Make corporate and capital gains taxes more progressive and double their ceilings.

The ongoing Covid-19 crisis has catalysed broad public support across nations for imposing levies on high earners. Though nobody likes higher taxes, the severity and rapid spread of the pandemic has, seemingly, made several sections of the wealthy more willing to assume greater responsibility for the welfare of the community at large. Combine this sentiment change with a desperate need for higher public spending, and it is now up to those in authority to successfully tap it. It calls for a carefully crafted, and easily executable plan that metes out fair treatment to all.
In the Indian context, efforts have been in the works for a while for evolving an iteration to effect the periodic movements of taxes. A Direct Tax Code, 2009 for the following five years was one such outcome. The change in Union Government in 2014 brought back the earlier practice of ad-hoc annual changes. However, in 2017, an expert group was tasked with suggesting a future course on a more definitive basis and altogether rewrite the extant Income Tax Act, 1961. The taskforce with Akhilesh Ranjan, a CBDT member as its convenor, drew up the Direct Taxes Code, 2019 and a draft of the new Income Tax legislation. For reasons not shared, the Government took a call to put it away without making the findings public, instead of acting upon the recommendations.
In addition to settling on a medium term path to act on, immediate equity considerations warrant making the rate differential wider between those who are just about eligible to pay personal income tax and those in the top rung. At present, on annual taxable income exceeding Rs 2.5 lakh and up to Rs 5 lakh, earners pay a 5% tax. It may be desirable to double the exemption limit to Rs 5 lakh, without insisting upon contributions for small savings, PF and insurance etc. The pandemic has broken the backs of many in this category and notable relief for this section is warranted. On the other hand, while retaining the prevailing slab rates for those with taxable incomes up to Rs 1 crore at 30%, it is time to consider higher slabs going up to 60% for income beyond this level. A potential framework would increase slab rates by 10% for every additional crore of taxable income, with the maximum rate being reached at Rs 4 crore. The prevalent surcharges up to 37% of the basic tax, and a further 4% education cum health cess, may altogether be dispensed while streamlining the structure.
As opposed to being kept nearly at a flat rate, the corporate taxation system must be made progressive, similar to the personal income tax structure.
Firms with larger profits must be distinguished from those just about able to make ends meet in their businesses. Furthermore, there is little justification to keep a differential rate between foreign and domestic companies. The existing 30% tax rate should be kept in place only for those entities which have a taxable profit below Rs 1 crore. As profits rise beyond that, a 5% increase in rates for every Rs 10 crore should be considered, with a ceiling rate of 40%; a level reached at Rs 21 crore in profits.
The 25% special tax rate for firms not claiming any sort of exemption and the 15% special tax rate for green field manufacturing facilities, both introduced wef 1 January 2019 can go. In addition, the turnover criteria between firms below and above Rs 400 crore may be done away with. The surcharges and cesses on any kind of corporate taxation need not remain in the revised structure. Such a move would introduce the much-warranted progression in corporate taxation. The allowances for investment and depreciation admissible would need tweaking to ensure that over time, the two combined do not exceed 100% of the value of the assets created.
While streamlining the corporate taxation, the scope of employment allowance which is tax exempted to businesses needs to be widened. It needs to be made admissible even for contract workers. Such a workforce is especially prevalent in manufacturing and most service industries, and there are several businesses where contract workers now outnumber the regular ones. Furthermore, expenditure incurred by employers on engaging apprentices and on skill upgradation of all workers may also be included.
We should also recognise that the experiment with a wealth tax has almost universally been unsuccessful, with only half a dozen smaller European countries currently having it. There is need to be circumspect about reintroducing it in India so soon after it was done away with in 2015. While the ostensible reason cited then was meagre collections, inadequacy in data collected on assesses’ assets (till recently income tax returns did not have columns for details of real estate assets, gold bonds or stocks) and limited ways and means for tax authorities to verify the position on the ground, were also no doubt responsible. Equally important was the reality that on many an occasion, the eligible asset holder did not have the liquidity to pay the wealth tax as there had been no recent transactions in these.
