FISCAL POLICY & TAXATION

Economic Development - Fiscal Policy & Taxation Central Delhi: 73, Near Axis Bank, Old Rajinder Nagar Delhi-60 |Contact: 9811906458, 9354341266|

CONTENT

FISCAL POLICY 1. FISCAL POLICY 1

1.1 Introduction 1.2 Objectives of Fiscal Policy 1.3 Types of Fiscal Policy 1.4 Tools of Fiscal Policy

1 1 1 1

2. REVENUE ACCOUNT 2

2.1 Revenue Receipts 2.2 Revenue Expenditure

2 2

3. CAPITAL ACCOUNT 2-3

3.1 Capital Receipts 3.2 Capital Expenditure

2 3

4. DIFFERENT KINDS OF DEFICITS 3-5

4.1 Monetised Deficit 4.2 Budget Deficit 4.3 Revenue Deficit 4.4 Effective Revenue Deficit (ERD) 4.5 Fiscal Deficit 4.6 Primary Deficit

4 4 4 4 4 5

5. FISCAL CONSOLIDATION 5-6

5.1 Fiscal Responsibility And Management (FRBM) Act, 2003 5.2 Objectives of FRBM Act 5.3 FRBM 2.0 - Amendments in FRBM Act, 2003

5 6 6

6. DIFFERENT TYPES OF GOVERNMENT BUDGETING 6-7

6.1 Line - Item Budgeting 6.2 Performance Budgeting 6.3 Zero - Based Budgeting (ZBB) 6.4 Outcome Budgeting 6.5 Gender Budgeting

6 6 7 7 7

7. ADDITIONAL CONCEPTS 7-9

7.1 Different Types of Debts 7.2 Ways And Means Advances (Wma) 7.3 Fiscal Drag 7.4 Fiscal Neutrality 7.5 Crowding Effect 7.6 Pump Priming 7.7 Economic Stimulus 7.9 Tax Expenditure

7 8 8 9 9 9 9 9

8. FINANCE COMMISSION-CONCEPTS AND DEFINITIONS 10

8.1 Tax Devolution 8.2 Divisible Pool

10 10

Economic Development - Fiscal Policy & Taxation Central Delhi: 73, Near Axis Bank, Old Rajinder Nagar Delhi-60 |Contact: 9811906458, 9354341266|

8.3 Grants-in-Aid 8.4 Fiscal Capacity/Income Distance 8.5 Fiscal Discipline

1010 10

TAXATION 1. TAXATION 11

Introduction 11

2. DIRECT TAX 11-14

2.1 Income Tax 2.2 Corporate Tax 2.3 Capital Gains Tax

12 12 12

3. INDIRECT TAX 14-18

3.1 Central Excise Duty 3.2 Goods and Service Tax (GST)

15 15

4. BASIC CONCEPTS 18-20

4.1 Tax Incidence 4.2 Tax Burden 4.3 Tax Base 4.4 Tax Shelter 4.5 Minimum Alternative Tax 4.6 Presumptive Tax

18 18 18 18 19 20

5. DOUBLE TAXATION AVOIDANCE AGREEMENT 21

Economic Development - FISCAL POLICY & TAXATION 1Central Delhi: 73, Near Axis Bank, Old Rajinder Nagar Delhi-60 |Contact: 9811906458, 9354341266|

TOPIC

1 FISCAL POLICY

1.1 INTRODUCTION Fiscal Policy refers to the policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment. It is the means by which the government adjusts its spending levels and tax rates to monitor and influence a nation's economy. Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when between 2-3%), increases employment and maintains a healthy value of money. Fiscal policy is very important to the economy. 1.2 OBJECTIVES OF FISCAL POLICY The following are the objectives of • To maintain and achieve full • To stabilize the price level. • To stabilize the growth rate • To maintain equilibrium in the balance of payments. • To promote the economic development of underdeveloped countries. 1.3 TYPES OF FISCAL POLICY There are two types of fiscal policy: Expansionary and Contractionary. • The objective of expansionary fiscal policy is to reduce unemployment. Thus, an increase in government spending and/or decrease in taxes are implemented that results in better GDP and reduced unemployment. However, it can also cause some inflation. • On the other hand, the objective of contractionary fiscal policy is to reduce inflation. Therefore, a decrease in government spending and/or an increase in taxes are implemented that leads to decreasing inflation. However, it can also trigger some unemployment. In other words, fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or loose. By contrast, fiscal policy is often considered contractionary or tight if it reduces demand via lower spending. 1.4 TOOLS OF FISCAL POLICY • The first tool is taxation. It includes income, capital gains from investments, property, sales etc. Taxes provide the major revenue source that funds the government. The downside of taxes is that whatever or whoever is taxed has less income to spend on themselves. That makes taxes unpopular. • The second tool is government spending. That includes subsidies, transfer payments including welfare programs, public works projects and government salaries. Whoever receives the funds has more money to spend. That increases demand and economic growth.

1. FISCAL POLICY


The Revenue Budget shows the current receipts of the government and the expenditure that can be met from these receipts.

2.1 REVENUE RECEIPTS Revenue receipts are receipts of the government which are non-redeemable, that is, they cannot be reclaimed from the government. They are divided into tax and non-tax revenues. • Tax revenues consist of the proceeds of taxes and other duties levied by the central government. Tax revenues, an important component of revenue receipts, comprise of: Direct taxes - which fall directly on individuals (personal income tax) and firms (corporation tax). Indirect taxes like excise taxes (duties levied on goods produced within the country), customs duties (taxes imposed on goods imported into and exported out of India) and service tax. Other direct taxes like wealth tax, gift tax and estate duty (now abolished) have never been of much significance in terms of revenue yield and have thus been referred to as 'paper taxes'. Direct taxes made up for 36.31 per cent of the total taxes in 2000 - 01. This ratio has risen to 51.05 per cent in 2015 - 16.

The ratio of direct taxes to total taxes in 2015-16 is the lowest in past 9 years with a peak of 60.78 per cent being hit in 2009 - 10. The ratio was 52.97 per cent in 2007 - 08 and over 56 per cent in 2013 - 14 and 2014-15. • Non-tax revenue of the central government mainly consists of: Interest receipts on account of loans by the central government; Dividends and profits on investments made by the government, Fees and other receipts for services rendered by the government. Revenue from Spectrum Auctions has been one of the major sources of Non-Tax revenue for its government. Cash, Grants-in-aid from foreign countries and international organizations are also included Revenue Expenditure:

2.2 REVENUE EXPENDITURE It is expenditure incurred for purposes other than the creation of physical or financial assets of the central government. It relates to those expenses incurred for the normal functioning of the government departments and various services, interest payments on debt incurred by the government and grants given to state governments and other parties (even though some of the grants may be meant for creation of assets). Budget document used to classify total expenditure into plan and non-plan expenditure. Since Budget 2017 - 18, the distinction between Plan and Non-Plan Expenditure has been done away. (Refer the 'Budgetary Reforms' later in this chapter). • Plan Revenue Expenditure was related to central Plans (the Five-Year Plans) and central assistance for State and Union Territory plans. • Non-plan expenditure, the more important component of revenue expenditure, covered a vast range of general, economic and social services of the government. The main items of non-plan expenditure were: • Interest Payments; • Defense services; • Subsidies; • Grants to State and UTs (Including the grants for the creation of capital assets) • Salaries; and • Pensions.

The Capital Budget is an account of the assets as well as liabilities of the central government, which takes into consideration changes in capital. It consists of capital receipts and capital expenditure of the government. This shows the capital requirements of the government and the pattern of their financing. 3.1 CAPITAL RECEIPTS All those receipts of the government which create liability or reduce financial assets are termed as capital receipts. The capital receipts in India include the following capital kind of accruals to the government:

3. CAPITAL ACCOUNT

2. REVENUE ACCOUNT


Examples of Debt Creating Capital Receipts Examples of Non-Debt Creating Capital Receipts• Loans raised by the government from the public (Market Borrowings). • Borrowing from the RBI. • Borrowing from the commercial banks and other financial institutions. • Loans received from foreign governments and international organizations. • Other items include small savings instruments such as Post-office Savings Accounts etc. and Provident funds.

