If 10% tax is deducted uniformly from all streams of income and diverted at source to the government, there will be enough revenue coming in steadily without the hassles of computation and refunds
Income is generated as earned income by way of salary from employment or income from occupation or business. Unearned income is derived as dividend from equity or interest from debt by giving loans or making deposits by deploying savings. At present, income is classified into five heads - salaries, interest, rent, business and other sources i.e., sources other than the previous four. Many of them are similar to the first four but classified as income from other sources, only because they do not clearly fit the definition of the first four. Now, tax deduction at source is done on all these incomes and then a return has to be filed by the taxpayer aggregating the income for deducting exemptions and finding the appropriate rate of tax.
The aggregation of incomes serves no real purpose except to make people believe that they get some exemptions. However, no one is actually exempt from tax, because everyone pays indirect tax on goods and services at the average rate of 15%. In the case of those who pay income tax, it actually means that they pay 45% if they are in the highest bracket of tax. Considering the exemption limit it has been determined that, the effective rate of tax to be deducted at source will be 10%. Therefore, if this 10% is deducted uniformly from all streams of income and diverted at source to the government, there will be enough revenue coming in steadily without the hassles of computation and refunds.
If we look at salaries we find that in respect of government salaries and pensions, what is given by government is taken back with lot of paperwork. Will it not be cost effective, if tax on government salaries is replaced by a 10% cut without having to do the paper work. A rupee saved for government is a rupee available to be spent on development, and the staff is released from preparation of tax deducted at source (TDS) documentation and available for more constructive work. For instance, in Sri Lanka, government salary was not taxed for 30 years on the ground that their salaries were deliberately fixed low compared with the commercial salaries. It is only recently that salaries above Rs50,000 per month have been included in the PAYE system just to show that they also pay tax.
In the alternative, in respect of all salaries there can be a payroll tax to be paid by the employer from the total wage bill leaving it to the employer to fix the wages without tax. There will be considerable saving in paper work as it will release the employees from filing returns. To give the department credit, this is being tried in a small way by accepting the form 16 of the employer as the return
. Thus, all salaries can be tax-free in the hands of the employees and yet they would all be contributing to the nation building. If there is some concern about progressive rate, we can think of maximum wage
similar to minimum wage, such that, those getting salary more than the maximum will have to surrender the excess to government.
The concept of gross pay is a purely notional amount. We all know that income is only that is available for us to spend. When one receives his pay, his main concern is for the amount actually in the pay cheques credited to his account or wage envelopes. Tax deductions on the gross pay figure appear to be a tax on income. However, it actually becomes the liability of the employer and also a priority debt. Therefore, in reality it is an employment tax concealed as wages with the additional surcharge of cost of compliance.
The system of deduction of tax at source or TDS is a hidden tax on the employers because of the cost of compliance. It is the computation of the notional gross pay by evaluating and adding the value of perquisites that creates the burden to the employee. Therefore, if the salary is also taxed at the point of distribution from the employer, there is no need for individual salary returns. The perquisite value could be incorporated in the computation of taxable income of the business by making appropriate disallowance. The enormous saving in paperwork, the value of paper and the relief to the class of assesses who feel oppressed, would be more than the revenue, if any, lost. Moreover, every employee can feel that he is contributing to the nation, as the flat small rate would be evenly distributed among all the employees. The pay slip could contain the amount contributed by him so that he can be proud of it.
Interest that was treated under a separate head was only interest from Government Securities, which has been repealed. Interest from banks and on loans and deposits are taxed as income from other sources unless derived from money lending business. In respect of interest, all payouts will be by financial institutions and business units and diversion at the time of credit with a fixed percentage should be enough. In respect of dividends from debt funds, there is already a dividend distribution tax by section 115-O
, which keeps the dividend income out of the computation of total income. If it is considered necessary, certain classes of assessees can be exempted from this diversion by leaving them out - for example, Senior Citizen Funds and Provident Funds can be exempted.
Income from Property
As far as income from property is concerned, it is actually a double taxation when the local authority also levies a tax based on annual rent. Perhaps it will be wise to leave rents alone unless there is evidence to show that the loss of revenue by not taxing rent is quite substantial. In any case, self-occupied property is exempted. If property is held as a business asset such income should be taxed as income from business.
Capital gains is actually not income at all but is deemed to be income. We have the added complication of the gains being offset by inflation and relief given by way of indexation of the cost for calculation of the real gains in respect of assets held for a long term. Short-term capital gains is included in the total income and would be part of business income if the asset were a business asset. Even at present capital gains in virtually kept out of the total income for computation. Some way has to be devised for diverting the tax on income from sale of assets held by individuals, which is not held as business assets. In the case of immoveable property, there is already the system of deducting tax at source
. Therefore, the next step in that regard is to keep it entirely out of total income just as in the case of lotteries
Income from Lotteries
The present system of taxing income from lotteries can be the forerunner for the new system. Such income though included in total income is separately taxed at a fixed rate and deducted at source
. Disclosure of this income in the income tax return is only for information and not for taxation. Since this information can be captured through the deduction process there is no need for filing a return.
Income from Business
Income from business is a class by itself. Even in the present system, it has its own computation formula. It also has international ramifications. The additional nuance is that different treatment is prescribed for business income of different status. If business income is treated separately as a stand-alone taxable identity irrespective of the status of the ownership, then we can do away with the classification of assessees.
It would also enable better census of business, if all businesses, conducted in any status, is required to be registered and taxed separately. In the case of individuals we can even think of limited liability partnership (LLPs) with the government as the other partner. In the US, individuals are encouraged to form one man companies to conduct business so that he takes a salary, which is subject to tax at source and the business income is computed separately. Share of income of the shareholders in companies are exempted as what they receive is already taxed in the hands of the company. Following the same pattern, it can be provided that every business unit should get registered and pay distribution tax on dividends, salaries and interest apart from income tax on its profits. In this way, business profits will be taxed separately and individuals need not be taxed on business income.
Apart from aggregating income for tax on total income, we also have another matter to consider. We have a wealth tax, which is now imposed only on non-performing assets (NPAs), which are practically these six items: buildings, motor cars, jewelry, boats and aircraft, urban land and cash in hand over Rs50,000. The department proceeds as if it has no way of knowing whether any individual holds these assets, unless the individual files a return. However, some kind of registration is required for holding all these assets except jewelry and it will be easy to compile a profile if all such registration is linked to the PAN number.
Similarly, unless the department gets information about all sources of income, the attempt to tax the total income becomes a difficult exercise. Every attempt to simplify the return is followed by adding columns for additional data, because simplifying requires sacrifice of details. Now even the declaration
for receiving income without deduction of tax one source of income requires details of all other assets held by the assessee. The best option will be to make a profile of each high net worth assessee and get it ratified by him. If the banks can be empowered to prepare a balance sheet for each account holder, then it will be convenient to check leakage of revenue. Perhaps the constitutional mandate for redistribution of wealth can be done only through wealth tax. Gifts are now taxed as income unless it is within the family. When the stream of income is taxed, transfer of capital will not matter.
(This is fifth part of a multi-part series on the vexing Indian tax system and the path to genuine reforms, adapted from Justice S Rangarajan Memorial Lecture in Bangalore delivered recently)
Tomorrow: Part6 - Expanding the Tax Net
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(Justice TNC Rangarajan is a former judge of Madras and Andhra Pradesh High Courts. Earlier, for more than 20 years, he was a Judicial Member of Income Tax Appellate Tribunal