Motor Spirit), Diesel, Aviation Turbine Fuel and natural gas||Once GST council decides the date they will be brought under GST-regime.
Until then refineries / oil-drilling companies have to pay excise duty+cess/surcharges to Union for production / manufacturing of these items. (and petrol pump owner, etc will have to pay VAT to states on their sale.)
Presently, Petrol & Diesel are also subjected to Union’s Road and Infrastructure Cess which goes into Public Account→ Central Road & Infrastructure Fund setup under Central Road Fund Act 2000 (The word “Infrastructure” was added by Budget-2018).
Full-Budget-2019increases the excise and road- infrastructure cess on petrol and diesel.
|GST Revenue Collection Figures|
|2017 monthly avg.
|2017 monthly avg.||2019 monthly avg. (Financial year yet to finish)|
|INR 89700 cr
|INR 98114 cr
|In some months crossed INR 1 lakh crore but more or less, zigzag pattern.|
- GST registered suppliers have to deposit the GST at the GSTN portal on monthly basis (except those who opted for the GST composition scheme).
- In monthly collection of GST, there are ups and downs based on seasonality.
|Budget-2020 Projections for Union Taxes in Descending order of Revenue:|
|Indirect taxes in ↓ order of revenue:||GST > Excise > Custom|
|Direct taxes in ↓ order of revenue:||Corporation Tax > Income Tax > STT|
STATES’ INDIRECT TAXES SUBSUMED IN SGST
|Indirect Tax of State Govt.||Whether replaced by SGST?|
|On sale of goods: State Value Added Tax (VAT) (also called “Commercial tax”)||Yes, By default VAT is replaced by SGST, but read below:
|State VAT on selling of:
1. Crude oil,
2. Petrol (Motor Spirit),
4. Aviation Turbine Fuel
5. Natural gas
|Once GST council decides the date, these will be brought under GST-regime. Until then, petrol pump owners, LPG gas distributors etc. will have to collect VAT (+ any cess / surcharges) from the customers and deposit to the state government.|
|State Excise on production of liquor for human consumption State.
VAT on sale of liquor for human consumption.
|They are completely kept out of GST. [unlike above petro items where GST council will implement it after “any specified” date]. Since inception of our Constitution, the power to tax liquor was with States, & it constituted a major source of revenue for them, so States were unwilling to hand it over in GST regime. Had Modi govt tried to bring liquor in GST-regime, then majority of the Vidhan-Sabhas may not have passed this Constitutional Amendment Bill.|
|ElectricityDuty||It is not replaced by SGST|
|Road Tax on vehicles.
|It is not replaced by SGST. Its status as direct/indirect tax is vague because in some states/ vehicle categories: buyer himself deposits while in some cases, seller required to collect & deposit.|
|Purchase tax on vehicle, boats, and animals||Replaced by SGST|
|Advertisement tax on hoarding, banners etc||Replaced by SGST|
|Luxury tax at Hotels, Spas, Resorts etc.||Replaced by SGST|
|Entry tax/Octroi for entry of goods in an area||Replaced by SGST|
|Taxes on Lottery, horse race betting, gambling etc.||Replaced by SGST. Since they’re ‘sinful/demerit goods’, they’re subjected to
28% = 14% CGST + 14% SGST
|Entertainment Tax on Cinema, Live Performance shows etc.-||Replaced by SGST unless levied by a local body. e.g. Kerala local bodies 10% on movie tickets.|
|GST – INPUT TAX CREDIT (ITC)|
- GST is a ‘destination based’ indirect tax on consumption of goods & services. It is applicable on supply of goods or services as against the previous indirect taxes that worked on the concept of manufacture, sale, exchange, transfer etc.
- “Input Tax Credit” is an aggregate total amount of tax paid by a registered dealer on the total purchases made by him within the State from other dealers.
|Goods / Services produced & supplied|
|In same the State (or UT without legislature)à Intra-state supply||In another State (or UT without legislature) àInter-state supply|
State / UT without legislature Levies→SGST / UTGST
|1. Union levies IGST àCGST + (SGST or UTGST depending on destination).
2. From this IGSTà CGST goes to Union, and the other portion goes to the Destination State/UT without legislature.
|Salient features of Input tax credit:|
- It can be adjusted against the tax payable by the purchasing dealer on his sales.
- It is available for purchase of goods made within the state by a registered dealer from another registered dealer.
- It is allowed for both manufacturers and traders
- Even for stock transfer/consignment transfer/branch transfer of goods out of the State, input tax paid in excess of 2% will be eligible for tax credit.
- In case of common goods used for taxable goods and tax free goods, ITC is allowed proportionately to the extent the purchases are used for the purpose of taxable goods.
- Thus, credit relating to the goods used in manufacture of exempted goods has to be reversed.
NOTE – Alcohol for human consumption, Crude oil, Petrol (Motor Spirit), Diesel, Aviation Turbine Fuel and Natural GasDoesn’t comes under GST.
|Q.Consider the following items: (CSE-2018)
|GST COMPOSITION SCHEME|
- It aims to rid the small taxpayers of tedious GST formalities and pay GST at a fixed rate of annual turnover.
- This tax has to be paid on quarterly basis.
- However, upon opting for this scheme, he cannot issue taxable invoice under GST law and can neither collect GST from his customers nor can claim Input Tax credit on his purchases.
|GST (Regular) scheme
|GST Composition Scheme|
|If an industrialist or seller is registered with GST, he must collect the taxes at above varying rates, and deposit them on the monthly basis at GSTN web-portal.||Such monthly compliance is very tedious for small entrepreneurs / small merchants so they may opt for GST Composition scheme wherein instead of above (5-12-18-28%) rates they’ll have to collect only flatrate GST of 1% on goods, 5% on restaurants, 6% on all services.|
|Advantage: He will get input tax credit,
Disadvantage: He’ll have to deposit tax & forms on monthly basis on GSTN web-portal
|Disadvantage: He will not get Input Tax Credit.
Advantage: He’ll not have to deposit tax/forms on monthly basis to GSTN web-portal. He’ll have to do it on Quarterly basis (3-3-3-3 months)
|Compulsory if turnover is above “specified” lakhs / crores.
|Optional scheme, not compulsory. Not every supplier is eligible. Only if turnover is below “y” lakhs / crores, and doing “z” type of business, then you will be eligible.|
|Registered taxpayers – about1.12 crore||Registered taxpayers– Hardly 17 lakh taxpayers|
|E-way bill system|
- An electronic bill generated by GSTN required in moving the goods of value exceeding Rs. 50,000 from one state to another.
- It will eliminate the need for separate transit pass in each state, thus, enabling hassle-free movement.
- Related: GST council announced the E-invoice (bill generation) from January-2020 on pilot basis, then E-way bill will not have to be generated separately. This will provide relief to businessman, will improve the tax-surveillance and fight against false ITC-credit claims through fake invoices. E-invoice shall be compulsory from 1April 2020.
|Reverse charge mechanism|
- Normally, a seller must collect the GST tax from buyer & deposit to the govt.
- However, in selected cases when seller is not registered with GST number, while buyer is registered with GST number, then buyer will have to deposit the tax to government.
- ‘Reverse Charge Mechanism’ is associated with GST, just like ‘E-way bill’ mechanism is associated with GST.
COMPENSATION TO STATES
- GST is a destination-based tax, therefore industrialized states are not happy with it. Consider a Nano car manufactured in Tata’s Plant in Gujarat and sold in Uttar Pradesh. (Destination) UP gets SGST, While (Source) Gujarat gets nothing.
- Although reverse is also true- UP’s bicycle sold in Gujarat, then Gujarat will earn SGST and UP will get nothing. But the industrialized states such as Gujarat, Maharashtra, Tamil Nadu, Haryana feared they’d get less SGST revenue in absolute terms compared to erstwhile VAT regime.
- For the Union govt, largest source of tax collection were corporate tax and personal income tax. Both are direct taxes and therefore kept out of the GST regime.
- For the state governments, VAT was largest source of tax income, but it is to be subsumed under GST, along with other indirect taxes, cess and surcharges levied by the states. Therefore, states were afraid their revenue income will decrease.
|Notable States that witnessed revenue increase in SGST (compared to VAT)||Notable States that witnessed revenue decline in SGST (compared to VAT)|
|Andhra Pradesh and some NE states à Mizoram, Manipur, Sikkim, Nagaland||Punjab, Himachal, Chhattisgarh, Uttarakhand, J&K, Odisha, Goa, Bihar, Gujarat and Delhi and others|
|Compensation to States: HOW?|
Parliament enacted GST Compensation to States Act 2017
- Under its provisions, GST council recommended Union Govt to impose “GST Compensation Cess” (on specified luxury & demerit goods, like –
- pan masala (60%), tobacco products (cess varies as per product),
- aerated water & Caffeinated Beverages (12%), coal / lignite (₹400 per tonne),
- motor vehicles-aircraft-yacht (3-22% depending on type of vehicle).
- The cess thus collected is used for compensating States for their revenue losses during the first five years since inception of GST.
- The formula uses 2015-16 as base year to measure states’ revenue, & assumes 14% annual growth in VAT system. (Then relatively, how much less rupee did state receive in SGST? = compensation will be given accordingly.)
- Liquor Taxes are outside GST-purview so Bihar / Gujarat / Nagaland / Lakshadweep / Parts of Manipur can’t ask more ₹ for compensation from this fund for having liquor prohibition.
ControversyàUnion is supposed to release compensation cess to states on monthly basis, but since 2019-August onwards payment pending. 2019-Dec: only partial compensation released. FM Nirmala. S says, “Sales are decrease, so we have not collected enough rupee to release the cess.” Non-BJP states first complained to GST council, but it did not help much. So now those State Govts even thinking of moving to Supreme Court, which hints that cooperative federalism is in danger.
|GST RELATED ORGANIZATIONS|
|National Anti-Profiteering Authority (NAPA)|
- GST provides input credit for most of the indirect taxes of the Union and State Government. So, entrepreneur’s cost of production should reduce, then he should also reduce the prices for consumers, yet many companies had not reduced their prices e.g. Domino’s Pizza, Nestle, Hindustan Unilever toothpaste & detergents etc.
- To teach them a lesson, To curb their profiteering, Union govt has set up NAA under Central Goods and Services Tax Act, 2017.
- Depending on the case, NAA can order the culprit company to:
- Reduce prices
- Refund money with interest to consumers
- Deposit money to Consumer Welfare Funds at union & state level
- Impose penalty upto 10% of profiteered amount
- Cancel registration.
- Further appeal→ High Court.
- This Authority shall cease to exist after two years from its inception (2017), unless GST council renews it.
- 2019-Jun: GST council extended it for another 2 years, which means all crooked companies have not yet stopped profiteering.
|Authority for Advance Ruling (AAR)|
- Diabetic foods supplements are subjected to 12% GST whereas pasteurized milk is subject to 0% GST. If Amul plans to launch ‘Amul Camel Milk’ with bottle label: “Camel milk is easy to digest, high in an insulin-like protein, hence beneficial for diabetic person.”
- So, whether Amul’s product be subjected to 0% GST or 12% GST? An entrepreneur would like to such have clarification from Tax authorities before starting the production, lest he gets tangled in raids and litigations afterwards.
- So, CGST Act, 2017 provides for a statutory body called Authority for Advance Ruling (AAR), where entrepreneur can seek such advance clarification.
- Higher appealà Appellate Authority for Advance Ruling (AAAR)
- Reduces litigation & harassment afterwards
- Ease of doing business
- Attract Foreign Direct Investment (FDI).
|GSTN (Not for Profit Company)|
- GSTN is a not-for-profit company governed under section 8 of the Companies Act 2013.
- Earlier, the centre held 24.5% equity and the States (including UTs Delhi & Puducherry) hold 24.5% equity in GSTN.
- 51% equity is with non-Government financial institutions (like HDFC Ltd, HDFC Bank Ltd, ICICI Bank Ltd, NSE Strategic Investment Co and LIC Housing Finance Ltd.)
- The Company has been set up primarily to provide IT infrastructure & services to Central and State Governments, tax payers and other stakeholders for implementation of the Goods and Services Tax (GST).
- 2018-May: GST Council approved acquisition of entire 51% equity held by non- Governmental institutions & distribute it equally between Centre and the State Governments.
- This company runs the GSTN online portal, where the suppliers register themselves, paytheir GST, claim input tax credits, generate e-way bills etc. [Infosys ltd. helped developthe web-portal.]
- GSTN Network ltd. also provides the IT infrastructure and software services to GST officials for monitoring the tax compliance, issuing notices, data mining etc.
- In future, such data could also be shared with the RBI’s public Credit registry so the lenders can have a 360 degree profile / complete picture of the borrower’s business.
GST Suvidha Providers (GSPs): These are selected private IT/Fintech companies that develop apps / software to help the taxpayers interact with GSTN portal.
|Project Saksham: Digital integration (2016)|
|Union Indirect Tax||CBEC’s Web-portal||Post- GST?|
|Service tax & Excise duty||ACES (Automation of Central Excise & Service Tax)||Service tax subsumed
– Excise only on selecteditems.
|Customs Duty||SWIFT (Single Window Interface for Facilitating Trade).||Customs duty not subsumed in GST.
HSN and SAC Codes
|Harmonized System of Nomenclature (HSN)
|HSNdeveloped by the World Customs Organization (WCO) is used for classifying goods for GST rates. e.g. Jarda scented tobacco = HAC code 24039930 = 28% GST.|
|Service Accounting Code (SAC)
|SAC are used for classifying services for GST rates. e.g. coaching services = SAC Code 999293 = 18% GST.|
|Benefit||HSN-SAC coding helps in computerised accounting, billing, digitization, surveillance & big data analytics by Tax authorities.|
|PAN VS GSTIN|
|Permanent Account Number issued by the Income Tax Department
|Goods and Services Tax Identification Number issued by the Central Board of Indirect Taxes & Customs (CBIC)|
|E.g. Suzlon Energy ltd: AADCS0472N||E.g. Suzlon Energy ltd: 24AADCS0472N1Z8|
|10-digit alphanumeric number (containing both alphabets and numbers)||2-digit state code+ 10 digits PAN number + 3 characters = total 15 characters (containing both alphabets and numbers)|
|Every income tax assesses – individual, HUF, firm, company, trust (internal different not imp.)||If Individuals / firms registered under the Pre-GST law (i.e., Excise, VAT, Service Tax etc.) or
– If your biz. Turnover is above a threshold limit of “x” lakhs for ordinary states or “y” lakhs in Special Category States. OR
– Merchants who sell through e-commerce aggregators like Amazon.
|Every PAN card holder is not required to have GSTIN. (e.g. a salaried employee)||Every GSTIN holder is required to have PAN card number. (Because its format is like that, observe “format” row above).|
|Only single PAN number allowed per individual.