• Recovery of Loans• Proceeds from the sale of shares of public eneterprises (Disinvestment)

3.2 CAPITAL EXPENDITURE All the areas which get capital from the government are part of the capital expenditure. It includes so many heads in India: • Loan Disbursals by the Government: The loans forwarded by the government might be internal (i.e., to the states, UTs, PSUs, FIs, etc.) or external (i.e., to foreign countries, foreign banks, purchase of foreign Bonds, loans to IMF and WB, etc.). • Loan Repayments by the Government of the Borrowings Made in the Past: Again loan payments might be internal as well as external. This consists of only the capital part of the loan repayment as the element of interest on loans is shown as a part of the revenue expenditure. • Capital Expenditure on defence by the Government: This consists of all kinds of capital expenses to maintain the defense forces, the equipment purchased for them as well as the modernization expenditures. • General Services: These also need huge capital expenditure by the government - the railways, postal department, water supply, education, rural extension, etc. • Other Liabilities of the Government: Basically, this includes all the repayment liabilities of the government on the items of the Other Receipts. With the merger of Plan and Non-Plan Expenditure, there have been changes in reported categories of expenditure. The Central Government expenditure is broadly classified into six broad categories of: • Establishment Expenditures of the Centre: This category includes salaries, medical expenses, wages, allowances, travel expenses, office expenses, training, professional services, rent paid, taxes, pensions, etc. This is expenditure that is incurred for maintaining the administrative entity, as opposed to expenditure incurred on programme and schemes. • Central Sector Schemes: These are schemes for which the central government provides the entire budgetary support and most of them are implemented by the central government. • Transfers under Centrally Sponsored Schemes: For these schemes, the central government shares the budgetary support with State or Union Territory government (based on a sharing pattern determined by the central government). These schemes are implemented by the State/UT governments. • Other Central Expenditure: This category includes expenditure on CPSEs and Autonomous Bodies. • Finance Commission Transfers: These are grants given under Article 275(1) of the Constitution to urban and rural local bodies, grant-in-aid to State Disaster Response Funds (SDRF) and post-devolution revenue deficit grant. • The revenue deficit grant is meant to cover gap in revenue expenditure after taking into account all the sources of revenue for states. Based on 14th Finance Commission's recommendations, 11 states receive these grants and about a third of the grant goes to Jammu and Kashmir. • Other Transfers (to States): This mainly includes additional central assistance for externally aided projects (given as grants or block loans) and special assistance to states.

A deficit is the amount by which a resource falls short of a mark, most often used to describe a difference between cash inflows and outflows. Deficit is the opposite of surplus and is synonymous with shortfall or loss. 4. DIFFERENT KINDS OF DEFICITS


4.1 MONETISED DEFICIT Monetized Deficit is broadly defined as the creation of money by the Central Bank to fund the fiscal deficit of the Government. The money so created is normally provided to the Government by the Central Bank against special securities created for this purpose. With the issue of more money to the government, the money supply in the economy increases, as a result of which the inflationary pressure prevails. Hence, we can say that monetized deficits are the part of a fiscal deficit that leads to the inflation in the economy. Until 1993, fiscal deficit in India was automatically monetized through the issue of special securities called Ad- Hoc Treasury Bills issued by the RBI on behalf of the Central Government to itself. After the crisis of 1991, this form of monetization came under severe criticism and following an understanding between the Central Government and the RBI, it was discontinued completely in 1997. 4.2 BUDGET DEFICIT Budgetary deficit is the difference between all receipts and expenses in both revenue and capital account of the government. This difference is met by the net addition of the treasury bills issued by the RBI and drawing down of cash balances kept with the RBI. The concept of budgetary deficit has lost its significance after the presentation of the 1997-98 Budget. In this budget, the practice of ad hoc treasury bills as source of finance for government was discontinued.

4.3 REVENUE DEFICIT Revenue deficit is the excess of total revenue expenditure of the government over its total revenue receipts. It is related to only revenue expenditure and revenue receipts of the government. Alternatively, the shortfall of total revenue receipts compared to total revenue expenditure is defined as revenue deficit. Revenue deficit signifies that government's own earning is insufficient to meet normal functioning of government departments and provision of services. Revenue deficit results in borrowing. Simply put, when government spends more than what it collects by way of revenue, it incurs revenue deficit.

A high revenue deficit warns the government either to curtail its expenditure or increase its tax and non-tax receipts. 4.4 EFFECTIVE REVENUE DEFICIT (ERD) Effective Revenue deficit is a new term introduced in the Union Budget 2012-13. Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. In other words, the Effective Revenue Deficit excludes those revenue expenditures which were done in the form of grants for creation of capital assets. Grants for creation of capital assets are defined as "the grants-in-aid given by the Central Government to the State Governments, constitutional authorities or bodies, autonomous bodies and other scheme implementing agencies for creation of capital assets". Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption expenditure of the Government. 4.5 FISCAL DEFICIT This is widely used as a summary indicator of the macroeconomic impact of the budget in several industrialized countries. This measure has been adopted by the IMF as the principal policy target in their programmes. In India, the government began to report the fiscal deficit only after 1991. Fiscal deficit is defined as excess of total budget expenditure (revenue and capital) over total budget receipts (revenue and capital) excluding borrowings during a fiscal year. Fiscal deficit is a measure of how much the government needs to borrow from the market to meet its expenditure when its resources are inadequate.

If we add borrowing in total receipts, fiscal deficit is zero. Clearly, fiscal deficit gives borrowing requirements of the government. A little reflection will show that fiscal deficit is, in fact, equal to borrowings. Thus, fiscal deficit gives the borrowing requirement of the government.


Greater fiscal deficit implies greater borrowing by the government. The extent of fiscal deficit indicates the amount of expenditure for which the government has to borrow money. How is Fiscal Deficit to be financed? Since fiscal deficit is the excess of government's total expenditure over its total receipts excluding borrowings, therefore borrowing is the only way to finance fiscal deficit. • Borrowing from Domestic Sources:

Fiscal deficit can be met by borrowing from domestic sources, e.g., public and commercial banks. It also includes tapping of money deposits in provident fund and small saving schemes. Borrowing from public to deal with deficit is considered better than deficit financing because it does not increase the money supply which is regarded as the main cause of rising prices. • Borrowing from external sources: It means borrowing from international institutions like World Bank, IMF and Foreign Banks. • Printing of new currency notes Another measure to meet fiscal deficit is by borrowing from Reserve Bank of India. This method of financing fiscal deficit is called as Monetised Deficit. (Discussed above)

Measures to reduce Fiscal Deficit: Some of the measures highlighted to reduce fiscal deficit are: • By reducing public expenditure A drastic reduction in expenditure on major subsidies. Reduction in expenditure on bonus, LTC, leaves encashment, etc. Austerity steps to curtail non-plan expenditure. • By increasing revenue Tax base should be broadened and concessions and reduction in taxes should be curtailed. Tax evasion should be effectively checked. More emphasis on direct taxes to increase revenue. Restructuring and sale of shares in public sector units.

4.6 PRIMARY DEFICIT Primary deficit is defined as fiscal deficit of current year minus interest payments on previous borrowings. In other words whereas fiscal deficit indicates borrowing requirement inclusive of interest payment, primary deficit indicates borrowing requirement exclusive of interest payment (i.e., amount of loan). It shows how much government borrowing is going to meet expenses other than Interest payments. Thus, zero primary deficits means that government has to resort to borrowing only to make interest payments.

According to Financial time's lexicon, "Fiscal consolidation is a reduction in the underlying fiscal deficit. It is not aimed at eliminating fiscal debt." Fiscal consolidation is a process where government's fiscal health getting improved indicated by reduced fiscal deficit which is manageable and bearable for the economy. Improved tax revenue realization and better aligned expenditure are thus components of fiscal consolidation. 5.1 FISCAL RESPONSIBILITY AND MANAGEMENT (FRBM) ACT, 2003 Reason for its Introduction • The FRBM Act was enacted in 2003 as rising government borrowing and the resultant government debts have seriously eroded the financial health of the government. High revenue deficit due to higher expenditure on subsidies, salaries, defence etc. compelled the government to make big borrowing from early 1990s onwards. • With inadequate revenues, government resorted to high level of borrowing. The borrowing again produced high interest payments. In this way, interest payments became the largest expenditure item of the government.

5. FISCAL CONSOLIDATION


• To arrest this financial weakness in its budget, the government has taken some serious deficit cut targets by introducing a law in the form of the FRBM. 5.2 OBJECTIVES OF FRBM ACT The major objectives of the Act are: • Institutionalizing Fiscal Discipline; • Reduction of Fiscal Deficit;

• Creating transparent Fiscal management system; • Achieve Inter-generational equity in fiscal management; • Long-Run macroeconomic stability; and • Better co-ordination between fiscal and monetary policy Important Provisions of the Act • The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by 2008-09. This will be realized with an annual reduction target of 0.3% of GDP per year by the Central government. • Revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination by 2008-09. • The central government shall not borrow from the Reserve Bank of India except by Ways and Means Advances (WMAs) to meet temporary excess of cash disbursements over cash receipts. • The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc. • The central government to lie before both Houses of Parliament three statements: Medium-term Fiscal Policy Statement, The Fiscal Policy Strategy Statement, and The Macroeconomic Framework Statement along with the Annual Financial Statement.

