India formed the Tax Reforms Committee in 1991 to lay out a roadmap for the reform of direct and indirect taxes as a part of the structural reform process. This was done to introduce the best approach of broadening the base, lowering marginal tax rates, reducing rate differentiation, simplifying the tax structure, etc. This article will highlight the tax reforms carried out in India that are important for the UPSC examination.

What is Tax Reform?

• Taxation is an important exercise for the economic and social development of the country. It provides the resources to use goods and services to the people.
• Various tax reform committees were constituted in India in 1971, 1977, but they suggested ad-hoc measures focused on the impending crisis.
• The Tax Reforms Committee of 1991 suggested a reduction in the rates of all major taxes, i.e., customs, individual, and corporate income and excise taxes to reasonable levels, maintaining progressivity but not such to induce evasion, broadening the base of all the taxes by minimizing exemptions and concessions, drastic simplification of laws and procedures, etc.

Issues With India’s Taxation System

• Retrospective taxation has impacted the inflow of foreign capital to India.
• An unstable policy environment pertaining to tariffs and taxes needs to be resolved to boost business and investments ties.
• The complex web of taxation laws of the Central and many State Governments cause complexities and litigation.
• Increased threshold provided in case of personal income taxes and exemptions, tax cuts, preferential tax rates, deferral of tax liabilities etc. lead to a lower tax base.
• Tax evasion and corruption undermine the governance practices by the state.
• Weakness of tax administration such as lack of technical expertise and financial resources, poorly drafted laws and corruption.
• Structural issues such as low financial literacy, a large share of the informal economy and a large number of cash based transactions.

Direct Tax Reforms

• Direct tax is a progressive tax as the proportion of tax liability rises as an individual or entity's income increases. Examples of direct taxes are income tax, corporate tax, dividend distribution tax, securities transaction tax, fringe benefits tax and wealth tax.
• Various committees such as Arbind Modi Committee on Income Tax Reforms and Akhilesh Ranjan Panel on formulating a new Direct Tax Code (DTC), aims to revise, consolidate and simplify the structure of direct tax laws (like Income-tax Act, 1961; Wealth Tax Act, 1957) in India into a single legislation

Need for Direct Tax Reforms

• Rationalization of income tax structure as the tax rate structure – slabs of 10%, 20% & 30% in personal income tax - has mostly remained the same in the last 20 years
• The urgency to simplify the corporate tax structure, for example in 2014-15, small companies having a profit of up to ₹1 cr paid an average tax rate of 29.37% while companies having a profit of greater than ₹500 cr paid an average tax rate of only 22.88%.
• Widen the tax base and prevent potential revenue loss due to lower tax rates and simplified tax structure.
• Maintain the balance between direct and indirect taxes, for instance, the contribution of direct taxes has declined from 60% in 2010-11 to 52% in 2017-18.

Measures Taken By The Government

• Various initiatives were launched to increase tax compliance such as the E- Sahyog portal to facilitate online filing of the returns; extension of Indian Customs Single Window Interface for Facilitating Trade (SWIFT), etc.
• Simplification of tax laws such as specific class of persons exempted from the anti-abuse provisions of Section 50CA and Section 56 of the Income Tax Act.
• Providing relief for startups with Capital gains exemptions from the sale of residential houses for investment in start-ups extended till FY21, resolving angel tax issues, etc.
• Providing various anti-tax avoidance measures such as Advanced Pricing Agreements (APAs), GAAR (General Anti-Avoidance Rules), etc.

Direct Tax Code (DTC)

It was envisioned to consolidate all direct tax laws of the central government and make the tax system more efficient and resilient. DTC intends to bring horizontal equity among different classes of taxpayers in line with best international practices. It will help to phase out the multiplicity of tax exemptions and deductions in order to widen and deepen the tax base. Such tax reforms will increase compliance, therefore simpler tax lead to a stable and robust taxation system.

Proposal for Direct Tax Code (DTC)

• The government adopted the proposed increased tax slabs in the financial year 2012 – 2013.
• Corporate Income Tax should be 30% with no surcharge on corporate tax.
• The Minimum Alternate Tax (MAT) rate should be 20% from the earlier tax rate of 18.5%.
• Few schemes like PF, Gratuity, pension funds, etc would still come under EEE.

*Click here to read more about the Direct Tax Code.

Vivad Se Vishwas Scheme

• This scheme was enacted with the goal to reduce pending income tax litigation, generating timely revenue for the government and benefiting taxpayers.
• The individuals/companies that opt for the scheme are required to pay a requisite tax following which all litigation against them are closed by the tax department and penal proceedings are also dropped.

*Click here to read more about the Vivad Se Vishwas Scheme.

Faceless Tax Assessment Scheme

• A taxpayer or an assessee is not required to visit an I-T department office or meet a department official for income tax-related businesses.
• It was launched in 2019 to promote an efficient and effective tax administration, minimizing physical interface, increasing accountability and introducing of team-based assessments.

