1
Q
What his Fiscal Federalism and what is the role of Finance commission?
A
Fiscal Federalism refers to the division of responsibilities of i) taxation and ii) expenditure between the different levels of the government. While the 7th schedule assigns many responsibilities to the States but their taxation power is relatively lower than Union’s. So, Finance Commission plays a key role in transferring union’s revenue resources to the state.
2
Q
Composition of Finance commission? eligibility for reappointment
A
- Article 280: President of India forms a Finance Commission (a quasi-judicial body) every 5th Year or earlier, with 1 chairman and 4 members.
- Eligible for re-appointment.
- Recommendations are not binding on the government but usually not rejected.
3
Q
15th FC Terms of Reference (TOR) ?
A
President of India has ordered them to study and recommend following:
- Union Taxes’ vertical devolution to the states, and its horizontal distribution among the states. (except cess, surcharge and IGST).
- Union’s grant-in-aids to the states.
- How to augment State Govts’ Consolidated funds to help their PRI/ULBs
- Any other matters referred by the President of India such as:
✓ Use Census-2011 for your calculation.
✓ Keep in mind Union’s responsibilities for New India 2022 vision.
✓ Recommend measures for Fiscal Discipline/ Consolidation for the Union and State governments.
✓ Should union continue to provide revenue deficit grants to States?
✓ How to finance the disaster management initiatives?
✓ Performance based incentives to the state governments?
✓ (2019-Jul) suggest ways for allocation of non-lapsable funds for defence and internal security.
✓ (2019-Oct) Award for the UT of J&K. (This terms of reference required under JAMMU AND KASHMIR REORGANISATION ACT, 2019.
4
Q
15th FC TOR: Apprehension of the states?
A
States Fear#1: Vision for New India 2022
States fear#2: Performance based incentives
States fear#3: Census-2011
States fear#4: Debt and Grants
5
Q
FC: Vertical devolution from union to States?
A
Finance Commission recommends the vertical devolution from the ‘divisible pool’ of union taxes. (Here IGST, Cess, Surcharge not counted.)
12 FC -2005-2010 - C.Rangarajan - 30.5%
13th FC 2010-2015 - Vijay Kelkar - 32%
14th FC 2015-2020 - YV Reddy - 42%
15th FC - 2020-2021 - NK Singh - 41%
*15th FC’s justification: Compared to 14th FC, 1% extra Union should keep for UTs of J&K & Ladakh’s security & other needs.
6
Q
How is horizontal tax devolution done among states according to 14th FC?
A
Finance Commission also gives formula for How to distribute states’ shares horizontally with individual States. 14th FC (YV Reddy)’s formula was…
Population: as per Census 1971 - 17%
Demographic Change as per Census 2011 (To consider the migration angle.) - 10%
Income-Distance: Based on per capita income of a state (GSDP ÷ its population). Accordingly, poorer states get more weight - 50%
Area: more area more weight - 15%
Forest-Cover: more forest cover more weight because of Opportunity cost (State can’t allow industries there, else it could have obtained some taxes) - 8%
Based on above formula, Highest to Lowest: Uttar Pradesh > Bihar > MP > WB > MH > Raj> ….. > Mizoram > Goa > Sikkim.
7
Q
How is horizontal tax devolution done among states according to 15th FC?
A
- Income Distance - 45%
- Area - 15%
- Population (as per Census-2011) - 15%
- Demographic Performance: States that have ⬇ Total Fertility Rate (TFR), will get ⬆₹₹. - 12.5%
- Forest and Ecology - 10%
- Tax Effort: States who’ve improved their per capita tax collection in the last 3 years = get more ₹₹ - 2.5%
8
Q
Finance Commissions & the fate of UTs of J&K & Ladakh?
A
Until 10th Finance Commission, the FC would also prescribe the revenue sharing formula between the Union Government and Union Territories.
➢ But this practice stopped since 11th finance commission i.e. Finance ministry itself
decides how much revenue will be shared with Union Territories based on its own
discretion
➢ Finance Commission no longer prescribed formula in this regard. But,
➢ 31st October 2019: The state of Jammu Kashmir was officially split into the union territories of Jammu Kashmir and union territory of Ladakh.
➢ Jammu and Kashmir Reorganization Act, 2019 mandates that:
o Whatever amount the former state of J&K was supposed to receive between 31/10/2019 to 31/3/2020 (as per 14th FC formula) …It will be distributed between these two new union territories on the basis of population ratio and other parameters.
o President of India shall require 15th FC to make award for UT of J&K.
o However, looking the 15th FC report, no separate share is given in vertical / horizontal tax devolutions. Simply 1% extra kept with Union to look after J&K & Ladakh, compared to 14th FC.
9
Q
Grants suggested by 15th FC (in ⬇decreasing order, 2020-21)
A
1) Local Bodies Grants (90k cr)
2) Post-Devolution Revenue Deficit Grants (74kcr)
3) Disaster Management Grants (41kcr)
4) Sector Specific Grants: Nutrition (~7700cr)
5) Special Grants: (~6700kcr)
6) Performance-based incentives
10
Q
States eligible for Post devolution Revenue Deficit Grants
A
Only 14 states eligible: Assam, Himachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Uttarakhand, Andhra,Kerala, Punjab, Tamil Nadu, West Bengal.
11
Q
Disaster Management Act, 2005 is under which ministry?
A
Disaster Management Act, 2005 → Ministry of Home Affairs looks after the subject.
12
Q
Sectors under Sector Specific Grants in FC?
A
Seven sectors: health, pre primary education, judiciary, rural connectivity, railways, statistics, housing.
13
Q
At present, 15th FC only recommended health → Nutrition grant- which ministry oversees this?
A
Ministry of Women and Child Development (MoWCD) will oversee its utilization.
14
Q
States eligible for Special grants?
A
Only 3 states eligible: Karnataka, Telangana and Mizoram.
15
Q
Some other recommendations by 15th FC to Govt
A
Some States have requested special category status But it’s not part of our mandate/Terms of Reference. So we’ve nothing to say on this matter.
Reform the direct taxation system → increase tax collection.
Reform GST’s operational challenges, slabs and rates.
Review the outcomes of all Government schemes. Merge/ abolish non-essential schemes → reduce Expenditure.