5.3 FRBM 2.0 - AMENDMENTS IN FRBM ACT, 2003 Union Budget 2012-13 saw introduction of amendments to the FRBM Act as part of Finance Bill, 2012. Concept of "Effective Revenue Deficit" and "Medium Term Expenditure Framework" statement are two important features of amendment to FRBM Act in the direction of expenditure reforms. • Effective Revenue Deficit (ERD) and not Revenue Deficit should be reduced to 0% by 31st March, 2015. • Fiscal Deficit should achieve the target of 3% by 31st March 2017. • "Medium Term Expenditure Statement be placed before Parliament along with this budget". Budgeting is the process of estimating the availability of resources and then allocating them to various activities of an organization according to a pre-determined priority. In most cases, approval of a budget also means the approval to various spending units to utilize the allocated resources.

6.1 LINE - ITEM BUDGETING In the late nineteenth century, line-item budgeting was introduced in some countries. The line item budget is defined as "the budget in which the individual financial statement items are grouped by cost centers or departments. It shows the comparison between the financial data for the past accounting or budgeting periods and estimated figures for the current or a future period". In a line-item system, expenditures for the budgeted period are listed according to objects of expenditure, or "line-items." These line items include detailed ceilings on the amount a unit would spend on salaries, travelling allowances, office expenses, etc. The line item budget approach is easy to understand and implement. It also facilitates centralized control and fixing of authority and responsibility of the spending units. Its major disadvantage is that it does not provide enough information to the top levels about the activities and achievements of individual units. 6.2 PERFORMANCE BUDGETING The concept of Performance Budgeting is essentially 'a technique of presenting Government operations in terms of functions, programmes, activities and projects'. Thus, governmental activities were sought to be identified in the budget in financial and physical terms so that a proper nexus between inputs and outputs could be established and performance assessed in relation to costs.

6. DIFFERENT TYPES OF GOVERNMENT BUDGETING


Under performance budgeting, the emphasis would get shifted from the means of accomplishment to the accomplishments themselves. The important thing under this technique was the precise definition of the work to be done or services to be rendered and a correct estimate of what that work or service would cost. A performance budget is prepared in terms of functional categories and their sub-division into programmes, activities and projects and not merely in terms of organizational units and the objects of expenditure. A performance budget thus developed in terms of costs and results facilitates management control by bringing out the programmes and accomplishments in financial and physical terms closely interwoven into one comprehensive document. 6.3 ZERO - BASED BUDGETING (ZBB) A system of Zero-Base Budgeting (ZBB) was first introduced in the United States Department of Agriculture in its 1964 fiscal year budget. It was based on the concept that all programmes of the Department were to be reviewed afresh from the base zero and not merely in terms of incremental changes proposed for the budget year. The Ministry of Finance formally introduced Zero-Base Budgeting in 1986 asking all the Ministries and Departments of the Government to adopt Zero-Base Budgeting approach with effect from the budget for 1987-88. The basic tenet of zero-based budgeting (ZBB) is that program activities and services must be justified annually during the budget development process. Benefits of ZBB The benefits of ZBB are substantial. These benefits are set out below: • Since ZBB does not assume that last year's allocation of resources is necessarily appropriate for the current year, all of the activities of the organization are re-evaluated annually from a zero base. Most importantly therefore, inefficient and obsolete activities are removed and wasteful spending is curbed. This has got to be the biggest benefit of zero-based budgeting compared to incremental budgeting and was the main reason why it was developed in the first place. • By its nature, it encourages a bottom-up approach to budgeting in order for ZBB to be used in practice. This should encourage motivation of employees. • It challenges the status quo and encourages a questioning attitude among managers. • It responds to changes in the business environment from one year to the next. • Overall, it should result in a more efficient allocation of resources. 6.4 OUTCOME BUDGETING Due to the realization that 'certain weaknesses have crept in the performance budget documents such as lack of clear one to-one relationship between the Financial Budget and the Performance Budget and inadequate target setting in physical terms for ensuing years' it was felt that there was need for tracking 'outcomes' and not the readily measurable 'outputs'. The first outcome budget was passed in the Parliament on August 25, 2005. The guidelines for the 2006-07 outcome budget provided that each Ministry/Department will separately prepare the outcome budget documents in respect of 'all Demands/ Appropriations controlled by them'. These contained: • Details about the mandate, goals and objectives as well as the policy framework and vision statement of the Ministry/Department • Details in indicated tabular format comprising financial outlays, projected physical outputs and projected/ budgeted outcomes. 6.5 GENDER BUDGETING The Budget year 2005-06 was very significant for women in the country, as for the first time the 'Gender Responsive Budgeting' (GRB) was adopted. The GRB is a method of planning, programming and budgeting that helps advance gender equality and women's rights. It serves as an indicator of the government's commitment towards the above mentioned objectives. So far, 57 government Ministries/departments in India have set up Gender Budgeting Cells, which is a positive step and will bring improvement in the lives of the women in society. Gender Budgeting is a powerful tool for achieving gender mainstreaming so as to ensure that benefits of development reach women as much as men. It is not an accounting exercise but an ongoing process of keeping a gender perspective in policy/ programme formulation, its implementation and review. GB entails dissection of the Government budgets to establish its gender differential impacts and to ensure that gender commitments are translated in to budgetary commitments.

7.1 DIFFERENT TYPES OF DEBTS In India, total Central Government Liabilities constitutes the following categories; • Internal Debt • External Debt

7. ADDITIONAL CONCEPTS


Public Debt in India includes Internal and External Debt incurred by the Central Government. Internal Debt includes liabilities incurred by resident units in the Indian economy to other resident units, while External Debt includes liabilities incurred by residents to non-residents. INTERNAL DEBT The major instruments covered under Internal Debt are as follows: • Dated Securities: These securities are primarily fixed coupon securities of short, medium and long term maturity which have a specified redemption date. These are the single-most important component of financing the fiscal deficit of the Central Government average maturity of around 10 years. • Treasury Bills: Zero coupon securities that are issued at a discount and redeemed in face value at maturity. These are issued to address short term receipt-expenditure mismatches under the auction program of the Government. These are primarily issued in three tenors, 91,182 and 364 day. • Securities issued against 'Small Savings': All deposits under small savings schemes are credited to the National Small Savings Fund (NSSF). The balance in the NSSF (net of withdrawals) is invested in special Government securities. • Market Stabilization Scheme (MSS) Bonds: These are governed by a Memorandum of Understanding between the Government of India and the Reserve Bank of India. MSS was created to assist the RBI in managing its sterilization operations. Government of India borrows under this scheme from the RBI, while proceeds from such borrowings are maintained in a separate cash account with the latter and is used only for redemption of T-bills /dated securities raised under this scheme. (For more information about the MSS Bonds, refer the chapter on "Monetary Policy") EXTERNAL DEBT External Debt is the portion of a country's debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions. When a country (that includes government, firms and individual) borrows money from other countries that is from non-residents, then an external debt is created. A debt crisis can occur if a country with a weak economy is not able to repay external debt due to the inability to produce and sell goods and make a profitable return. The International Monetary Fund (IMF) is one of the agencies that keep track of the country's external debt.

7.2 WAYS AND MEANS ADVANCES (WMA) The method of deficit financing or monetization of the government deficits as practiced was discontinued with effect from April 1, 1997. It was replaced by Ways and Means Advances scheme. This step was taken following the agreement reached between Central Government and the Reserve Bank of India (RBI) on March 26. 1997. In subsequent years, the entire requirement is being met through the 'Ways and Means' Advance (WMA) system and market borrowing. The WMA is an overdraft facility from the RBI. The facility is available for 10 days. The interest rate on WMA and overdraft are linked to the repo rate. Under the new scheme of WMA: • RBI provides facilities for temporary accommodation of the financial needs of the government up to a ceiling (or limited amount) fixed in advance. The government's receipts (through taxes, etc.) fall short of government expenditure. To meet this gap the RBI allows from time to time the government to draw upon the credit extended by it. • The credit/loan thus drawn has to be repaid or in technical language the government vacates WMA from time to time. As a result, the WMA will be reduced to zero at the end of the financial year. Thus, the WMA is purely a mechanism to bridge

the temporary mismatch between the government's receipts and expenditure. • While it is a gap-tilling device, it cannot be drawn upon to any amount as limits have been fixed on the maximum amount that can be availed of by the government. • Another feature of the scheme is the interest charged on WMA and overdraft facility. Loans under WMA will be charged interest that is related to the repo. The interest on the overdraft will be higher by two percent points above that charged for WMA. • The minimum balance required to be maintained by the Government of India with RBI will not be less than Rs. 100 crores on Friday, on the date of closure of the Government of India's financial year and on June 30, and not less than Rs. 10 crore on other days. 7.3 FISCAL DRAG Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.