Indirect Tax Framework

• Indirect taxes are consumption-based taxes that are applied to goods or services when they are bought and sold.
• The government receives indirect tax payments from the seller of the good/service, the seller, in turn, passes the tax on to the end-user i.e. buyer of the good/service.
• Examples of indirect taxes are goods and services tax, customs duty, excise duty, sales tax, etc.

Goods and Services Tax (GST)

• This indirect tax system was introduced to collect and reduce tax evasion, is easy to understand for the customer and will reduce the tax burden for industry, it ensures that there is no cascading effect of the tax and there is the harmonization of tax laws, procedures, and rates of tax. GST is applicable to the supply of goods or services as compared to the manufacture of goods or on sale of goods or on the provision of services.

*Click here to read more about GST.

Recent Measures by The Government

• Taxation Laws (Amendment) Ordinance 2019 provided a concessional tax regime of 22% for all existing domestic companies from FY 2019-20 if they do not avail any specified exemption or incentive.
• Taxation Laws (Amendment) Ordinance 2019 has led to a reduction of the tax rate to 15% for new manufacturing domestic companies if such company does not avail any specified exemption or incentive
• The rate of MAT has also been reduced from 18.5% to 15%
• The Finance Act, 2020 removed the Dividend Distribution Tax (DDT) under which the companies are not required to pay DDT.

Conclusion

Earlier tax reforms suffered from increased red-tapism and other bureaucratic hurdles that resulted in the development of a complex tax system. This complexity and presence of multiple layers encouraged leakage, corruption thereby decreasing the tax base. Various tax reforms were carried out in direct and indirect taxation that resulted in simplification of tax structure and better compliance.

FAQs

Question: What are tax reforms in India?

Question: What is the Goods and Services Tax (GST)?

Question: What were the objectives of the 1991 tax reforms in India?

Question: What are direct and indirect taxes?

Question: What are some of the recent tax reforms in India?

MCQs

1. Which of the following taxes was replaced by the Goods and Services Tax (GST) in India?

a) Income tax

b) Wealth tax

c) Value Added Tax (VAT)

d) Corporate tax

2. Which of the following reforms was introduced as part of the 1991 tax reforms in India?

a) Introduction of GST

b) Reduction in personal income tax rates

c) Faceless tax assessments

d) Implementation of demonetization

3. What is the purpose of the Faceless Income Tax Assessment System introduced in India?

a) To provide face-to-face consultations between taxpayers and authorities

b) To improve transparency and reduce corruption in tax assessments

c) To increase the direct involvement of tax officials

d) To eliminate the need for income tax returns

4. Which of the following is an indirect tax in India?

a) Corporate tax

b) Capital gains tax

c) Goods and Services Tax (GST)

d) Wealth tax

5. What was the primary objective of the 1991 tax reforms in India?

a) Increase government revenue

b) Promote foreign investments

c) Simplify the tax structure and improve compliance

d) Increase tax rates

GS Mains Questions and Model Answers

Q1. Analyze the significance of the Faceless Income Tax Assessment System introduced in India and its impact on tax administration.

 Answer: The Faceless Income Tax Assessment System was introduced in 2020 as part of a series of tax reforms aimed at improving transparency, reducing corruption, and making the tax assessment process more efficient. It is a major step towards digitizing tax administration and minimizing direct interactions between taxpayers and tax officials, which has historically led to corruption and harassment.

Key Features:

• Anonymous and Faceless: The system ensures that taxpayers do not know which officials are handling their assessments, and vice versa. This reduces discretionary power and potential misuse by tax officers.
• Centralized Processing: The assessments are centrally handled through the National E-Assessment Centre, which assigns cases to tax officers in a random manner.
• Transparent and Efficient: With minimal human intervention and the use of artificial intelligence and big data analytics, the system increases efficiency in processing cases and reduces subjectivity in assessments.

Impact on Tax Administration:

• Reduction in Corruption: By eliminating face-to-face interactions, the system significantly reduces opportunities for bribery and corrupt practices that plagued the tax system earlier.
• Efficiency and Speed: The system allows quicker and more accurate processing of tax returns, reducing the backlog of pending cases. It also saves time and effort for taxpayers, as the assessments can be done online without visiting tax offices.
• Wider Use of Technology: The Faceless Assessment System integrates modern technology into tax administration, including e-verification of documents, leading to a more tech-driven tax ecosystem.
• Taxpayer Confidence: The system helps build confidence among taxpayers by offering a fairer and more transparent process. This, in turn, is expected to improve compliance.

Q2. Discuss the impact of Goods and Services Tax (GST) on federalism in India.

 Answer: The Goods and Services Tax (GST), implemented in July 2017, was a landmark tax reform that fundamentally reshaped India’s indirect tax system. It replaced a multitude of state and central taxes with a unified tax structure, creating a common national market. However, it also raised concerns about its implications for Indian federalism, given that taxation is a critical area of governance for both the Union and state governments.

