Cannons of Taxation

Cannons of Taxation

The noted 18th century English economist, Adam Smith, had enunciated the cannons of taxation in his much acclaimed book “An Inquiry into the Nature and Causes of the Wealth of Nations” which was popularly called as “Wealth of Nations”. According to Smith there are four basic cannons of taxation, which are based on the concepts of equality, certainty, convenience and economy.

1. Is should be Equitable – It means equal treatment of similarly situated taxpayers. The equity is horizontal and vertical. Horizontal equity - all purchasers of the same equity pay the same tax. Vertical equity: unequally situated taxpayers being taxed on their ability to pay as per progressive taxation philosophies.

He says: 'The subjects of every state ought to contribute towards the support of the government as nearly as possible in proportion to their respective abilities that is in proportion to the revenue which they respectively enjoy under the protection of the state.' This canon embodies the principle of equity or justice and lays down the moral foundation of the tax system. 'It is not unreasonable that the rich should contribute to the public expense not only in proportion to their revenue but something more than that proportion,' Smith had written in his Wealth of Nations. Thus, tax should in proportion to the ability to pay.

2. It should be Convenient – a tax should be readily and easily assessed, collected, and administered.

The cannon of convenience states that every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.

3. It should be Certain – the consistency & stability in the prediction of taxpayers' bills and the amount of revenue collected over time.

The canon of certainty is highlighted in the following statement by Smith: "The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought all to be clear and plain to the contributor and to every other person. Where it is otherwise, every person subject to tax is put, more or less, in the power of tax-gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of each aggravation, some present or perquisite to himself." Certainty is needed not only from the point of view of the tax payer but also from that of state.

4. It should be Economical – compliance and administration of a tax should be minimal in terms of cost.

Finally the cannon of economy dictates that every tax ought to be so contrived as both to take out and to keep out of the pocket of the people as little as possible, over and above what it brings into the public treasury of the state.

He also propagated three additional criteria:

1. Adequacy - a tax should have the ability to produce a sufficient and desired amount of revenue to the taxing authority.

2. Achievement of social and economic effects - the use of taxes to reallocate resources to achieve various specific social and economic objectives.

3. Neutrality - a tax should not encourage inefficient allocation of resources by being so extreme that taxpayers make counterproductive economic decisions.

Some later economists subsequently added a few more canons to Smith's four described above. Among these are: elasticity, flexibility, simplicity and diversity.

If we try to weigh the taxation practices in India in the balance of Adam Smith’s above cannons, we may perhaps see we are moving in the opposite direction of Adam Smith. In India, where rich escape from paying taxes by hook or crook, the les privileged is forced to shoulder the burden of nation building. In many cases, the ability to pay taxes is inversely proportional to the tax they actually pay!

The convenience, consistency, stability, certainty etc. are words unknown to the authorities. Taxation statutes are seemed to be high school laboratories where the mandarins of the south blocks learn the art of ‘Tinkering’.

If you look at the economy, we see crores spend to collect lakhs. On the other side, Government is collecting easy money in the form of taxes like FBT, Dividend Tax etc.

Our ancient Economist and Philosopher “Kautilya” wrote in ‘Arthasasthra’ that the collection of taxes from the people should be like a bee collecting honey from a flower without disturbing the flower.

Wishful thinking in India, isn’t it?

Rajat Tulli and Rahul Anand of the Delhi-based Happily Unmarried hawks gift goodies across states. They’ve been at it for six years now but still dread the three-letter ‘TAX’ word. And here’s proof—‘Taxes Must Be Simple’—that’s the high-hanging plaque hugging the low-faux ceiling of their Okhla office, with no strings attached.

“Our biggest problem is Form ‘C’, which is issued by the Sales tax Department to all traders that in turn need to be handed over to anyone they buy their stocks from,” says Tulli. “It’s impossible to lay your hand on Form ‘C’ without bribing. Transparency is a joke in the Sales Tax Department,” he smirks. His disdain is valid. Taxation laws in India were meant to be followed, not understood. If you run a small business in India, you probably agree whole-heartedly with the above statement.