This fiscal drag has the effect of reducing Aggregate Demand and becomes an example of deflationary fiscal policy. It could also be viewed as an automatic fiscal stabilizer because higher earnings growth will lead to higher tax and therefore moderate inflationary pressure in the economy. One cause of fiscal drag is the consequence of expanding economies with progressive taxation. In general, individuals are forced into higher tax brackets as their income rises. The greater tax burden can lead to less consumer spending. For the individuals pushed into a higher tax bracket, the proportion of income as tax has increased, resulting in fiscal drag. 7.4 FISCAL NEUTRALITY Fiscal neutrality occurs when taxes and government spending are neutral, with neither having an effect on demand. Fiscal neutrality creates a condition where demand is neither stimulated nor diminished by taxation and government spending. A balanced budget is an example of fiscal neutrality, where government spending is covered almost exactly by tax revenue - in other words, where tax revenue is equal to government spending. A situation where spending exceeds the revenue generated from taxes is called a fiscal deficit and requires the government to borrow money to cover the shortfall. When tax revenues exceed spending, a fiscal surplus results, and the excess money can be invested for future use. 7.5 CROWDING EFFECT The crowding out effect is an economic theory stipulating that rises in public sector spending drive down or even eliminate private sector spending. Though the "crowding out effect" is a general term, it is often used in reference to the stifling of private spending in areas where government purchasing is high. A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect. Sometimes, government adopts an expansionary fiscal policy stance and increases its spending to boost the economic activity. This leads to an increase in interest rates. Increased interest rates affect private investment decisions. A high magnitude of the crowding out effect may even lead to lesser income in the economy. With higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms. This leads to lesser investment ultimately and crowds out the impact of the initial rise in the total investment spending. Usually the initial increase in government spending is funded using higher taxes or borrowing on part of the government. 7.6 PUMP PRIMING Pump priming is the action taken to stimulate an economy usually during a recessionary period, through government spending, and interest rate and tax reductions. Pump priming assumes that the economy must be primed to function properly once again. In this regard, government spending is assumed to stimulate private spending, which in turn should lead to economic expansion. Pump priming involves introducing relatively small amounts of government funds into a depressed economy in order to spur growth. This is accomplished through the increase in purchasing power experienced by those affected by the injection of funds, with the goal of prompting higher demand for goods and services. The increase in demand experienced through pump priming can lead to increased profitability within the private sector, which assists with overall economic recovery. 7.7 ECONOMIC STIMULUS Economic stimulus consists of attempts by governments or government agencies to financially stimulate an economy. An economic stimulus is the use of monetary or fiscal policy changes to kick start growth during a recession. Governments can accomplish this by using tactics such as lowering interest rates, increasing government spending and quantitative easing, to name a few. 7.9 TAX EXPENDITURE Tax Expenditures, as the word might indicate, does not relate to the expenditures incurred by the Government in the collection of taxes. Rather it refers to the opportunity cost of taxing at concessional rates, or the opportunity cost of giving exemptions, deductions, rebates, deferrals credits etc. to the tax payers. Tax expenditures indicate how much more revenue could have been collected by the Government if not for such measures. In other words, it shows the extent of indirect subsidy enjoyed by the tax payers in the country. Tax expenditures or the revenue forgone are sanctioned in the tax laws. A statement of the same, (as far as Federal/Union/Central Government is concerned) is presented to the Parliament at the time of Union Budget by way of a separate budget document titled "Statement of Revenue Foregone". It lists the revenue impact of tax incentives or tax subsidies that are part of the tax system of the Central Government. This document also estimates the revenue to be foregone during the proposed financial year on the basis of the revenue foregone figures of the previous financial year.


8.1 TAX DEVOLUTION One of the core tasks of a Finance Commission as stipulated in Article 280 (3) (a) of the Constitution is to make recommendations regarding the distribution between the Union and the states of the net proceeds of taxes. This is the most important task of any Finance Commission, as the share of states in the net proceeds of Union taxes is the predominant channel of resource transfer from the Centre to states. 8.2 DIVISIBLE POOL The divisible pool is that portion of gross tax revenue which is distributed between the Centre and the States. The divisible pool consists of all taxes, except surcharges and cess levied for specific purpose, net of collection charges. Prior to the enactment of the Constitution (Eightieth Amendment) Act, 2000, the sharing of the Union tax revenues with the states was in accordance with the provisions of articles 270 and 272, as they stood then. The eightieth amendment of the Constitution altered the pattern of sharing of Union taxes in a fundamental way. Under this amendment, article 272 was dropped and article 270 was substantially changed. The new article 270 provides for sharing of all the taxes and duties referred to in the Union list, except the taxes and duties referred to in articles 268 and 269, respectively, and surcharges on taxes and duties referred to in article 271 and any cess levied for specific purposes. 8.3 GRANTS-IN-AID Horizontal imbalances are addressed by the Finance Commission through the system of tax devolution and grants-in-aid, the former instrument used more predominantly. Under Article 275 of the Constitution, Finance Commissions are mandated to recommend the principles as well as the quantum of grants to those States which are in need of assistance and that different sums may be fixed for different States. Thus one of the pre-requisites for grants is the assessment of the needs of the States. The First Commission had laid down five broad principles for determining the eligibility of a State for grants. • The first was that the Budget of a State was the starting point for examination of a need. • The second was the efforts made by States to realize the potential • The third was that the grants should help in equalizing the standards of basic services across States. • Fourthly, any special burden or obligations of national concern, though within the State's sphere, should also be taken into account. • Fifthly, grants might be given to further any beneficent service of national interest to less advanced States. Grants recommended by the Finance Commissions are predominantly in the nature of general purpose grants meeting the difference between the assessed expenditure on the non-plan revenue account of each State and the projected revenue including the share of a State in Central taxes. These are often referred to as 'gap filling grants'. Over the years, the scope of grants to States was extended further to cover special problems. Following the seventy-third and seventy-fourth amendments to the Constitution, Finance Commissions were charged with the additional responsibility of recommending measures to augment the Consolidated Fund of a State to supplement the resources of local bodies. This has resulted in further expansion in the scope of Finance Commission grants. The Tenth Commission was the first Commission to have recommended grants for rural and urban local bodies. Thus, over the years, there has been considerable extension in the scope of grants-in-aid. 8.4 FISCAL CAPACITY/INCOME DISTANCE The income distance criterion was first used by Twelfth FC, measured by per capita GSDP as a proxy for the distance between states in tax capacity. When so proxied, the procedure implicitly applies a single average tax- to- GSDP ratio to determine fiscal capacity distance between states. The Thirteenth FC changed the formula slightly and recommended the use of separate averages for measuring tax capacity, one for general category states (GCS) and another for special category states (SCS). 8.5 FISCAL DISCIPLINE Fiscal discipline as a criterion for tax devolution was used by Eleventh and Twelfth FC to provide an incentive to states managing their finances prudently. The criterion was continued in the Thirteenth FC as well without any change. The index of fiscal discipline is arrived at by comparing improvements in the ratio of own revenue receipts of a state to its total revenue expenditure relative to the corresponding average across all states.