Only single PAN number allowed per company.
Subsidiary firms will have to get separate PAN numbers.
|If firm operates from more than one state, then a separate GST registration is required for each state.
If a firm has multiple subsidiaries, they have to get GST number for each.
|Prevent evasion of direct taxes||Prevent evasion of GST, and help the entrepreneurs claim their input credits.|
PAN number is required for various activities like opening of bank account, opening of demat accounts (for trading in securities), obtaining registration for GST, VAT-Excise registration (for Petrol-Liquor dealers) etc. So, PAN is slowly becoming a Common Business Identification Number (CBIN) or simply Business Identification Number (BIN).
PAN/GSTIN vs UID (=Aadhar Card)
|PAN and GSTIN||UID (=Aadhar Card)|
|Issued by the direct and indirect tax authorities that function under Ministry of Finance.
|Issued by a Statutory body- Unique Identification Authority of India (UIDAI) that functions under Ministry of Electronics and Information Technology (MeitY).|
|These Tax authorities derive powers from:
– Income Tax Act 1961
– Goods & Service Tax Acts in 2017.
|Aadhaar Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016
|Primary objective of these id-numbers is to reduce tax evasion by tracking the transactions.
|Primary objective is to eliminate bogus beneficiaries in government schemes & reduce subsidy leakage. Auxiliary benefits: Identifying dead bodies, tracking criminals, mobile number ownership, tax evasion etc.
|Their format contains both numbers and alphabets.||Unique Identification number (UID) or Aadhaar is a 12-digit number. No alphabets.|
|Issued for individual humans, HUF/firms/companies/trusts**.||Only for living resident of India. Not given for companies. Resident is defined as person who lived in India for 182 days or above in last 12 months.
Full-Budget-2019: we will consider giving immediate Aadhar card to NRIs with Indian Passport, so they don’t have to wait till about 180 days. It will help them get through KYC bank/share market transaction.
|One human → one PAN number only. No age limit. Minors can also join.||same
|About INR110 Fees to get PAN card.
No fees to get GSTIN
|No fees to get Aadhar.
|Compulsory to enrol if your income or turnover is beyond “specified” rupees**.||Voluntary to enrol.
-Photograph & Date of Birth (in case of “Human”)- Address.
-Name, Date of Birth, Gender, Address.
-Mobile & Email (optional) Biometric info:
– Ten Fingerprints, Two Iris Scans, and Facial Photograph.
| ** Full-Budget-2019: More than 120 crore Indians Aadhaar card but all don’t have PAN card. Earlier, it was compulsory to give PAN card number when filling income tax. But if you don’t have PAN Card you can simply quote your Aadhaar number to file Income Tax returns.
– Later IT-department clarified that whoever quotes Aadhar number because he doesn’t have PAN card à we’ll issue him PAN card on suo-moto basis later on.
Budget-2020 added technical reforms in this process.
- GST covers both goods and services, with standard rates, minimal number of cess/surcharges.
- GST online portal and e-way bill system reduces the interface between tax-officials and the assesses, thereby reducing the scope of harassment, bribery and Inspector Raj.
- Improving the Ease of doing business and business environment overall.
- GST provides input credits to suppliers thereby incentivizing them to sell with invoice at every stage. Thus, GST will expand our tax base and improve tax collection, and deter tax evasion.
- GST Input credit system reduces the cascading effect of taxes, this reduces cost of manufacturing &selling, while its anti-profiteering authority ensures that such benefits are passed on to the customers in the form of reduced MRP.
- Federal nations such as Canada and Australia shifted from VAT to GST regime. It helped boosting their revenue, GDP and exports.
- Thus, GST will help to create a unified common national market for India, &catalyse “Make in India”.
- State government charged VAT on sale of goods, but VAT rates were not uniform throughout India. For instance, a laptop bag might attract 12%VAT in one state and 18%VAT in another. This provided scope for ‘rate arbitrage’(buying from another state for profiteering, even if same item available in home state). Then State government will have to deploy more officials at the check posts, leading to bribery, harassment, inspector-raj.
- SGST/UTGST rates are uniform throughout India, so there is no scope of rate arbitrage. Whether you buy a laptop from Chennai or Mumbai the GST% tax rate will be same.
|GST Benefit: Zero Rated Exports|
- When company buys raw material or intermediate goods it will have to pay GST but if final product is exported outside India (or sent to Special Economic Zone/SEZ in India), it will be subjected to 0% IGST.
- So, whatever GST the company had paid on the inputs, all of that will become its “Input Tax Credit” (and company can use this ITC to pay for the taxes on the purchase of raw material and intermediate goods in the next time), thus reducing its cost of production. This will improve price competitiveness of Indian products in foreign markets.
- Australia and other GST countries also follow similar “zero rated export” regime.
|Q. What is/are the most likely advantages of implementing ‘Goods and Services Tax (GST)’? (CSE-2017)
Select the correct answer using the code given below:
- High Rates and Multiple Slabs
- If Union and States abolished existing indirect taxes (Excise, Custom and VAT), then their revenue income will obviously decline. Therefore, GST rate needed be high enough to sustain any fall in revenue collection. Such ‘ideal’ rate of GST is called Revenue Neutral Rate (RNR). In, Singapore GST only 7%, Australia GST only 10%.
- Whereas India has four slabsà5-12-18-28% Many daily necessities are in 18% GST slab. Indirect taxes regressive in nature & harm purchasing power of poor.
- Petrol, diesel, electricity are not subjected to GST regime So, businessman cannot claim GST-input credit on them. Even when crude oil prices are declines in the international market, the Union and State governments do not reduces their Union excise and state VAT on the petroleum fuels, which further aggravates the inflation and business cost.
- Frequent changes harming long term business planning
- Frequent changes in GST rates makes it difficult for the companies to plan long term business strategies. E.g. In 2019-Sept, GST on Caffeinated beverages hiked from 18% → 28%. This will decrease the sales. If any soft-drinks company had invested in expansion of plant-production capacity, it would suffer.
- 15th Finance Commission Chairman NK Singh criticized frequent changes in GST rates.
- Fall in collection – For GST system to sustain, every month minimum INR 1 lakh crore must be collected, but this is not happening every month, Due to →
- Protectionism by USA, EU and China affects and reduces Indian exports which results into poor manufacturing and service sector production. Overall reduction in GST collection.
- Automobiles, consumer durables (TV, fridge etc), real estate reduces due to variety of factors.
- Unscrupulous traders setup shell companies and generate fake invoices to claim input tax credit through Circular Trading. As a result, States are complaining that GST compensation cess amount is not released in a timely fashion by the Union Government. This affects State funded welfare schemes.
- Inconvenience to Small Traders
- In GSTN web-portal, the traders have to deposit the GST on monthly basis, upload various forms & invoice details, generate e-way bills. While government has tried to keep these online forms/ mechanisms as simple as possible, but since many small traders are not proficient with computer, excel / accounting software, internet, digital payments – GSTcompliance creates inconvenience to them, and forces them to hire full time accountants, raising their cost of operations.
Counter argument: Even in erstwhile VAT system they had to upload similar things so, it’s not entirely new or alien system imposed upon them. Besides, they can opt for the GST composition scheme where they have to upload things on quarterly basis instead of monthly basis. GSTN portal also provides free accounting software to small traders so they don’t have to spend rupee in buying proprietary software like Tally.
- GSTN server crashes often so traders can’t upload things on time, and then they’ve to pay penalty for crossing monthly deadlines.
Counterargument: GST Council has reduced the late-fees, GSTN portal has been given technical upgrades to reduce the glitches/outages.)
- With the aforementioned features and benefits, GST will help India progress towards “One Nation, One Tax, One Market”.
- Indeed, the introduction of GST is truly a game changer for Indian economy as it has replaced multi-layered, complex indirect tax structure with a simple, transparent and technology–driven tax regime.
- Thus, GST eliminates cascading of taxes and reduces transactional and operational costs, thereby enhancing the ease of doing business and catalysing “Make in India” campaign.
Finance Commission (Art. 280)
- Fiscal Federalism refers to the division of responsibilities of–
- Expenditure between the different levels of the government.
- While the 7th schedule assigns many responsibilities to the States, but their taxation power is relatively lower than Union’s. So, Finance Commission plays a key role in transferring union’s revenue resources to the state.
Article 280: President of India forms a Finance Commission (a quasi-judicial body) every 5th Year or earlier, with 1 chairman and 4 members. Eligible for re-appointment. Recommendations are not binding on the government but usually not rejected.
|1st Finance Commission||The First Finance Commission of India was appointed in 1951, for the period1952-57 by the President of India and was chaired by K. C. Neogy.|
|14th Finance Commission||Headed by Y.V Reddy. Recommendation Period: 1st April, 2015 to 31st March, 2020|
|15th Finance Commission||Setup in 2017-Nov. Originally, it was meant to cover: 1st April, 2020 to 31st March, 2025. But later, Govt ordered it to submit two reports.|
|15th FC Terms of Reference (TOR)|
President of India has ordered them to study and recommend following:
- Union Taxes’ vertical devolution to the states, and its horizontal distribution among the states. (except cess, surcharge and IGST).
- Union’s grant – in – aids to the states.
- Ways and means to augment State Govts’ Consolidated funds to help their PRI/ULBs
- Any other matters referred by the President of India such as:
- Use Census-2011 for your calculation.
- Keep in mind Union’s responsibilities for New India 2022 vision.
- Recommend measures for Fiscal discipline, Fiscal consolidation for the Union and State governments. Whether union government should continue to provide revenue deficit grants to States?
- How to finance the disaster management initiatives?
- Performance based incentives to the state governments.
- (2019-Jul) suggest ways for allocation of non-lapsable funds for defence and internal security.
- (2019-Oct) Award for the UT of J&K. (This term of reference required under Jammu And Kashmir Reorganisation Act, 2019)
|15TH FC’S TOR: APPREHENSION OF THE STATES|
|Apprehension 1: New India 2022|
- 15th FC is required to keep New India 2022 vision in mind (aims to double the farmers’ income, provide housing for all, achieve 175GW of renewable energy etc.).
- 15th FC also required to keep in mind Union’s additional burden regarding defence, internal security, infrastructure, railways, climate change, commitments towards administration of UTs without legislature etc.
- TOR indirectly implying that 15th FC should give less than 42% to state governments because union government needs more resources for aforementioned activities. So, Non-BJP states are angry- “Tax devolution is our constitutional right”.
|Apprehension 2: Performance based incentives|
15th FC asked to recommend performance-based incentives based on (list not exhaustive)
|Performance parameter||Concerns of the state|
|State’s Efforts in expansion of tax-net
|– Manipur cannot do as much as Maharashtra in deepening the GST tax net, owning to the variety of economic, geographic and political factors (frequent bandh and blockades).
– Constitution provides for a separate GST council with representatives of state governments. FC does not have state representatives.
|State’s Efforts in population control
|Gangetic plain states’ total fertility rate higher, so they’re apprehensive that Kerala & other Southern States will get more money.|
|State’s efforts in controlling the expenditure on populist measures
|Southern states have been running populist schemes for free TV, Fridge, Mixer, Idli at rupee 1 etc. Similarly, Northern states run schemes for farm-loan waiver, free bicycle, mobile & laptop schemes. They fear they will be reviewed negatively, and union will get to keep more money for itself.|
|State’s Efforts in controlling power sector losses
|Electricity theft is a rampant problem in certain Gangetic states, but their ruling parties turn blind eye because of electoral populism of farmers and villagers. Now they are apprehensive of getting less money.|
|Behavioral changes to end open defecation.
|States resent that Swatchh Bharat Mission is ‘imposed upon them’. FC devolution is their Constitutional right, and not tied to their implementation of central schemes.|
|Apprehension 3: Census-2011|
- For horizontal distribution of taxes among states, 14th FC had used Census-1971 data. Census-1971 population was given 17% weight i.e. more populous state will get more funds.
- 15th FC’s Terms of Reference (TOR) requires NK Singh to use only Census-2011 data.
- But Southern states have reduced their fertility rate between 1971 to 2011, whereas Northern states could not- due to poverty, illiteracy and lack of healthcare infrastructure. So, Southern states fear Northern states will get proportionately more funds if Census-2011 is used.
|Apprehension 4: Debt and Grants|
- Article 293: States can’t borrow without consent of the Union. So, what additional conditions should the Union impose on the states when they (states) borrow from market / external sources?
- TOR even requires 15th FC to make recommendations in this regard. States fear it will reduce their autonomy in raising loans from the market.
- 15th FC will also examine whether to abolish revenue deficit grants given to the States. (although 15th FC has continued this grant)
|15th FC TOR: Conclusion|
Economic Survey 2016-17 had observed ‘aid-curse’ in context of Redistributive Resource Transfer (RRT) i.e. over the years, Special Category States received large amount of funds via Planning Commission and Finance Commissions yet couldn’t perform well in poverty removal or economic growth due to lack of accountability and poor governance.
- The 15th FC TOR aims to link the fund transfers with performance and accountability parameters. While states are apprehensive, but such measures are the bitter pills that we’ll have to swallow eventually to enhance India’s human dev. & economic growth.
|TAX DEVOLUTION BY FINANCE COMMISSION|
|TAX DEVOLUTION FROM UNION TO STATES|
|VERTICAL TAX DEVOLUTION FROM UNION TO STATES|
Finance Commission recommends the vertical devolution from the ‘divisible pool’ of union taxes. (Here IGST, Cess, Surcharge not counted.)
|Finance Commission||Chairperson||States Share|
|12th (2005-10)||C. Rangarajan||30.5%|
|13th (2010-15)||Vijay Kelkar||32%|
|14th (2015-20)||VY Reddy||42%|
|15th (2020-21)||NK Singh||41%*|
|*15th FC’s justification: Compared to 14th FC, 1% extra Union should keep for UTs of J&K &Ladakh security & other needs.|
|HORIZONTAL TAX DEVOLUTION AMONG STATES|
|Population: as per Census 1971||17%|
|Demographic Change as per Census 2011 (To consider the migration angle.)||10%|
|Income-Distance: Based on per capita income of a state (GSDP ÷ its population). Accordingly, poorer states get more weight||50%|
|Area: more area more weight||15%|
|Forest-Cover: more forest cover more weight because of Opportunity cost (State can’t allow industries there, else it could have obtained some taxes)||8%|
|15th FC horizontal distribution formula components|
|Income Distance: State GSDP divided by its Population = per capita GSDP. For most states, Haryana’s per capita GSDP is taken as benchmark. How poorer is your state compared to Haryana that much more rupee state will get.**||45%|
|Area: More area then more rupee||15%|
|Population (as per Census-2011): More population will transfer more rupee.||15%|
|Demographic Performance: States that have reduced Total Fertility Rate (TFR), will get more rupee.||12.5%|
|Forest and Ecology: More forest will result into more rupee.||10%|
|Tax efforts – States who have improved their per capita (State) tax collection in the last 3 years will get more ₹₹||2.5%|
** Note: computing income distance: the Highest per capita GSDP: 1) Goa 2) Sikkim 3) Haryana 4) Himachal. But since Goa, Sikkim are very small states with a unique economic situation, so it’ll distort statistical formula. So, there are some internal fine tunings done in formula. Long story cut short: Haryana taken as benchmark for most states. If you’ve more intellectual curiosity about how above indicators are calculated in real life, you may spend waste time reading the original report –https://fincomindia.nic.in/
|15th FC: Horizontal devolution: States’ share in decreasing order|
|ANY type of UT||0% here|
|Finance Commissions & the fate of UTs of J&K & Ladakh|
- Until 10th Finance Commission, the FC would also prescribe the revenue sharing formula between the Union Government and Union Territories
- However, this practice stopped since 11th finance commissione. Finance ministry itself decides how much revenue will be shared with Union Territories based on its own discretion. Finance Commission no longer prescribed formula in this regard.