We need a law on “Public Financial Management System” it’ll prescribe the budgeting, accounting, internal control and audit standards to be followed at all levels of government.
Govt should follow FRBM Act with full sincerity in letter and spirit.
16
Q
Tax devolution and grants for states under AB?
A
Corona = Union’s tax income decreased but still under Atma-Nirbhar → Union has given assurance to release Tax Devolution and grants to the states as per the figures announced in the Budget and Finance Commission report.
17
Q
FC, PC, NIITI Aayog - constitutional/statutory or executive bodies? chairman?
A
FC- Constitutional body Art 280
PC and NITI - Created by executive resolution, so neither constitutional non statutory. Both headed by Prime Minister as the chairman.
18
Q
FC, PC, NIITI Aayog - Year formed and action plan?
A
FC - 1951: 1st FC setup under KC Neogy
PC - - 1951: PC set up and over the years designed 12 Five Year plans (12th FYP: 2012-2017)
- 2014: Dissolved by 16th LokSabha
NITI - - 2015: Formed.
- Three Year Action Agenda (2017-20).
- Seven Year Strategy Document.
- Fifteen Year Vision Document (2017-32).
19
Q
Brief functions of FC
A
- Taxes’ Vertical Devolution and horizontal distribution among states.
- any other matters referred by the President in TOR
- Each Finance Commission arrived at its own methodology. E.g. 14th FC: 42% vertical, and 5 factor formula for horizontal distribution.
20
Q
Brief functions of PC
A
- How much money should union give to each state for implementation of Union’s centrally sponsored schemes (CSS)?
- How much money should union government give to the five year plans of the state governments?
- To answer these Qs, PC would use Gadgil Mukherjee formula (designed in 8TH FYP)- based on population, per capita income, special problems etc. of a state.
21
Q
Brief functions of NITI Aayog
A
It is not in its scope of work to decide how much money should be given to each state. That component is decided by the Finance Ministry.
- NITI’s primary objective is to serve as the think tank of the Government of India,
- Helps in policy design.
- Helps in monitoring schemes’ through its dashboard e.g. ‘School Education Quality Index’, ‘SDG India Index’, ‘Digital Transformation Index’
22
Q
(Pre19-SetA) Q69. In India, which of the following review(s) the independent regulators in sectors like telecommunications, insurance, electricity etc. ?
- Ad Hoc Committees set up by the Parliament.
- Parliamentary Department Related Standing Committees
- FinanceCommission
- Financial Sector Legislative Reforms Commission
- NITI Aayog
Answer Codes: (a) 1 and 2 (b) 1 , 3 and 4 (c) 3, 4 and 5 (d) 2 and 5
A
A
23
Q
What are special category states and its benefits?
A
- 1952: The National Development Council (NDC) was set up, consisting of PM, CMs and other representatives to approve the five year plans prepared by the Planning Commission. But became obsolete with establishment of NITI Aayog.
- 1969: 5th Finance Commission recommended giving extra funds and tax-relief to certain disadvantaged states. Over the years, NDC added more states into the Special Category List based on
✓ (i) hilly and difficult terrain
✓ (ii) low population density and / or sizeable share of tribal population
✓ (iii) strategic location along borders with neighbouring countries
✓ (iv) economic/infrastructural backwardness
✓ (v) non-viable nature of state finances. - Examples: 8 North Eastern states and 3 Himalayan States (JK, Uttarakhand, HP). Post- 370 removal, J&K is no longer in this list.
- Benefits of Sp.Cat. States?
✓ Industrialists will be given benefits in Union-taxes for setting up factories in these states.
✓ In Centrally Sponsored Schemes (CSS) Union will bear
higher burden (90:10).
✓ FC & PC would assign more weightage in their formulas to give’em more funds.
- 14th FC: Previous Finance Commissions would assign extra weightage & funds to Sp.Cat states, but 14th FC stopped this practice.
- But, whenever elections are near, W.Bengal, Bihar and Andhra CMs would demand Sp.Cat. status & blame Union for ‘injustice’.
- 15th FC: Some States have requested special category status. But it’s not part of their mandate/Terms of Reference.
- So, at present, Sp.Cat states don’t get additional revenue/grants in FC’s formula. Although, Union upon its own discretion continues to give them certain benefits in CSS.
24
Q
Criticism by ES for Special Category states
A
Economic survey 2016-17: Noted that Sp.Cat states have received lot of funds & grant from previous FCs and PCs, and yet they have not made any tangible progress in improving public administration or removing poverty (=” Aid Curse”).
Similar problem with the States having abundant mineral resources (“Resource Curse”).
- Economic Survey 2017-18: Noted that compared to Brazil, Germany and other countries with federal polity, India’s State Governments and Local Bodies are collecting less amount of tax for two reasons :
- 1) Constitution has not given them sufficient taxation powers.
- 2) Even where constitution gave them powers like collection of Agricultural Income Tax, Land Revenue, Property Tax: The States/Local Bodies are shy of collecting taxes due to electoral politics.
- Result? Poor quality of Public Schools, Public Transport, Police, Drinking Water and Sanitation.
25
Cost sharing for Sp.Cat States and Hill Union Territory Status for J&K?
While Finance commissions no longer give extra weightage to ‘Sp.Category States’ in horizontal tax distribution formula, but Union provides them additional funding for their welfare schemes from Union’s own pocket.
"Special Category States"
- North-Eastern States, and TWO Himalayan Hilly States: Himachal Pradesh and Uttarakhand# - Depending on the scheme, union may contribute 80-90% of the scheme cost, rest will be borne by the State.
- Other States: who are not in above category (UP, Bihar, etc.) and Union territory (UT) with legislature: Delhi, Puducherry, Jammu & Kashmir - Union may bear lower burden than Sp. Category states e.g. 50:50, 60:40 etc.
UT without legislature: Ladakh, Andaman Nicobar etc. - 100% funded by Union
```
#Before removal of Article 370, the State of J&K was previously in Special category. But as a UT with legislature, J&K will get lower assistance from Union in the welfare schemes.
So, 2019-Aug: Central Government considering creating a new category ‘Hilly Union Territory' so J&K may continue to received 90:10 funding.
```
26
What is tax planning or tax mitigation?
When person invests money in LIC/PPF/Pension funds etc.in such manner that he can claim various deductions legally available in the Income Tax Act. It’s neither illegal nor unethical.