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8. FINANCE COMMISSION-CONCEPTS AND DEFINITIONS

Economic Development - Fiscal Policy & Taxation 11Central Delhi: 73, Near Axis Bank, Old Rajinder Nagar Delhi-60 |Contact: 9811906458, 9354341266|

TOPIC

2 TAXATION

INTRODUCTION Taxation refers to the practice of government collecting money from its citizens to pay for public services. Taxes are generally an involuntary fee levied on individuals or corporations that is enforced by a government entity, whether local, regional or national in order to finance government activities. In economics, taxes fall on whomever pays the burden of the tax, whether this is the entity being taxed, like a business, or the end consumers of the business's goods. It is a monetary burden laid upon individuals or property owners to support the government. It is not a voluntary payment or donation, but an enforced contribution towards the government. The prime reason for levy of taxes is that they are the basic source of revenue to the government which can be utilised by the government for its expenses like defence, healthcare, education, different infrastructure facilities like roads, dams, highways etc. The authority of the government to levy tax in India is derived from the Constitution of India, which allocates the power to levy taxes to the Central and State governments. All taxes levied within India need to be backed by an accompanying law passed by the Parliament or the State Legislature. There are mainly two forms of taxes namely Direct and Indirect taxes. These are defined according to the ability of the end taxpayer to shift the burden of taxes to someone else. Direct taxes allow the government to collect taxes directly from the consumers while indirect taxes allow the government to expect stable and assured returns through the society.

Besides these two conventional taxes, there are also other taxes that have been brought into effect by the Central Government to serve a particular agenda. 'Other taxes' are levied on both direct and indirect taxes such as the recently introduced Swachh Bharat Cess, Krishi Kalyan Cess etc.

Direct Taxes, as the name suggests, are taxes that are directly paid to the government by the taxpayer. It is a tax applied on individuals and organizations directly by the government. One of the bodies that overlook these direct taxes is the Central Board of Direct Taxes (CBDT) which is a part of the Department of Revenue (under the Ministry of Finance). The examples of Direct Taxes are: • Income Tax • Corporate Tax • Capital Gains Tax • Wealth Tax • Securities Transaction Tax

2. DIRECT TAX

1. TAXATION


2.1 INCOME TAX • Income tax is the most common and most important tax that an Indian must pay. • It is charged directly on the income of a person. • The rate at which it is charged varies, depending on the level of income. • It's charged to individuals, co-operative societies, firms, companies, Hindu Undivided Families (HUFs), trusts and any artificial judicial person. • Income tax is charged on an income known as "taxable income", which is: • Taxable income = (total income) - (applicable deductions and exemptions). Its two basic types are: (1) Personal income tax, levied on incomes of individuals, households, partnerships, and sole-proprietorships; and (2) Corporation income tax, levied on profits (net earnings) of incorporated firms. Personal Income Tax Slab Rates for Financial Year 2017-2018 2.2 CORPORATE TAX Corporate tax is the income tax that is paid by companies from the revenue they earn. It is generally levied on the profits earned. The companies and business organizations are taxed on the income under the provisions of Income Tax rules. For example a domestic company, which has revenue of less than Rs. 1 crore per annum, won't have to pay this tax but one that has a revenue of more than Rs. 1 crore per annum will have to pay this tax. It is also referred to as a surcharge and is different for different revenue brackets. It is also different for international companies where the corporate tax may be 41.2% if the company has revenue of less than Rs. 10 million and so on. For domestic companies: A domestic company in India refers to any enterprise that has its base location in India and is of Indian origin. Given below is the tax rate applicable to domestic businesses in the country. • A flat rate of 25% corporate tax is levied on the income earned by a domestic corporate. • A surcharge of 5% is levied in case the turnover of a company is more than Rs.1 Crore for a specific financial year. • 3% educational cess is levied. • Corporate tax is also levied on the global earnings of the domestic company. This takes into account income earned by the company abroad. For international companies: A foreign company means an enterprise that has operations and origin in any other country except India. The taxation rules are not as simple for foreign enterprises as for domestic businesses. Corporate tax on foreign companies depends a lot on the taxation agreements made between India and other foreign countries. For example, corporate tax on an Australian company in India will depend upon the taxation agreement between the governments of India and Australia. 2.3 CAPITAL GAINS TAX Capital gains tax (CGT) is charged on the gains in the financial year in which the capital asset is transferred, but the tax is only payable in the financial year in which the money from transfer/sale proceeds are actually received by the assessee. Capital gains are not applicable when an asset is inherited because there is no sale, only a transfer. However, if this asset is sold by the person who inherits it, capital gains tax will be applicable. The Income Tax Act has specifically exempted assets received as gifts by way of an inheritance or will. What are Long-Term and Short-Term Capital Assets? Short-term capital asset - An asset which is held for not more than 36 months or less is a short-term capital asset. Long-term capital asset - An asset that is held for more than 36 months is a long-term capital asset. Some assets are considered short-term capital assets when these are held for 12 months or less. This rule is applicable if the date of transfer is after 10th July, 2014 (irrespective of what the date of purchase is). The assets are: • Equity or preference shares in a company listed on a recognized stock exchange in India • Securities (like debentures, bonds, govt. securities etc.) listed on a recognized stock exchange in India • Units of UTI, whether quoted or not • Units of equity oriented mutual fund, whether quoted or not • Zero coupon bonds, whether quoted or not When the above listed assets are held for a period of more than 12 months, they are considered long-term capital asset.


In case an asset is acquired by gift, will, succession or inheritance, the period this asset was held by the previous owner is also included when determining whether it's a short term or a long-term capital asset. In the case of bonus shares or rights shares, the period of holding is counted from the date of allotment of bonus shares or rights shares respectively. Tax on Short-Term and Long-Term Capital Gains Tax on long-term capital gain: Long-term capital gain is taxable at 20% + surcharge and education cess. Tax on short-term capital gain when securities transaction tax is not applicable: If securities transaction tax is not applicable, the short-term capital gain is added to your income tax return and the taxpayer is taxed according to his income tax slab. Tax on short-term capital gain if securities transaction tax is applicable: If securities transaction tax is applicable, the short-term capital gain is taxable at the rate of 15% +surcharge and education cess. Securities Transaction Tax (STT) STT is a type of direct tax payable on the value of taxable securities transaction done through a recognized stock exchange in the country. STT was introduced in the Budget of 2004 and implemented in Oct 2004. The objective behind the levy is to mitigate tax evasion as the same is taxed at source. Stocks, futures, option, mutual funds and exchange traded funds come under the ambit of STT. The rate of taxation for STT is set by the government and depends upon the type of security and type of transaction, whether purchase or sale. For equity transactions that are delivery-based, STT for purchase and sale is 0.1% of turnover and for intra-day transactions, STT for purchase is nil and sale is 0.025% of the turnover. Banking Cash Transaction Tax (BCTT) BCTT is a type of direct tax that was first introduced in 2005 on cash transactions exceeding a specific amount from the bank by a customer but after four years it was rolled back on 1 April 2009. During this period it was 0.1%. Recently, the Committee of Chief Ministers headed by Andhra Pradesh Chief Minister Chandrababu Naidu on Digital Payments has recommended the restoration of Banking Cash Transaction Tax (BCTT). It is a proposed method of taxation which would be charged on all forms of bank transactions - credit and debit. The tax would be charged on both - cheque payments and electronic methods of transactions. The tax would be collected by government and equally distributed between Centre and the respective state where transaction took place. 'Google Tax' or 'Facebook Tax' or 'Equalization Levy' The Google Tax was brought in the Union Budget 2016-17. However, it is known as Google Tax around the world, yet in India it is known as the "EQUALIZATION LEVY". It was announced to introduce a tax on the income as accrue to a foreign e-commerce company outside of India. As per the Union Budget 2016, the budget states that any individual or entity who use Non-Resident technology services shall pay 6% of the total gross payment as the equalization levy to the government, but only if the total gross payment exceeds one lakh rupees for the single financial year. It is known as Google Tax or Equalization Levy. This Law is specially made for the foreign e-commerce company who has no permanently fixed establishments in India. Specified services include online and digital advertising or any other services for using the digital advertising space will accrue such tax. This list, however, may be expanded soon. Let's take an example: assume that A runs a company and is liable to pay Rs 5 lakh to a foreign company to advertise with them. With the new tax in place, A will have to withhold 6% of the amount - i.e. Rs 30,000 - and pay the balance Rs 4.7 lakh to the foreign company for its services. The withheld amount will be paid to the government. It remains to be seen whether the foreign company will stand to bear the loss by simply accepting lower margins because of the new tax or will they hike the advertising rate taking the new tax into account? If the latter happens, which is most likely, the Indian business owner, in this case, A, will bear the loss. Advantages of Direct Taxes 1. Social and economic equity This form of taxation indicates social justice as it is based on the ability to pay. The economic situation of persons determines the rate at which they are taxed. Also the progressive nature of direct taxation can help reduce income inequalities. 2. Certainty of tax to be paid The tax payer is certain as to how much tax is to be paid, as the tax rates are decided in advance. The same implies for the government where it can estimate the tax revenue from direct taxes. 3. Economical and lower cost mechanism Collection of direct taxes is generally economical. Like in the case of personal income tax, the tax can be deducted at source