- 31st October 2019: The state of Jammu Kashmir was officially split into the union territories of Jammu Kashmir and union territory of Ladakh.
Jammu and Kashmir Reorganization Act, 2019 mandates that:
|Whatever amount the former state of J&K was supposed to receive between 31/10/2019 to 31/3/2020 (as per 14th FC formula) …It will be distributed between these two new union territories on the basis of population ratio and other parameters.|
|President of India shall require 15th FC to make award for UT of J&K. However, looking the 15th FC report, no separate share is given in vertical / horizontal tax devolutions. Simply 1% extra kept with Union to look after J&K & Ladakh.|
|GRANTS FROM UNION TO STATES|
Apart from the tax devolution, FC would also suggest Union to give grant to the states (grant are different from loans, grants need not return with interest).
|14th FC suggested following types of grants→|
- For All States: Grants for Panchayati Raj Institutions (PRI) and Urban Local Bodies (ULB). These grants will be subdivided into two parts: basic grant and (10-20%) performance-based grants.
- For All States: Disaster Management Grants.
- For 11 States: Post-Devolution Revenue Deficit Grants for ~11 States.
|15th FC suggested following types of grants (in decreasing order, 2020-21)|
- Local Bodies Grants
- Post-Devolution Revenue Deficit Grants
- Disaster Management Grants
- Sector Specific grants – Nutrition
- Special Grants
- Performance-based incentives
|15th FC: Performance Indicators for Performance-Based Incentives|
- Implementation of Agriculture Reforms
- Power (Electricity) Sector Reforms
- Promotion of Domestic and International Tourism
- Education, esp. of girls
- Enhancing Trade including Exports
- Development of Aspirational Districts (=backward districts identified by NITI Aayog)
If States perform well in above areas, they will get more financial grants than other States in subsequent years.
|15th FC: Other recommendations to Govt|
- Some States have requested special category status. But it’s not part of our mandate/Terms of Reference. So we’ve nothing to say on this matter.
- Reform the direct taxation system which would increase tax collection.
- Reform GST’s operational challenges, slabs and rates.
- Merge/abolishnon-essential schemes → reduce Expenditure.
- We need a law on “Public Financial Management System” PFMS will prescribe the budgeting, accounting, internal control and audit standards to be followed at all levels of government.
- Govt should follow FRBM Act in letter and spirit. Avoid off-budget borrowings through parastatal entities.
|15th FC Report for 2020-21: conclusion|
- Sustainable Development Goal-10 (SDG): reduce inequality within the country.
- SDGGoal –16 requires nations to build effective, accountable and inclusive institutions at all levels.
- In this regard, 15th FC has tried to provide a framework for
- Equitable distribution of revenue
- Incentives tied with performance.
- It will greatly help to improve India’s human development and economic growth.
PERMANENT STATUS TO FINANCE COMMISSION
Introduction: Shaktikanta Das, the Governor of RBI and a member of the 15th Finance Commission (FC), has recommended giving a permanent status to the FC, wherein the old commission continues to implement & monitor the recommendations till the next commission starts functioning.
Arguments against giving permanent status to FC
- India already have a GST Council where states & union can deliberate on issues related to indirect taxes. If there is an economic crisis they can finetune the GST formula and GST-distribution to address it.
- We already have a NITI Aayog acting as a permanent think-tank on all the matters related to economy and governance.
- Both NITI Aayog and GST Council provide a platform for cooperative federalism.
- Indian economy and Indian Union has functioned successfully for over 70 years with this mechanism, so there is no need for such constitutional amendments and experimentations.
- Even if the Finance Commission is given a permanent status, the states ruled by opposition parties will continue to allege injustice & partiality, just like they allege with the functioning of Election Commission. Then, the Union Finance Ministry’s precious time will be wasted in filing counter-responses to the States at FC.
- Further, we already have the CAG to audit the accounts of the Union and the States.
- Therefore, giving permanent status to Finance Commission will result in overlapping responsibilities and duplication of efforts.
|Argument in favour of giving permanent status to FC|
- Election Commission has a permanent status even though elections are to be conducted every 5 years. Previous Lok Sabha’s speaker continues to hold position until new Lok Sabha meets for the first time. Following this rationale, Shaktikanta Das’s suggestion that “Previous Finance Commission should continue to function & oversee the implementation of its recommendations until new FC is formed” is a valid suggestion.
- Finance Commission recommendations are valid for a block of 5 years. Even if there is a war, disaster, famine or an economic crisis which may affect the revenue collection of the union vs. the demands by the States, still, the FC-formula/recommendations cannot be modified/finetuned in-between the five years. So, even if Union/states are feeling any injustice in the FC-formula, they have to wait for five years to make pleas to the next Finance Commission.
- If FC has a permanent secretariat/office, dedicated staff will keep all the records and knowledge bank for future reference, and a few officers will act as ‘Resource Persons’ to assist the new panel. Then, there will be more consistency in the FC recommendations.
- Such permanent body can keep a constant vigil on the Union and State finances & revenue collections and hold them accountable for any transgressions or lethargy.
Present approach of the union governments is if they are not getting enough taxes, they will simply borrow more money and changing the FRBM targets as per their convenience.
- Previously, Union and States designed their five-year plans, and so it made sense to have a ‘five-year formula for tax distribution’. But now the five-year planning system has been discontinued.
|Give permanent status to FC or not?|
|In-favor||Considering the aforementioned benefits, Finance Commission should be given a permanent status for better monitoring, accountability, grievance redressal in the matters related to fiscal federalism.|
|Against||Considering the aforementioned issues, the present constitutional and institutional mechanisms are adequate for fiscal federalism; they do not merit any changes for the time being.|
FC VS PC VS NITI
|Finance Commission||Planning Commission||NITI Aayog|
|Art. 280– Constitutional body
|Created by executive resolution, so neither constitutional non statutory. Both headed by Prime Minister as the chairman.|
|1951: 1st FC setup under KC Neogy
|1951: PC set up and over the years designed 12 Five Year plans (12th FYP: 2012-2017)
– 2014: Dissolved by Modi Government.
– Three Year Action Agenda (2017-20).
– Seven Year StrategyDocument. – Fifteen Year Vision Document (2017-32).
|Vertical and Horizontal Devolution of taxes + any other matters referred by the President in TOR
– Each FC arrived at its own methodology. E.g. 14th FC: 42% vertical, and 5 factor formula for horizontal distribution.
|PC would use Gadgil-Mukrjee formula (designed in 8thFYP)- based on population, per capita income, special problems etc. of a state.
|It is not in its scope of work to decide how much money should be given to each state. That component is decided by the Finance Ministry.
– NITI’s primary objective is to serve as the think tank of the Government of India,
– Helps in policy design.
– Helps in monitoring schemes through its dashboard e.g. ‘School Education Quality Index’, ‘SDG India Index’, ‘Digital Transformation Index’
|Q. In India, which of the following review(s) the independent regulators in sectors like telecommunications, insurance, electricity etc. ? (CSE-2019)
(a) 1 and 2
(b) 1, 3 and 4
(c) 3, 4 and 5
(d) 2 and 5
|SPECIAL CATEGORY STATES|
|1992||The National Development Council (NDC) was set up, consisting of PM, CMs and other representatives to approve the five-year plans prepared by the Planning Commission. But became obsolete with establishment of NITI Aayog.|
|1969||5th Finance Commission recommended giving extra funds and tax-relief to certain disadvantaged states. Over the years, NDC added more states into the Special Category List based on –
1. hilly and difficult terrain
2. low population density and / or sizeable share of tribal population
3. strategic location along borders with neighbouring countries
4. economic and infrastructural backwardness
5. non- viable nature of state finances.
|Examples||8 North Eastern states and 3 Himalayan States (JK, Uttarakhand, HP).|
|Benefits of Special Category status|
- Industrialists will be given benefits in Union-taxes for setting up factories in these states.
- In Centrally Sponsored Schemes (CSS), Union will bear higher burden (90:10).
- FC & PC would assign more weightage in their formulas to give them more funds.
14th FC: Previous Finance Commissions would assign extra weightage & funds to Sp .Cat states, but 14th FC stopped this practice. So, at present, Sp. Cat states don’t get additional revenue/grants in FC’s formula. Although, Union upon its own discretion continues to give them certain benefits in CSS. – But, whenever elections are near, W. Bengal, Bihar and Andhra CMs would demand Sp. Cat. status & blame Union for ‘injustice’.
15th FC: Some States have requested special category status. But it’s not part of our mandate/Terms of Reference
|Economic Surveys and Sp. Cat States|
|Economic survey 2016-17
|Noted that Sp. Cat states have received lot of funds & grant from previous FCs and PCs, and yet they have not made any tangible progress in improving public administration or removing poverty (Aid Curse). Similar problem with the States having abundant mineral resources (“Resource Curse”).|
|Economic Survey 2017-18
|Noted that compared to Brazil, Germany and other countries with federal polity, India’s State Governments and Local Bodies are collecting less amount of tax for two reasons:
1. Constitution has not given them sufficient taxation powers.
2. Even where constitution gave them powers like collection of Agricultural Income Tax, Land Revenue, Property Tax: The States/Local Bodies are shy of collecting taxes due to electoral politics. Result? Poor quality of Public Schools, Public Transport, Police, Drinking Water and Sanitation.
|Hill Union Territory Status for J&K:|
While Finance commissions no longer give extra weightage to ‘Sp. Category States’ in horizontal tax distribution formula, but Union provides them additional funding for their welfare schemes from Union’s own pocket.
|Category → Welfare schemes||Cost sharing|
|“Special Category States”
– North-Eastern States,
– Two Himalayan Hilly StatesàHimachal Pradesh and Uttarakhand
|Depending on the scheme, union may contribute 80-90% of the scheme cost, rest will be borne by the State.|
|Other States: who are not in above category (UP, Bihar, etc.)
Union territory (UT) with legislature: Delhi, Puducherry, Jammu & Kashmir.
|Union may bear lower burden than Sp. Category states e.g. 50:50, 60:40 etc.
|UT without legislature Ladakh, Andaman Nicobar etc.||100% funded by Union
Before removal of Article 370, the State of J&K was previously in Special category. But as a UT with legislature, J&K will get lower assistance from Union in the welfare schemes. So since 2019-Aug, Central Government considering creating a new category ‘Hilly Union Territory’ so J&K may continue to received 90:10 funding.
PREVIOUS YEAR QUETIONS
- Explain the salient features of the constitution (One Hundred and First Amendment) Act, 2016. Do you think it is efficacious enough ‘to remove cascading effect of taxes and provide for common national market for goods and services’? – CSE GS2-2017
- Comment on the important changes introduced in respect of the Long-term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT) in the Union Budget for 2018-2019. – CSEGS3-2018
- Enumerate the indirect taxes which have been subsumed in the Goods and Services Tax (GST) in India. Also, comment on the revenue implications of the GST introduced in India since July 2017 – CSE GS3-2019
- Black Money is a money that concealed from the tax authority. It is an income or transaction that is taxable yet not reported to the tax authorities.
- There have been several estimates regarding the extent of black money economy also called as parallel economy. Some of the estimates suggest it to be as high as up to fifty to hundred percent.
- Although black money in India is decades old problem, it has become real threat post liberalization.
- Illegal activities such as crime and corruption, non-compliance with taxation requirements, complex procedural regulations, cultural and social practices, globalization along with weak institutional policy, legal and implementation structures have further augmented the black money economy.
Data/fact – As of May 2019, the total untaxed foreign assets mined was ₹12,500 crore.
|Sources of Black Money|
In particular following are some of the mechanisms through which black money is circulated, utilized and the profits earned are further invested in other sectors to generate further money.
- Real estate: Due to rising prices of real estate, the tax incidence applicable on real estate transactions in the form of stamp duty and capital gains tax can create incentives for tax evasion through under-reporting of transaction price.
- Bullion and jewellery market: The purchase allows the buyer the option of converting black money into gold and bullion, while it gives the trader the option of keeping his unaccounted wealth in the form of stock, not disclosed in the books or valued at less than market price.
- Financial markets transactions: IPO manipulations, Rigging of market such as use of shell companies.
- Public procurement: Public procurement has grown phenomenally over the years – in volume, scale, and variety as well as complexity. The Competition Commission of India had estimated total public procurement figure for India at around 10 to 11 lakh crore per year and provides ample scope of corruption due to rigged procurement process.
- Non-profit organizations: Taxation laws allow certain privileges and incentives for promoting charitable activities which are misused and manipulated. Used to park funds of corrupt politicians and businessmen.
- Informal Sector and Cash Economy: Cash transactions, large un-banked and under-banked areas contribute to the large cash economy in India.
- External trade and transfer pricing: Transfer profit/income to no tax or low tax jurisdictions by MNCs.
- Tax Havens: Tax havens are typically small countries/ jurisdictions, with low or nil taxation for foreigners who decide to come and settle there.
- Offshore Financial Centres: Describe themselves as financial centres specializing in non-residential financial transactions but are logical extensions of the traditional tax havens.
- Hawala: It is an informal and cheap method of transferring money from one place without using banks etc. It operates on codes and contacts and no paperwork and disclosure is required.
