Abstract:
This research paper intends to examine everlasting changes and reforms in the Indian taxation system and associated laws. A review of evolution in the taxing system has been critically analyzed along with their impact and effectiveness. Tax is the source of revenue for the government, and it also acts as an economic indicator at the same time. Hence understanding the structure of taxes, types of taxation and laws related to taxation becomes crucial for the taxpayer. Taxes affect the population and government in many ways, like an intertwined relation where a healthy tax system nourishes the public services, infrastructure and social programs, but on the other hand, an ineffective taxation system stifles economic growth and exacerbates inequality. It is attempted by this research paper to understand the direct taxes and indirect taxes under the Indian taxation system, and measure their impact and validity. This paper also analyzes the legal reforms made in the Indian taxation system post-independence, impact of trade liberalization and recent reforms. It understands the Income Tax Act, 1961 and Goods and Services Act, 2005, finding out the need for reforms. The paper also attempts a comparative analysis between India and other nations in order to recognize scope of improvement. Many issues relating to the taxation system are put forward followed by suggestions in order to achieve equality in terms of economy and a better financial future for the nation.
Keywords: Tax structure, income inequality, investments, legal reforms, economic growth.
Introduction:
India’s taxation system follows a three-tier federal system consisting of central government, state government and local municipalities. Article 256 of Constitution of India declares the bodies who have the authority to levy taxes and also a division of taxation for various subject matters is provided. Those are the Central government imposing Income tax, Excise Duty and Corporation Tax, State government imposing Land Revenue, Stamp Duties, Taxes on profession, trades and employment, and the Local bodies imposing property taxes and water or drainage taxes. The 73rd Amendment Act of 1993 and 74th Amendment Act of 1994 gave tax levying powers to Panchayat and Municipalities respectively. Value Added Tax (VAT) replaced the existing general sales tax laws in 2005. Many tax experts have proposed the Direct Tax Code (DTC) to rationalize and simplify the taxation structure in India. But it remains unimplemented till date. The Indian tax structure comprises two types of taxes: Direct taxes and Indirect taxes. Direct taxes are charged on incomes of corporations or individuals, and such corporations or individuals are liable to deposit the taxes themselves. Direct taxes include income tax, corporation tax, dividend tax, capital gain tax, wealth tax, gift tax, land revenue, professional tax or agricultural income tax. Direct taxes assist in curbing income inequality and curbing inflation by controlling money supply within a nation. Indirect taxes are those which are paid for sales or for goods and services received. The sellers of such goods or providers of such services have to collect the taxes and deposit them. Indirect taxes include custom duty, exports duty, road and passenger duty, property taxes, stamp duty and electricity duty. Indirect taxes strengthen the federal structure of the Indian government and also increases the tax base. In order to widen the tax base and increase tax revenue collections while simultaneously ensuring distributive and social justice, a well-planned approach for simplification of types of taxes is essential within the taxation system of India. One of the ways of achieving it can be done by reducing tax rates on several mass consumer goods and services.
The history of taxation shares as old a term as that of civilization, serving as a strong backbone of the nation. It does so by generating revenues driven by official government bodies via various means. India, the world’s largest population with over 1.4 billion sharing 17.76% of total world population People dedicate a significant role to taxation as the driving force of the economy. This vast population presents many opportunities as well as challenges for the Indian tax system. Some opportunities could be seen by widening of the tax base by providing a large pool of taxpayers hereby assisting the government to increase its revenue collection, it can pave the path for economic growth by forming tax policies that incentivize investment, entrepreneurship and innovation and also consumption taxes can be benefited by this vast market size with increase in disposable incomes. Challenges can be witnessed in the form of administrative complexity like managing tax administration processes, efficient data collection and tackling issues of tax evasion demands infrastructure development and skilled workforce, integrating informal sector to formal economy becomes crucial, considering the tax burden on lower-income groups becomes important to strike balance between revenue generation and social equity. The concept of income polarization has evolved in these current times. 80% of the income-earners, who earn less than 2.5 lakhs per annum are not considered in the taxpayer data, raising a concern for exclusion of a major portion of income-earners falling below taxable threshold. The SBI research data also suggest a 90/10 ratio which implies that there is an increase of income gap between top 10% and bottom 10% being 6.7 in 2017-2018 to 6.9 in 2022-2023.