(TDS) from the income or salaries of the individuals. So, the government does not have to spend much in tax collection as far as personal income tax is concerned. 4. Relatively Elastic Increase in the income of individuals and companies, leads to increase in the yield from direct taxes also. An increase in tax rates would increase the tax revenues. Thereby, direct taxes are relatively elastic. 5. Controls inflation Direct taxes can help control inflation. When the inflation is on the uptrend, the government may increase the tax rate. With an increase in tax rate, the consumption demand may decline, which in turn may help reduce inflation. Disadvantages of Direct Taxes 1. Tax Evasion There is higher tax evasion in our country due to high tax rates, poor documentation and corrupt tax administration. This helps in suppressing the correct information about incomes easily and thereby with manipulating accounts, evasion on tax is encouraged. 2. Impacts Capital Formation Direct taxes can affect savings and investments. Due to tax implications, the net income of individuals reduces, in turn reducing their savings. Reduction in savings results in low investment, affecting the capital formation in the country. 3. Arbitrary Rate of Taxation The direct taxes are arbitrary. There is no objective defined for determining the tax rates of direct taxes. Also, the exemption limits in personal income tax, wealth tax, etc., are also determined in an arbitrary manner. Therefore, direct taxes may not always fulfill the requirement of equity. 4. Imbalance in Sectoral taxation In India, there is sectoral imbalance as far as direct taxes are concerned. Certain sectors like the corporate sector is heavily taxed, whereas, the agriculture sector is 100% tax free.

Indirect taxes are those taxes that are levied on goods or services. They differ from direct taxes because they are not levied on a person who pays directly to the government; instead, they are levied on products and are collected by the person selling the product. The examples of Indirect taxes are: • Sales Tax • Service Tax • Value Added Tax • Custom Duty and Octroi • Excise Duty • Goods and Service Tax (GST) - Refer to the later section as this tax has merged all the indirect taxes. Custom Duty The Customs Act was formulated in 1962 to prevent illegal imports and exports of goods. Besides, all imports are sought to be subject to a duty with a view to affording protection to indigenous industries as well as to keep the imports to the minimum in the interests of securing the exchange rate of Indian currency. Duties of customs are levied on goods imported or exported from India at the rate specified under the customs Tariff Act, 1975 as amended from time to time or any other law for the time being in force. Under the custom laws, the various types of duties are leviable. • Basic Duty: This duty is levied on imported goods under the Customs Act, 1962. • Additional Duty (Countervailing Duty) (CVD): Duties that are imposed in order to counter the negative impact of

import subsidies to protect domestic producers are called countervailing duties. In cases foreign producers attempt to subsidize the goods being exported by them so that it causes domestic production to suffer because of a shift in domestic demand towards cheaper imported goods, the government makes mandatory the payment of a countervailing duty on the import of such goods to the domestic economy. The WTO permits member countries to impose countervailing duty when the exporting country gives export subsidy. Export subsidy will help the exporters to sell the product at a lower price in the international market. A parity between the price of imported products (that enjoys export subsidy) and the domestic products (that doesn't enjoy any subsidy) has to be ensured. For this, a Countervailing Duty is essential as it can raise the price of the imported product. Here, CVD is imposed to countervail (overcome) export subsidy. • Anti-dumping Duty: Sometimes, foreign sellers abroad may export into India goods at prices below the amounts charged by them in their domestic markets in order to capture Indian markets to the detriment of Indian industry. This is known as dumping. In order to prevent dumping, the Central Government may levy additional duty equal to the margin of dumping on such articles. There are however certain restrictions on imposing dumping duties in case of countries which are signatories to the GATT or on countries given "Most Favoured Nation Status" under agreement.

3. INDIRECT TAX


India is contemplating the merger of two bodies that handle anti-dumping and import safeguard actions, seeking to counter protectionist measures imposed by developed economies at a time when world trade has shrunk because of tepid demand. Anti-dumping and countervailing measures in India are administered by the Directorate General of Anti-Dumping and Allied Duties (DGAD), which functions under the commerce ministry; safeguard actions such as temporary restrictions on the import of a product or higher duties come under the ambit of the Directorate General of Safeguards, which functions under the finance ministry. The commerce ministry has proposed merging these two bodies into one called the Directorate General of Trade Remedies (DGTR), which will be similar to the US International Trade Commission (USITC)." We want to ensure that this country is not a victim of too much protectionist measures by other countries at a time of slowdown in global trade. We want to put all the trade remedy options under one umbrella and build up expertise," the commerce ministry official said. • Export Duty: Such duty is levied on export of goods. At present very few articles such as skins and leather are subject to export duty. The main purpose of this duty is to restrict exports of certain goods. • Education Cess: Education Cess is leviable @ 2% on the aggregate of duties of Customs. • Secondary and Higher Education Cess: Leviable @1% on the aggregate of duties of Customs. 3.1 CENTRAL EXCISE DUTY The Central Government levies excise duty under the Central Excise Act, 1944 and the Central Excise Tariff Act, 1985. Central excise duty is tax which is charged on such excisable goods that are manufactured in India and are meant for domestic consumption. The term "excisable goods" means the goods which are specified in the First Schedule and the Second Schedule to the Central Excise Tariff Act 1985. It is mandatory to pay Central Excise duty payable on the goods manufactured, unless exempted e.g.; duty is not payable on the goods exported out of India. 3.2 GOODS AND SERVICE TAX (GST) GST is a single tax on the supply of goods and services, right from the manufacturer to the consumer. It is one indirect tax for the whole nation, which will make India one unified common market. The salient features of GST are: • The GST would be applicable on the supply of goods or services as against the present concept of tax on the manufacture or sale of goods or provision of services. • It would be a destination based consumption tax. This means that tax would accrue to the State or the Union Territory where the consumption takes place. • It would be a dual GST with the Centre and States simultaneously levying tax on a common tax base. The GST to be levied by the Centre on intra-State supply of goods or services would be called the Central tax (CGST) and that to be levied by the States including Union territories with legislature/Union Territories without legislature would be called the State tax (SGST)/ Union territory tax (UTGST) respectively. • The GST would apply to all goods other than alcoholic liquor for human consumption and five petroleum products, viz. petroleum crude, motor spirit (petrol), high speed diesel, natural gas and aviation turbine fuel. • The GST would replace the following taxes currently levied and collected by the Centre:

Central Excise Duty Duties of Excise (Medicinal and Toilet Preparations) Additional Duties of Excise (Goods of Special Importance) Additional Duties of Excise (Textiles and Textile Products) Additional Duties of Customs (commonly known as CVD) Special Additional Duty of Customs (SAD) Service Tax Central Surcharges and Cesses as far as they relate to supply of goods and services.

• State taxes that would be subsumed under the GST are: State VAT Central Sales Tax Luxury Tax Entry Tax (all forms) Entertainment and Amusement Tax (except when levied by the local bodies) Taxes on advertisements Purchase Tax


Taxes on lotteries, betting and gambling State Surcharges and Cesses so far as they relate to supply of goods and services. • The mechanism of GST Council would ensure harmonization on different aspects of GST between the Centre and the States as well as among States.

