Insights into Editorial: Sort out the tax maze
09 April 2016
Recent Panama leaks have exposed various loopholes in India’s tax regime. It is widely being assumed that tax havens are used only for illegal activities. However, tax havens are more likely to be used not just for illegal activity but even for legitimate businesses.
- People prefer tax haven for the sake of avoiding taxes. But there are very thin lines between the legal and the illegal. The difference between tax evasion and tax avoidance is one such line.
- Tax evasion involves not paying taxes on your income and is illegal. Tax avoidance, on the other hand, is about managing your taxes across different tax jurisdictions to take advantage of differences in tax rates, such as corporate tax rates, in tax treatment of different kinds of income, such as capital gains, and in tax treaties among countries.
- Tax havens such as Panama, the British Virgin Islands and the Bahamas try to attract business by offering low tax rates and easy compliance.
Problems with Indian tax regime:
In India, tax rates are higher, the system is complicated and capital controls restrict foreign financial transactions.
- Various tax laws have made compliance more costly in India. India is ranked 157 in the ease of paying taxes.
- Further, the effective tax on profit is higher: The corporate tax rate and the dividend distribution tax put together make the tax rate on profits nearly 50%.
- The capital gains tax makes financial transactions even more unattractive. This regime is made more tortuous by an onerous set of capital controls.
Tax avoidance as cheating:
Some countries, including OECD countries, consider even tax avoidance as illegal.
A number of OECD initiatives have been taken to reduce tax avoidance:
- An agreement on Base Erosion and Profit Shifting (Beps) aims to prevent companies from choosing low-tax jurisdictions to book profits in.
- The Automatic Exchange of Information (AEOI) framework will facilitate information flows among signatories.
- The Foreign Account Tax Compliance Act (Fatca) targets non-compliance by US taxpayers and compliant countries have to provide customer information to the US government.
However, there are some cases in which the actions are clearly illegal-
- First, when the underlying activity is criminal, say, drug or arms trade. These activities are covered under the Prevention of Money Laundering Act. As a member of the Financial Action Task Force, India works with other member countries to prevent the use of the proceeds of crime.
- The second is when there are cases of tax evasion: A person does not declare to the tax authorities in her home country her income, which is paid into a bank account of her company in Panama, and no taxes are paid. Here, a distinction between tax evasion and avoidance is relevant. If taxes have been paid in the tax haven at its lower tax rate, then there may be no illegality. When India introduces the General Anti-Avoidance Rule (Gaar), some of these activities may become illegal.
- The third case is if there is a violation of capital controls. This is an India-specific issue. Under the Liberalised Remittance Scheme (LRS), every Indian resident is allowed to invest $2,50,000 abroad every year. In 2004, the limit was one-tenth of this. Money remitted abroad is from income on which tax has already been paid. If the amount invested abroad exceeds the amount allowed by the RBI, it is a violation of the law.
- Fourth, the illegality may be the non-declaration of assets held abroad. A provision in the Finance Bill introduced in 2015 made it criminal not to declare foreign assets in annual tax returns. If the assets held in tax havens have been declared, then it is not illegal to hold them.
Why be concerned about these issues?
There is a widespread perception that offshore companies are conduits for money laundering, illegal transactions, tax evasion or parking unexplained wealth. Hence, it is necessary to keep an eye on such activities and prevent them.
- First, rationalisation of capital controls should be a top priority. Many government reports have laid out the path forward.
- Second, India must move to a simple tax regime with lower compliance costs. The blueprint is ready in the Direct Taxes Code.
The new government at the Centre has the opportunity to simplify our tax laws that reduce the scope for disputes between taxpayers and revenue authorities. The objective should be to encourage voluntary compliance and severely penalise tax evasion. This, along with clarity on introduction of a new Direct Taxes Code and a roadmap for the implementation of a nationwide Goods and Services Tax, will go some way in creating a non-adversarial tax climate conducive to growth and investment. In the long run, this is the only sustainable path to revenue generation.