India heavily relies on attracting foreign and domestic investors in order to become a 5 trillion-dollar economy. But due to lack of clarity in tax regulations creates a roadblock for potential investors. Amendments have become an integral part of Indian tax laws which can be unsettling for investors who require stability for a long-term planning. Subjecting new tax rules to past transactions create an environment of hostility and distrust for investors. In 2015, the case of Castleton led to amendments of Section 115JB of the Income Tax Act, 1961 in order to clarify the exclusion of capital gains, interest or income for computation of book profits in case of foreign companies. Discussions of inapplicability of Minimum Alternate Tax (MAT) on Foreign Institutional Investors (FIIs) were also highlighted in the judgment. Another measure of understating lack of uncertainty for investors can be attributed to the high number of tax disputes in India. The average time for dispute resolution is estimated at 3.4 years for direct tax appeals and 1-2 years for indirect tax appeals both done to the Commissioner. Supreme court pendency for direct tax matters is 4-7 years and for indirect tax matters is 5-8 years. There are many disagreements in Double Taxation Agreements (DTAs) which hinder cross-border investments by not ensuring prevention of being taxed on the same income in two countries. Hence, as an impact there is an increase in compliance cost for the investor, risk of aversion and investment delays are created and ultimately a reduction in foreign direct investments (FDI) can be seen.
The Goods and Services tax which was implemented in the year 2017 aimed to simplify the tax system and increase compliance. The government, since this implementation, has considered several legal and procedural changes for administrative processes. But with time, several challenges have been witnessed by the taxpayers, and further reforms are yet needed. Taxpayers face several issues like (1) Facility to file revised return which is allowed by Income Tax Act and even VAT law, but not with GST as a scope of rectification of human error, (2) issues of tax credit mismatch as the GST law puts 100% responsibility on taxpayer to ensure that supplier pays tax to government. The Union Budget of 2022 imposed restrictions to address defaults of suppliers like non-compliance with registration, reporting and payment of taxes, such restrictions cause hardships to recipients. (3) Higher rate of interest in late payment but less interest rate for late refund.
Research Methodology:
This research paper explored the evolution of Indian tax laws, need of reforms in laws, major focus areas like income inequality, FDI and technological advancements in taxation administrative systems through secondary data analysis. By reviewing government resources, legal databases and academic publications, this paper will chronologically track the key changes with thematic analysis of each of them. This paper acknowledges the ideas put forward by various authors and highlights the important findings in them with further emphasis and inputs. Overall, this methodology aims to provide a comprehensive understanding of the taxation system in India.
Review of Literature:
Understanding the taxation system in India and its effect on corporations and individuals in India is essential to maintain a needed balance between growth and socio-economic equality. This has been done by (Jha, 2013) in his research paper on “Tax Structure in India and its effect on corporate and individual in India” where he suggests that there is a need to reduce dependency on indirect taxes and increase the direct taxes on richer sections to compensate the loss. He also suggests checking the transfer pricing in corporate tax evasions.
(Pramod Pandey, 2017) in his paper of “The impact of Indian Taxation on its Economic Growth” describes the taxation system in India, defines various taxes that exists, overviews the tax collection pattern in India, analyzes the impact of direct and indirect tax on economic growth, identifies the problems like provision for minimum taxes, simplification of tax procedures, high tax evasions, complex system with multiple taxes and multiples rates increasing of indirect taxes, corruption and education.