27
What is black money?
It is an income or transaction that is taxable yet NOT reported to the tax authorities/concealed from the tax authority.
28
What is Parallel Economy?
The economy that runs on black money.
29
What is Tax Evasion?
When person hides income or transaction from tax authorities, and thereby evades paying taxes. It’s illegal.
30
What is Tax Avoidance?
When person discloses his income and transactions to tax authorities but uses legal loopholes to avoid paying taxes.
E.g. Bollywood stars who register digital media companies in Tax Havens. It may not be illegal in every case, but still unethical.
31
What is a Tax Haven?
Is a country that demands little taxes from foreigners and offers legal loopholes for Tax Avoidance & opportunities for Tax Evasion. E.g. Liechtenstein, Mauritius, Marshall Islands, Cayman Islands, Panama, Nauru, Vanuatu etc. These countries are geographically small, & without viable economy. So they offer such mechanism to attract foreign investors and foreign tourists.
32
What is Money laundering?
- When drug trafficking, ransom, corruption and other criminal activity generates substantial profits, the criminal tries to spend / invest / hide the money without attracting attention.
- Money laundering is the process of disguising the
source of money, as if it came from a legitimate activity, & then channelize it into banks, share market and other financial intermediaries.
33
What is Hawala?
- Hawala is an illegal money transfer / remittance system. Money is paid to an agent who instructs an associate in the relevant country or area to pay the final recipient.
- Although used by Indian workers in middle east because lower commission than post-office/bank transfers, + better network in remote areas.
34
What are Shell firms, Post-box/ Letter-box companies?
They do not have any active business operations. Created with sole objective of money laundering/tax evasion/avoidance E.g.
Mishail Packers and Printers Pvt Ltd. allegedly setup by Misa Bharti Yadav to launder ₹1.2 crores (as per Enforcement Directorate).
35
What are Panama Papers (2016) Paradise Papers (2017) Mauritius papers (2018)?
- International Consortium of Investigative Journalists is a USA based nonprofit organization.
- They released these incriminating documents from certain law firms in tax havens & showed how notable people across the world engaged in tax avoidance/ evasion. Amitabh Bachchan & Aishwarya Rai also named in some them.
36
What is Tax Terrorism?
- Happens when tax authorities put undue pressure on an honest taxpayer to pay more taxes.
- 2012: Vodafone won a case against income tax department in the supreme court related to Capital Gains Tax on purchase of Hutch mobile company.
- Afterwards, UPA government amended the Income Tax Act with retrospective effect and issued fresh notices against Vodafone. This is called Tax Terrorism.
37
What is TDS/TCS?
Tax Deduction at Source (TDS)
Tax Collection at Source (TCS)
These are the mechanism to discourage tax evasion.
38
What is aPAN Card?
10 letters alphanumeric numbered assigned to all taxpayers in India by Income Tax Dept.
39
What are the notable organisations which fight against black money?
```
Enforcement Directorate (ED)
Directorate of Revenue Intelligence
Financial Intelligence unit (FIU-2004)
Financial Action Task Force (FATF-1989)
OECD (1961)
```
40
ED is under which Ministry and dept? What does it enforce?
FinMin → Department of Revenue → ED is a Specialized financial investigation agency to enforce following laws
1. Foreign Exchange Management Act, 1999 (FEMA)
2. Prevention of Money Laundering Act, 2002 (PMLA)
41
Directorate of Revenue Intelligence is under which Ministry and dept? What does it enforce?
FinMin → Department of Revenue →CBIC → DRI is an agency against Customs/Narcotics/Wildlife/Arms related smuggling & illegal activities.
42
What does Financial Intelligence unit (FIU-2004) do?
It analyses the suspected financial transactions in domestic and crossborder levels & reports directly to the Economic Intelligence Council (EIC) headed by the FM
43
What is Financial Action Task Force (FATF-1989)? What does it do? HQ?
- is a brainchild of G7, Combating Money laundering and terror finance. HQ@Paris. India became member in 2010.
- Greylist: nations that safe haven for terror financing and money laundering. E.g. Pakistan, Syria, Yemen, Iceland, Jamaica and Mauritius, are on the grey list
- Blacklist: nations that are not cooperating in the global fight against money laundering, terrorist financing. Iran and N.Korea
44
What is OECD (1961)? What does it do? HQ?
Organisation for Economic Co-operation and Development
HQ@Paris.
Works for International cooperation in the matters of economy and taxation.
Known for Base erosion and profit shifting (BEPS) Norms.
India is not a member of OECD, yet.
45
What is Prevention of Money Laundering Act (PMLA-2002)? What are its functions under tax evasion (hiding income/transaction)
1998: UN General Assembly (UNGA) declaration on Money Laundering → 2002: India enacts this law to combat money laundering with search-seizure-arrest-penalty.
Main agency? Enforcement Directorate.
Cases are heard @ PMLA Adjudicating Authority → PMLA Appellate Tribunal → High Court
It also empowers the RBI, SEBI, IRDAI and other regulators to make norms for Banks/NBFCs & punish the errant parties.
E.g. RBI’s Know Your Customer (KYC) norms and Anti-Money Laundering (AML) standards.
2013: Online Magazine Cobrapost’s sting operation proved ICICI, HDFC and Axis Bank were flouting norms so RBI Imposed a heavy penalties.
46
Acts to fight against tax evasion by hiding income/transaction?
Prevention of Money Laundering Act (PMLA-2002)
Undisclosed Foreign Income & Assets Act (UFIA-2015)
Benami Transactions Prohibition Act (BTPA- 1988, 2016)
47
What is Undisclosed Foreign Income & Assets Act (UFIA-2015)? What does it do?
➢ It requires Indian residents to disclose their foreign assets (e.g. bungalow in Dubai, Bank account in Switzerland) and income coming from foreign sources (e.g. shell company in Cayman Island) in their income tax returns.
➢ Foreign source income will be subjected to 30% income tax. No deduction, exemption or rebate will be given on it.
➢ Violation = Penalty + upto 10 years jail time. If a company is found violating the Act, then every person responsible to the company shall also be liable for punishment unless he proves that it was done without his knowledge.
➢ It also empowers the Union to enter into agreements with other countries for the tax exchange of information.