For any business, big or small, ensuring tax compliance is a major challenge. Old taxation thresholds have not been revised in decades and wars continued to be waged in court over several conflicting and opaque provisions in the law. Nitin Shingala, managing director, TMF Services India Private Limited puts tax audits on top of his list. “Tax audits are a hassle for professionals and emerging companies today. Under Section 44 of the Income Tax Act, professionals with gross receipts of Rs 10 lakh annually and businesses with gross receipts of Rs 40 lakh annually, have to get a tax audit done every year by a chartered accountant. These limits were fixed in 1994 by the government and have not been revised since, which has resulted in major headaches for the small entrepreneur,” says Shingala. The counter-argument here is that smaller companies aren’t conscientious about maintaining their books of accounts, and compulsory tax audits force them to do so. “But when the Government has embarked on a ‘trust the taxpayer’ regime, is this still relevant?” Shingala questions.

Hiring a foreign architect to landscape your office? You have to contend with our service tax laws. Today, the government has identified over 100 services that are liable to pay ST, which is charged at an effective rate of 12.36%. The biggest complaint here is that there isn’t enough clarity among the services listed, which leads to confusion. Take, for example, a small company that engages the services of a foreign architect to landscape its office. If the architect had been Indian, he would be paying 12.36% as ST to the government. But in case of one who is a foreign resident, the company has to bear the brunt of ST. Not just that, for tax purposes, the company has to register with the Service Tax Authority under the category of ‘Architect’ before making the payment. This is true for most foreign resident professionals hired by Indian companies. Silly? Its true! According to Section 10A of the Income Tax Act, new undertakings in a free trade zone are eligible for various concessions.

The Delhi-based chartered accountant firm Jaikumar Tejwani & Co’s CEO Jaikumar Tejwani says, “However, seeking exemption by the government is a challenge for a manufacturing unit setting up a plant in an SEZ because the government mechanism is still not in place and it’s not easy to derive tax benefits for novice enterprises in an SEZ.” Similarly, there are many issues related to tax deducted at source, fringe benefit tax, dividend distribution tax which make achieving compliance an extremely tricky proposition. Messy compliance rules are not good for any business that is still in the initial growth phase. Wading through the ponderous formalities involved costs valuable time and energy, which would be better invested in the core business. Shingala recalls, “Our firm recently handled compliance for a Singapore-based firm. The rules were so clear that I only had to visit the company a couple of times a month; the rest of it was done by me right here in Mumbai.” Startups that are venture-funded are often handheld through the initial compliance stages. Says Pravin Gandhi, managing partner of Seed Fund, “We need to make sure that there is sufficient awareness about tax issues. If there is no internal expertise in the form of a CFO or legal team, we connect the company to a third party firm that will help them get over tax compliance related challenges.”

It all stems from inadequate or inaccurate domain knowledge of the promoters. “When you’re a startup, you have less domain knowledge owing to inexperience, and tax consultants and authorities exploit this ignorance of newcomers,” contends Anil Bhardwaj, secretary-general of Federation of Indian Micro and Small & Medium Enterprises (Fisme). Take the case of Ranjan Roy of the Rs 6-crore Mumbai-based Aeon Medical. Though he’s been into the business for two years now, he fears the tax framework so much that he goes out of his way to comply with the statutory requirements. “To stay away from trouble, we pay advance tax at the cost of profitability,” he says. And like many others, Aeon is not in a position to afford tax consultants. “The corporate tax rules for large and small companies should be different because their needs and aspirations are different,” he emphasizes.

A small entity has to meet several compliances in the course of its business in India. Some of such compliances are laid out under Income Tax Act, 1961. Now for the law: An entity carrying on business or profession whose total sales, turnover or gross receipts are, or is likely to exceed Rs 5,00,000 in any previous year and who has not been allotted any permanent account number (PAN), is obliged to obtain a PAN. Then, an assessee is liable to withhold taxes at specified rates from specified payments, which it has to make and deposit with the authorities within a prescribed time period. “The entity is required to maintain details regarding name, address and PAN of the payee and issue the certificate for such payments and also file detailed returns periodically about these payments, which take a lot of time and adds to the operating cost of the entity,” says FoxMandal Little’s tax consultant Ajay Gupta. The entity is also required to file an annual income-tax return, along with detailed financial statements and several other annexures. This takes a lot of time to fill up as all the financial figures and other details have to be filled in a prescribed format. Fringe benefits, as outlined in Section 115WB of the Income-tax Act, 1961 (“IT Act”), means any privilege, service, facility or amenity, directly or indirectly provided by an employer to his employees (including former employees) by reason of their employment. They also include reimbursements made by the employer, either directly or indirectly, to the employees for any purpose, contributions by the employer to an approved superannuation fund etc. The employer is liable to pay tax at the rate of 30% on a notional value of 5%, 20 % or 50% of the expenses incurred for the aforesaid purposes. “This tax is actually a hardship on the company as the expenses which could otherwise be claimed as deduction from profits, becomes chargeable to the fringe benefit tax. The entity is also required to maintain a detailed record of these calculations, and at times, the compliance cost is more than the amount of revenue it generates for the government,” says Gupta.