- Investment through Innovative Derivative Instruments: Such as Participatory Notes.
Causes of Black Money
- Non-compliance with tax requirements.
- Complex procedural regulations.
- Money laundering.
- High tax rate
- Bureaucrats-political leaders nexus
|How black money is detrimental to economic health?|
- There is a distortion in investment in economy. With black money the investment is made in high end and luxury goods.
- Huge loss of taxes amounting to billions.
- Black money leads to further corruption by creating a vicious cycle.
- Generating black money means that quality is compromised in public sector projects where black money is used to manipulate tenders and offer kickbacks.
- Investments that must have been made in the country giving the necessary boost to economy are invested elsewhere.
- Since, RBI cannot control the black money cash flow in economy, it dilutes its policies targeting inflation.
- High prices of real estate especially in big cities are due to deep pockets filled with black money.
- Forward trading of goods by cash rich speculators cause fluctuation in prices due to hoarding.
- National security is threatened because black money is used to finance criminal activities.
- Black money generated from drugs and smuggling is being used to operate terror networks.
Black money estimates – No clear estimate of black money owned by Indians and stashed abroad is available. In 2019, the National Institute of Financial Management reported to the Lok Sabha Standing Committee on Finance, that the estimate is about $216 billion-$490 billion. This is one-seventh the estimate quoted ahead of the 2014 elections.
|Steps taken by government to curb black money generation and flow|
- Tax Reforms:
- Rationalization of income tax with greater tax base and lower taxes.
- Tax Deduction at Source (TDS) in which the tax is deducted from the payment itself by the payee.
- Voluntary Disclosure Schemes: The government allows reporting black money generated through tax evasion in a given time frame, as government has given in the Black Money Bill passed this year.
- Removing currency after certain time (demonetisation): So that unaccounted wealth is either brought into economy or becomes useless.
- Encouraging Cashless transactions: Government has recently announced tax benefits for making online payments for amount greater than twenty thousand rupees.
- Legislative Framework:
- Prevention of Money Laundering Act, 2002
- Benami Transactions Prohibition Act, 1988
- Lokpal and Lokayukta Act
- Prevention of Corruption Act, 1988
- The Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015
- International Cooperation:
- Multilateral Convention on Mutual Administrative Assistance in Tax Matters
- Financial Action Task Force
- United Nations Convention against Corruption
- United Nations Convention against Transnational Organized Crime
- International Convention for the Suppression of the Financing of Terrorism
- United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances
- Egmont Group for international intelligence gathering regarding money landing and terrorism Financing
- Cooperation through G20, Bilateral agreements
- Appropriate legislative framework related to: Public Procurement, Prevention of Bribery of foreign officials, citizens grievance redressal, whistle blower protection, UID Aadhar.
- Setting up and strengthening institutions dealing with illicit money: Directorate of Criminal Investigation Cell for Exchange of Information, Income Tax Overseas Units- ITOUs at Mauritius and Singapore have been very useful, Strengthening the Foreign TAX, Tax Research and Investigation Division of the CBDT.
- Developing systems for implementation: Integrated Taxpayer Data Management System (ITDMS) and 360- degree profiling, Setting up of Cyber Forensic Labs and Work Stations, implementation of Goods and Services Tax and Direct Tax Code.
- Imparting skills to personnel for effective action: Both domestic and international training pertaining to the concerned area. For instance, the Financial Intelligence Unit-India (FIU-I) makes proactive efforts to regularly upgrade the skills of its employees by providing them opportunities for training on anti-money laundering, terrorist financing, and related economic issues.
- Electoral Reforms: Elections are one of the biggest channel to utilize the black money. Appropriate reforms to reduce money power in elections.
Thus, a holistic and all round attack from within and outside the country is the need of the hour.
Terminologies related to taxation and black money
|When person hides income or transaction from tax authorities, and thereby evades paying taxes. It is illegal and punishable offence.|
|When person discloses his income and transactions to tax authorities but uses legal loopholes to avoid paying taxes. It may not be illegal in every case, but still unethical.|
|It is a country that demands little taxes from foreigners and offers legal loopholes for Tax Avoidance & opportunities for Tax Evasion. E.g. Mauritius, Marshall Islands, Cayman Islands, Panama etc. These countries are geographically small, & without viable economy. So they offer such mechanism to attract foreign investors and foreign tourists.|
|Money laundering||Money laundering is the process of disguising the source of money, as if it came from a legitimate activity, & then channelize it into banks, share market and other financial intermediaries.
When drug trafficking, ransom, corruption and other criminal activity generates substantial profits, the criminal tries to spend/ invest/ hide the money without attracting attention.
|Hawala is an illegal money transfer or remittance system. Money is paid to an agent who instructs an associate in the relevant country or area to pay the final recipient.
Although used by Indian workers in middle east because lower commission than post-office/bank transfers. Hawalas have better network in remote areas.
|Shell firms, Post-box/ Letter-box companies
|They do not have any active business operations. Created with sole objective of money laundering/tax evasion/avoidance E.g. Mishail Packers and Printers Pvt Ltd. allegedly setup by Misa Bharti Yadav to launder ₹1.2 crores (as per Enforcement Directorate).|
|Panama Papers (2016) Paradise Papers (2017)
Mauritius papers (2018)
|International Consortium of Investigative Journalists is a USA based non-profit organization.
They released these incriminating documents from certain law firms in tax havens & showed how notable people across the world engaged in tax avoidance/ evasion.
|Tax Deduction at Source (TDS)
and Tax Collection at Source (TCS) are the mechanism to discourage tax evasion.
|10 letters alphanumeric numbered assigned to all taxpayers in India by Income Tax Dept.|
|Tax Planning / Tax Mitigation
|When person invests money in LIC/PPF/Pension funds etc. in such manner that he can claim various deductions legally available in the Income Tax Act. It is neither illegal nor unethical.|
|When tax authorities put undue pressure on an honest taxpayer to pay more taxes.
In 2012, Vodafone won a case against income tax department in the supreme court related to Capital Gains Tax on purchase of Hutch mobile company.
Afterwards, UPA government amended the Income Tax Act with retrospective effect and issued fresh notices against Vodafone.
National and International organisations dealing with Black money
|Enforcement Directorate||Ministry of Finance (Department of Revenue) à ED is a Specialized financial investigation agency to enforce following laws
Foreign Exchange Management Act,1999 (FEMA)
Prevention of Money Laundering Act, 2002 (PMLA)
|Directorate of Revenue Intelligence
|Ministry of Finance (Department of Revenue) à CBIC à DRI is an agency against Customs, Narcotics, Wildlife, Arms related smuggling & illegal activities.|
|Financial Intelligence unit
|It analyses the suspected financial transactions in domestic and cross-border levels & reports directly to the Economic Intelligence Council (EIC) headed by the FM|
|Financial Action Task Force
|FATF is a brainchild of G7, Combating Money laundering and terror finance. HQ – Paris. India became member in 2010.|
|Grey list à Nations that safe haven for terror financing and money laundering. E.g. Pakistan, as of Jan-2020.|
|Blacklist à Nations that are not cooperating in the global fight against money laundering, terrorist financing. Iran and N. Korea|
|Org. For Eco. Coop. & Development
|Works for International cooperation in the matters of economy and taxation. Known for Base erosion and profit shifting (BEPS) Norms. India is not a member of OECD, yet.
HQ – Paris
Tax Evasion (Hiding Income / Transaction)
|Prevention Of Money Laundering Act (PMLA-2002)|
- UN General Assembly (UNGA) declaration on Money Laundering in 1998. Following this, in 2002, India enacts this law to combat money laundering with search-seizure-arrest-penalty. Nodal agency is Enforcement Directorate.
- Cases are heard at PMLA Adjudicating Authority à PMLA Appellate Tribunal à High Court
- It also empowers the RBI, SEBI, IRDAI and other regulators to make norms for Banks/NBFCs & punish the errant parties.
- g. RBI’s Know Your Customer (KYC) norms and Anti-Money Laundering (AML) standards.
|Undisclosed Foreign Income & Assets (UFIA)-2015|
- It requires Indian residents to disclose their foreign assets (e.g. bungalow in Dubai, Bank account in Switzerland) and income coming from foreign sources (e.g. shell company in Cayman Island) in their income tax returns.
- Foreign source income will be subjected to 30% income tax. No deduction, exemption or rebate will be given on it.
- Violation à Penalty + upto 10 years jail time. If a company is found violating the Act, then every person responsible to the company shall also be liable for punishment unless he proves that it was done without his knowledge.
- It also empowers the Union to enter into agreements with other countries for the tax exchange of information.
Budget-2019: If a person was resident in India at the time of acquiring an undisclosed asset (and later ran away from India, acquired citizenship elsewhere like Nirav Modi, Mehul & Mallya), still his properties will also be subjected to this law.
|Benami Transactions Prohibition Act (BTPA-1988/2016)|
- Benami refers to properties that buyer registers in the name of his relative, personal staff (Driver, Gardner) or a non-existent/ fictitious persons to avoid tax authorities’ attention.
- Original act of 1988 failed to deliver robust results. So govt. amended in BPTA in 2016.
- Nodal Agency – Income Tax Department.
- Cases are heard at PMLA Adjudicating Authority à PMLA Appellate Tribunal à High Court
- Violation à Confiscation of property + penalty + upto 10 years jail time.
|Q. With reference to the ‘Prohibition of Benami Transactions Act’, find correct statement(s): (CSE -2017)
(a) 1 only
(b) 2 only
(c) 1 and 3 only
(d) 2 and 3 only
|Tax Evasion And Budget-2019|
- provides (indirect tax) credits to exporters for the inputs used in the manufacturing of export products. However, some miscreants generate fake invoices to claim such credits. If the amount is ₹ 50 lakh or above, it will be made a non-bailable and cognizable offence.
- Cash-based economy – more opportunities for tax evasion and avoidance. So, need to encourage less-cash economy
- If a businessman has annual turnover more than ₹ 50 crore → No MDR on him or his customer. RBI and Banks will absorb these MDR costs. Govt. will amend Payments and Settlement Systems Act, 2007 to implement this.
- 2% TDS on cash withdrawal exceeding ₹ 1 crore in a year from a bank account from a single user account in post office / bank.
- Often, businessman deposits black money in his wife’s account and when/if raided, wife feigns ignorance about who deposited money in her account. So, Nirmala S. promised to initiate technical reforms so that no one can deposit money in others’ account without the account holder’s permission.
- Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019
|Tax (Evasion) disclosure schemes|
- Under such amnesty schemes, a tax-evader can declare his undisclosed income, pay the taxes and penalty.
- Then, Income Tax Department will not pursue case against him. (Although Police may still pursue case if income is from narcotics, kidnapping, extortion etc.)
|Income Declaration Scheme (IDS)
|Offer was 45% (30% tax + 7.5% surcharge + 7.5% penalty).
of the undisclosed income shall be taken away by govt.Validity – 2016 June to Sept. Around INR 67,000 cr black money was declared.
|Pradhan Mantri Garib Kalyan Yojana (PMGKY)||Launched after Demonetization Validity – Dec 2016 To April 2017
Around 50% of the undisclosed income shall be taken away by Govt. as Tax + Penalty + Pradhan Mantri Garib Kalyan Cess.
Further, 25% of the undisclosed income shall be deposited in RBI’s ‘Pradhan Mantri Garib Kalyan Deposit Scheme, 2016’. It will be a fixed deposit for 4 years with zero % Interest rate. The PM Garib Kalyan cess, and deposit will be used for schemes related to irrigation, housing, toilets, infrastructure, education, health etc. The scheme was not so successful, hardly around INR 5000 cr. declared.
|Sabka Vishwas (L.D.S)
Scheme in budget-2019
For Service &
|Above ₹ 3.75 lakh crore tax revenue is locked in the service tax and excise duty related cases.
Budget-2019: Launched Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019
Businessman accepts his fault, Tax officials gives a ‘discount/relief/waiver’ in the penalty/late-fees, and the matter is settled instead of litigating in courts for years & years.
|Vivaad Se Vishwas Scheme for Direct Taxes à Budget-2020|
- Presently, more than ₹9 lakh cr worth direct tax cases are pending before Appellate Forums viz. IT Commissioner (Appeals) → Income Tax Appellate Tribunals (ITAT) → High Court → Supreme Court.
- In Budget-2020 announced “Direct Tax Vivad se Vishwas Bill/Act, 2020”.
- Scope: Appeal related to Income tax or Corporation Tax, pending before a forum as of 31 Jan 2020.
- Taxpayers can settle with IT dept in following manner :
- If IT dept filled appeal → he has to pay 50% of disputed tax amount
- If Taxpayer filled appeal → he has to pay 100% of the disputed tax amount
- In both situations, he will get a complete waiver/relief from interest and penalty.
- Scheme has certain variations if tax amount is settled but interest/penalty/arrear is disputed.
- Above scheme is valid upto 31 March 2020. Afterwards, there is modified formula upto 30 Jun 2020 wherein he may have to pay some small extra amount.
|Scheme is not applicable if:||Person is under prosecution for criminal activities.|
|If black money is hidden in foreign countries.|
|Controversies associated with scheme|
- Southern India’s Members of Parliament angry that Hindi scheme name is used.
- Both honest and dishonest tax payers are treated equally. Even dishonest tax payer can now settle without paying interest/penalty.
- Income Tax officials’ job-transfer etc will be linked to how many cases they solve in this scheme. They are also asked to work on weekends to fulfill these targets. This could result into resentment and demotivation among staff.
|Other Initiatives w.r.t Tax Evasion|
|Banking Cash Transaction Tax (BCTT)
|A 0.1% direct tax levied on cash withdrawals from banks. Started by Chidambaram but later withdrawn (2005-09).
Objective was to encourage less-cash economy and data mining of transactions.
|Banking Transaction Tax (BTT)
|A proposal by a Pune based think-tank to Baba Ramdev that all the direct and indirect taxes of the Union and the states should be abolished and replaced with 2% tax on banking transactions. Impracticable because such experiments were tried and failed in Australia and other countries as people shifted to using barter system, diamonds and gold for transaction.
2017: Govt clarified they are not considering any such proposal.
|SC’s SIT on Black Money 2014
|Chairman: Retd. SC Justice M. B. Shah, and senior tax officials. They recommended various measures against Black Money hidden in India, in overseas banks, P-Notes etc. SC ordered Govt to implement its recommendations.|
|CBIC/CBEC’s project for digital re-engineering related to GST.
