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The taxpayer community and the public at large hope that the government would announce some bold policy initiatives to further rationalise the direct tax regime in the upcoming Budget and take initiatives to leave more money in the hands of the common taxpayer.
The government recently reduced the corporate tax rates for domestic companies, to bring the tax rates on a par with competing economies. The move came as a welcome surprise to India Inc. and has fuelled expectations from the upcoming Union budget 2020. The taxpayer community and the public at large now hope that the government would announce some bold policy initiatives to further rationalise the direct tax regime in the upcoming Budget and take initiatives to leave more money in the hands of the common taxpayer.
While the expectations are at an all-time high, it is also a matter of fact that the government must keep an eye on the fiscal deficit to allay fears of global investors and the rating agencies. Nevertheless, with a strong political mandate and the current economic slowdown, some of the below tax initiatives, if announced in the budget, would boost the confidence of investors and spur growth in the economy.
With the unprecedented corporate tax rate cut, the government has addressed issues pertaining to supply-side. The government should now shift its focus on demand side constraints and take measures to boost consumption.
It is pertinent to note that the savings rate in the country has declined in the recent past. This could eventually become a cause of concern in near future, as India looks for various sources to fund its huge infrastructure requirements and capital investments. According to the 2019 Economic Survey, gross household savings have contracted to 17.2% of GDP in 2017-18 from 23.6% of GDP in 2011-12.
Therefore, increasing the existing tax slab rates applicable to individual taxpayers or reduction in the tax rates in each slab or a combination of both would go a long way in increasing the disposable income in the hands of individuals thereby encouraging consumption and savings in the economy.
It should be noted here that the slab rates were last changed in 2014 when the current government presented its first budget. Since then, there has not been any major change in these limits, except for introduction of tax rebate to resident individual taxpayer having total income up to ₹5 lakh.
An interesting point to note here is that according to media reports, even the recently constituted Direct Tax Code (DTC) Task Force recommended sweeping changes to income tax rates applicable to individual taxpayers.
Therefore, it may be an opportune time to reconsider the tax slabs on the following lines:
Less than ₹2.5 lakh: NIL
₹2.5 - 10 lakh: 10%*
₹10 - 20 lakh: 20%
₹20 lakh - ₹2 crore: 30%
Above ₹2 crore: 35%
*With full rebate up to ₹5 lakh
According to certain studies, in relation to the assessment year 2018-19 (financial year 2017-18), enhancing the base slab to ₹1 lakh would positively impact approximately 27% of the total individuals who file income-tax returns(ITRs), having a total income of approximately ₹10 trillion.
Thus, the government may consider amending the tax slab which would benefit large population of taxpayers. Any relative short-term impact of tax foregone as a result of these announcements, is likely to be offset by increase in tax compliance and the availability of funds for more savings and investments, which in turn would generate more income and more taxes in future.
According to the current tax regime, an Indian company is required to pay dividend distribution tax (DDT) of 21.17% on declaration payment of dividends. This DDT is an additional income tax collected from the company over and over the corporate income tax. Thus, while the corporate tax rate is only 25.17% (after including surcharge and cess), and even lower in case of new manufacturing companies, the effective tax rate goes up to 41% after including DDT in case of a company having a 100% dividend payout ratio.
This can be explained with the help of the following example:
Suppose a company has a profit before tax of ₹100 crore:
Profit before tax: ₹100 crore
Corporate tax (A): ₹25.17 crore
Profit after tax: ₹74.83 crore
DDT (B) ₹15.84 crore
Total tax (A) + (B) ₹41.01 crore
Another point that merits consideration is that the dividend received is exempt from tax in the hands of shareholder if the same does not exceed ₹10 lakh. If the dividend income exceeds ₹10 lakh, an individual taxpayer is also required to pay additional income tax at the rate of 10% on such excess dividend. This further compounds the overall tax burden, in the hands of the shareholder.
Additionally, since DDT is levied as an additional income-tax in the hands of company, there is a debate if the same can be claimed as a credit by a non-resident investor under the domestic law of its home country. Failure to claim the credit ultimately results in a higher tax cost for a foreign shareholder.
To overcome these issues, the government may abolish DDT in the forthcoming budget. Instead, it may introduce taxation of dividend in the hands of shareholders directly i.e. the classical system of taxation of dividends. This would not only remove double taxation for resident shareholders, but also allow foreign shareholders to claim treaty benefit.
Further, as the corporate income is already taxed in the hands of the company, and the dividends are distributed from post-tax profits, the effective tax rate on dividends should also be brought down, to say 10%. This would encourage companies to distribute dividends which would further add to the tax kitty.
The government, vide Finance Act 2018, introduced capital gain tax at the rate of 10% on sale of long term (held for more than one year) listed equity shares and equity oriented mutual funds if the gains exceeded ₹1 lakh. These long-term capital gains (LTCG) were earlier exempt from tax.
In line with its objective of making India an attractive investment destination, the government should re-consider the LTCG tax on listed equities. To this end, the government may consider increasing the minimum holding period requirement for qualifying as a long-term capital asset from the current one year to say two or three years to ensure that funds remain in the system for a relatively longer time.
If there is one section in the Income tax Act, that most individual taxpayers know and benefit; then it is section 80C tax deduction. Under this provision, a taxpayer is allowed a deduction from his total income of up to ₹1.5 lakh.
The provision covers various items of expenditures and investments such as expense towards school tuition fees, life insurance premium, contribution to a provident fund, pension fund.
This particular provision may be rationalised to encourage and boost investment in the economy.
Accordingly, section 80C should be pruned to allow for deduction only in respect of investments made by a taxpayer. Further, the existing limit of ₹1.5 lakh should be increased to at least ₹2.5 lakh.
Alternatively, a separate provision allowing tax deduction of up to ₹1 lakh may be introduced for investments into long term infrastructure projects, capital and bond market etc. This would stimulate private investment into the economy through alternative sources of investment vehicles for long-term investment requirements of the economy.
It is a tight rope walk for the government to meet demands of different stakeholders and to manage fiscal deficit. Some bold policy announcements, relief to the common man, additional dosage of relief to the corporate world, with some leeway on the fiscal deficit with an honest commitment to set the path right once the economy recovers, should do the magic to make the forthcoming budget a memorable one that can help India steer towards a $5 trillion economy.
This article was also featured in Livemint, 24 January 2020.