➢ General Budget-2019: If a person was resident in India at the time of acquiring an undisclosed asset (and later moved away from India, acquired citizenship elsewhere), still his properties will also be subjected to this law.
48
What is Benami Transactions Prohibition Act (BTPA- 1988, 2016)? What does it do?
➢ 1988’s original act did not achieve much results →
amended in 2016.
➢ Main Agency? Income Tax Department.
➢ Benami refers to properties that buyer registers in the name of his relative, personal staff (Driver, Gardner) or a non-existent/ fictitious persons to avoid tax authorities’ attention.
➢ E.g. 2018: Misa Bharti Yadav (allegedly) bought farmhouse in the name of her brother- in-law Nilesh Kumar.
➢ Cases are heard @ PMLA Adjudicating Authority → PMLA Appellate Tribunal → High Court
➢ Violation = Confiscation of property + penalty + upto 10 years jail time.
49
❓MCQ. With reference to the ‘Prohibition of Benami Transactions Act’, find correct statement(s):(Asked in UPSC-Pre-2017)
1. A property transaction is not treated as a benami transaction if the owner of the property is not aware of the transaction.
2. Properties held benami are liable for confiscation by the Government.
3. The Act provides for three authorities for investigations but does not provide for any appellate mechanism.
Answer Codes: (a) 1only (b) 2 only (c) 1 and 3 only (d) 2 and 3 only
B
50
Tax evasion - General Budget 2019 announcements
- Stick Carrot method
| - Tax (Evasion) disclosure schemes (“surrender = lesser punishment”)
51
What are Tax (Evasion) disclosure schemes under general budget 2019?
Under such schemes, a tax-evader can declare his undisclosed income, pay the taxes and penalty. Then, Income Tax Department will not pursue case against him. (Although Police may still pursue case if income is from narcotics, kidnapping, extortion etc.)
- Income Declaration Scheme (IDS)
- Pradhan Mantri Garib Kalyan Yojana (PMGKY) Launched after Demonetization Validity? 2016-Dec: To 2017-April
- Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019 (‘LDS’) In budget-2019, For Service Tax & Excise Duty
52
What is Income Declaration Scheme (IDS)?
Offer? 45% of the undisclosed income shall be taken away by govt as (tax 30%+ surcharge 7.5% + penalty 7.5%).
Validity? 2016 June to Sept. ~67,000 cr black money was declared.
53
What is Pradhan Mantri Garib Kalyan Yojana (PMGKY) Launched after Demonetization? Validity?
Validity? 2016-Dec: To 2017-April
- ~50% of the undisclosed income shall be taken away by Govt. as Tax + Penalty + Pradhan Mantri Garib Kalyan Cess.
- Further, 25% of the undisclosed income shall be deposited in RBI’s ‘Pradhan Mantri Garib Kalyan Deposit Scheme, 2016’. It’ll be a fixed deposit for 4 years @ ZERO % Interest rate.
- The PM Garib Kalyan cess, and deposit will be used for schemes related to irrigation,housing,toilets,infrastructure, edu, health etc.
- The scheme was not so successful, hardly ~ ₹ 5000 cr. declared.
54
What is Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019 (‘LDS’)?
In budget-2019. For Service Tax & Excise Duty
- > ₹ 3.75 lakh crore tax revenue is locked in the service tax and excise duty related cases.
- General Budget-2019: Launched Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019
- Businessman accepts his fault, Tax officials gives a ‘discount/relief/waiver’ in the penalty/late-fees, and the matter is settled instead of litigating in courts for years & years.
55
What is Vivad se Vishwas Scheme for Direct Taxes under Budget-2020?
Demerits?
It is a scheme for recovering tax evasion amount in General Budget 2020
Presently, >₹9 lakh cr worth direct tax cases are pending before Appellate Forums viz. IT Commissioner (Appeals) → Income Tax Appellate Tribunals (ITAT ) → HC → SC. So, Budget-2020 announced “Direct Tax Vivad se Vishwas Bill/Act, 2020”.
- Scope: Appeal related to Income tax or Corporation Tax, pending before a forum as of 31/Jan/2020. Then,
- Taxpayers can settle with IT dept in following manner
o A) If IT dept filled appeal → he has to pay 50% of disputed tax amt
o B) If Taxpayer filled appeal → he has to pay 100% of the disputed tax amt
- In both situations, he'll get a complete waiver/relief from interest and penalty
- Above scheme is valid upto 31/March/2020. Afterwards, there is modified formula upto 30/Jun/2020 wherein he may have to pay some small extra amount.
- This scheme is not applicable if:
o person is under prosecution for criminal activities
o If black money is hidden in foreign countries.
Demerits?
1) both honest and dishonest tax payers are treated equally. Even dishonest tax payer can now settle without paying interest/penalty.
2) Income Tax officials’ job-transfer etc will be linked to how many cases they solve in this scheme. They’re also asked to work on weekends to fulfill these targets. = resentment among staff.
56
What is Tax Ordinance 2020 under Atmanirbhar Bharat 2020?
- Vivad se Vishwas Scheme & Sabka Vishwas LDS deadline = extended
- Income tax, TDS, TCS, GST: last date for filling = extended
- TDS rates decreased so tax-payer left with more money for spending → shopping / demand increase → economic revival
57
What are some other initiative taken to curb Tax Evasion?
Banking Cash Transaction Tax (BCTT: 2005-09)
(Suggested) Banking Transaction Tax (BTT)
SC’s special investigation team (SIT) on Black Money 2014
Operation Clean Money 2017
Project Insight 2017
Restrictions on Cash Transactions, 2017
Electoral Bonds, 2017
58
What is Banking Cash Transaction Tax (BCTT: 2005-09)?
A 0.1% direct tax levied on cash withdrawals from banks. Started by Chidambaram but later withdrawn (2005-09). Objective was to encourage less-cash economy and data mining of transactions.
59
What is SC’s special investigation team (SIT) on Black Money 2014?
Chairman: Retd. SC Justice MB Shah, and senior tax officials.
They recommended various measures against Black Money hidden in India, in overseas banks, P-Notes etc.
SC ordered Govt to implement its recommendations.
60
What is Operation Clean Money 2017?
Income Tax Dept. verified large bank deposits made in the aftermath of demonetization.
61
What is Project Insight 2017?
(Related) Project Saksham 2016?
