India should experiment with higher tax rates: Shome

Any tax economist in terms of corporate decision making would like the headline rate to be reduced so that the incentives can also be reduced. That is, you amplify the base and then you setup rules for anti-avoidance, says Parthasarathi Shome, advisor to finance minister.

"So, you get the proper base that you can apply, and that is what we would like," he says. However, finally there has to be some broad understanding of revenue implications. For example in the last Budget, because of the overall situation, we still had to have a surcharge over a certain amount of profits in the case of corporations, he adds.   The finance minister said that the government would be able to rationalise some of the rates also. But there could be an issue of revenue productivity. "It also would depend if the number of tax-payers on the individual side can be expanded." About taxing the super-rich, he says that a country like ours, with extreme scales of distribution of income should not shy away from experimenting with some higher rates. Here is the edited transcript of his interview with CNBC-TV18 Q: You have been working very closely with the direct tax code (DTC). You were in fact one of the original architect of this first draft. How much of the original spirit of the DTC do you think can be brought back to this second draft because a lot of people say that the current draft is a very pale version of what was originally envisioned? A: What I can honestly say is that the draft that we are working on is the 2010 draft. Given that the parliamentary committee on finance is given very copious comments on this draft, we are addressing first and foremost their comments to see what can be incorporated and where we have what kind of comments. In the process, we are also looking at the possibility of enhancing some of the aspects over and above the parliamentary committee. This is being done under the direct guidance of the finance minister who is taking the meetings. He has asked me to look into it carefully so the work proceeding accordingly. Q: Some of the recommendations of the standing committee are in line with what you had originally proposed, take tax slabs for instance. Originally broad tax slabs have been proposed, they have been narrowed now, but the standing committee has recommended liberalising them. Do you see the fiscal space in this macro economic environment to liberalise tax slabs in the final draft? A: This issue can be looked at in different ways. First and foremost, the tax rates in the slabs, it’s a good idea to set it to begin with in the DTC. Remember, the code is really Gita of taxation. Therefore one can do that. However, every finance minister I would like to presume would want to kind of give and touch upon his or her own view on the rates and the slabs. So you cannot set it in stone in a DTC. However, I think at the same time for example, we do have the highest marginal rate if you look at 30 percent, even every high income comparable to the highest incomes globally and in very few countries other than Singapore you have a rate such as 30 percent. So we have some things in the rate structure also that I feel should look into. Those I think finally the finance minister given the comments from the committee will decide because they can be decided not looking at it in code terms but in terms of what is best for the country in terms of incentives and the overall scenario at the moment. I don’t think that can be set in stone. But, it is also true that our ranges are relatively narrow at the moment. Remember, given our tax payer profile, we do have to cover many tax payers within a relatively narrow range of taxable incomes. That is why our tax slabs are that narrow. But since they were set by this finance minister some years ago, incomes have grown considerably. That would imply that there is some space for expansion but I don’t think that is the kind of issue that should necessarily be the consent of a DTC. I am not saying that it will not be done this month but even if it is, I am saying that will change over time. For example, there is one idea, why don’t you make your slabs move with inflation. Q: That’s something that the standing committee has also proposed, the mechanism based on consumer price index. A: Yes. The issue of course there is that’s an idea because otherwise what sometimes happens is that just because of inflation you are dragged up to a higher income tax rates bracket and pay even though your real income is the same. To set again a inflation indexed income tax rate means in a way that even when incomes are growing very fast, you would have to think twice before you increase rates or when your incomes are in a trough that you reduce your rates because all your are really concerned about primarily in such instances is that are you covered for inflation. So that’s why some tax economists don’t like the idea purely of inflation indexing. Q: Do you see this idea being accepted going forward? A: We have discussed this with finance minister. Let’s see how we come out. Q: You have spoken about incomes that are not captured in higher incomes. We have seen a tax on super-rich this year. Do you see the justification for another tax slab above 30 percent to capture those high incomes? A: I would say that while 90 percent, 70 percent, 60 percent rates are very high and are disincentive generating the UK has experimented currently with 50 percent. I don’t think in a country like ours with such extreme scale of distribution of income that we should shy away from really experimenting with some higher rates. _PAGEBREAK_ Q: So are you talking about a 50 percent rate on the super rich? They are not going to like you very much. A: No. Tax researchers are not necessarily universally liked. So we have to have other aspects about ourselves that might be liked. Q: Is this seriously being considered, a higher tax rate for the super-rich? A: No, those are the kind of things that the committee has recommended in great detail in their part one of comments. Then they have specific comments in their part two which are more what I would say are the direct tax code components. So, we are