It’s not a ‘drive against black money’ but for ‘Ease of Paying Taxes’.
|Aaykar Setu||CBDT’s mobile app to pay Income Tax.|
|Operation Clean Money 2017||Income Tax Dept. verified large bank deposits made in the aftermath of demonetization.|
|Project Insight 2017
|Income Tax Dept. hired L&T Infotech Ltd. to develop an integrated platform for data mining & tracking tax evaders.|
|Restrictions on Cash Transactions, 2017
|Budget 2017 → Finance Act, 2017 entails that if anyone accepts ₹ 2 lakh and above cash in a day / in multiple transactions related to one ‘event’, then penalty by Income Tax Dept will be 100% of the cash received. Banks, post office, government organisations are exempted.|
Here, people will not hide the transaction, they will declare transactions in their official records, but will use legal loopholes to avoid paying taxes.
|Double Taxation Avoidance Agreement (DTAA) & Round Tripping|
- It is a tax treaty signed between two or more countries.
- Objective – A taxpayer resides in one country and earns income in another, then he need not pay (direct) tax twice in two countries for the same income.
- g. India Mauritius DTAA (1982): If a Mauritius person / company buy shares in India and sells them at profit, then he need not pay Capital Gains Tax (CGT) in India. Only the Mauritius government can ask CGT from him. And vice-versa.
- Loophole – India has around 10-20% CGT whereas Mauritius has around 0-3% CGT (depending on nature of asset, how long the buyer kept asset before selling etc). So many Indian Politicians, Businessmen and Bollywood actors would transfer the money using Hawala to their shell companies in Mauritius, and then make those Mauritius shell companies to invest back in Indian assets & avoid paying Indian CGT. This process is called Round Trippinge. money that leaves the country through various channels and makes its way back into the country as foreign investment.
- Similar loophole in India Singapore DTAA.
- In 2016, the government amended the treaties, even Mauritius and Singapore investments in India will be subjected to Indian taxes.
|Tax Avoidance through Non-Resident Status|
|If a person is
|Has to pay his IT on income coming from India?
|Has to pay IT on global income e.g. income coming from the USA/China?|
|Ordinarily resident of India||Yes||Yes
|If India has a double taxation avoidance agreement (DTAA) with other nation, then above things may differ (e.g. recall erstwhile Mauritius CGT-round tripping example)|
|Changes by Budget-2020|
|Definition in Indian Tax laws||Before Budget- 2020||Budget- 2020
|Ordinarily Indian Resident is a person who stays in India for:||182 days or above in a year
|120 days or above
|Non-resident is a person who stays outside India for:||182 days or above in a year
|246 days or above
|Implications à Person will have to stay out of India for a longer period if he want to be treated as “Non-Resident” to avoid taxes on his global income.|
Budget-2020: A citizen of India (even if he is staying abroad), but if he is not liable to tax in any other country then he will have to pay tax in India. E.g. United Arab Emirates and Bahrain where no income tax is payable.
- A PoEM is aimed at ensuring that sufficient economic activity takes place in a particular country and determining a foreign company’s residential status.
- It also helps to assess if companies are setting up shell subsidiaries abroad to evade taxes.
- In other words, it has been defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.
- PoEM guidelines in India became applicable from FY16-17.
- The shift to PoEM signifies a shift from an objective criterion for tax residence to subjective criteria.
- Bollywood Producer “A” forms a shell company in Mauritius (because it has a very low rate of corporation tax). He gives this company international movie distribution rights for his Indian movie at ₹ 10 only. Then, Mauritius company makes ₹ 50 crore profits, but he would not pay any taxes in India saying it’s a foreign company making profits from foreign territories, so Income Tax Department of India has no jurisdiction.
- But, here the Place of Effective Management is India, from where the Bollywood producer was really taking the decisions of this shell company.
- Budget-2015 introduced the concept of POEM. Such overseas / foreign company will be subjected to India’s 40% Corporation tax + cess + surcharge.
|Base Erosion & Profit Shifting (BEPS)|
- When MNCs shift profit from its source country to a tax-haven to avoid / reduce paying taxes, its known as “BEPS”.
- 2019-July: India ratified the OECD’s joint Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (commonly referred to as MLI)
- Multinational Company (MNC) “A” opens fast food outlets in India & makes ₹ 50 crores profit. By default, it should be subjected to 40% Corporation tax in India.
- But then MNC shows its Indian outlets had taken loan / raw material / patented technology from MNC’s shell firm in Singapore (where Corporation tax is 0-2%). So, after deducting these operating costs, it has zero profit, so in India, it will pay only 18.5% Minimum Alternative Tax (MAT), instead of 40% Corporation tax.
- Transfer pricing happens whenever two subsidiary companies that are part of the same multinational group, trade with each other.
- Suppose Coca Cola’s (Indian Subsidiary company) buys Sosyo Company’s shares or soda formula at ₹ 10 crores, and then sells it to Coca Cola’s (Cayman Islands subsidiary company) at ₹ 10 rupees. Then ₹ 10 is the transfer price.
- Coca Cola (Cayman Islands) further sells Sosyo’s shares / Soda-Formula to other companies at very high price. Yet, Indian tax authorities will not get any Capital Gains Tax (CGT) even though Coca-Cola (USA holding company) may be making profit (Capital Gains) of billion$ from this ‘Indian Asset’ (Sosyo).
- 2001: Transfer pricing related provisions added in the Income Tax Act. But they were quite strict leading to ‘tax terrorism’ by IT officials who would slap notices on every transaction, resulting into ‘No ease’ of doing business for MNCs.
|Authority for Advance Rulings (AAR)|
- After above episode, Pepsi (India) would like to know in advance whether its transfer price of ₹ “y” or its imported / exported item worth ₹ “z” is agreeable to tax authorities or not? lest it suffers from notices, raids and litigations afterwards.
- For this purpose, Authority for Advance Rulings (and their Appellate bodies) have been set up under the Income Tax Act, Customs Act and even GST Act.
- Advance Pricing Agreement (APA) à If in previous example, Coca Coal approached AAR and an agreement was signed between taxpayer and a tax authority that “Transfer price of ₹ y is agreeable to both of us, and will not attract any notices / raids / litigations afterwards.”
|General Anti Avoidance Rule (GAAR)|
- Till now we learned how Indians and foreigners avoid tax payment in India through loopholes like DTAA, POEM, BEPS, Transfer Pricing etc.
- So, UPA Govt setup economist Parthasarathi Shome panel who suggested General Anti Avoidance Rules (GAAR), they were incorporated in Income Tax Act in 2012.
- GAAR empowers Income Tax officials to send notices to both Indians and foreigners for suspected Tax Avoidance. For Tax evasion, we have separate laws- PMLA, UFIA, BTPA.
- However, critics alleged GAAR will result in tax terrorism, harassment, no ease of doing business. So successive Budgets kept delaying the GAAR- implementation. Finally done on 1/4/2017.
|Angel Tax on Startup Investments (2012)|
- Angel investors are the rich people who occasionally invest equity-capital in start-up companies. (Whereas Venture Capital Companies do the same thing but on regular & serious basis)
- Startup Entrepreneur Sunder Yadav registers a phony “Sunder Construction” as an (unlisted) Public Limited Company with ₹ 10 Face Value Shares, and sells them to Angel Investor Sadhu Yadav at a premium price of ₹ 1,000 per share.
- But, even construction sector’s (listed) public limited companies like DLF’s shares are selling around for ₹ 230.
- Thus, Sundar-startup’s shares are above ‘fair market price’. So, this is not a genuine “Angel investment” but rather a facade for laundering Sadhu Yadav’s money from construction, corruption or extortion business.
- So, UPA Budget-2012 required Sunder Construction (the Startup Company) to pay 30% Tax + Penalty on the investment they received from Angel investor Sadhu Yadav. This is dubbed as ‘Angel Tax’.
- Norms were further tightened by Modi-regime, but then controversy that Angel Tax will discourage the growth of startup companies so norms relaxed- ‘Angel Tax will not apply if Startup’s turnover is less than ₹ “x” crores or if startup was registered for upto “y” years & other technical ball by ball commentary’
Budget-2019: If Start-ups and their investors provide the required declarations and information, then IT dept will settle the matter, and will do no further scrutiny.
|Reforms To Reduce Tax Terrorism / Harassment|
At the same time, IT dept. also needs to become more friendly towards honest taxpayers, while reducing the scope of tax avoidance. Here notable measures are →
|Rajaswa Gyan Sangam 2016 & 2017
|Organised by CBDT & CBIC for idea exchange between policy makers and senior tax officers.
2016: Modi gave them RAPID Mantra: R for Revenue, A for Accountability, P for Probity, I for Information and D for Digitization.
|Direct Tax Code 2010
|This bill aimed to replace the Income Tax Act, 1961 with simpler provisions. But, lapsed with 15th Lok Sabha dissolution in 2014.|
|Easwar Panel on Direct Taxes 2015||To simplify the provisions of IT Act, 1961, to remove ambiguities that cause unnecessary litigations & hardships to Taxpayers.|
|Direct Tax Code Taskforce 2017
|2017: Setup by CBDT to draft New Direct Tax Legislation (Law) to replace IT Act 1961.
– 2019: Chairman Akhilesh Ranjan submitted report
|2017: CBDT’s mobile app that helps you calculate and pay Income Tax, claim TDS refunds etc.|
|Ease in paying Customs Duty:
Portals/Apps by CBIC
|Indian Customs Electronic Gateway (ICEGATE) web portal for e- services related to the Customs duty.
ICEDASH web portal: public can view daily data on customs clearance at seaports and airports. (launched 2019-Nov)
ATITHI mobile app: for international travelers to file the customs declaration in advance (e.g. ‘we are leaving or coming with “x” gms of gold/diamonds/electronics etc on which y% customs duty is applicable/exempted’). So, they don’t have to waste time at airport queues in filing such declarations. (launched 2019-Nov)
|Budget-2019: Ease of paying taxes & reducing tax-terrorism à Pre-filled online forms for Tax Payers|
- will extract our financial data from Banks, Stock exchanges, Mutual Funds, EPFO, Employers’ TDS submissions etc. and provide you with a Pre-filled tax returns containing your salary income, capital gains from share/bond, bank interests, etc.
- This will help in two ways:
- Personal income tax payers’ time and energy saved
- Accuracy of reporting income and paying taxes
|Faceless interaction between Tax payers and Tax official|
- In case of personal interaction between the assessee and Income Tax official, there will be more chances of harassment or bribery. So, Govt. has launch two reforms:
- Cases will be allotted in random computerized lottery basis to IT officials without disclosing the name, designation or location of the Officer.
- Faceless assessment in electronic mode. E.g. assessee received a notice about discrepancy in his reported income vs TDS submitted by his banker, then at initial stage assessee need not visit IT-office, simply give clarification in web-portal.
Budget-2020: Faceless appeal process introduced. So, even in appeal stage, assessee need not physically visit IT commissioner / tribunal.
|Document Identification Number (DIN)|
Whenever Tax official sends letters to taxpayers regarding search authorisation, summons, arrest memo, inspection notices etc. All such documents will have computer generated ‘Document Identification Number’ (DIN).
|2019-Oct||Central Board of Direct Taxes (CBDT) implemented DIN system.|
|2019-Nov||Central Board of Indirect Taxes and Custom (CBIC) implemented DIN system|
Benefits of DIN system
|It will create a digital directory of communication between tax authorities and taxpayers. Transparency, accountability, efficient and faster clearance of cases, because all the information available at the click of a mouse.|
|If a document doesn’t have DIN number, it will be treated invalid. Thus, DIN system will prevent the corrupt tax officials from sending fake notices to harass/blackmail taxpayers for bribes.|
Director Identification Number (DIN): Director of every company is required to obtain this number from the Ministry of Corporate Affairs under the provisions of Companies Act. It helps monitoring the company act provisions related to “one person can’t be director in more than ‘n’ number of companies” etc.
|Taxpayers’ Charter in Budget-2020|
- A citizens’ charter is a document of commitments made by a government agency to the citizens in respect of the services being provided to them.
- Budget-2020 à CBDT will declare a Taxpayers’ Charter. So, Tax payer will easily know what services / complaint redressal mechanisms are available to him. This will result into reduction in taxpayer’s harassment.
|1991||Citizen charter system first started in UK by PM John Major|
|1997||Introduced in Indian union ministries/departments|
Global Treaties, Agreements & Indexes
|Tax Information Exchange Agreement (TIEA)|
- India has signed such agreements with multiple countries. It enables mutual sharing of information to detect tax avoidance and tax evasion. Example,
- 2019-May: India has notified a tax information exchange agreement (TIEA) with the Marshall Islands whose Capital is Majuro; it’s the first country in the world to launch sovereign cryptocurrency named, Sovereign Coin.
- Nodal agency à On Indian side, CBDT is the Nodal agency for such agreements.
|USA’s Foreign Account Tax Compliance Act (FATCA-2010)|
- USA’s FATCA Act requires foreign financial Institutions (such as Indian Banks, Pakistani Insurance Companies, Chinese Mutual Funds etc) to report the assets held by Americans.
- This helps US Tax authorities to detect tax avoidance / evasion by Americans who are hiding income outside USA.
|Global Financial Secrecy Index|
- Prepared by London based Think Tank ‘Tax Justice Network (TJN)’.
- It uses 20 indicators to measure the countries on their financial secrecy, opportunities for Tax Avoidance, BEPS etc.
- 2020 Ranking: 1st rank Cayman Islands > USA > Switzerland…
- India ranks at 47th position.
Economic Survey On Taxation And Fiscal Capacity
|Observations of The Economic Surveys of 2015, 2016, 2017-|
|1.||Democracy is a contract. Taxation is the economic glue that binds government and citizens into this contract.|
|2.||But, whenever government delivers poor quality of service in public schools, hospital etc. → middle class and rich citizens will “EXIT” towards the private school and hospitals → Then they also feel ‘moral right’ to evade / avoid taxes, because they are no longer using public services. Result? hardly 4 percent voters are taxpayers (23% is desirable, as per our level of development against BRICS nations.)|
|3.||Govt gets less taxes → poor fiscal capacity → poor services → vicious cycle continues and results in decline of govt’s accountability towards citizens.|
|The reasons for poor Tax: GDP in India|
- Lack of civic sense among people that paying taxes is their basic duty.
- Presence of informal sector, parallel economy, cash based
- Low per capita income, high level of poverty. Concentration of income in the hands of few- who are greedy to engage in tax evasion & avoidance.
- Election funding as the mother source of corruption, and therefore black money
- Politician-Builders-Mafia nexus.
- Due to political considerations, state governments and local bodies do not levy all the taxes authorised by the constitutiong. tax on agricultural income. So our (direct) tax base is narrow.
- Loopholes in the tax laws which encourage tax avoidance using Domestic and Offshore channels.