A business, whose total turnover for the accounting year or years relevant to the assessment year exceed Rs 40 lakh, is required to get his accounts compulsorily audited by a chartered accountant. This is in addition to the statutory audit or any other audit that might have been conducted for the company. Besides, availing of credit as such becomes difficult if the credit of services rendered and availed of are in different periods. Service Tax assessees are required to file a half-yearly return in Form ST-3 or ST-3a in triplicate to the Superintendent, Central Excise, dealing with Service Tax work. The return is to be filed within 25 days from the last day of the half-year it relates to and should be accompanied by copies of all T.R.6 challans issued in the half-year. Phew, and if that weren’t enough, assessees filing returns for the first time are also required to furnish to the department a list of all the accounts maintained by them relating to Service Tax. With such hard nettles to grasp, consider the US-returned Yogesh Bansal’s newbie social networking site ApnaCircle.com. A year into the trade, and he’s thrown in the towel bamboozled by the country’s gargantuan tax structure. “Tax laws in India are hazy and the time consumed on tax compliance here creates further barricades to business.” That’s when the flat ornamental tablet with the ‘Taxes Must Be Simple’ message at Happily Unmarried suddenly starts sinking in.

Source: ET

Multipicity of Statutes - a common man's nightmare

India is known for its cumbersome, complicated and multiple enactments which can be deciphered and interpreted by an expert only. For an ordinary business man who want to set up a small business will find time only to deal with various statutory formalities, rather than doing business. He has to get his company registered, if he go in for a incorporated body structure. Or he has to draft a partnership deed if he enters into a partnership. Then comes the list of statutory formalities to be complied with:

1. License from local authority
2. License under Shops & Establishment Act
3. PAN
4. TAN, if he is going to deduct tax
5. IE Code, if he going to import or export
6. Central Excise Registration, if he is manufacturing something
7. Service Tax Registration, if he is providing any service out of 100 and odd specified services
8. VAT Registration
9. CST Registration
10. Industrial License
11. Factories & Boilers Registration
12. Package Commodities Act - Registration
13. Standard Weights & Measures Act - Registration and stamping of all measuring apparatuses
14. License under Prevention of Food Adulteration Act, if you deal in any food items
15. If you sell any insecticides and pesticides, get a license for that
16. If you sell any kind of OTC medicines, get a license
17. PF
18. ESI
19. Labour Welfare Fund
20. Minimum Wages Act
21. Payment of Gratuity Act
22. Payment of Bonus Act
23. Contract Labour Abolition Act
24. Payment of Wages Act
25. Maternity Benefits Act
26. Industrial Establishments (National & Festival Holidays) Act

These are the list of statutes coming into mind. But actual compliance requirements are in fact more. All these statutes require maintenance of specific registers and records, which are in most of the case duplication of work. The same data has to be recorded in more than one registers to satisfy different statutes.

In many cases, still, maintenance of registers in electronic mode is not permitted.

Intricacies and interpretation of individual statutes and resulting confusion and chaos can not be explained here. It has to be experienced!

Over the top of all, the bureaucracy and the inspection raj and related extra legal affairs!

If you want to do business amidst this, even god cannot save you from bankrupsy!

MY FIRST POST

Hi

I am James Antony, a Chartered Accountant (Certified Public Accountant) from Cochin, India. This blog is dedicated to the discussion on taxation laws in India.

India is known for its cumbersome, complicated and multiple enactments which can be deciphered and interpreted by an expert only. Even experts find it difficult too!

We have in India, there are two types of taxation, mainly. One is Direct Taxes and Indirect Taxes. There can be another classification - Federal taxes and State Taxes.

Direct Taxes

Main taxes coming under direct taxes are Income Tax, Wealth Tax (Federal Taxes) and Agricultural Income Tax ( State Tax)

Indirect Taxes

Under the indirect taxes, there comes Central Excise, Customs, Service Tax (Federal Taxes) and Value Added Tax (State tax).

There are a lot of other taxes also, but the incidence to them are small and hence I am not elaborating on it more.

(Any comments, querries and suggestions welcome)

James Antony FCA