also looking at part one at the moment and finally the finance minister will think over it. I am sure he will discuss with Prime Minister and maybe some of his cabinet colleagues. But yes he is discussing that with at the moment. Q: Do you see a reduction in corporate tax and perhaps a reduction also in the number of exemptions that are given? A: Certainly rationalisation of exemptions is a major part of 2010 and 2009 as well and the parliamentary committee's comments that will certainly be mainstay of the concreteness of the reforms that we proposed today. Q: Will that translate into a lower corporate tax rate? A: Any tax economist in terms of corporate decision making would like the headline rate to be reduced so that the incentives can also be reduced i.e. you amplify the base and then you setup rules for anti avoidance. So, you get the proper base that you can apply, that is what we would like. However, finally there has to be some broad understanding of the revenue implications. For example in the last Budget because of the overall situation we still had to have a surcharge over a certain amount of profits in the case of corporations. So, hopefully and finance minister said it would be for a year. So, hopefully we would be able to rationalise some of the rates also, let's see but there is a revenue productivity issue. It also would depend for example if the number of tax payers on the individual side can be expanded because we do know that there is a potential for expansion of that base. So, if all of that – how it works out, how the administration can expand the base would also reflect on the corporate side. Q: One of the other key areas that the Standing Committee has spoken about is the securities transaction tax (STT). We have seen that being reduced over the years and there is a demand for it to be abolished under the Direct Tax Code (DTC) which is also something you had proposed in the first round. Do you see the space for that happening this time? A: If you recall in the last Budget what the finance minister did was to bring it down. It is a slight distortion but for STT paid there are a lot of other tax aspects that are based on that STT paid element, for example the short-term capital gains tax. So, it is also like a monitor that you are on the exchange – you pay the tax when you are doing that – so mainly it has been brought down to 0.01 for all the – and that has been kind of homogenised with the commodity transactions tax because we found 99 percent of commodities were not being delivered and they were non-delivery based. So, they were quite speculative so they were equalised in a way, the tax rates also. So I don’t think at the moment that we can remove the STT simply because some of the other aspects of taxation are based on the STT being kind of there. So, only those at a paid STT are paying some other taxes or not paying some of the taxes. Q: The finance minister said often enough in the recent past that foreign investment is no longer a choice but an economic imperative. There were some features of DTC that had caused concern to foreign investors for instance the controlled foreign corporation (CFC) provisions, the general anti avoidance rule (GAAR) provisions. Now, on GAAR with your report there has been clarity but provisions such as the CFC do you think in the current macro economic environment there is a need dilute these? A: CFC is a provision which several advanced countries have introduced. UK recently after long deliberations, over three years or longer has introduced CFC. Given that we do have foreign subsidiaries of our own Indian companies increasingly as foreign investment is flowing out, which is fine. We do need to have a kind of a long arm to reach and to see and examine what these relationships are, whether they are artificially constructed, whether dividends are in the right manner being repatriated to India or not and to have a kind of a neutral base with those who are doing this in the right way and those who are not. So, I do think that we need CFC however at the same time it is very clear that we should have a kind of neutral regime. It should not be a roving search for what kind of links you have and so on and so forth. So, that is another area where finance minister is going through with fine tooth comb as to what are the CFC rules that we would have. Q: On international transactions, M&A transactions more clarity, slight dilution in the stringent norms? A: I would not say necessarily dilution, wherever the norms stringent or not were not clear. What I think he is trying to do is to put in that clarity so that the interpretation would be clear and the investors would be able to take the investment decision under more clear kind of set of principles and application. Q: Do you see the DTC being introduced in the monsoon session of Parliament and if that is the case by when do you see an actual implementation of the DTC? A: The finance minister has indicated very recently that he will introduce it in the monsoon session. I can only tell you that we are working very hard with him and he is also working very hard on the matter. _PAGEBREAK_ Q: The countries largest indirect tax reform is the goods and services tax (GST). Much to everybody's surprise the Prime Minister said in Japan that it would be up to the next government to introduce GST, while the finance minister had been saying there was a strong chance for the GST to be introduced soon enough. At what point did the negotiations with states breakdown because the finance ministry had given the signal of providing central sales tax (CST) compensation in the Budget and what we saw from outside was a building of consensus? A: I think it is not an issue of the negotiations breaking down at all. There was such a huge breach –how much of the breach have you closed is the issue. One breach is ofcourse the matter of revenue loss compensation. The other is still remaining structural issues. On the revenue matter it is basically the outlook of the states at the moment. Finance minister had already allocated almost Rs 9400 crore to compensate them for the remaining amount of 2010-11 and had indicated then after that we will also compensate for