Impact on Fiscal Federalism:

• Unified Tax Structure: GST brought about uniformity in tax rates across states, leading to a significant reduction in the autonomy of states to levy taxes on goods and services within their jurisdiction. States lost powers to independently impose taxes like VAT and octroi.
• GST Council: The GST Council, a constitutional body comprising representatives from both the Union and state governments, is responsible for making decisions on GST rates, exemptions, and procedural matters. This body reflects the spirit of cooperative federalism, as decisions are made collectively.
• Revenue-Sharing Mechanism: GST created a system of revenue-sharing between the Union and the states. The revenue generated under GST is shared between the central government and the states based on a predetermined formula. However, states have expressed concerns about the delays in GST compensation, particularly following the economic slowdown and the COVID-19 pandemic.
• Compensation for States: To address concerns of revenue loss, the GST (Compensation to States) Act, 2017 was introduced, promising states compensation for any shortfall in revenue for five years after the GST’s implementation. However, delays in compensations have led to friction between states and the Union, challenging the federal arrangement.

 Cooperative Federalism: The GST Council promotes cooperative federalism, as decisions on tax rates, exemptions, and rules require a consensus between the central government and the states. This has fostered collaboration, although disagreements have emerged, particularly during economic crises.

Q3. Examine the role of tax reforms in promoting economic growth and development in India.

Answer:Tax reforms in India have played a critical role in promoting economic growth and development by improving the efficiency of the tax system, increasing government revenues, reducing evasion, and making the country more attractive for investments. Over the past few decades, a series of tax reforms have been introduced to modernize the tax structure, simplify compliance, and create a more equitable system.

Improved Revenue Collection: Tax reforms, including the introduction of Goods and Services Tax (GST) and Direct Tax Code reforms, have helped broaden the tax base and improved tax collection efficiency. By reducing loopholes and simplifying tax procedures, the government has been able to collect more revenue, which can be allocated to infrastructure, social services, and development programs. For example, GST has streamlined indirect taxes, reducing tax evasion and leakage.

Encouraging Investments: The reduction in corporate tax rates and simplification of tax laws have made India a more attractive destination for both domestic and foreign investments. In 2019, the government reduced the corporate tax rate to 22% for existing companies and 15% for new manufacturing companies, which has had a positive impact on investor sentiment.

Promoting Compliance: Tax reforms like the Faceless Assessment System and digital platforms for tax filing have made compliance easier for taxpayers, reducing the administrative burden and corruption. Increased compliance has led to higher revenue collection and a broader tax base.

Reducing Inequality: Reforms in direct taxation, such as progressive income tax rates, have aimed to reduce economic inequality. Taxes are levied at higher rates on individuals and businesses with higher incomes, while the tax burden on the lower-income groups is minimized.

Boosting Formalization of the Economy: The implementation of GST has led to greater formalization of the economy. Small and medium enterprises (SMEs) and businesses that were earlier part of the informal sector are now part of the formal economy due to the digital nature of GST registration and compliance. This formalization has increased transparency and improved tax collection.

Previous Year Questions on Tax Reforms in India

1. UPSC Prelims 2020

Question: Which one of the following taxes was abolished in India post the implementation of GST?

A) Income tax

B) Property tax

C) Service tax

D) Corporate tax

Explanation: Service tax, which was levied on the provision of services, was subsumed into GST after its implementation on July 1, 2017. GST brought together various indirect taxes, including service tax, into a single tax regime.

2. UPSC Mains 2019

Question: Examine the impact of the Goods and Services Tax (GST) on the Indian economy.

Explanation:The implementation of GST in 2017 was one of the most significant tax reforms in India’s post-independence history. It replaced a plethora of indirect taxes such as VAT, service tax, and excise duty with a unified tax structure. The impact of GST on the Indian economy can be examined in several dimensions:

Creation of a Unified National Market: GST has helped eliminate the barriers to interstate trade and created a single national market by harmonizing indirect taxes across the country. This has reduced logistics costs and improved supply chain efficiency.

Simplification of Tax Structure: By consolidating various indirect taxes into one, GST has simplified the tax system, reducing compliance costs for businesses. Earlier, businesses had to deal with multiple taxes at different stages, leading to a cascading effect (tax on tax). GST has eliminated this cascading effect.

Boost to the Formal Economy: GST’s digital infrastructure, such as e-invoicing and e-way bills, has encouraged businesses to come into the formal economy. This has broadened the tax base and increased tax compliance.

Initial Challenges: The initial phase of GST implementation faced challenges such as technological issues with the GST Network (GSTN), compliance burdens for small businesses, and confusion over multiple tax rates. However, these issues have gradually been addressed through policy adjustments.

Impact on Inflation: Initially, there were concerns that GST would increase inflation, especially for services. However, the actual inflationary impact was limited, as essential goods and services were placed in lower tax slabs.