(Related) Aaykar Setu
Income Tax Dept. hired L&T Infotech ltd to develop an integrated platform for data mining & tracking tax evaders.
(Related) Project Saksham 2016: digital re-engineering related to GST. It’s not a ‘drive against CBEC/CBIC’s project for black money’ but for ‘Ease of Paying Taxes’.
(Related) Aaykar Setu: CBDT’s mobile app to pay Income Tax.
62
What is Restrictions on Cash Transactions, 2017?
Budget 2017 → Finance Act, 2017 → if anyone accepts ₹ 2 lakh /> CASH in a day / in multiple transactions related to one ‘event’, then Income Tax Dept penalty = 100% of the cash received.
Banks, post office, government organisations are exempted
63
What is Tax avoidance? and what are the measure taken to stop it?
Here, people will not hide the income/transaction, they’ll blatantly declare transactions in their official records, but will use legal loopholes to avoid paying taxes.
Measures taken:
- Double Taxation Avoidance Agreement (DTAA) & Round Tripping
- Tax Avoidance through Non-Resident Status
- Place of Effective Management (POEM)
- Base Erosion and Profit Shifting (BEPS)
- Transfer Pricing
- Authority for Advance Rulings (AAR)
- General Anti-Avoidance Rules (GAAR)
- Angel Tax on Startup Investments (2012)
64
What is Double Taxation Avoidance Agreement (DTAA) & Round Tripping?
➢ DTAA is a tax treaty signed between two or more countries.
➢ Objective? A taxpayer resides in one country and earns income in another, then he need not pay (direct) tax twice in two countries for the same income.
➢ e.g. India Mauritius DTAA (1982): If a Mauritius person / company buy shares in India and sells them at profit, then he need not pay Capital Gains Tax (CGT) in India. Only the Mauritius government can ask CGT from him. And vice-versa.
➢ Loophole? India has ~10-20% CGT whereas Mauritius has ~0-3% CGT. So many Indian Politicians, Businessmen and Bollywood actors would transfer the money using Hawala to their shell companies in Mauritius, and then make those Mauritius shell companies to invest back in Indian assets & avoid paying Indian CGT. This process is called Round
Tripping i.e. money that leaves the country through various channels and makes its way back into the country as foreign investment.
➢ Similar loophole in India Singapore DTAA.
➢ 2016: The government amended the treaties = even Mauritius and Singapore investments in India will be subjected to Indian taxes.
65
What is Tax Avoidance through Non-Resident Status?
Ordinarily resident of India:
- Has to pay his IT on income coming from India
- Has to pay IT on global income e.g. income coming from the USA/China
Non-residents:
- Has to pay his IT on income coming from India
- Does not have to pay IT on global income e.g. income coming from the USA/China
If India has a double taxation avoidance agreement (DTAA) with other nation, then above things may differ
Budget-2020 changed these definitions:
Ordinarily Indian Resident = person who stays in India for → 182 days/> in a year (Before Budget- 2020)
→ 120 days/> (Budget- 2020)
Non resident = person who stays outside India for
→ 182 days/> in a year (Before Budget- 2020)
→ 246 days/> (Budget- 2020)
Implications? Person will have to stay out of India for a longer period if he want to be treated as “Non-Resident” to avoid taxes on his global income.
Budget-2020: A citizen of India (even if he is staying abroad), but if he is not liable to tax in any other country → he’ll have to pay tax in India. E.g. United Arab Emirates and Bahrain where no income tax is payable.
Then critics started opposing it, so govt made some technical clarifications →
✓ bonafide Indian workers in other countries are not targeted.
✓ Only the Indian citizens who deliberately shift residence to avoid taxes in India, will be targeted.
66
What is Base Erosion and Profit Shifting (BEPS)?
➢ Multinational Corporation (MNC) “M” opens fast food outlets in India & makes ₹ 50 crores profit. By default, it should be subjected to 40% Corporation tax in India.
➢ But then MNC shows its Indian outlets had taken loan / raw material / patented technology from MNC’s shell firm in Bahamas (where Corporation tax is 0-2%). So, after deducting these operating costs, it has zero profit, so in India, it will pay only 18.5% Minimum Alternative Tax (MAT), instead of 40% Corporation tax.
➢ Thus, when MNCs shift profit from its source country to a tax-haven to avoid / reduce paying taxes, its known as “BEPS”.
➢ 2019-July: India ratified the OECD’s joint Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (commonly referred to as MLI)
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What is Transfer Pricing?
➢ Transfer pricing happens whenever two subsidiary companies that are part of the same multinational group, trade with each other.
➢ Suppose Coca Cola’s (Indian Subsidiary company) buys Sosyo Company’s shares or soda formula at ₹ 10 crores, and then sells it to Coca Cola’s (Cayman Islands subsidiary company) at ₹ 10 rupees. Then ₹ 10 is the transfer price.
➢ Coca Cola (Cayman Islands) further sells Sosyo’s shares / Soda-Formula to other companies at very high price. Yet, Indian tax authorities will not get any Capital Gains Tax (CGT) even though Coca-Cola (USA holding company) may be making profit (Capital Gains) of billion$ from this ‘Indian Asset’ (Sosyo).
➢ 2001: Transfer pricing related provisions added in the Income Tax Act. But they were quite strict leading to ‘tax terrorism’ by IT officials who’d slap notices on every transaction, resulting into ‘No ease’ of doing business for MNCs.
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What is Authority for Advance Rulings (AAR)? What is Advance Pricing Agreement?
➢ After above episode, Coca Cola (India) would like to know in advance whether its transfer price of ₹ “y” or its imported / exported item worth ₹ “z” is agreeable to tax
authorities or not? lest it suffers from notices, raids and litigations afterwards.
➢ For this purpose, Authority for Advance Rulings (and their Appellate bodies) have been set up under Income Tax Act, Customs Act and even GST Act (Recall Amul Camel Milk).
➢ Advance Pricing Agreement (APA)= If in previous example, Coca Cola approached AAR and an agreement was signed between taxpayer and a tax authority that “Transfer price of ₹ y is agreeable to both of us, and will not attract any notices / raids / litigations afterwards.”
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What are General Anti-Avoidance Rules (GAAR)?
Govt setup economist Parthasarathi Shome panel suggested General Anti Avoidance Rules (GAAR) → they were incorporated in Income Tax Act in 2012.
