Monday, January 13, 2014

Reviving Tax Structure of India

Introduction to Tax Structure

It is said that, "Human is a Social animal." And said very correctly. Human is an animal that lives in a society. Being an animal, it always tries to suppress other humans, and being in society it tries to protect the co-humans. The main aim of society hence is to protect the humans from other humans. Hence the difference between evil and good created, and a system was created to punish the evils. Then an Organisation was setup that will look into the system, implement the system to protect co-humans. This giant organisation has been named as Government. 

Those who were rich felt the threat of theft and all kinds of insecurity. And they needed governance more. Hence they used to donate to the Government for security. Later, the purpose of Government changed, and they needed more money. Again, some people refused to support the Government. Hence the Tax structure took birth. 

Main object behind the tax structure was to collect more money from the rich to run the Government. But later, it was thought that more a people spends, or uses the facilities should be taxed more. 

It gave rise to two basic kinds of tax. 1. Direct Tax - Assuming that rich should pay more. 2. Indirect Tax - Assuming that those who spend more should be taxed. 

Allmost all the nations of this world have designed the tax structure taking both these concepts, so is India. 

Direct Tax

The tax that is levied on a person directly by the Government is known as direct taxes, as the tax is paid directly to the Government, without any middle man. These taxes are computed based on one's income or profit or wealth. The main motive behind the tax is, let the rich pay more. 

But the rich found their own way to pay less. They do it by way of corporations or say companies. They earn income, spend and pay tax on the balance. While the middle class people earn income, pay tax and spend the balance. The poor section does not pay this tax. 

How the rich reduce tax liability ?

Its very easy to reduce tax liability, just create a virtual person [VP] (which does not have any real existence, the existence is merely because of an agreement or say a piece of paper). Do all incomes and expenses by this VP, pay tax on the balance Income. You need to spend money for foreign trips ? Easy, just arrange a Board of Directors meeting abroad, spent it on you, and pay less tax. 

You want to have lavish dinner in a hotel ? Fine, no problem, just dont forget to get the bill from the hotel and book it as Entertainment Expenses and dont pay tax on this.  You want to use a car ? Let the Car be owned by the VP, and the fuel cost will be deducted from your income and you will pay less tax. 

But this does not happen with a middle class people, who earns money as an employee. He needs to pay tax first and then if any thing is left, he will dream of going abroad or getting a car.

Tax on Income is mother of Corruptions

I always tried to understand one thing, when a people thinks its a matter of social pride to acquire more wealth, why he does not declare income more then what he has earned ? And the answer is, he has to pay tax on his incomes. If he declares more income, he will have to pay more.

Thats why, people declare income less then what they have earned and pay less tax to the Government. And the Income on which Tax has no been paid is termed as Black Money. The Government hence needs to create a large system to control this black money.

If we ever can remove the concept of tax on Income, then these set of people will not hesitate to show their real income, and there by we can end one "module of corruption".

Indirect Tax

Indirect Tax is imposed on the basic idea that, those who can spend more really owns more money, hence they should be taxed more. This is nothing but a kind of Expenditure tax. This is called indirect tax, because the tax is not paid directly to the Government, but to a middle man, who in turn pays the money to Government. 

Taxes like CENVAT, VAT, Entry Tax, Service Tax are indirect taxes. In these cases, the ultimate consumer needs to pay tax. And tax is collected by each middleman starting from the producer of the goods.

But the reality is, the middleman keeps some portion of this tax for himslef and the balance is paid to Government. 

How the Middleman keeps Tax collected from other ?

Indirect tax structure has been designed in such a way that, tax will be paid only by the poor individuals. The rich can get the benefit by way of VP as explained above. Thats why I say they keep some portion of tax money which should have been paid to Government. 

Except the VP concept, there is one more way to get profit from this tax structure. This is done by way of "Tax Credit on Input". 

Suppose, Mr.A purchased Commodity X for Rs. 100 and paid indirect tax (IDT) of Rs. 5. He now sold X for Rs. 110 and collected IDT of Rs. 7. Mr. A will pay Tax now just Rs. 2 on the assumption that he had already paid Rs.5 to the previous middleman. 

Question is, did he really pay Tax of Rs. 5 earlier ? Surprisingly the answer is no. Because he had already booked his cost including this Rs.5 and charged to the ultimate consumer. The difference of which will be treated by him as "profit". So ultimately the ultimate consumer had paid not just Rs. 7 for tax, but more then that (hidden as profit margin).

Ideal Tax Structure

From my days of CA Student, when ever I used to study the papers like Tax and Accounts, I used to go into deep thought on how to keep them correct. If we see the Accounting system today, then we will see that, neither the Profit and Loss statement represents correct profit (because of some sort of assumptions) nor the Balance Sheet shows a correct value of assets and liabilities (On that given date, if the Company is sold out, the amount recoverable will not be equal to Capital + Reserve, and at any given date, General Reserve will not be represented by some assets). Similar with the case of Taxes. In some cases, an Individual pays more tax then another Individual having higher income.