- Direct taxes like wealth tax, gift tax and estate duty suffered from loopholes, lax monitoring and evasion. They didn’t yield much revenue. Hence even referred as ‘paper taxes’, and had to be abolished ultimately.
Tax base: means the total value of all the income, property, etc. on which tax is charged.
|Economic Survey 2019 – “Use Behavioural Economics to improve Tax Compliance”|
|· Plato said, “What is honoured in a country, is cultivated there.” Indians join military because:
2. Because serving in the armed forces is considered ‘honourable’.
· So, we should use the principles of Behavioral Economics enhance tax compliance. We have to modify the social norm from “evading taxes is acceptable” to “paying taxes honestly is honourable.”
Tax morale is the intrinsic motivation of taxpayers to pay taxes. When tax morale is down → motivation for tax evasion increases.
Table. Tax Morale is affected by two types of fairness
|Fairness||Vertical Fairness||Horizontal Fairness|
|Tax Payer’s thought process →
|What I pay in taxes is commensurate to the benefits I receive as services from the Government.||There should not be a great difference in the taxes paid by the ‘similar’ sections of society|
|His Tax morale is lowered when →
|He sees taxpayers’ money wasted in public expenditure (like Mayawati’s elephant statutes) instead of better quality of water, road, education or electricity.||If a salaried employee and a shopkeeper are earning ₹8 lakhs per annum, still the salaried employee is forced to pay more taxes than this shopkeeper, because
-TDS on salary whereas shopkeeper underreports his sales in cash payment.
-Shopkeeper shows less profit through fictitious business expenditures.
|under-constructions projects should show signboards “Your tax money at work”
-Reminding tax payers that public goods can only be provided in return for tax compliance. Most people in your local community pay their taxes on time.
|SMS, billboards highlighting self-employed individuals who pay good amount of tax.
-Public shaming of individuals who don’t pay taxes. It will scare other tax-evaders that the probability of their detection has increased.
-Avoid Tax Amnesties. Give stringent punishment to tax evaders.
|Recommendations by CEA Subramanian K.|
- In Hinduism, Islam and Christianity à unpaid debt is considered a sin. So, advertisements should highlight how tax evasion is a violation of such “spiritual/religious norms”.
- Top 10 highest taxpayers within a district à They should be given VIP-treatment such as faster boarding privileges at airports, special “diplomatic” type lanes at immigration counters, fast-lane on roads and toll booths, etc.
- Highest taxpayers over a decade à Important places should be named after them e.g. roads, trains, schools, universities, hospitals and airports.
- Ease in Paying Taxes à Pre-populated Income Tax forms with easy to understand terms. Even if a person’s tax liability is zero, he should be required to fill Income Tax form.
- Automated TDS as and where possible and timely release of Tax refunds.
MISC. TERMS w.r.t. TAXATION
Non-Tax Revenue Receipts
|Notable sources of Non-Tax revenue (In descending order)||2020-21
||~1.7 lakh cr.
||~2.2 lakh cr.
||~ 2300 cr.
||~4 lakh cr.
Total Revenue Receipts = Net Tax receipts (~16.0 Lakh cr) + Non-Tax receipts (~4 Lakh cr) = ~20 Lakh cr. This implies the fact that revenue budget: the tax receipts >> non-tax receipts
Revenue-expenditure are usually associated with:
- Expenditures spent on day to day functioning of the organs of the state such as salaries & pensions, stationery, electricity bill, phone bill etc. in Executive, Judiciary, Legislature; Various Constitutional & Statutory bodies.
- Expenditures that do not create income generating assets or permanent assets or financial assets. So, money spent on loan-interests, subsidies, scholarships, grants etc. are Revenue Expenditure.
Grant à Amount does not have to be returned with interest by the receiver. Whereas, if Govt gave ‘loans’ to States/CPSE/Foreign Countries then it is an income generating financial asset and hence counted under Capital Expenditure
Revenue expenditure And Subsidies
|Tax (₹ ~16 lakh crores in Budget 2020)||Subsidies (₹ ~ 2.6 lakh cr. in Budget 2020)|
|Tax is a compulsory contribution imposed by State.
Refusal to pay the tax is punishable.
|A subsidy is a benefit given to an individual or firm by the government to reduce some type of burden. A person may refuse to accept the subsidy, he will not be punished.|
|Tax does not promise specific and direct goods/services to the taxpayer.||A specific benefit is promised.|
|Types of subsidies|
|Given in direct cash (or bank transfer)||PM Kisan Rupee 6000/year in three installments, LPG Pahal about Rs. 200 per cylinder.|
|Given in kind||Free school bags, uniform and books to the poor children, free medicines in public hospitals, free insurance.|
|Indirect subsidies||Cheap fees in government colleges, cheap kerosene, cheap urea, cheap crop insurance premium etc. Here govt. is paying some money to an organization so they may provide goods/services at cheap rate to the beneficiary.|
|Regulatory subsidies||E.g. If State Electricity Regulatory Commission directs companies- that electricity to farmers must NOT to be beyond ₹ “Specified” per unit.|
|Procurement subsidies||E.g. FCI purchasing at food grains from farmers at minimum support price (MSP).|
|Interest subsidies / subvention||Govt pays “Specific%” interest on agriculture, MSME, affordable housing loans.|
|Impact of Subsidies|
- Merit Goods – Healthcare, education, scientific research, LPG, solar panels, wind mills etc. Here subsidies can increase the positive externalities. Cheap LPG led poor’s don’t use firewood. This would result into more trees & less indoor pollution.
- Subsidies on diesel, kerosene generate negative externalities on the environment.
- Urea subsidies to industries makes urea cheaper to farmers. This led to excessive consumption which results into soil & water pollution, algae-blooms.
- Subsidy leakage : When ghost/proxy beneficiaries (non-existent persons propped up by corrupt officials), and ineligible (rich) people are receiving subsidy.
Past Economic Surveys on subsidy delivery
Economic Survey 2019: Use ‘Behavioural economics’ to reduce subsidy bill
To reduce Government’s subsidy burden, Above the Poverty Line (APL) households should be encouraged to voluntarily surrender their LPG subsidies. North eastern states have shown higher rate of subsidy surrender as compared to other states. Following reforms required:
- People have a strong tendency to go with the status quo. So, ‘Default ticked option’ in LPG registration forms should be ‘I wish to give up the subsidy’, so a person will be ‘forced’ to untick the option to avail the subsidy benefit.
- Similarly, income tax forms should contain extra-fields with pre-ticked options like ‘I want to give up LPG subsidy’.
- The online /SMS-based ‘subsidy giving up process’ should be quick and hassle-free. It should not take more than a few minutes. Because every additional minute required to complete the formalities will increases the chances that person drop out in the middle of the process.
- People act positively when they see others act positively, and particularly when they can relate to such individuals. So, online “scroll of honour” should show name/photos/social media-profiles of others in their area who gave up subsidies.
- Advertisements to highlight that “Rich people are helping in poverty removal by giving up subsidies”.
- When people are watching a movie with social message (such as Padman, Toilet Ek Premkatha etc), it should contain ad asking people to give up full / partial subsidy.
- Once a person gives up subsidy, he should be shown the photos of poor people benefitting from his act / or a video with a beneficiary saying ‘thank you’.
Revenue expenditure And 7th Pay Commission
- Setup by Ministry of Finance (Department of Expenditure).
- First Pay Commission: Srinivasa Varadachariar (1946).
- 7th pay commission – (Retd) Justice A.K. Mathur (2014). Its recommendations became effective from 1 January 2016. Major highlights were:
- New system of “Pay Matrix” instead of previous system of pay band and grade pay.
- Regulatory bodies salaries increased: Chairman ₹ 4.50 lakh/ month, members ₹ 4 lakh/ month
- Minimum pay in Central service increased to ₹ 18k / per month (Group-D).
- Maximum pay: ₹ 2.25 lakh per month for Apex scale (e.g. Secretary of a Dept.), and ₹ 2.50l (for Cabinet Secretary)
- It adopted Aykroyd formula to computing wages at periodic interval. So, critiques believe there will not be an 8th Pay Commission because salaries will be updated automatically at regular interval, using this formula.
- It abolished various type of ‘interest free allowances’g. Purchase of bicycle etc.
- It continued ‘interest-bearing advances’ for purchase of computer, house building (upto ₹ 25 lakhs).
- Various reforms for defence and CAPF services.
- Made stronger rules in Modified Assured Career Progression (MACP) system so lazy officials don’t get promoted.
Dr. Aykroyd formula tracks the changes prices of the commodities used by a common man.
|Dearness Allowance (DA)||
|House Rent Allowance (HRA)||
|One Rank One Pension (OROP)||
National Recruitment Agency (NRA)
Revenue Deficit (2.7% of GDP for 2020)
- When government spends more than its income in revenue account, it incurs Revenue Deficit.
- Revenue deficit = Revenue expenditure – Revenue receipts.
- Since a major part of revenue expenditure is committed expenditure – like Interest repayment on previous loans, staff-salaries & pensions which Govt cannot avoid – so it is quite difficult to reduce the revenue deficit.
- So, when revenue deficit increases, government will be forced to borrow more money or cut down the expenditure in the capital part – Such as less new schools, bridges, hospitals and other critical infrastructure. This will result in lower human development and lower economic growth
- For instance – less new bridges could reduce the demand of steel/cements, so poor employment opportunities for workers and eventually reduction in growth of those sectors.
Effective Revenue Deficit: (1.8% of GDP for 2020)
- Effective Revenue Deficit = Revenue Deficit – Grants to various bodies which were spent for creation of Capital Assets.
- We have counted Grant-in-Aid to States, Local Bodies as ‘Revenue Expenditure’, but some portion of that fund may have been spent by the States, Local Bodies for building Panchayat-Bhavan, Disaster Management Training Institutes, Cranes and Bulldozers for Disaster rescue operations etc. which are actually “Capital Assets”.
- This led to evolution of new Concept of ERD which was introduced in Budget 2011 (By Chidambaram)
Capital Part: Receipts (₹ ~10 lakh Cr for 2020)
|Capital Debt Receipts
|Capital Non-Debt Receipts|
|~ INR 7.40 lakh cr from Internal Borrowing increased:
· From RBI,
· From market (Banks, NBFCs)
· From small savings (Post-Office Savings Accounts, Kisan Vikas Patra, etc),
· From Provident Funds (EPFO, PPF)
|~ INR15,000 cr Loan Principal recovered reduced (i.e. Union government would have given loans to state governments, foreign countries, public sector companies etc.). so when they return Principal amount back that is counted here.
|~ INR 57,000 cr External borrow increased: from foreign countries & international institutions like IMF World Bank, BRICS bank etc.||INR 2.10 lakh cr Disinvestment:
i.e. Union selling its shares from Public Sector Undertakings (PSUs) / Central Public Sector Enterprises (CPSEs).
|Bigger portion of Capital Receipts come from this side||Smaller portion|
Budget-2019: Foreign Borrowing in Foreign Currency
Budget-2019 – Finance Minister Nirmala S. announced, “India’s sovereign external debt to GDP is among the lowest (about 5%). The Government would start raising a part of its borrowing programme in external markets in external currencies.”
|Arguments in favor|
- In domestic market, the ‘crowding out of private corporate borrowers’ will decline.
- Corporates will be able to mobilize more funds from local market. This will facilitate factory expansion, jobs, GDP growth.
- In the advanced economies such as USA, EU the loan rates are very low, so our government may be able to get cheaper loans.
- Total (cumulative) internal debt of Union is about INR 96 lakh crores, whereas external debt is INR 68 lakh crores so if we borrow a little more from external sources it will not harm.
Crowding out – This refers to a phenomenon where increased borrowing by the government to meet its spending needs causes a decrease in the quantity of funds that is available to meet the investment needs of the private sector. However, government spending does not always lead to a crowding out of private investment in the economy.
- Risk of Exchange Rate – If rupee weakens against the dollar during the bond’s tenure (for instance, USD1: INR60 → INR70), the government would have to return more rupees to pay back the same amount of dollars. Then the loan may turn out to be ‘more expensive’ than originally anticipated.
- It’s true that presently Indian Government’s external borrowing is very low, but once this ‘door’ is opened, subsequent governments may get tempted to borrow more and more from the foreign sources to finance their (populist) welfare schemes, ultimately it can result into crisis when exchange rates turn volatile.
- Better to increase the foreigners’ investment limit in G-Sec (in ₹ currency) and attract them to come to India, rather than we going ‘abroad’ to get their money in USD currency.
|From the aforementioned analysis, it’s evident that challenges outweigh the potential benefits. Noted economists such as Dr. Raghuram Rajan are apprehensive about sovereign borrowing from external markets in foreign currency. Therefore, this idea, though well-intended, requires more deliberation.|
|Considering above points, sovereign borrowing from external markets in foreign currency may not be a bad idea, provided that it’s done in a judicious and prudential manner.|
CAPITAL RECEIPTS : DISINVESTMENT
Public sector enterprise = Any commercial or industrial undertaking owned and managed by the government to maximise social welfare and uphold the public interest.
|They can be Classified into three parts:|
|Departmental Undertakings||Statutory Corporations
|Directly part of a ministry e.g. Postal, Railways, Ordnance Factories. They can be created easily, no laws required, no registration required||Created by an act of Parliament or state legislature. E.g. RBI Act, SBI Act, LIC Act, FCI Act, EPFO Act. etc, SIDBI, NABARD, NHB, EXIM..
|Registered under the Companies Act, Govt’s shareholding is 51% or more. Coal India ltd, GAIL, SAIL, NTPC, IOCL, BHEL & various Public Sector Banks and NBFCs which are not statutory corporations.|
|High level of ministerial interference
|Middle of both sides
|More operational flexibility, less interference by Ministers
|CAG will audit directly||Some of these Acts provide for internal audit & exclude CAG from auditing the Corporation. E.g. RBI, LIC.||Companies Act requires them to produce audited reports. CAG will empanel the (private) auditors for them.|
|Their earning will go directly in Public Account / CFI||Their profit earning goes to shareholders in the form of dividend.
|Answerable in RTI Act||Answerable in RTI Act||Answerable in RTI Act|
|Their employees are considered govt. employee subjected to service and discipline rules framed by the government.||Not considered govt employees. Their service /discipline conditions are governed by the respective organizations’ internal manuals.
Public sector Undertaking (PSU) = PSU is a collective term for Centre’s + State’s + Local Bodies’ Public Sector Enterprises.
Significance of corporations and companies à Development of infrastructure, affordable services, regional balance, prevent concentration of economic power in the hands of Corporates and MNCs, employment opportunities, national development.