Components of GST: CGST, SGST and IGST When the centre and states are merging their prominent indirect taxes under GST, both should get their own share in the GST. For this, the GST Council has adopted a dual GST with two components - the Central GST (CGST) and the State GST (SGST). Objective of this division is sharing the revenue from the unified GST between the centre and states. Central and State GST There is sharing of GST by the centre and the tax accruing state at 50:50 ratio. For example, if a good is taxed at 18%, out of this, 9% will go to the centre and the remaining 9% will go to the state where the good is consumed. The GST going to the Centre is called as Central GST (CGST) and that toes to the States is known as State GST (SGST). Here, the centre and the concerned state will equally share GST on goods and services. Basically, GST is a destination based or consumption tax. Meaning of a destination based tax is that tax revenue (SGST) will go to the consuming state and not to the producing state. In the case of intrastate production and consumption (production and consumption takes place in the same state), the share of SGST will accrue to the concerned state where as the share of CGST should be credited to the center's account. Integrated GST (IGST) The IGST comes to play when the commodity is produced in one state and is traded to another state (interstate trade). In this case, the share of SGST should go to the consuming state (as the GST is a destination based tax). As a consumption based tax i.e. the tax SGST share should be received by the state in which the goods or service are consumed and not by the state in which such goods are manufactured. As per the GST law (Article 269 A), an Integrated GST (IGST) would be levied and collected by the Centre on interstate supply of goods and services. This tax will be collected by the Centre to ensure that the supply chain or interstate trade is not disrupted. GST Council Most systemic changes need the support from dedicated institutions; and if the change is big, we have to create fresh institutions. In the case of GST, the responsibilities were tremendous as the Centre and the States have to reach consensus on ceding their taxation power to create a common tax for goods and services. Finance Minister Arun Jaitely at the inauguration of GST described it as an outcome of political coordination. To realize the coordination process, the 101st Constitutional Amendment created the GST Council after Article 279A. The GST Council comprises of the representatives of Centre and States. Voting pattern in the GST Council was also unique. The Centre will have one-third vote. All states together will have a two-third. To adopt a resolution, three-fourth majority would be required. Following are the members of GST Council: • Union Finance Minister • The Union Minister of State, in-charge of Revenue of finance... Member • The Minister In-charge of finance or taxation • State Finance Ministers • Two representatives from UTs The GST council will be chaired by the Union finance minister. A state finance minister will be deputy chairman. Functions of the GST Council • The council will have the last say in finalizing the shape of the GST. • It will finalize the tax rate under the GST as well as the revenue threshold for traders to be exempt from this tax. • It will prepare the model Central, State and Integrated GST laws. • It will make recommendations on the taxes, cesses and surcharges that will be subsumed by the GST. • It will also decide if and when petroleum and petroleum products will come under the GST's ambit. • The council will also decide which goods and services will be exempt from the tax to protect the common man as well as the fine print of the sharing of administrative duties between the central board of excise and customs and the state tax officers. • The council will also have the final say on the mechanism to resolve disputes that may arise between the centre and the states or between states GSTN - IT Infrastructure The work-horse entity that was created to function as a digital platform for administering the tax transactions by tens of thousands of business entities is the Goods and Services Tax Network (GSTN).


The Goods and Services Tax Network (GSTN) is a non-government non-profit private limited company created for providing the front end and back end IT and infrastructural support for the working of GST. It is registered as a non - profit Company under the New Companies Act in March 2013. Following are the main functions of GSTN: • Facilitating registration; • Filing of returns and forwarding the returns to Central and State tax authorities; • Computation and settlement of IGST; • Matching of tax payment details with banking network; • Providing various Management Information System reports to the Central and the State Governments based on the tax payer return information; • Analysis of tax payers' profile; and • Running the matching engine for input tax credit. As a non-government the Governments -Centre, states plus UTs hold 49% of GSTN. Central government holds 24.5% while the remaining governmental share of 24.5% is held by sub-national governments (states and UTs). The remaining 51% share is divided among five financial institutions—LIC Housing Finance with 11% stake and ICICI Bank, HDFC, HDFC Bank and NSE Strategic Investment Corporation Ltd with 10% stake each. Private sector IT vendors will develop the web or mobile base interfaces for taxpayers to interact with the GST network. They will be called as GST Suvidha Providers. Composition Scheme under Goods and Service Taxes (GST) The Composition scheme under the GST is an easy, low procedure and compliance friendly tax scheme for small and medium enterprises. Under the scheme, firms under a threshold limit of turnover can pay a fixed percentage of their turnover as tax. They need to fill only reduced number of returns compared to normal tax payers under GST. The salient features of the Composition Scheme are: • Less number of tax returns: A tax payer under the Composition Scheme under GST will be required to file summarized returns only on a quarterly basis. On the other hand, for others, they must file three monthly returns. In total, the normal GST payer must submit 37 returns. • Turnover limit for the Scheme: The Composition Scheme can be availed by any taxpayer whose turnover is less than Rs. 1.5 crores. • The Composition scheme is for businesses dealing in goods. Services providers are can't avail the scheme. But restaurants can opt for the scheme. • Scheme is available for only intra-state suppliers: The Composition Scheme is available only for intra-state supplies. This means that dealers engaged in inter-state supplies cannot opt for the scheme. • No Input Scheme Facility is available: A Composition scheme firm is not allowed to avail input tax credit of GST. • No requirement for detailed records keeping: A firm under Composition Scheme is not required to maintain detailed records as in the case of a normal taxpayer. • E-Commerce firms can't opt for the Composition Scheme. What are the benefits of Composition Scheme? The scheme clearly gives benefits to the SMEs. Their compliance burden has been reduced. Similarly, the administrative cost of engaging with thousands of small firms has been curtailed from the angel of tax administration. This will give relief to the GST Network as well. Following are the main benefits of the Composition Scheme. Reduced Compliance Burden for SMEs For a normal GST payer, he has to file 37 tax returns in a year. But for a Composition Scheme firm, only four tax filing is needed in a year. This indeed reduces the tax compliance burden of the small businesses. Besides, the Composition Scheme firm need not keep detailed books of accounts on a daily basis and supporting documents. Reduced Tax Liability For a firm under the Composition Scheme, he has to pay a low fixed percentage of his turnover as tax. The rate is 1% for manufacturers, 2.5% for restaurant service providers, 0.5% for other suppliers of turnover. No cash block under input tax credit: High Liquidity For normal taxpayers, some of his funds will be blocked as Input Tax Credit and this can be drawn back only after the supplier files his return. In the case of the Composition Scheme, there is no input tax credit and no blocking of funds. Transitional Provisions A taxpayer opted for Composite Scheme can migrate to the status of a normal GST firm. The benefits of GST can be summarized as under: For business and industry • Easy compliance: A robust and comprehensive IT system would be the foundation of the GST regime in India. Therefore, all tax payer services such as registrations, returns, payments, etc. would be available to the taxpayers online, which would make compliance easy and transparent.


• Uniformity of tax rates and structures: GST will ensure that indirect tax rates and structures are common across the country, thereby increasing certainty and ease of doing business. In other words, GST would make doing business in the country tax neutral, irrespective of the choice of place of doing business. • Removal of cascading: A system of seamless tax-credits throughout the value-chain, and across boundaries of States, would ensure that there is minimal cascading of taxes. This would reduce hidden costs of doing business. • Improved competitiveness: Reduction in transaction costs of doing business would eventually lead to an improved competitiveness for the trade and industry. • Gain to manufacturers and exporters: The subsuming of major Central and State taxes in GST, complete and comprehensive set-off of input goods and services and phasing out of Central Sales Tax (CST) would reduce the cost of locally manufactured goods and services. This will increase the competitiveness of Indian goods and services in the international market and give boost to Indian exports. The uniformity in tax rates and procedures across the country will also go a long way in reducing the compliance cost. For Central and State Governments • Simple and easy to administer: Multiple indirect taxes at the Central and State levels are being replaced by GST. Backed with a robust end-to-end IT system, GST would be simpler and easier to administer than all other indirect taxes of the Centre and State levied so far. • Better controls on leakage: GST will result in better tax compliance due to a robust IT infrastructure. Due to the seamless transfer of input tax credit from one stage to another in the chain of value addition, there is an in-built mechanism in the design of GST that would incentivize tax compliance by traders. • Higher revenue efficiency: GST is expected to decrease the cost of collection of tax revenues of the Government, and will therefore, lead to higher revenue efficiency. For the consumer • Single and transparent tax proportionate to the value of goods and services: Due to multiple indirect taxes being levied by the Centre and State, with incomplete or no input tax credits available at progressive stages of value addition, the cost of most goods and services in the country today are laden with many hidden taxes. Under GST, there would be only one tax from the manufacturer to the consumer, leading to transparency of taxes paid to the final consumer. • Relief in overall tax burden: Because of efficiency gains and prevention of leakages, the overall tax burden on most commodities will come down, which will benefit consumers.

4.1 TAX INCIDENCE It shows the entity on which tax is imposed. It is different from the tax burden as shown below: if government increases tax on petrol, oil companies may absorb it if competition is intense or they may pass it on to private motorists. Tax incidence here refers is on companies and the burden may be on the consumer. 4.2 TAX BURDEN It means those who actually pay taxes-from whom it is collected. Depending on the market forces involved, a tax can be absorbed by the seller or the buyer (in the form of higher prices), or by a third party like seller, employees in the form of lower wages. 4.3 TAX BASE The value of goods, services and incomes on which tax is imposed. When economists speak of the tax base being broadened, they mean a wider range of goods, services, income etc. has been made subject to a tax, In the case of income tax, and the tax base is taxable income. Some kinds of income are excluded from the definition of taxable income, such as savings. For sales tax, the tax base is the value/volume of items that are subject to tax; essential goods, for example, are not part of the tax base. 4.4 TAX SHELTER It is any technique which allows one to legally reduce or avoid tax liabilities. It is a way in which the taxpayer can invest his income in a particular kind of investment that gives tax concessions. Difference between tax avoidance and tax evasion There are provisions in the law that allows one to save and invest in a manner that leads to reduction in taxable income. If these provisions are used for the benefit, it is called tax avoidance. It is lawful to take all available tax deductions. Tax evasion, on the other hand, is a punishable offence. Tax evasion typically involves failing to report income, or improperly claiming deductions that are not authorized.