➢ GAAR empowers Income Tax officials to send notices to both Indians and foreigners for suspected Tax Avoidance.
➢ But critics alleged GAAR will result in tax terrorism, harassment, no ease of doing biz.
So successive Budgets kept delaying the GAAR- implementation. Finally done on 1/4/2017.
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What is Angel Tax on Startup Investments (2012)?
Angel investors are the rich people who occasionally invest equity-capital in start-up companies out of hobby / timepass / profit motive.
Startup Entrepreneur registers a phony “Sunder Construction” as an (unlisted) Public Limited Company with ₹ 10 Face Value Shares, & sells them to Angel Investor "Z" @a premium price of ₹ 1,000 per share.
But, even construction sector’s (listed) public limited companies like DLF’s shares are selling around for ₹ 230.
Thus, thee startup’s shares are above ‘fair market price’. So, this is not a genuine “Angel investment” but rather a facade for laundering money from construction, corruption or extortion business.
- So, Budget-2012 required Sunder Construction (the Startup Company) to pay 30% Tax + Penalty on the investment they received from Angel investor. This is dubbed as ‘Angel Tax’.
Norms were further tightened by the next govt, but then controversy that Angel Tax will discourage the growth of startup companies so norms relaxed- ‘Angel Tax will not apply if Startup’s turnover is less than ₹ “x” crores or if startup was registered for upto “y” years
Budget-2019: IF Start-ups and their investors provide the required declarations and information, then IT dept will settle the matter.
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Reforms to reduce Tax terrorism/harassment?
Income Tax Department has to become strict / coercive to fight against Tax evasion.
At the same time, IT dept. also needs to become more friendly towards honest taxpayers, while reducing the scope of tax avoidance.
Here are some notable measures →
- Rajaswa Gyan Sangam 2016 & 2017
- Direct Tax Code 2010
- Easwar Panel on Direct Taxes 2015
- Direct Tax Code Taskforce 2017
- Aaykar Setu
- Ease in paying Customs Duty: Portals/Apps by CBIC
- Budget-2019: Ease of paying taxes & reducing tax-terrorism - 1) Pre-filled online forms for Tax Payers
2) Faceless interaction between Tax payers and Tax official
- Document Identification Number (DIN)
- Taxpayers’ Charter in Budget-2020
-
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What is Rajaswa Gyan Sangam 2016 & 2017 under Reforms to reduce Tax terrorism/harassment?
Organised by CBDT & CBIC for idea exchange between policy makers and senior tax officers.
2016: The PM gave them RAPID Mantra: R for Revenue, A for Accountability, P for Probity, I for Information and D for Digitization.
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What is Direct Tax Code 2010 under Reforms to reduce Tax terrorism/harassment?
This bill aimed to replace the Income Tax Act, 1961 with simpler provisions. But, lapsed with 15th LokSabha dissolution in 2014.
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What is Easwar Panel on Direct Taxes 2015 under Reforms to reduce Tax terrorism/harassment?
To simplify the provisions of IT Act, 1961, to remove ambiguities that cause unnecessary litigations & hardships to Taxpayers.
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What is Direct Tax Code Taskforce 2017 under Reforms to reduce Tax terrorism/harassment?
- 2017: Setup by CBDT to draft New Direct Tax Legislation (Law) to replace IT Act 1961.
- 2019: Chairman Akhilesh Ranjan submitted report
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What is Aaykar Setu under Reforms to reduce Tax terrorism/harassment?
2017: CBDT’s mobile app that helps you calculate and pay Income Tax, claim TDS refunds etc.
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What is Ease in paying Customs Duty: Portals/Apps by CBIC under Reforms to reduce Tax terrorism/harassment?
1. Indian Customs Electronic Gateway (ICEGATE) webportal for e- services related to the Customs duty.
2. ICEDASH webportal: public can view daily data on customs clearance at seaports and airports. (launched 2019-Nov)
3. ATITHI mobile app: for international travellers to file the customs declaration in advance. So, they don’t have to waste time at airport queues in filing such declarations. (launched 2019-Nov)
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Provisions in Budget-2019: Ease of paying taxes & reducing tax-terrorism ?
1) Pre-filled online forms for Tax Payers:
We’ll extract your financial data from Banks, Stock exchanges, Mutual Funds, EPFO, Employers’ TDS submissions etc. and provide you with a Pre-filled tax returns containing your salary income, capital gains from share/bond, bank interests, etc. This will help →
1.1) Income tax payers’ time and energy saved. He’ll not have to consult Chartered Accountant for every small matter on how to fill form.
1.2) Accuracy of reporting income and paying taxes
2) Faceless interaction between Tax payers and Tax official:
Personal interaction between the assessee and Income Tax official = more chances of harassment / bribery. So, we’ll launch two reforms:
2.1) Cases will be allotted in random computerized lottery basis to IT officials without disclosing the name, designation or location of the Officer.
2.2) Faceless assessment in electronic mode. E.g. assessee received a notice about discrepancy in his reported income vs TDS submitted by his banker, then at initial stage assessee need not visit IT-office, simply give clarification in web-portal.
3) Budget-2020: Faceless appeal process introduced. So, even in appeal stage, assessee need not physically visit IT commissioner / tribunal.
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What is Document Identification Number (DIN) under Reforms to reduce Tax terrorism/harassment?
What are its benefits?
Whenever Tax official sends letters to taxpayers regarding search authorisation, summons, arrest memo, inspection notices etc. All such documents will have computer generated ‘Document Identification Number’ (DIN).
✓ 2019-Oct: Central Board of Direct Taxes (CBDT) implemented this.
✓ 2019-Nov: Central Board of Indirect Taxes and Custom (CBIC) implemented this.
DIN system benefits?
✓ It’ll create a digital directory of communication between tax authorities and taxpayers. Transparency, accountability, efficient and faster clearance of cases, because all the information available at the click of a mouse.
✓ If a document doesn’t have DIN number, it’ll be treated invalid. Thus, DIN system will prevent the corrupt tax officials from sending fake notices to harass/blackmail taxpayers for bribes.
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What is Director Identification Number (DIN)?
Director Identification Number (DIN): Director of every company is required to obtain this number from the Ministry of Corporate Affairs under the provisions of Companies Act.
