On exemptions and tax incentives
The National Institute of Public Finance and Policy released a working paper some time back on, Raising the Tax-Ratio by Reiningin the “Tax-Breaks” An Agenda for Action
Are all the tax concessions and exemptions logical and do they make good economic sense? Some interesting observations of the paper.
SEZ – infrastructure and not fiscal concession is the incentive
There is no good evidence to support the case for tax incentives for SEZ units apart from remission of customs and domestic trade taxes which should apply to all exports irrespective of whether they are located in an SEZ or outside.
For improving the attraction of SEZs what is needed most is a world class infrastructure. Fiscal incentives rank low in the attractions of SEZs; they may be used as a convenient channel for routing profits earned elsewhere through SEZs to escape taxation.
The revenue cost of tax incentives for SEZ investors is difficult to estimate in the absence of requisite data. Informal discussions with officials in the Income-tax Department suggest that the loss may be nearly Rs. 10,000 crorefrom the income tax holiday alone. The revenue forgone on account of excise and customs, though sizeable, should not be counted as loss since these remissions are available for exports from anywhere in the country.
The extension of tax holidays to SEZ units has been unwarranted, especially after section 80HHC benefits have been done away with. A case can at best be made for providing some inducement for infrastructure development as it tends to be front loaded in terms of investments and costs. The tax holiday for others is unjustified and should be terminated forthwith.
Regional exemptions – no good?
Region-specific tax holidays are objectionable also on economic efficiency ground, as they create a tendency to shift businesses to areas that do not have a comparative advantage for the activity in question
Given the present environment where e-commerce is taking roots, there is a possibility of bill transactions being undertaken from areas where the incidence of tax is lower. This, however, does not imply that the goods need to be delivered out of the place where the billing is actually done. While the administrative departments of the indirect taxes would like to check for the level of activity in the enterprise, this lies outside the domain of the Income-tax Department because of tax holiday. It is thus possible that in some cases it is only the billing activity which moves to the specified jurisdiction, not the entire manufacturing activity, especially if the incentive available relates only to income tax. This would mean an erosion of the tax base in the rest of the country and not so much the generation of new incomes or expansion of the base.
The tax holidays extended to Himachal Pradesh and Uttranchal are particularly objectionable because they virtually negate whatever incentive the holidays for investment in the N-E states had been providing. A study has revealed that
++ No large-scale investment has taken place as a result of the policy:
++ Small and medium enterprises dominate the scenario, with low investment, low value added, and low employment.
++ Several excise intensive units reflect only the final stage of manufacturing activity, entailing relatively low investment and employment, and figure among the major excise beneficiaries.
++ Developed states within the region continue to attract most of the investment: Assam and Meghalaya account for 91 percent of the investment.
++ Better connectivity with the mainland, quality of infrastructure and logistics, security concerns are identified as the driving force for the observed pattern of location of investment.
++ With the tax holidays extended to Uttaranchal and Himachal Pradesh, most of the investments will flow to them, as they are strategically better placed to attract investors, with closer connectivity to the major markets and therefore having a competitive edge in attracting investment.
The study comes out with the recommendation that, what would be more helpful for the N-E states is, creation of better infrastructure. Manipur does not have a kilometer of railway line even after over fifty five years of independence
agricultural income
Exclusion of agricultural income from the income tax base is a legacy of history dating back from pre-independence days (and not just a creation of the constitution) and does not stand to reason now.
When income tax was first introduced in India in 1860, agricultural income was taxed on the same footing as other incomes. However, after a transitional period from 1860 to 1886, the law that laid the basis of income taxation in India on a permanent footing viz., the Act of 1886, excluded agricultural income from the tax base on the ground that by that time a cess had been imposed on land revenue which was already quite burdensome and so subjecting agricultural incomes to income tax would amount to double taxation.
The constitutional scheme of assignment while assigning the power to tax agricultural income to the states, stipulated that 'agricultural income' will have the same meaning as given in the Income-tax Act.
However, whereas in the 1800s and even till the time of independence, land revenue comprised a substantial proportion of government's revenues, at present land revenue (including surcharges and cesses based on land revenue) and agricultural income tax (introduced in a number of states since 1938) account for a relatively small proportion, approximating barely 0.7 percent, of the total tax revenue of states.
Thus, the argument about double taxation, which provided the original rationale for exclusion of agricultural income from central income tax is no longer valid.
Small Scale Industries
Small scale industries account for approximately 35 percent of total exports and 40 percent of value added from industry, but contribute very little to the exchequer, as they enjoy generous treatment in taxation.
The rationale for protection to the small scale sector, first articulated in the Industrial Policy Statement of 1948, was promotion of employment, wide dispersal of industrial growth, and also the Gandhian ideology of self-supporting village economy
The benefit of exemption should apply only to really small units, who, by our criteria, do not ordinarily have clearances of more than Rs. 50 lakhs in the previous/current year, inclusive of all items which are currently excluded while computing the clearance. All other units should be fully taxed with the benefit of credit for tax paid on inputs.
No large-scale investment has taken place as a result of the policy:
Small and medium enterprises dominate the scenario, with low investment, low value added, and low employment.