Challenges à Political interference, lack of innovation and consumer responsiveness, employee unions, loss making enterprises.
- Ministry of Heavy Industries & Public Enterprises decides the norm for Ratna Companies.
- “Ratna Companies” given for the flexibility in operations like hiring more professionals, acquisition of other companies etc. without requiring government approval for every small decision.
|Category||Condition and examples|
· Very few companies here
– Bharat Heavy Electricals,
– Bharat Petroleum Corp,
– Coal India,
– GAIL (India) ,
– Hindustan Petroleum,
– Indian Oil,
– Oil & Natural Gas Corporation (ONGC)
– Power Grid Corporation,
– Steel Authority of India (SAIL)
*Above examples are taken on 1 January 2020. Their status is subject to change and updation.
|BSNL – MTNL Merger|
- Bharat Sanchar Nigam Ltd (BSNL, 2000, HQ Delhi)
- Mahanagar Telephone Nigam Ltd (MTNL, 1986, HQ Delhi) to provide services in Delhi, Mumbai; later also providing services in Mauritius.
- But both of them suffering from heavy losses, unable to compete against the private telecom sector.
- 2019: Telecom Ministry decided to merge MTNL with BSNL. Existing employees are offered voluntary retirement scheme (VRS) to reduce the staff cost.
|Government policy towards disinvestment|
- Disinvestment implies reducing the govt shareholding upto 51% in a Government company.
- Privatization / Strategic Disinvestment – Reducing the government shareholding below 50%.
|Arguments in favour||Reduced govt. shareholding will facilitate entry of private investors in the board of directors. This will impart more efficiency, innovation and autonomy. Disinvestment proceeds can be used for welfare schemes, and reducing the fiscal deficit.|
|Argument Against||MNC monopolies, exploitation of worker, job loss among others.|
Disinvestment & Privatization from 2014-19
Depending on the Company, following methods of Disinvestment could be use:
- Converting Private Limited Company to public limited company and issuing Initial Public Offers (IPOs) e.g. Indian Railway Catering and Tourism Corporation (IRCTC) and Rail Vikas Nigam Ltd (RVNL)
- Exchange Traded Funds (ETFs): CPSE-ETF, Bharat-22-ETF
- Institutional placement Programme (IPP): offer shares only to non-retail investors.
- Offer for sale (OFS): offer shares to both retail and non-retail investors
- Share Buyback i.e. Govt. company itself buys the shares owned by Government, thereby decreasing Government’s shareholding portion viz a viz private sector’s shareholding.
Incumbent govt. shut down many sick Govt companies such as HMT watches, Hindustan Photo Film etc.
Budget-2016 renamed Finance Ministry’s Dept. of Disinvestment into Dept. of Investment & Public Asset Management (DIPAM). Further, Finance Minister led Ministerial panel called Alternative Mechanism (AM) decides which govt companies should be disinvested / privatized.
|Disinvestment targets since last 4 budgets:|
|Target (Lakh cr)||1||0.80||1.05 lakh cr||2.10 lakh cr.|
|Target achieved or not||Yes||Yes||No||–|
Budget-2019: Govt planned to earn ₹1.05 lakh cr from disinvestment but hardy 65,000 cr earned, because investors’ response lukewarm, due to slowdown in economy.
Strategic Disinvestment (from 2014-2019)
- Strategic Disinvestment: It implies selling a substantial portion of Government shareholding in a CPSEs along with transfer of management control to a private party. In true sense, it means 51% or higher shareholding with private players and 49% or lower with Government.
- For this action, NITI Aayog prefers to use the term ‘strategic disinvestment’, ‘strategic sale’ instead of ‘privatization’, lest the opposition parties create uproar about it.
- NITI Aayog has identified Air India, Pawan Hans, Dredging Corporation, Scooters India, Bharat Pumps Compressors, Hindustan Fluorocarbon, Hindustan Newsprint, Cement Corporation of India etc. for strategic disinvestment. List has been approved by DIPAM.
|Budget-2019 à Finance Minister Nirmala S. announced:|
- will again try for strategic disinvestment of Air India & other selected CPSEs.
- will monetize the unused land assets of CPSEs (e.g. selling / renting). → Government Land Information System (GLIS) portal launched to keep track of all such land assets.
- will relax foreign investment limits in the CPSEs. – Even for non-strategic-disinvestment, Govt. will change the policy in following manner:
In Nov 2019, Govt. announced plans for strategic disinvestment of five public sector units (PSUs):
|1. Bharat Petroleum Corp Ltd (BPCL). Big international oil companies including Saudi Aramco are keen to buy BPCL, given its strong presence in fuel retail outlets.|
|2. Shipping Corporation of India|
|3. Container Corporation of India (CONCOR)|
|4. Tehri Hydro Development Corp of India and|
|5. North Eastern Electric Power Corporation (NEEPCO) will be sold to National Thermal Power Corporation (NTPC, a public sector company).|
|Q. Why is the Government of India disinvesting its equity in the Central Public Sector Enterprises (CPSEs)? (CSE-2011)
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Economic Survey 2020 – Privatization And Wealth Creation
Strategic Disinvestment (privatisation) to enhance profitability
- In 1980s, UK PM Mrs. Margaret Thatcher started privatization of the Govt companies such as British Telecom, British Airways, water and electricity companies etc. It resulted in enhancing profitability for those companies.
- Economic Survey 2020 à analysed 11 Indian Govt companies that were privatized during BJP/NDA PM Atal Bihari Vajpayee tenure (1998-2004) such as Hindustan Zinc, Bharat Aluminium Company Ltd. (BALCO), Maruti Suzuki, Indian Petrochemicals Corporation Ltd. (IPCL), Modern Food India Ltd. (MFIL) etc.
- After strategic disinvestment (privatization) these Indian companies’ sales, profitability etc. greatly increased because of:
- Technology Up-gradation
- Efficient management practices by Private professionals.
- Better human resource management
- Adoption of best practices and efficient work culture
- Conclusion – Privatized PSUs help in economic growth & employment generation.
|Strategic Disinvestment (Privatization) and adoption of Singapore Model|
- In 1974, Singapore Govt. set up a holding company “Temasek Holdings Company” (THC). Then the Government transferred its shares of PSUs to THC. However, THC sold them in market and this makes privatization complete.
- of India has 264 CPSEs under 38 different Ministries/Departments.
- Economic Survey 2020 à suggested, we should also create a Holding Company just like Singapore, for our strategic disinvestment (privatization) drive.
- Benefits – Professionalism and autonomy to the disinvestment programme. If an individual ministry tried individual company’s privatization then:
- Ministry’s officers may not have experience for it.
- Internal resistance by employee unions to sell it off.
- So, better let a separate holding company look after this process.
Its notable components in decreasing order are:
- Capital assets for various schemes, ministries, departments (Building, vehicles..)
- Giving debt/equity finance to PSUs & foreign institutes, giving loans to State Govt & Foreign Govt. Finance Ministry – Dept of Economic Affairs (DEA)’s Indian Development and Economic Assistance Scheme (IDEAS) gives such funds to foreign nations.
- Union repaying loan principal for Internal Debts
- Union repaying loan principal for External Debts.
Types of Deficits
A deficit occurs when a resource, money, in particular, is less than the amount required. A budget deficit and a trade deficit are the two main types of deficits. A deficit adds to one’s debt, which most do not consider financially healthy.
|Surplus budget||If the government’s income is more than its expenditure|
|Balanced budget||If the government’s expenditure is equal to its income|
|Deficit budget||If the government’s expenditure is more than its income|
- Types of Deficit
- Revenue Deficit
- Effective Revenue Deficit
- Budget Deficit
- Fiscal Deficit
- Primary Deficit
|Revenue Deficit||Revenue expenditure minus Revenue receipts||2.7% of GDP
|Effective Revenue Deficit||Revenue Deficit minus Grants for creation of capital assets||1.8% of GDP
|Budget Deficit||Budget expenditure minus Budget receipt||–|
|Fiscal Deficit||Budget Deficit plus Borrowing||3.5% of GDP|
|Primary Deficit||Fiscal Deficit minus interest to be paid on previous loans||0.4% of GDP
|Q. Find Correct Statement(s) (CSE-2017)
- Fiscal Deficit = Budget Deficit + Borrowing.
- This borrowing includes internal borrowing [such as through Small Savings Scheme, and the G-Secs subscribed by Banks/NBFCs + Borrowing from RBI] + External Borrowing.
- As per Sukhmoy Chakravarti Committee report, it was implemented in 1997-98.
- Primary Deficit = Fiscal deficit minus the interest to be paid on the previous loans.
- Mentioned in Finance Minister Manmohan Singh’s budget speech of 1993.
- If the government continues to borrow year after year, it leads to accumulation of debt and the government has to pay more and more interest.
- These interest payments themselves add more burden to borrow next year.
- So, to get a clearer picture of how much is the government borrowing for new programs, they look at another indicator, known as primary deficit.
- When the revenue of the government is shorter than its expenditure then this situation is dealt by printing more currency, buying from public and foreign institution. This temporary arrangement of the money is known as the deficit financing.
- Taxes cannot be increased beyond a point because it may force people to evade taxes / discourage their motivation to work (Laffer Curve).
It is worth to mention that deficit financing is equal to fiscal deficit of the country.
|Sources of Deficit Financing|
- Printing new currency notes.
- Borrowing from internal sources (RBI, General Public, Ad-hoc Treasury Bills & government bonds etc.)
- Borrowing from External Sources (like borrowing from developed countries and International institutions like World Bank, IMF, etc.)
|Purposes of Deficit Financing|
- To overcome the problem of lack of funds for speeding up the country’s development.
- Promote additional investment in the country to side away the adverse impacts of depression period of the country.
- To arrange fund for ensuring the holistic development of the country.
- To arrange fund for the unforeseen events and arrange resources for wartime
- To upgrade the infrastructure of the country so that the taxpayers of the country are convinced that the tax paid by them is spent on the right things.
Negative Consequences of Deficit Financing
- Increase in deficit which leads to increased borrowing by Govt.
- Adverse Impact on Saving -Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely.
- Increase in inflation due to the increase in the supply of money in the economy.
- Decrease in average consumption level due to higher inflation.
- Increase in income disparities, because rich get more opportunities due to higher supply of money in the economy. In fact it is not possible for the people to maintain the previous rate of saving due to rising prices.
- Adverse Impact on Investment – Deficit financing effects investment adversely. When there is inflation in the economy trade unions/employees demand higher wages to survive.
- Economist David Ricardo argued that during high deficits, people save more, because they become precautious about future hike in taxes. It’s called “Ricardian equivalence” (and if people begin to spend less and save more, then companies will face unsold inventories, a new problems for economy)
- If government borrows more money from households & financial intermediaries (LIC, EPFO, Banks via SLR), then that much less money will be available for loans to private corporate borrowers à Crowding Out Effect
- Financial repression of the households – If Government forces SBI, LIC, EPFO to buy its G-sec using public deposits and thereby depriving households of the optimal return.
- Erosion of operational freedom – Govt (forcing) NABARD to buy its ₹ 15,000 crore Swachh Bharat Mission (Gramin) Bonds with maturity period of 10 years. Govt (forcing) RBI and others to pay higher dividend.
- High level of fiscal deficit – International Credit Rating Agencies will downgrade the sovereign rating for India. Investors will demand more interest from govt for buying new G-Sec, if unsold then RBI forced to buy G-Sec (and print more Money to give to Govt). It is called “Monetization of Deficit”. It can result in hyperinflation
Deficit financing leads to inflation. A high price level as compared to other countries will make the exports more expensive and thus they start declining. On the other hand rise in domestic income and price may encourage people to import more commodities from abroad. This will create a deficit in balance of payment and the balance of payment will become unfavourable.
Famous economist Keynes was the strong supporter of the deficit financing in the developing countries so that these countries can be pulled out from the vicious circle of poverty, unemployment and under production
Laffer Curve – The Laffer curve shows how tax revenues change when the tax rate is either increased or decreased. Typically, it has an inverted-U shape.
- Extra Budgetary Resources (EBR) are loans taken by public sector undertakings and Govt. organizations. For example:
- Govt not releasing food subsidy to Food Corporation of India (FCI) and thereby FCI to borrow money from National Small Savings Fund (NSSF) for its food schemes.
- Ministry of Housing and Urban Affairs → (Autonomous body) Building Materials and Technology Promotion Council → they borrowed ₹ 60,000 crores in next 4 years to finance the PM Awas Yojana (Urban).
- Here repayment of the entire principal and interest is done from the Central Govt Budget eventually, behind the curtains.
- EBR measures are announced after passing of budget so, they may escape the same general level of media-reporting, parliament debate or audit. This practice widely considered detrimental for financial transparency & accountability.
|Economic Survey- 2020:|
From Budget 2016 to 2019, govt raised more than ₹1.45 lakh cr through EBR. These EBRs are not taken into account while calculating the Fiscal Deficit. However, they’re counted while calculating Govt debt or public debt.
Deficit Financing: Associated Terms
|Redemption||Repay the loan principal and interest at regular interval. Also known as Terminal Annuity|
|Sinking Fund||Govt. creates a special fund and keeps depositing money in it regularly. So at the time of G-sec maturity, it has enough ‘buffer’ money to honor the loan repayment. First introduced in England|
|Conversion / restructuring||Converting old loan into new loan with modifications in interest / tenure.|
|Evergreening||Taking new loan to repay the old loan|
|Govt. does not recognize its obligation to repay the loan. E.g. After Russian Revolution (1917) Lenin’s Govt. refused to pay the loans taken by the previous Czar regime from Britain & France.|
Fiscal Consolidation (Fiscal Prudence)
- Fiscal Consolidation refers to the policies undertaken by Governments (national and sub-national levels) to reduce their deficits and accumulation of debt stock. It is not aimed at eliminating fiscal debt.
- Fiscal Consolidation involves reduction in government expenditure to control its Fiscal Deficit. Such as:
- Reducing the leakages of subsidies and funds by targeted delivery of schemes and subsidies through Direct Benefit Transfer (DBT) through Jan-Dhan Aadhar Mobile (JAM) trinity.
- Reducing the quantum of subsidies: e.g.
- Deregulation of Petrol prices (2010) and later Diesel (2013)
- 2016: Oil Ministry began to block LPG-Pahal subsidies to persons with annual taxable income of ₹ 10 lakh and above.
- 2017: Oil Ministry asked oil companies to keep raising prices of subsidised kerosene by 25 paise every fortnight until the subsidy is eliminated.