“Income and Wealth Inequality in India, 1922-2023: The Rise of the Billionaire Raj” by (Bharati et. al, 2024) discusses the increasing trend of higher disparity between rich and poor in India. It focuses on the need for transparency of wealth statistics, formulating policies to consider the rising inequality and understanding the role of caste in the interplay of income and wealth inequality.
“Towards tax justice and wealth redistribution in India” by (Chancel et. al, 2024) concentrates on the extreme concentration of wealth on the top. This paper proposes an idea of taxing 2% on net wealth exceeding 10 crores and 33% inheritance tax on wealth exceeding 10 crores. They estimate that this alone would generate GDP of 2.7% in revenues. If taxes are coupled on the same valuation wealth, the GDP would estimate to 6.1%. Such potential revenues are extremely large even if only 0.04% of adults are taxed, excluding the 99.96% not affected by the tax. This signifies that the total wealth of 0.4% of the population is 25% larger than India’s entire economy.
Method:
This research provides a comprehensive method to understand the inter-relation between economic growth, income inequality and taxation policies in India. A thorough literature review has been done, along with quantitative and qualitative analysis of data. The quantitative analysis included national statistical data and qualitative analysis included opinions of experts in respective fields of taxation and economics. Methods of improving FDIs have been understood by comparing with policies of other nations. This research paper proposes various policy recommendations in order to nullify income inequality through progressive tax reforms, which thereby provides economic development and equitable social outcomes as a byproduct. This paper is guided by ethical considerations to maintain the validity of findings.
Issues and Challenges:
This research paper focuses on three components and areas of taxation and recognizes the need for reforms in such areas. These include wealth and income inequality relationship with taxation, Foreign Direct investments and taxation laws, and lastly Technological advancements and assistance to taxpayers. Let’s break down each issue and have a deeper understanding of each.
- Income inequality, wealth and taxation:
A study by World Inequality Lab consisting of renewed researchers along with Thomas Piketty suggested that the income distribution in India was more equitable in the British era rather than in present times. 2023 itself produced 94 new billionaires making the total number of billionaires in India to be 271 as per global rich list by Hurun Research Institute. The study analyzed the annual tax tabulations since 1922 and found out that the highest inequality was seen during the inter-war colonial period in 1930-1947, where 20-21% of national income was held by the top 1%. Ironically, now the top 1% hold 22.6% of the income.
There has been an uptick in wealth concentration accelerating through the 2000s alongside income inequality which was 45% in 1961 to 65% in 2022-23. The top 1% possesses 54 million Rupees which is 4 times more than an average Indian. Research shows that if wealth and income concentration are simultaneously examined, in 2022 the wealth concentration accelerates rapidly than incomes at the very top of the distribution with wealth being 40.2% and income being 22.6%. Such events contribute towards creation of social and economic disparities, limiting the mobility of lower-income groups to climb the economic ladder, reducing the demand of goods and services due to decrease in disposable incomes and hence, social unrest and political instability.
- Foreign Direct Investments (FDIs)and Tax laws:
India intends to attract FDI and provides many incentives like creating Special Economic Zones (SEZs) to exempt import duty, VAT, income tax etc. One such policy is called the Double Tax Avoidance Agreement (DTAA) in order to promote trade and investment. There are many supposed allegations of treaty shopping, round-tripping and black money flows via various jurisdictions due to which India had amended treaties with countries like Mauritius, Singapore and Cyprus. Non-residents are taxed based on Income Tax Act, 1961, but DTAAs supersede domestic laws if they offer lower tax burden. Investors choose out of three taxes in case of FDIs that is rate in investors country, rate in India or rate specified in DTAA. Tax exemptions on capital gains are a major factor influencing FVI routing decisions. This is followed by Netherlands, Spain and France are preferred for routing FDI to India.
