The Hindu Business Line : The incentive disincentive

CRITICS of the Income-Tax Department have to reckon with the fact that the tax code is riddled with exemptions and deductions, making it difficult even for the best of tax administrators to recover successfully legitimate tax dues of the Government. Once a deduction/exemption is engrafted into the code, it is almost impossible to delete the provision from the statute. Corporate houses have a field day, choosing to interpret the provision in the manner most suited to gain tax advantage. In the mean time, courts come up with their own reading of the law. There are 148 exemption provisions and each one of them has suffered interpretation at the highest level.

Export profits

The export profit rebate under Section 80HC has attracted maximum attention. Section 80A permits deduction from the gross total income, amounts specified in Sections 80C to 80U. Limitation on such deduction is laid down under Section A (2). The aggregate amount of the deduction under Chapter VI A should not exceed the gross total income of the assessee. Section 80 HHC (3) provides for the computation of the deduction. The computed amount is deducted from the gross total income as per Section 80HHC (1). What happens if the computation under Section 80HHC(3)(c) results in a loss? The term `deduction' itself means tax concession. Can there be a concession when there is a loss? Exemption can be enjoyed not merely by the exporter but also by a supporting manufacturer if the former had disclaimed the benefit.

For enjoying the concession, the supporting manufacturer should have sold the goods manufactured to an export/trading house recognised by the Government. In case an export house incurs loss, it can issue a certificate of disclaimer so that the supporting manufacturer can claim the benefit even if the exporter incurs a loss. It is possible that in a mixed business, there is loss from the export of trading goods and profits from self-manufactured goods. In a recent ruling, the Bombay High Court had to consider the argument that export deduction be given for profits from self-manufactured goods, ignoring the loss from export of trading goods.

The court pointed out that the acceptance of this argument would mean extending the benefit both to the supporting manufacturer and the export house. This will defeat the very object of Section 80HHC (1). Unless there is profit, there cannot be tax concession for the assessee. Disclaimer falls under Section 80HHC(1), not Section 80HHC (3)(c).

Accordingly, the word `profit' in Section 80HHC(1) should be interpreted as excluding loss. As per Section 80HHC(1), this will also apply to reduction of deduction for disclaimer in tax concession. Profit, as used in Section 80HH(c)(1), does not include losses. On the other hand, the word `profit' in Section 80HHC(3c) includes losses (PCA Laboratories Ltd vs CIT — 25 ITR 401). Tantalising semantics, no doubt, but that is how the law is developed.

Effect of tax reforms

Contrary to expectations, a recent empirical study (by Ravindran Dholakia and Deepak Kappoor, taking the balance-sheet data of 557 private sector companies and dividing them into exporting and non-exporting groups) has shown that the tax contribution of exporting firms is much lower than that of non-exporting companies and the median value of tax provision as a percentage of net sales turns out to be considerably higher for exporting companies than for the non-exporting ones for each year from 1980-81 to 1995-96. Does it mean that the tax incentives for exports are not as substantial enough? After all, they are proportional to the export intensity, which is not very high for the private corporate sector. Second, exporting firms have higher profitability than non-exporting ones. And, non-exporting companies enjoy several tax concessions and exemption — "backward area development", "priority sector" and so on.

The research analysts conclude thus: "Tax policy or export incentives do not seem to be major influencing factors. It is perhaps the profitability and the financial performance of the firms that could determine the behaviour of this ratio over time. This finding does not seem to support the hypothesis of a categorical shift in the development strategy from import substitution to export promotion actively pursued by the Government since 1991." (Economic and Political Weekly, December 8, 2001).

The policy reforms have no doubt increased the importance of export activity for the private non-financial corporate sector. There has been an increase in the number of exporting companies. The overall, as well raw material, import intensity is found to be higher for exporting, rather than non-exporting, companies. Reforms have helped the non-exporting ones to improve their margins.

There has been an increase in the net worth of companies irrespective of their exporting status. The policy reforms have adversely affected the value addition in the non-exporting companies because they have been pushed to the lower end of the domestic market. The Government has shown courage in initiating steps to eliminate export incentives over a period.

Secs 10A and10B

Apart from Section 80 HHC, Sections 10A and Sec 10B contain special provisions in respect of newly established undertakings in free-trade zones and 100 per cent export-oriented undertakings.

The Parthasarathy Shome Panel found no justification in the continuation of Section10A and 10 B incentives, as the inter-national competitiveness of exports covered under Section 10A is greater than exports from outside special economic zones.

Similarly, the incentive under Section 10B amounts to a premium on licensing. The panel has also suggested the deletion of Sections 80IA and 80IB, as empirical evidence suggests that the concessions have not significantly contributed to the industrial development of backward areas.

The tax rate

When the incentive provisions were introduced, the tax rates were high. Despite steep rates of 55 per cent on public companies and 65 per cent on private companies, the effective tax rates after utilising Chapter VI A concession worked out to only 19 per on an average.

Several leading corporate houses avoided paying any corporate tax at all because of the high depreciation and the incentive provisions. Even after the introduction of MAT, 42 leading corporate houses did not pay MAT despite declaring high dividend.

The incentive provisions have been a drag on the revenue-mobilisation efforts of the Government. There is a strong case for the abolition of Chapter VIA.

This may not be possible at one stroke. Even while gradually withdrawing the concessions, the Government must think of reducing the corporate tax rate to 30 per cent.

Already, there are moves to bring the tax rates of foreign companies on a par with those of domestic companies. Such equalisation may not be equitable. As the Bombay High Court pointed out in a French bank case, foreign companies have no obligation to submit to the socio or economic objectives visualised in the fiscal laws.

Even while reducing the tax rates on corporate houses, some distinction is called for in the tax rates on domestic and foreign companies.

Long-term fiscal policy

A long-term fiscal policy (LTFP) — lasting, say, for five years — seems to be the need of the hour. It will avoid the temptation of resorting to ad-hocism in tax policy.

There will be continuity and certainty, enabling domestic and foreign investors to make their own calculations about the profitability of the venture they are contemplating.

There will be less arbitrariness in decision-making. The spectre of development rebate vanishing only to reappear as investment allowance or the startling case of the gift tax law itself being abolished following the non-implementation of the law to tax gift as income, would not have been possible if an LTFP was in place. In the coming Budget, the Finance Minister should make a beginning in this regard.

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