4. BASIC CONCEPTS


Tax Haven In a country that offers foreign individuals and businesses little or no tax liability in a politically and economically stable environment. Tax havens also provide little or no financial information to foreign tax authorities. Individuals and businesses that do not reside a tax haven can take advantage of these countries' tax regimes to avoid paying taxes in their home countries. Tax havens do not require that an individual reside in or a business operate out of that country in order to benefit from its tax policies. Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Islands, Hong Kong, the Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, Switzerland and St. Kitts and Nevis are all considered tax havens. However, pressure from foreign governments that want to collect all the tax revenue they believe they are entitled to have caused some tax haven countries to sign tax information exchange agreements (TIEAs) and mutual legal assistance treaties (MLAT) that provide foreign governments with formerly secret information about investors' offshore accounts. Hidden Taxes These are the taxes that are indirectly assessed upon consumer goods without the consumer's knowledge. Hidden taxes are levied upon the goods at some point during the production process and therefore raise the cost of the goods sold. However, this tax is never revealed directly to the consumer, who simply pays a higher price for the good, not knowing that part of that price is due to this tax. Some ad valorem taxes are an example of a hidden tax, as are taxes that are imposed at the wholesale level. Most consumers are aware that there is a tax on retail goods (sales tax), but this is by no means the only tax levied on consumer goods. Hidden taxes are almost invariably passed on to the consumer. Negative income tax: Subsidy is a negative income tax. It is a taxation system where income subsidies are given to' persons or families that are below the poverty line. The government will send financial aid to a person who files an income tax return reporting an income below a certain level. Pigovian Taxes The Pigovian tax is imposed on bodies that have a negative externality. Let's take an example, pollution. Externality means impact of one person's actions on the well being of an outsider (bystander or third party). For example, the seller and consumer of cigarettes together will harm the third person with pollution. Example of negative externality is exhaust fumes from automobiles. Positive externality refers to a good effect on the third party. For example, restoration of historic buildings, research into new technologies. Carbon tax is one example in the context of the need to discourage fossil fuels and encourage renewable sources due to climate change threat. Tax Buoyancy It refers to the percentage change in tax revenue with the growth of national income. That is, growth-based increase in tax collections. Tax Elasticity Tax elasticity is defined as the percentage change in tax revenue in revenue to the change in tax rate and the extension of coverage. Buoyancy, on the other hand is the response to economic growth when the base increases but there is no change in the rate. Tax Stability It means no frequent changes and continuity of policy in a predictable and transparent manner. Although revenue from different taxes varies from year to year, revenue stability is desirable because it makes it easier for a government to build a credible spending and borrowing plan for the year ahead. Taxes whose revenue is relatively stable contribute to overall revenue stability. Market players also can plan better. Tobin Tax James Tobin an economist, proposed a worldwide tax on all foreign exchange transactions when foreign capital enters a country and when it leaves. The aim is to check speculative flows. Long term investment - generally FDI, will not suffer as it does not invest for speculative (short term) reasons like FIIs. 4.5 MINIMUM ALTERNATIVE TAX MAT is a tax levied on profit-making entities that don't pay corporate income tax because of exemptions and incentives. Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the Income Tax Act, but the profit and loss account of the company is prepared as per provisions of the Companies Act. There were large numbers of companies who show book profits as per their profit and loss account (according to the Companies Act) but do not pay any tax by showing no taxable income as per provisions of the Income Tax act. Although the companies show book profits and may even declare dividends to the shareholders, they do not pay any income tax. These companies are popularly known as Zero Tax companies. In order to bring such companies under the income tax act net, MAT was introduced in 1996. They are required to pay MAT at 18.5% in 2015.


Book profit is Profit which is notional made but not yet realized through a transaction, such as a stock which has risen in value but is still being held. It is also called unrealized gain or unrealized profit or paper gain or paper profit.

4.6 PRESUMPTIVE TAX Presumptive Tax the Estimated Income Method of assessment for certain categories of businesses is prevalent in several countries. Presumptive taxation involves the use of indirect means to ascertain tax liability, which differ from the usual rules based on the taxpayer's accounts. The term presumptive is used to indicate that there is a legal presumption that the tax payer's income is no less than the amount resulting from application of the indirect method. Inverted Duty Structure Higher import duty on the raw materials than on the finished product is called inverted duty structure. It puts the domestic manufacturers at a disadvantage making them uncompetitive. Let us take for instance, compact fluorescent lamps (CFLs), where the import duty on raw materials for manufacturing CFLs is 9.7 percent more than on finished bulbs. This skewed duty structure makes domestic CFL manufacturers uncompetitive. There is no Basic Customs Duty for import of solar cells and modules. However, under the existing duty structure, the inputs (like EVA, Tedlar, Toughened Glass) which go into the manufacturing of solar cells and modules attract duty .This results in an inverted duty structure, which favors the import of the cells I modules and puts the domestic manufacturers to a disadvantage. Similarly, if rubber is imported at a higher duty than tire, manufacturing them in India is discouraged. The Economic Survey (2010-11) said FTAs also lead to a new type of inverted duty structure with duties for final products being lower from FTA partners compared to duties for the previous-stage raw materials imported from non-FTA countries. "This acts as a disincentive to local manufacturing which is not competitive against FTA imports because of the inverted duty structure phenomenon," the Survey said. Import duty on raw silk is more than silk fabric (2013 December). Laffer Curve Invented by Arthur Laffer, this curve shows the relationship between tax rates and tax revenue collected by governments. The chart below shows the Laffer curve: The Laffer Curve describes how changes in tax rates affect government revenues in two ways. One is immediate, which Laffer describes as "arithmetic." Every dollar in tax cuts translates directly to one less dollar in government revenue. The other effect is longer-term, which Laffer describes as the "economic" effect. It works in the opposite direction. Lower tax rates put money into the hands of taxpayers, who then spend it. It creates more business activity to meet consumer demand. For this, companies hire more workers, who then spend their additional income. This boost to economic growth generates a larger tax base. It eventually replaces any revenue lost from the tax cut. The Laffer curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100%, shown as the far right on his curve, all people would choose not to work because everything they earned would go to the government. Governments would like to be at point T*, because it is the point at which the government collects maximum amount of tax revenue while people continue to work hard. Base Erosion and Profit Shifting (BEPS) Base erosion and profit shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Firms make profits in one jurisdiction, and shift them across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax rates and, thus, not paying taxes to in the country where the profit is made. The BEPS project is a joint initiative between G20 countries and the OECD, works towards the development of a coherent global taxation system which addresses BEPS concerns. The Organization for Economic Cooperation and Development (OECD) states that BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises.

Latest Developments The controversy has erupted after the income-tax department issued notices to more than 50 foreign portfolio investors to pay MAT. To address the concerns, a panel led by Justice A.P. Shah was set up to clarify on this issue. The committee recommended that MAT cannot be levied on foreign portfolio investors as well as foreign companies who have no permanent establishment in India. Government accepting the recommendations of committee has exempted foreign portfolio investors (FPIs) from the MAT levy. Also, foreign companies without a permanent establishment in India will be exempt from minimum alternative tax (MAT).


A DTAA is a tax treaty signed between two or more countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same income. A DTAA applies in cases where a tax-payer resides in one country and earns income in another. DTAAs can either be comprehensive to cover all sources of income or be limited to certain areas such as taxing of income from shipping, air transport, inheritance, etc. India has DTAAs with more than eighty countries, of which comprehensive agreements include those with Australia, Canada, Germany, Mauritius, and Singapore, UAE, the UK and US. DTAAs are intended to make a country an attractive investment destination by providing relief on dual taxation. Such relief is provided by exempting income earned abroad from tax in the resident country or providing credit to the extent taxes have already been paid abroad. DTAAs also provide for concessional rates of tax in some cases.

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5. DOUBLE TAXATION AVOIDANCE AGREEMENT

Date post:	11-Dec-2021
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