A blueprint to encourage tax compliance
Partner - Tax & Regulatory Services, EY
Associate Director - Tax & Regulatory Services, EY
The Indian tax administration is at its nadir. A fundamental and deep reform is urgently called for. There is no time to lose if investment is to be revived and its full potential reached, and an eventual tax revolt through capital flight or other direct protests is to be averted."
In making these recommendations in the first report of the Tax Administration Reform Commission (TARC), Dr Parthasarathi Shome minces no words.
He paints a grim picture of the tax administration in India. He has earned a reputation of speaking his mind against the bad policies of the government, including tax administration. In his first report on the General Anti-Avoidance Rules (GAAR), he recommended against its use and observed that GAAR is an extremely advanced instrument of tax administration - one of deterrence, rather than for revenue generation - for which intensive training of tax officers, who would specialise in the finer aspects of international taxation, is needed.
In his second report on retrospective taxation, he emphasised that retrospective amendments should be introduced only in the rarest of rare cases. And, in the most recent TARC report on tax administration, he has been equally daring, making many recommendations which are bold, yet well-researched, based on a comprehensive review of the current practices of tax administration and a thorough understanding about them.
"…if an institution could have spirit, then the current Indian tax administration lacks that spirit. Functioning in a vacuum, it has lost its purpose as revealed in its behaviour, for its stated vision and mission are scarcely observed in its operational style. Its singular objective of protecting revenue without accountability for the quality of tax demands made is commonly believed to have severely affected the investment climate in India and in investment itself." It is perhaps these aspects which earned it the label of "tax terrorism", which the Bharatiya Janata Party promised to do away with in its manifesto.
There are several factors that are responsible for this sad state. The first is the singular objective of meeting revenue targets, which are set in isolation with little regard to the performance of the economy and the implied potential revenues. Second, there is virtually no focus on taxpayer services. The TARC report observes that the taxpayers express helplessness against rude or arbitrary behaviour of officers with little accountability in practice. The third aspect is the archaic and inefficient organisation of the tax department.
In modern tax jurisdictions, the goal of tax administration is not to maximise revenue but to minimise compliance gaps and maximise voluntary compliance. Revenue officers are under pressure to meet the revenue targets even if not sustainable. Blind revenue targets cause unjust pressure on good taxpayers. They have an adverse impact on tax officer equilibrium. Tax refunds are routinely delayed on the pretext of seeking more information to confirm their validity. Even transfer pricing (TP) measures are used for revenue generation.
To make matters worse, defective formulation and implementation of tax laws and rules become revenue raising instruments. Retrospective tax amendments introduced in the 2012 Budget of Pranab Mukherjee are an example of such defective policy formulation, which have caused so much harm to the economy and stained India's image around the world.
Focus on revenue targets is like putting your hand in the cookie jar. If you grab too many cookies, the large fist will not allow you to pull out any. However, if you clench a few between your fingers, it is feasible to enjoy them.
Too many high-pitched tax demands (the large-fist approach) only lead to disputes, which block revenues and discourage voluntary compliance. A good example is TP. India has acquired the dubious distinction of having the largest number of TP disputes. As many as 4,000 TP cases are being contested in the courts in India. By contrast, TP litigation in most advanced jurisdictions is a rarity. In places such as the UK and Japan, only one or two cases in a year reach the court level.
Taxpayers can share numerous instances of the lack of customer focus of the tax department. For example, recently, a taxpayer declared interest income of Rs 2,59,032, but by oversight was short of the actual amount by Rs 589. The taxpayer received a notice from the tax department, accusing him of "concealing" income worth the amount, and threatening punitive action if further information was not provided. This reflects the ruthless attitude of the authorities. The report provides other examples, including those of taxpayers made to wait many hours for meetings with officials, CEOs of the companies being asked to appear when CFOs or accounts official would suffice and the likes.
The department has a mission/vision statement, but it is more of a lip service to the taxpayers. For instance, it promises timely refunds, but TARC confirms that instructions are given from the top to slow down the refunds in the last quarter of the financial year.
The current structure of tax administration has two boards for direct and indirect taxes, headed by the revenue secretary. It is very seldom that the revenue secretary will have the technical skills of tax policy or tax administration. His tenure is not long enough to acquire these skills. TARC recommends that the position of revenue secretary be abolished. The segregation of tax administration in two silos should be broken. There is a lack of coherence in policymaking and enforcement by the two departments. Even within each department, non-sharing of information leads to inefficiencies. For instance, the audit of Cenvat and service tax is not co-ordinated currently.
TARC calls for the formation of a tax council, responsible for tax policy and analysis, and drafting of tax laws. Tax administration would then focus on minimising compliance gaps, without contorting interpretation of tax laws or adopting policies just to maximise revenues. Revenue goals and projections would be the responsibility of the tax council. The goal of the tax department should be to collect the taxes due efficiently with least cost of compliance and administration.
The TARC report has come out at the right time. A new government with a new mandate and thinking should consider the recommendations with a fresh eye. The report provides a complete blueprint to make the tax administration less adversarial, stripped of tax terrorism. The changes will be applauded by taxpayers, encourage voluntary compliance, and make the tax administration more productive and effective.