CST. However there was an expectation that states would also move forward with the Constitutional Bill and passing the value added tax (VAT) Acts in their states. As they do that this compensation will be rolled out, but simply the exigency of time is such that it will not be finished. So, during this period I think some of the other matters that is also the remaining structural issues, matters of the constitutional amendment and the VAT Acts of the different states being passed. Originally the idea was there will be only Act in parliament then the states wanted own VAT and the finance minister agreed. So that process has to be gone through. The exigency of time will likely take us beyond – ofcourse the states could sort of intensify the process. However, I think Prime Minister must have been looking at all these different possibilities as to how much time all of this would take. Q: One of the basic oppositions to the GST from the state side stems from the fact that it does impact their fiscal autonomy. That is a right that they do not want to give up. The second is the political opposition. So, if you look at the states who are opposing it – states such as Gujarat and Madhya Pradesh who are most vocal in their opposition and they happen to be Bharatiya Janata Party (BJP) ruled states. Do you think any government will be able to overcome this political opposition and do you think that the concern of fiscal autonomy can be addressed because that is inherently opposed to the very structure of GST? A: Fiscal autonomy I really don’t think – that is why the states wanted their own VAT Acts. The centre has agreed with that. So, I think this is fully preserved. Also within government the legal advice is that there is no kind of challenge to our constitution. So, I don’t think - the way it is being setup ensures that fiscal autonomy between states and the centre is maintained. In terms of the political opposition, if you recall in the VAT introduction also the opposition states whether they were National Democratic Alliance (NDA) states or whether they were other opposition states. They stayed out at the beginning and then they came in one by one. I feel that when they were ready in a way, but at the same time it was also clear by that stage that VAT is quite revenue productive. In the GST that challenge is a little deeper because the GST is not just at the state level. GST is both at the central and the state level. Q: Talking about Vodafone now, the question that is being asked is that the income tax (I-T) Act does not provide for conciliation. The powers are with the assessing officer, you have the provision of the settlement commission. So, on what basis is the government going ahead and seeking cabinet approval for something that is not even legally tenable? A: On Vodafone I have not commented at all because I chaired that independent committee setup by the then finance minister was the Prime Minister. Since then everything is in that interim report. Then we made some comments or modified some of the recommendations in our final report after getting comments on the interim report. That final report for whatever reasons has not been made public by the finance ministry. I have continued to wear two hats. I wear a hat as a chairman of that committee and I am also advising the finance minister. _PAGEBREAK_ Q: I am asking you to put on your hat of a person who authored that report and answer what do you think the conciliation process should seek to achieve because you had recommended in your report that one of the possible ways out of this was a penalty waiver and interest waiver. Do you think the conciliation process can seek to achieve a penalty and interest waiver because Vodafone also wants a waiver on the principal amount? A: That is exactly for the revenue department and the tax department to decide under finance ministers guidance. Now if as his advisor finance minister asked me what to do on this particular issue, I would tell him but as long as this is in process I shouldn’t comment. In general the conciliation is an issue that you can find even UN. Blessed by the UN there is a conciliation process in the commercial and trade sense. So, conciliation as a concept is not a relegated only to that. It can be extended to other areas, but they will have to examine that very carefully and see how much it can be extended. Q: Are you now hopeful that once the conciliation process with Vodafone is complete, those changes would also be made to the Section 9 retrospective amendment because they have bearing on international transactions, on cross border merger and acquisitions (M&As) which are of huge concern to foreign investors? A: If something is being applied retrospectively or retroactively then I am concerned. As a tax person I don’t hide that fact. However there are some case that may not be retrospective. Some cases which are prospective etc, so ideally I would look at it that way. Therefore we really have to look at it case by case and then for government to get the best thing out. Similarly for the tax payer because this is a clear case of an Edgeworth–Bowley box. You have the two ends of the diagonal of this rectangle and both have point somewhere in the middle where they can each maximize their utilities. Q: What is that number where the maximum utility is achieved? A: Since you are an economist you are always talking in economic terms – but that depends on that contract curve. Where on the contract curve they end up. So, each one will gain but we can't say how the total gain will be shared. Q: Do you think after this conciliation mechanism with Vodafone there is the space to institutionalise this for other companies as well? Do you see a scheme for resolving litigation through conciliation? A: To me these things depend more on retrospectivity and prospectivity. If it is prospective and very clear then its role is somewhat lower. If it is retrospective then its role is wider. So, one will have to see that. At the same time I am sure no government wants to give the impression that if there is any disagreement even in the future we will just negotiate. I think that no tax department or no government would want to do anywhere in the world.