From both an administrative purpose as well as from the tax payers’ convenience point of view, it is desirable to attempt to achieve the same goals through amending the extant capital gains scheme. At present, the long-term capital gains tax rate viz. where real estate and gold bonds assets have been held for more than three years and equity and mutual funds for over a year, is 20% of the time-indexed gains. In case of shorter term gains, the applicable personal income tax slab rate holds. While retaining the current broad scheme of capital gains, long term capital gains too need to move away from a flat rate to a more progressive structure, just as existing personal income tax rates and the proposed corporate structure above. Slab rates should be linked to the quantum of capital gains realised during the assessment year, with the minimum rate being the existing 20%. Tax slabs beyond Rs 20 crore of gains may be increased by 5% for every additional Rs 10 crore gain, till reaching the highest slab rate of 40%, which would become applicable to long term gains exceeding Rs 60 crore.
A capital gains levy, unlike the concept of a wealth tax, does not make holding wealth per se taxable since it applies only when net of time-indexation, profits are realised from a sale. Giving it a progressive character would make it equitable, as well lend itself to administrative convenience since eligible gains are realised through receipt of cheques and other bank instruments, as well tax returns necessarily reflecting gains on the sale of assets. With banks, stock exchanges, and deed sub-registrars now linked digitally to the tax office, it is no longer easy to conceal a transaction of monetary significance.
Another area of change which a revised capital gains scheme must address is adding provisions to entice wealthy Indians to gift assets and property to charity during their lifetime to avoid large capital gains tax bills. Without a cap being imposed on the various itemised deductions for high earners, a proposal to that end would incentivise the wealthy and their heirs to give away assets that appreciate over time to non profit organisations.
Introducing a slab system, along with doubling the maximum rates for corporate and capital gains, as well as for personal income tax rates, would clearly link taxation to an ability to pay amongst taxpayers. Doing away with complicated existing surcharges and cesses would simultaneously improve adherence and serve the urgent requirement to significantly increase inflows into the pool of taxes shareable with the states. Such fairness to the states would also facilitate their coming on board to include the excluded items such as petrol, diesel and natural gas into the GST regime.
The restructure of tax rates by way of introducing the new slab-rates should be done over a defined time-period and not entirely effected in one stroke. The process could begin in the next Union Budget with the stepping up of rates being limited to adding one additional slab every year, with the proposed ceiling rates in the above three taxes attained over two to four years.
Since four new slabs are proposed to be introduced in the income tax rates, moving up annually by 10% from the existing 30% to 60% would take three years, while corporate tax rates would move up from 30% to 40% in two years, given only two slab rates of 5% each would get added. The capital gains escalation from 20% to 40% would take 4 years as each slab rate-differential is 5%. While their impact would be staggered, the entire set of proposals should, however, be announced at one go to make the process transparent and predictable for all stakeholders. This would also give the impacted assessees the requisite space and time to prepare for higher outgoings, and provide ample notice to adjust business plans. The removal of surcharges and cesses would also have to be calibrated, with their complete removal coinciding with the maximum rate being reached.
While any substantive tax increase plan would need to be pitched with zeal by Prime Minister Narendra Modi himself, the fair treatment of all, including targeted payers, will have to form the hallmark of the programme. While the suggested changes outlined here will be a meaningful change, such a move has parallels with the prevailing western tax thinking, especially in the US, where endeavours are under way for several upward revisions to finance programs for “building back better” post the pandemic. Undoubtedly, every country is unique with national governments making changes according to their own circumstances and ground realities. However, understanding what has and hasn’t worked elsewhere, and aligning with the global thinking on progressiveness in taxation, can be valuable as India reforms its own tax-system.
Dr Ajay Dua, a development economist and a public policy expert, is a former Union Secretary.