- Shutting down loss making PSU. E.g. Hindustan Photo Films, HMT Bearings, HMT Chinar Watches, Tungbhadra Steel, Hindustan Cable & HMT Watches (2014).
- Privatization of loss making PSU and PSBs. e.g. 2018- IDBI à LIC, 2018- Tried to sell off Air India, but unable to find any buyer.
- 2014-16: Government setup an Expenditure Management Commission under Bimal Jalan to suggest ways to reduce its Expenditure.
- Austerity measures e.g.
- 2018– Bengal govt issued directives to its departments banning flower bouquets and mementoes in public functions, banning officials meetings at private hotels, frequent installation of AC, car purchases, office renovations etc. & restricting the number of foreign tours by Ministers / IAS etc., More use of video-conferencing instead of physical travel.
- 2019: PM’s Cabinet Committee on Investment and Growth (CCIG) ordered all Union ministries to reduce wasteful expenditure on travel, food and conferences by 20%.
|Q. There has been a persistent deficit budget year after year. What can be done by the government to reduce the deficit? (CSE-2015)
- When government reduces taxes and/or increases public procurement to boost the demand & growth in economy, it is called “Fiscal Stimulus”.
|Manmohan’s Fiscal Stimulus (2008)|
- Post-subprime crisis in USA, PM Manmohan announced Fiscal Stimulus (2008) such as :
- Cut in the Excise duty & Custom Duty on exports
- Businessman were given additional depreciation benefits in Income Tax & Corporation Tax, if they purchased new commercial vehicles.
- Hiked the Minimum Support Prices (MSP) for farmers.
- However, the economic surveys observed that such Fiscal Stimulus create new set of problems by increasing the fiscal deficit in the subsequent years.
|Fiscal Stimulus of 2019|
Aug 2019 – Car sales and GDP growth sharply decreased. Foreign investors exiting on large scale from India. So, Finance Minister Nirmala. S announced in 2019-September:
- Reduced tax burden on companies
- Indian companies corporation tax slabs decreased from 25-30% to 15-22%.
- Reduced tax harassment
- No start-ups will be subjected to ‘angel tax’.
- All tax notices to be issued from centralised system to ‘end harassment of taxpayers’ by individual officials.
- GST refunds would be given to entrepreneurs within 30 days.
- Violation of Corporate Social Responsibility (CSR) will be treated as a civil offense and not a criminal offense.
Budget-2019 had hiked surcharge on the income tax paid by Super-rich. As a result, Foreign investors were exiting from India, fearing extra tax burden. So, Govt. will undo that budget announcement.
- will fix the issues concerning PSBs
- will infuse ₹ 70,000 crore to public sector banks, order them to link loan interest rates with repo rate or other external benchmarks so, loans may become cheaper especially for home, auto sector. This will boost sales, revive economy
- will encourage car sales & other consumption
- Vehicle depreciation increased from 15% to 30% (meaning Businessman will get more tax benefits in Income Tax and Corporation Tax). This will encourage businessman to buy new vehicles.
- Government departments will buy new petrol/ diesel vehicles.
- GST council will reduce GST rates on 5 star hotels, outdoor catering, GST compensation cess on passenger vehicles etc.
Plus many other fragmented reforms to decrease taxes, or to enhance Government spending on highway projects etc. are done every now and then.
| Q. Which one of the following statements appropriately describes the “fiscal stimulus”? (CSE-2011)
- Fiscal Discipline refers to a state of an ideal balance between revenues and expenditure of government, in an economy.
- If the fiscal discipline is not maintained, then the government expenditure exceeds government receipts.
- Under this condition, the government would have to borrow funds or incurred deficit financing from the central bank. This may depreciate the currency and create inflation in an economy.
- Fiscal drag happens when government’s net fiscal position (minus taxation) fails to cover the net savings desires of the private economy, it is also called the private economy’s spending gap.
- The resulting lack of aggregate demand leads to deflationary pressure, or drag, in the economy, essentially due to lack of state spending or to excessive taxation.
- One cause of fiscal drag is bracket creep, where progressive taxation increases automatically as taxpayers move into higher tax brackets due to inflation. This leads to moderation of inflation, and can be characterized as an automatic stabilizer of the economy. Fiscal drag can also be a result of a hawkish stance towards govt. finances.
For instance, if government has targeted to keep the fiscal deficit within 3.3% percent of GDP, but if it crosses that limit, it is called as fiscal slippage.
FRBM Act 2003
- Fiscal Responsibility and Budget Management Act aims to make the Central government responsible for ensuring inter-generational equity in fiscal management and long-term macro-economic stability.
- Originally it required Union and States to control their deficits with following targets:
|By 2008||Reduce Fiscal Deficit to 3% of GDP (for Union) and 3% of GSDP (for States).|
|By 2008||Eliminate Revenue deficit i.e. make it 0% of their respective GDP or GSDP.|
|While some of the state governments achieved them, but successive union governments struggled to meet these targets so they kept amending the act to extend the deadlines and targets.|
|E.g. Amendment 2012: No need to have 0% Revenue deficit. Instead it required 0% Effective Revenue Deficit by 2015. These deadlines were extended even further in subsequent Finance Bills.|
|FRBM Review Panel under N.K. Singh (2016-17)|
|Jaitley felt FRBM Act targets were too rigid and did not allow any room for the government to address any crisis e.g. farm loan waivers during drought period or unemployment allowance during global financial crisis are not possible if government strictly wants to control fiscal deficit at 3% of GDP.|
- So, he constituted a panel under NK Singh (former IAS, 15th FC chairman) to review the FRBM act. RBI Governor Urjit R. Patel & CEA Arvind Subramanian were also in the committee.
|Recommendations FRBM Panel:|
- Replace the existing FRBM act with a new act, with an “Escape clause”e. During a war, drought or economic crisis, the government should be temporarily allowed to cross breach targets. Govt. amended FRBM act for this.
- Set up an independent “Fiscal Council” for monitoring. Yet to setup such council.
- Adopt a fiscal road map for the union from 2017 to 2023 gradually reduce Union Debt to GDP, Fiscal Deficit and Revenue Deficit So, citing NK Singh report (as an excuse), Budget 2018 amended the FRBM targets:
|Indicator (% of GDP)||2018- 19||2019-20||2020-21
|3.3% (reality 3.8%)||3.1% (reality 3.5%)||3.0%
|Union Debt: GDP reduce it gradually:||2017à ~ 46.5%, 2018à 48.4%;
2019à 48.0% (reality- 2019 above 50%)
|General (Union + State) Debt to GDP:||Gradually reduce to-
|FRBM – Trigger Mechanism and Escape Clause FRBM Act|
- Section 4(2) of FRBM act provides for a trigger mechanism to escape the deficit control related clauses in the act i.e. Govt. can over-cross the targets in following situations:
- National Security / Act of War
- National calamity
- If agriculture output and farm incomes collapse
- Fall in GDP growth rate beyond x% level
- Structural reforms in the economy with unanticipated fiscal implications.
During above ‘trigger conditions’
|FRBM Act Section 4(2): Govt may over cross/ deviate the fiscal deficit target by upto 0.5% of GDP as recommended by NK Singh’s FRBM review Committee.|
|Individual State Govts may also do similar (e.g. over cross by 0.5% of GSDP), but they’ve to amend their state FRBM Act accordingly with this provision|
Budget-2020: Finance Minister cited “Structural reforms in the economy with unanticipated fiscal implications” to escape the FRBM targets for 2019-20 and 2020-21.
|Fiscal deficit||Original target||Over crossed After Trigger Mechanism|
- Primary deficit target 0% (2020-21): shifted to 2022-23.
- Revenue Deficit and Effective Revenue Deficit also over crossed but anyways FRBM Act has abandoned targeting them since 2018’s amendment.
|ES19||Had suggested Government to reduce deficit through fiscal prudence.|
|To revive growth in the Indian economy, the Govt. should relax fiscal deficit targets, putting differently, give fiscal stimulus to revive economic growth.
ES20 Identified following challenges in 2020-21 in reducing deficit:
· Slowdown in Indian and global growth
· Rising trade protectionism,
· Geopolitical situations in West Asia, Oil price and resultant tax collection will be affected.
In 2018, instead of immediately reducing the Fiscal deficit to 3.0% Finance Minister Jaitley promised to reduce it to 3% in 2020-21 like a glider gradually descending on its landing target. Hence subsequent Finance Ministers keep reiterating that we will continue on that ‘Fiscal Glide’ path.
Although Budget-2020 Finance Minister Nirmala. S used FRBM-trigger to escape it, temporarily.
FRBM Act: Documents
FRBM Act requires the Union Government to present 3 documents along with the budget:
- FRBM Documents
- Fiscal Policy Strategy Statement
- Macroeconomic Framework Statement
- Medium-term Fiscal Policy Statement
|Fiscal Policy Strategy Statement||To explain how Govt. is controlling the deficits, and whether there is going to be any deviation from the target.|
|Macroeconomic Framework Statement||To show economic data – GDP, growth rate, import-exports, and government’s receipts and expenditure etc.|
|Medium-term Fiscal Policy Statement||For next 3 year projections, as shown in following table:|
Bodies Associated With Fiscal Responsibility
|Expenditure Management Commission (2014)||Ministry of Finance setup EMC under Dr. Bimal Jalan.
Commission gave suggestions on how to reduce fiscal deficit, how to reduce subsidy bill etc
|Public Debt Management Agency (PDMA)
|RBI decides on the repo rate and also undertakes open market operation for buying and selling of G-sec. Most of the G-sec are purchased by public sector banks, insurance and pension funds. As Banking-regulator, the Reserve Bank is able to nudge PSBs to subscribe to G-sec. So, this creates a ‘conflict of interest’ for RBI in its role as à Banking regulator vs Public Debt manager.|
|Budget-2015||Proposed creating an independence Public Debt Management Agency to takeover these functions of RBI. But later plan was put on a back burner due to RBI’s objections.|
|2019||NITI Aayog Vice Chairman Rajiv Kumar again reiterated the need to setup PDMA.|
Public Expenditure Management: Challenges
- Public expenditure management deals with allocation of Government’s economic resources into three channels:
- Public administration
- Economic growth
- Welfare schemes.
- Post Liberalization, Privatization and Globalization (LPG) reforms in 1991, the management of public expenditure is facing challenges on the following fronts:
|Nationalisation of banks,
International economy was not so greatly interconnected Basel norms less stringent.
|Twin balance sheet syndrome, government required to recapitalise the public sector banks because they cannot do it on their own → Financial burden has increased|
|Monetary Policy and Fiscal Policy|
|High level of fiscal deficit. RBI’s monetary policy which mandated high level of SLR to finance Government’s borrowing using bank depositors’ money.||– Private sectors investment demand, consumerism has increased therefore RBI is forced to cut down the SLR to increase the loanable funds.
– Since high level of fiscal deficit was one of the reasons for BOP crisis, now Government has statutory FRBM requirements to control fiscal deficit.
– RBI has statutory requirement to control inflation – So rampant borrowing from RBI is becoming difficult for government
|Share of private sector in India’s economic growth and employment generation was limited due to the License Quota Inspector Raj.
|– Drastically increased.
– Private sector requires ₹20 lakh crores every year for sustaining the current level of Economic Growth and Employment generation
– Therefore, if the government does not control fiscal deficit → crowding out of the private investment = challenges for India’s growth story.
|Public Sector Undertaking|
|Loss making public sector undertakings were supported by the Government as white elephant.||– Difficult to sustain the PSUs against the heavy competition of private sector be it Air India or BSNL.
– Govt unable to pay salaries, even no buyers for their privatization
|Population was sparse.
Most people didn’t have access to TV, fridge, mobile, internet or social media. Their demand for electricity was low.
|– Population has increased.
– Aspiration of people have increased
– They want clean water, 24/7 electricity, good quality of roads; – Lot of money required for infrastructure finance,
– Railway alone requires 50 lakh crore between 2016-30.
– Govt. can’t spend more than 1.6 lakh crore a year.
|Right to education, right to food, right to work (MGNREGA) were not yet ‘legal rights’||– Now they have become legal rights so the govt. is required to allocate large amount of funds for them.
– food subsidy costs more than ₹ 1.8 lakh crore, MGNREGA ₹ 60k crore
– Post-LPG era, the level of education and demand for various amenities, and even per capita income has increased, but that has not been a corresponding increase in our tax to GDP (11%, whereas countries with similar growth have more than 20%).
– This puts further strain on Public Expenditure Management
|Small size of Govt. staff Their salary levels were also low.||– Public aspirations have increased, number of welfare schemes increased, Border Security challenges increased → employees have increased
– 6th pay commission and 7th pay commission → salaries have increased.
Challenge à ‘Contracting out of the jobs’ to keep revenue deficit minimal. NPS where Employee himself is largely responsible for his pension etc.
Thus, in the aftermath of LPG reforms:
- Nation’s per capita income has increased, Govt’s expenditure has increased, demands for infrastructure investment has increased.
- But there has not been an adequate increase in the tax to GDP levels.
- As a result, public expenditure management has become a challenge to the government.
Types of Schemes
- Not too long ago, there were hundreds of centrally sponsored schemes (CSS) with overlapping objectives and duplication of efforts.
- 2015-16: NITI Aayog forms Shivraj Singh Chouhan Panel for rationalization of CSS → Ultimate outcome is:
Central Sector Schemes
- Central Sector Schemes are 100% funded by Union Govt.
- Examples: Urea Subsidy, MDR Subsidy, Jan Aushadhi Scheme, Bharat NET, Pradhan Mantri Gramin Digital Saksharta Abhiyan
- In the union budgets, collectively more outlay allotted for these type of schemes.
|Centrally Sponsored Schemes|
In Centrally Sponsored Scheme, states may have to bear some cost.
- Core of the Core Scheme
- Core Scheme
|Core of the
|Those schemes deal with social protection and social inclusion are given first priority in the funding for National Development Agenda.
Only 6 schemes: MNREGA, NSoAP (100%), Umbrella schemes for SC, ST, Minorities & other vulnerable groups. For these schemes, UPA-era funding pattern will continue.
|Core Scheme||E.g. PM Gram Sadak Yojana, PM Awas, Swachh Bharat, AMRUT & Smart cities etc. Here funding pattern could be 50:50, 60:40, 70:30, 75:25, 80:20 or 90:10 depending on a particular scheme and depending on whether it’s a general / special category state.|
For any union territory without legislature: 100% funding by Union for any scheme in any category. We will look at the schemes’ features in the respective pillars.
To disburse scheme money & monitor it in effective manner, Finance Ministry’s Dept of Expenditure Controller General of Accounts (CGA) created Public Financial Management System (PFMS) web-portal.