How Much Income Tax did You Pay this Year?

One takes these things for-granted as per the definition. So, one sort of knows that Indian companies pay more than 30% of their profits as the Corporate Income Tax. According to Wikipedia:

For companies, income is taxed at a flat rate of 30% for Indian companies, with a 10% surcharge applied on the tax paid by companies with gross turnover over Rs. 1 crore (10 million). Foreign companies pay 40%. An education cess of 3% (on both the tax and the surcharge) are payable, yielding effective tax rates of 33.99% for domestic companies and 41.2% for foreign companies...

This belief is also reinforced by the high-decibel noise about this tax-burden (and need for "tax incentives" to promote growth and entrepreneurship, etc.) which is made by the industry captains and media... one assumes that this is how things must be!

Well, at least, I thought so - till I came across Mayank Krishna's posting on his blog....

Digging further, I learnt that the "effective tax rate" (i.e., those that the companies pay) is substantailly lower than the "actual (i.e., the prescribed) tax rate".

In an interview in Business World, Parthasarathi Shome, the advisor to the Finance Minister, noted:

"...The effective tax rate of all companies is 19.26 per cent (a sample of 301,376 companies). Now, every group based on the profit before tax shows that every group is lower than this average other than the Rs 0-1 crore tax group (with 164,352 companies). These companies are 24.29 per cent. The greater than Rs 500 crore companies come close to the average at an effective rate of 19.1 per cent and every other group is actually lower."

Which is an interesting obsevation: Companies in Rs 0-1 tax group pay the highest, 24.29%, in tax!!! - which is still below the actual tax rate (and is higher than income tax rate for many salaried people)...

In fact, this table below from an earlier issue of BW, shows that some of our stalwart corporations pay just 10-12% or even less as corporate tax - e.g., Reliance Industries (8.41%), Infosys (12.61%), Wipro (10.95%), TCS (11.72%), Bharti Airtel (7.29%),..and GE Shipping only 2.97% !!!




So how do companies manage not to pay taxes?

Two articles from July 14, 2003 issue (by Anjuli Bhargava), "Taxpayers ko Gussa Phi Kyon Aata Hai", and "Incentive to Evade" (registration maybe required) provide some interesting insights.

According to Kelkar Committee Report on Direct Taxes (2003) almost 2/3rd taxes remain unpaid due to "legal leaks in the system". This tax evasion happens through "legal leaks", i.e., the loopholes in the tax laws, the exemptions and the incentives. If one adds the outright fraud, the loss to the exchequer will be many-fold, e.g.,

In 2003, of the 5.69 lakh companies, only 3.49 actually filed returns. The number of companies that actually paid any taxes would be a fraction of even this number. After the formation of Tax Information Network, and electronic monitoring, this number must have decreased. Nevetheless, it is still a substantial proportion of companies (specially, the big ones).

There are also a number of companies that suddenly stop filing returns. Some of these "stop filers", of course, are companies that may have actually shut down. The number of "stop filers" (both corporates and individuals), however, has been increasing: from 15 lakh in 1986-87 to 71 lakh in 1996-97 to over 90 lakh in 2003-04. And, given the numbers, it is difficult for the IT dept to really verify it.

But apart from such illegal "tax evasion", corporates routinely use (and have access to) "legal" means to evade taxes. This is because, in India, as one of the articles mentions "the web of exemptions, incentives and loopholes that have been offered to private industry is so complex that even income tax authorities cannot see through".

Unlike in India, in most other countries where tax reforms (i.e., reducing tax rates) happened, the governement simultaneously also the exemptions and incentives. In India, on the other hand, the reduction in tax rates have paralleled increase in incentives and exemptions - which perhaps says a lot about the influence of industry lobby groups, ranging from CII, Nasscom, etc., to perhaps... Ok, whatever!

For instance, exemptions in Section 10 A and B of Income Tax Act, one has a long list of reasons for not paying taxes.A company can avail tax holidays on profits for (1) setting up operations in backward areas, (2) for getting into specific business areas, and even for (3) companies with high gestation periods. (An earlier post on SEZs, is an indicative example of such tax holidays that Indian corporates get)

While one may say that these corporate incentives/exemptions/subsidies are required to build a robust economic infrastructure, but these concessions, apparently are used by many companies to increase their profits (and increase returns to the shareholder) than to really add to the economy.

Here are some instances (quoting from the articles):

• "In the absence of an agreed definition of “manufacturing”, several enterprises take advantage of the available tax incentives for activities that involve only processing (the product is basically manufactured at another location and a bit of value addition is done at the unit located in the backward area, but not the actual production from scratch)."
  
  
• "Enterprises producing the same goods at different locations claim that the entire production has been done in the backward region unit to claim incentives even when the goods are produced at a location outside the backward area. Other enterprises, with different units to produce goods at different stages of production, some located in backward areas and others outside the backward areas, have tended to undervalue supplies to units in backward areas (and conversely, overvalue supplies to units outside the backward areas) to reduce the tax liability everywhere."
  
  
• "...common expenses of enterprises located in backward areas have tended to be allocated to units outside the backward area to reduce the taxable profit.".... According to one IT official: "These companies often have ‘faceless factories’. They run a bogus operation in a backward area and claim tax benefits, though the actual production is done elsewhere... here is usually some kind of façade, a bit of infrastructure, but no real production there. So, they can inflate expenses also. They run a parallel system of sales and have a legitimate business also, but what enters the books is only what they want to pay as tax."
  
  
• "...incentives, available to exporters and export-oriented units, have been among the worst abused for years and exporters of all categories have taken advantage of these. Other than overinvoicing the export turnover to claim a higher incentive, exporters have often deducted income attributable to domestic sales along with the income from exports. Claims are made for deductions for export of goods that are ineligible for the incentives (like mineral oil, unprocessed minerals and ores). Unaccounted incomes of businesses have been channelled and shown as export profits to avoid paying taxes on such incomes and to convert the black money into white. Several domestic 100% EOUs in software technology parks sell products to a sister concern after showing a large value addition. The sister concern gives a confirmation that it will export the product purchased from the EOU without specifying any time frame for carrying out this commitment. On the basis of this commitment alone, incentives are claimed under Section 10 A (whether the products are actually exported usually goes unchecked)."

Etc... The list goes on...