It helps monitoring the company act provisions related to “1 person can’t be director in more than ‘x’ number of companies” etc.
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What is Taxpayers’ Charter in Budget-2020 under Reforms to reduce Tax terrorism/harassment?
- A citizens’ charter is a document of commitments made by a government agency to the citizens in respect of the services being provided to them.
e. g Dept of Post's citizen charter reads, "we'll deliver speed post anywhere in India by 4-5 days →ELSE complain online to this website & we'll solve it → if not solved in 90 days then complain to Postmaster General → then to Chief Postmaster General.”
- 1991: citizen charter system first started in UK by PM John Major
- 1997: introduced in Indian union ministries/departments.
- Budget-2020: CBDT will declare a Taxpayers’ Charter. So, Tax payer will easily know what services / complaint redressal mechanisms are available to him= ⬇taxpayer’s harassment
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What are the Global treaties, agreements and indices for Taxation?
- Tax Information Exchange Agreement (TIEA)
- USA’s Foreign Account Tax Compliance Act (FATCA-2010)
- Global Financial Secrecy Index
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What is Tax Information Exchange Agreement?
India has signed such agreements with multiple countries. It enables mutual sharing of information to detect tax avoidance and tax evasion. Example,
➢ 2019-May: India has notified a tax information exchange agreement (TIEA) with the Marshall Islands.
➢ On Indian side, CBDT is the the nodal agency for such agreements.
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What is USA’s Foreign Account Tax Compliance Act (FATCA-2010)
USA’s FATCA Act requires foreign financial Institutions (such as Indian Banks, Pakistani Insurance Companies, Chinese Mutual Funds etc) to report the assets held by Americans.
➢ This helps US Tax authorities to detect tax avoidance / evasion by Americans who are hiding income outside USA.
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What is Global Financial Secrecy Index ?
Prepared by London based Think Tank ‘Tax Justice Network (TJN)
➢ It uses 20 indicators to measure the countries on their financial secrecy, opportunities for Tax Avoidance, BEPS etc.
➢ 2020 Ranking: 1st rank Cayman Islands>USA> Switzerland,....India (47).
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What is demonitization?
Definition? Demonetization is the wholesale withdrawal of currency notes from circulation.
➢ RBI Act 1934: Every banknote is a legal tender. However, RBI Central Board can recommend the Government of India to notify specific currency note(s) should no longer be treated as legal tenders. Then FinMin → Department of Economic Affairs makes official gazette notification.
➢ 1946: ₹ 500 Notes demonetized; 1978: ₹ 1000, ₹ 5000, ₹10000 Notes demonetized.
➢ 2016-Nov-8th: Public was ordered to deposit the (old) Mahatma Gandhi series currency notes ₹ 500 and ₹ 1,000 (called “Specified Bank Notes: SBN”) into Banks and post-offices latest by 30th December 2016. And all the banks and post offices where ordered to deposit such SBN into RBI.
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What is Specified Bank Notes (Cessation of Liabilities) Ordinance?
From 31st December 2016, RBI Governor not required to honour “I promise to pay...” or exchange the SBN. Except for NRIs: deadline little bit relaxed, with
certain caveats.
- Public prohibited from keeping SBN, except for research or numismatics or
museum- and that too in limited amount. This ordinance became Act in 2017.
➢ India is not the only country in the world to do demonetisation. Sweden ( 2013),
European Union ( 2016) and even Pakistan (2015) has done it for their currency notes.
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Why Demonetise ₹ 500 & 1000?
➢ Demonetization is usually done in the aftermath of hyperinflation, war & regime- change.
➢ India did it to combat Corruption, Black money, Counterfeiting and Terror finance.
➢ We had 12.04% Cash to GDP ratio, one of the highest in the world. Currency printing & transportation cost alone was 1.7% of GDP.
➢ “Soil rate” is the rate at which notes are considered to be too damaged to use and returned to the RBI.
➢ For ₹ 500 & 1000 SBN, soil rate was much lower than the currency notes of ₹ 10 to 100. (implying that 500-1000 SBN were used more for ‘storing black money’, rather
than using in transactions.)
➢ So, experts made mathematical comparison of the foreign countries’ economic development, soil rates of their foreign currency notes etc. and arrived at a figure ₹ 3 lakh crores of Indian black money is stored in SBN (=2% of GDP).
➢ So if SBN were demonetised, the black money holders will not return their currency notes into banks (fearing IT-RAIDS) and thus black money will be destroyed.
➢ But in reality, ~99.30% of the SBN were returned back into the banking system, so hardly ₹ 10,720 crore of black money was destroyed by the demonetisation of 2016.
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How did 99.30% SBN returned into banking system?
If the mathematical modelling was correct, then only 80% of the SBN should have returned back, & 20% SBN (presumed to be Black Money) should not have returned. But, Black money owners used following tricks to deposit their SBN in bank accounts:
1. Businessmen / Politicians used their drivers, cooks, gardeners, personal staff members and relatives as Money mules. This is evident from exponential rise in the deposits in Pradhan Mantri Jan Dhan bank accounts.
2. SBN were given out as “loans” to poor & as advance salaries to workers.
3. Agents who tied up with corrupt bankers who exchanged SBN without KYC verification.
4. SBN deposited in Cooperative Banks as back-dated Fixed Deposits, because Cooperative Banks didn’t use Core Bank Solution (CBS) so it was possible to tamper records.
5. SBN deposited in banks and then shown as income from sale of (fictitious) grain stock etc. So, IT-dept can’t demand tax on it (and most state governments not levy tax on agricultural income due to populism/vote bank politics).
6. SBN deposited in shell companies & shown as income from (fictitious) sale and invoices.
7. SBN donationed to trust, temples & political parties with backdated receipts (and those entities are exempted from Income Tax on their income.).... And so on
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99.30% SBN returned, but Demonetization not failed experiment because?
✓ Those who could not return their SBN, have lost their black money (₹ 10,720 crore)
✓ Those who used poor people are money mules- must have paid some commission to them. So even if government did not get tax from black money, atleast poor people benefited. Thus, indirectly demonetization helped in redistribution of wealth.
✓ Further, during Operation Clean money, IT-dept issued notices to the suspicious bank accounts where large amount of money was deposited. Such shell firms & their benami properties are being seized.