One thing I realised that, tax on profits or expenditures is not the correct way of tax, as these two terms can be manipulated. What is real is to be taxed, not what is not real and gets existence just because of an agreement.

That "REAL" asset is nothing but Cash. I propose Tax on Cash inflow, because only Cash Flow can not be manipulated. The procedure is very simple. Say a person received Rs. 100, in a month, then he will need to pay Rs.1 as tax for that month. No other Direct tax or Indirect tax.

Where is the Problem ?

The problem is with present infrastructure. We do not have infrastructure to calculate exact cash inflows of a particular person.

What is the Solution ?

Implementing Tax on cashflows is not as difficult as it seems, what we need is a proper infrastructure and awareness so that all the individuals will be able to use the Banks, so that maximum number of people will transact through banks. In this case, we can easily identify the Cash receipts by a person, and we can collect tax. In other words, the person paying Cash will need to deduct a percent of money from the receiver and pay that to Government. Its just like the Indirect Tax, but the levy is not on expenses, nor on Incomes, but on cash flows.

Who will Collect and Pay tax ?

Tax will be collected and paid by those, who employ others persons, i.e. the Business houses. its only the business houses those generate cash.

Step by Step Approach

1. Define Business House and mode of Formation : 

    Law need to be modified so that, none other then a Company can do business. In other words, if some one wants to do business, he must do it, by way of a Corporate entity duly registered. There can not be any other form of Business entities.

   One will ask then, can a small tea vendor or a small pan shop who are uneducated register themselves as a Company ?

   Answer is, relaxation can be given to the deserved section of people. A threshold limit should be provided, in terms of Capital Investment, or Number of Employees or Turnover etc. so as to identify the weaker section of people. 

2. Mode of Business and Payment of Tax

    - All Corporates will have to transact through bank. They can not purchase goods other then by way of bank payment, and duly deducting Tax on Value of Purchase. Banks can be given the role as Clearing house. When a persons asks a bank to pay Rs. 100 to another person, the bank will pay Rs. 99 to the person and Re.1 as Tax to Government.

 - A corporate can not sale goods for Cash beyond a certain limit, say Rs. 100. If some one pays cash, the corporate needs to record Identity of the payer. If the payer is not a corporate, it can not deduct tax on these cash payments.

 - All cash receipts on a given date must be deposited with the Bank on the same day.No Tax should be levied on depositing cash with the Bank (to encourage cash deposit).

 - No payment can be made by cash other then to an Individual, and no tax to be levied on cash payments.

3. Filing of Accounting Report and Tax Payment Report

    Every Corporate will have to prepare accounts, get them audited and a return of the same to be filed with the Government. In the Audit Report, the Auditor will Certify the daily Cash Flow Statement during the period, and amount of Tax paid on the same. No other Tax payment Return need to be filed.

What Regulatory Framework needs to be created ?

No new regulatory frame works need to be established other then the System of Corporate Affairs.

Will this system be able to generate more revenue for the Government ?

In the long run, this system will generate more revenue for the Government as compared to the present tax structure. Even today, if Tax can be collected only on the payments made by NEFT or RTGS at 1%, it will surpass the Budgeted revenue of Rs. 16.00 lakh cr for the Fiscal Year 2013-14.

Will it not promote Corruption ?

The general perception is that, with implementation of this tax structure, a new era of corruption will emerge. i.e. people will try to make cash sales more and more, or say people will try to avoid banking transactions. This is true to some extent. But with little modification of the present infrastructure, we can solve this issue too. Following steps should be taken -

 - No salary can be paid in cash
- Cash can not be withdrawn from Bank or from ATMs
- Step should be taken at panchayat level to ensure that all shops have bank payment system. Responsibility of this should be on the member of Local Body.
- Steps should be taken to ensure all small mode of transports have facility of payment through bank.

Will the System not compel the poor to pay tax too ?

What is to understand is that, this tax structure intends to charge tax on cash, not on people, nor in transaction. If we see closely, this system will provide a relief to the poor, as they now do not need to pay huge indirect tax.

Can the uneducated mass accept this system ?

India today implemented a system, where the subsidy amount is now deposited with the bank account of the beneficiary. If this system can be implemented, why the proposed tax structure can not be implemented ? What we need is, to create required infrastructure within a particular time frame, and switch over to the new system on that date.

What is the 1st Step ?

Step-1 ti implement the proposed tax structure is -
 - Replace the Existing Currency with a New set of Currency.
 - Every person will need to deposit what every currency he has with the bank, and in turn get a bank transaction card.
- New currency can be withdrawn from ATMs for say a year or two. Within these period infrasture is to be created so as to ensure payment vide bank at every location of India. Every store, every shop, every auto rickshaws should have online payment system.

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