Budget 2019 | How direct tax reforms can drive economic growth

Raju Kumar

After bringing back the BJP-led NDA government to power with a tremendous majority, the Indian electorate will now look forward to structural reforms which should improve the health of the economy by attracting investments and providing employment opportunities.

The current tax infrastructure encompassing laws, rules, judicial precedence and numerous tax officials executing it, clearly needs a re-look. The government will certainly need to focus on increasing direct tax collections, taxpayer base and compliance. These multiple objectives can be achieved by simplifying tax laws, procedures and improving the tax administration.

Keeping this in perspective, a slew of big-bang economic reforms that should please Indian businesses and foreign investors are likely to be pursued. Plans to introduce changes in the direct tax regime by truncating an effective tax rate that is as high as 35 percent, widening the tax base and making it easier for sincere individuals and corporate entities to comply with tax laws would be welcome. Lower tax rates will act as an incentive for taxpayers to comply with the direct tax regime, file returns and pay tax, while augmenting the government’s revenue. Lowering the tax rate will also leave more disposable income in the hands of consumers, spurring them to spend more, and in the process accelerating the faltering economic growth.

In this context, the dividend distribution tax (DDT) reform could also be looked at. Considering the corporate tax rate and DDT on dividend distributions, the effective tax rate on profits in India can potentially be greater than 50 percent. With other countries bringing their tax rates to a moderate level (a recent example is the US – 21 percent post tax reforms), we could expect some reform to the DDT regime – possible reduction to rate, application of beneficial rates under existing double tax avoidance agreements or bringing back classical system of withholding tax on dividends.

Further, in 2017, the Modi government formed a task force to draft a new direct tax legislation or code (direct tax code) to replace the existing 50-year-old Income Tax Act. With the report scheduled to be submitted by July 31, it is expected that this will bring about simplification on multiple fronts and create a regime that envisages timely settlement of disputes. Further, other aspects that may be addressed as part of the direct tax code could be a reduction in the cost of compliance and administration and reduce the ambiguities in laws.

Further, aspects which could continue from the first term of the Modi government could include an increase in transparency and accountability for taxpayers (for instance, the new income tax return forms ask for much more detailed information than before). The government is also expected to continue its clean money campaign so as to fine-tune tax rules and laws to plug leakages and put a check on cash transactions. Further, alignment to BEPS related changes should continue under the new government.

The new government should continue to focus on improving innovation and improve manufacturing and revitalise its Make in India initiative, which should help the government give a much-needed boost to job creation. In February, the national policy on software Products – 2019 was approved by the government. The new government is expected to pursue this agenda with the idea to increase India's share of the global software product market ten-fold by 2025. Tax breaks/ incentives may follow to support other policy interventions in this regard.

In its poll manifesto, BJP promised to turn India into a $5 trillion economy by 2025 and reiterated its promise to double farm income by 2022. As the new government presents its first budget, we expect the tax to be a key driver in this endeavour. Even as economic expectations are high, the government will have to first aim at consolidating the economy through reforms and then focus on investment-driven growth.

Raju Kumar is Tax Partner, EY India. Views expressed are personal.