✓ With Project Insight & Op. Clean Money: IT dept fetched ₹ 1.30 lakh crore in taxes and penalty, attached ₹ 7000 crore worth Benami properties, ₹ 1600 crore worth foreign assets & de-registered ~3.40 lakh shell firms. (says the Int-Budget-2019).
✓ The number of PAN card registration, IT returns, registrations under excise / VAT / GST have greatly increased in the aftermath of demonetisation which proves that crooked people have learned lesson. More than 1 cr. new IT assesses added in 2017.
✓ Tax collection has increased from ~₹ 6 lakh crores (2013) to ~₹ 12 lakh crores (2018).
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The reasons for low Tax: GDP in India?
1) Lack of civic sense among people that paying taxes is their basic duty.
2) Presence of informal sector, parallel economy, cash based economy provides ample opportunities of hiding income.
3) Low per capita income, high level of poverty. Concentration of income in the hands of few- who are greedy to engage in tax evasion & avoidance.
4) Election funding as the mother source of corruption → therefore black money. Politician-Builders-Mafia nexus.
5) Due to political considerations, state governments and local bodies do not levy all the taxes authorised by the constitution e.g. tax on agricultural income. So our (direct)
tax base is narrow. [Tax base: means the total value of all the persons/ income/property, etc. on which tax is charged.]
6) Loopholes in the tax laws which encourage tax avoidance using Domestic and Offshore channels.
7) Direct taxes like wealth tax, gift tax and estate duty suffered from loopholes, lax monitoring and evasion. They didn’t yield much revenue. Hence even referred as ‘paper taxes’, and had to be abolished ultimately.
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What is tax base?
means the total value of all the persons/ income/property, etc. on which tax is charged.
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How to improve Tax Compliance?
Use Behavioural Economics to improve Tax Compliance
❖ Plato said, “What is honored in a country, is cultivated there.” Indians join military because 1) salary 2) because serving in the armed forces is considered ‘honorable’.
❖ So, we should use the principles of Behavioral Economics to enhance tax compliance. We’ve to modify the social norm from “evading taxes is acceptable” to “paying taxes honestly is honorable.”
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What is tax morale?
it is the intrinsic motivation of taxpayers to pay taxes. When tax morale is down → motivation for tax evasion increases.
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How is Tax Morale affected?
Tax Morale is affected by two types of fairness:
Vertical fairness:
1- Tax Payer’s thought process → What I pay in taxes is commensurate to the benefits I receive as services from the Government.
2- His Tax morale is lowered when → He sees taxpayers' money wasted in public expenditure (like elephant statutes) instead of better quality of water, road, education or electricity.
Solution(s)
✓ under-constructions projects should show signboards “Your tax money at work”
✓ Reminding tax payers that public goods can only be provided in return for tax compliance. Most people in your local community pay their taxes on time.
Horizontal fairness
1- Tax Payer’s thought process → There should not be a great difference in the taxes paid by the ‘similar’ sections of society.
2- His Tax morale is lowered when → If a salaried employee and a shopkeeper are earning ₹8 lakhs per annum, still the salaried employee is forced to pay more taxes than this shopkeeper, because
- TDS on salary whereas shopkeeper underreports his sales in cash payment.
- Shopkeeper shows less profit through fictitious business expenditures.
Solution(s)
✓ SMS, billboards highlighting self-employed individuals who pay good amount of tax.
✓ Public shaming of individuals who don’t pay taxes. It’ll scare other tax-evaders that the probability of their detection has increased.
✓ Avoid Tax Amnesties. Give stringent punishment to tax evaders.
Further, CEA Subramanian K. suggested:
✓ Top 10 highest taxpayers within a district → They should be given VIP-treatment such as faster boarding privileges at airports, special “diplomatic” type lanes at immigration counters, fast-lane on roads and toll booths, etc.
✓ Highest taxpayers over a decade → Important places should be named after them e.g. roads, trains, schools, universities, hospitals and airports.
✓ In Hinduism, Islam and Christianity - unpaid debt is considered a sin. So, advertisements should highlight how tax evasion is a violation of such “spiritual/religious norms”.
✓ Ease in Paying Taxes: Pre-populated Income Tax forms with easy to understand terms. Even if a person’s tax liability is ZERO, he should be required to fill Income Tax form.
✓ Automated TDS as and where possible and timely release of Tax refunds.
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What is Laffer Curve?
- American economist Arthur Laffer: if (direct) tax rates are increased above a certain level, then tax revenue collection will fall because higher tax rates discourage people from working and/or encourage them to engage in tax evasion and tax avoidance).
- So, tax-cuts could lead to higher tax revenue collections.
- Budgets from 2017 onwards: The lowest Income Tax slab was cut from 10% to 5%; The corporation tax on small sized companies was also brought down from 30 % to 25% in a phased manner.
- 💼Budget-2020: new optional Income tax slabs.
- USA Budget-2017: Corporation tax cut down from 35 % to 15%
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What is Tax buoyancy?
If GDP grew by x%, then how much % Income tax collection will grow?
- E.g. if income tax collection growth rate is 11% when GDP growth rate is 10%, then Income Tax’s tax buoyancy is 1.1
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What is Tax elasticity?
If first income tax slab increased from say 5% to 15%, then in absolute terms how much more IT-revenue will be generated?
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Net Tax Revenue of the Govt in decreasing order
1 - Gross Tax Revenue
(=Union’s Direct taxes, incl. cess and surcharge + Union’s Indirect taxes incl. cess and surcharge + Union territories without legislature: their direct and indirect taxes)
2- Net Tax Revenue of Union
(Gross Tax Revenue - Minus the Tax devolution to States as per the Finance Commission - Minus Contributions to National Disaster Response Fund in Home ministry)
3- Union’s Direct taxes, incl. cess and surcharge
4- Union’s Indirect taxes incl. cess and surcharge.
- For Union: direct taxes income is >> indirect taxes.
- But if we summed all the taxes of union, state and local bodies then indirect taxes income >> direct taxes.
5- the Tax devolution to States as per the Finance Commission
6- Union territories without legislature: their direct and indirect taxes:
7- Contributions to National Disaster Response Fund in Home ministry**
**Public Account → National Disaster Response Fund is a statutory fund under Disaster Management Act, 2005. Previously, called National Calamity Contingency Fund (NCCF).