- Technological advancements and assistance to taxpayer:
As mentioned in the discussion of the introduction of this research paper, there are many issues faced by taxpayers in India. With everlasting amendments, instability in tax rates and dependency on indirect taxes, there is a need for infrastructural development and adoption of technology to assist the taxpayers with a flawless process of taxation. This can thereby improve efficiency, compliance and overall satisfaction with the system. Issues with the present taxation system are (1) Relying on manual processes which discourages timely filing and increases human error, (2) Complexity in tax codes which makes it difficult for small businesses and individuals to understand their filing obligations, (3) Limited services to taxpayers like guidance, support through filling process and resolution of queries. These issues impact the economy by creating a tax-to-GDP ratio which is supposed to hit the record of 11.7% in 2024-2025. This can also lead to creation of an informal economy and corruption.
Suggestions:
To address the issues this research paper intends to formulate appropriate suggestions by concluding recommendations by various sources and extensive research of them.
Income inequality affects medium and long-term goals of growth by lowering the demand of the poor and middle-class. Extreme concentration of wealth and income leads to disproportionate influence on government and society. Measures like direct cash transactions to the poor are not the ultimate solution to addressing these issues. Rather, public investments on health and education should be the priority of the government. Investments should cover a broad-base of social sections, wealth and income distributions should be done in an effective manner and a system of progressive wealth taxation should be built. Many legal reforms like (1) Imposing higher tax rates from high earners and reducing tax burden from law earners, (2) Scrutinizing tax exemptions by limiting tax exemptions that benefit high-income individuals disproportionately, (3) Targeting tax haves to discourage companies from shifting to low-tax jurisdictions by making stricter transfer price regulations or anti-avoidance rules, (4) introducing wealth tax on net assets of certain threshold and inheritance tax on large estates.
Foreign Direct Investments leads to boosting the economic growth of a country as well as job creation, potentially lowering the tax burden on low-income groups. This can be done by (1) Maintaining comparative corporate tax rate with respect to other developing countries, (2) Providing strategic tax benefits and stable tax laws to avoid investor distrust, (3) Providing a business environment by streamlining regulatory processes for establishing businesses in India as well as their operations, development in infrastructure and workforce. (4) Focusing on specific sectors like manufacturing, renewable energy, technology and proposing Public-Private Partnerships to encourage FDIs.
In order to assist the taxpayers of the nation many steps can be taken by the government to assure a smooth process of filing, compliance and dispute resolutions. Some of them are (1) Scope of rectification and amendment provided to taxpayers to avoid exorbitant compliance costs, (2) Improving the GSTN portal to it full capacity to avoid fraudulent activities and fake invoices, (3) Formation of GST appellate tribunal to reduce the burden of taxation cases, interest costs and GST refunds, (4) Updating the user interface and simplifying it shall help in ease of doing business, (5) Creating a federal institution under Society Act consisting of experts from center and states addressing non-policy matters.
Conclusion:
An increasing GDP means nothing if the harsh reality of income inequality is not confronted. Within the same nations when there is a visible disparity between the lifestyles and burdens of different groups of people, the concept of privilege and misfortune is born. The lack of inclusivity where the concentration of wealth is limited to a very small proportion of the population and burden of paying revenues to the government still lies upon the lower-income masses, narrowing the income gap becomes not just a moral imperative but also an effective tool to strengthen the economy. The majority of poor and middle class who lack the disposable income miss out on the means to create opportunities of self-employment for themselves, leading to decrease in innovation and development of skilled workforce. This research paper identifies the scope of improvement, more importantly, the need of improvement in such areas and proposes various suggestions towards a system of progressive taxation and social investments by means of higher contribution towards taxes by higher-income group which allows the government to focus on education and health facilities in order to create a productive workforce which ultimately leads to attracting investments. It also ensures that the government serves the interests of the broader population and curbs undue influence of the wealth. Focusing on attracting investments by strategic policy-making contributes to economic growth as well. Bringing changes in the taxation laws and ensuring strict implementation becomes the key while considering the interplay between the three parameters of taxation as suggested by this research paper. By focusing on these three interconnected elements, India would get a step closer to addressing growth and equity as two sides of the same coin, and not as competing goals.
Aradhana Panda
KIIT School of Law