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  Date: 5th Aug 2009

 Compiled by: M Sathya Kumar  

Can Tax Laws ever be simplified ?

The hardest thing in the world to understand is the Income Tax.

— Albert Einstein

The often quoted statement is : ‘Equity and taxes are strangers’; one could add that ‘tax laws and simplicity are also strangers’. In the Wealth of Nations, Adam Smith famously noted that complexity makes taxes "more burdensome to the people than they are beneficial to the sovereign". The cost of taxes is not just the taxes we pay, but also the cost of complexity, popularly now termed as ‘compliance cost’. There seems to be universal agreement that the present tax code is way too complex and needs to be completely overhauled.

Tax laws world over are complex, but the Indian Income-tax Act has the unique distinction of being amended every year, often retroactively and at times the law is amended even before it has become applicable. This has resulted in an already complex law being made almost incomprehensible.

Our tax laws live up to Senator Spark M. Matsunaga’s statement :

Why Tax laws are complex ?

Equity and certainty are two basic canons of taxation that constitute the foundation of all discussion on the principles of taxation. The canon of equity demands that tax paid should be commensurate to the respective abilities of the tax-payers. That the rich should contribute to the public expense not just in proportion to their revenue, but more than that. The canon of certainty, as Adam Smith put it so succinctly entails that "the tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person, so that the taxpayer is not put in the power of the tax gatherer".

2.2 The economic reality is that no other branch of law touches human activity at so many points and therefore tax laws will necessarily be complex. The unfortunate truth is that it is difficult to design a tax code that is simple and yet provides both equity and certainty.

2.3 The Government in the past has appointed several committees to rationalise and simplify tax laws. Each report is a complete report, but the irony is that the authorities have been selective in accepting recommendations. This selective approach of the authorities has further complicated the law. The need of the changing environment, if India is to emerge as an economic superpower, is to bring about clarity in tax laws, where ‘tax liability’ can be determined with certainty.

What is complexity ?

Taxation concepts by themselves are complex and are troublesome enough, but when expressed in complex language, the confusion is worse confounded. Hence, the case for simplicity is usually considered as self-evident and is advocated as the panacea for all tax woes. However, there is hardly any agreement as to what simplicity entails. For some, it means encoding the tax law in a simple and easy to understand language. To others simplification means a statute that contains a minimal number of distinctions and exceptions, so that all arrangements or transactions with similar economic effects receive the same tax treatment. In other words, deletion of exemptions and deductions for different economic interest groups, resulting in a small and simple Income-tax Act with fewer sections.

Can simplicity be achieved ?

Simplicity can be achieved by adopting any one of the following broad parameters :

• A "butcher’s knife" approach. This could be outrageously discriminatory and grossly inequitable and unfair to a lot of people. For example, a fixed tax of Rs.10,000 for every individual (irrespective of his income) would be very simple, but would be totally unacceptable and unjust.

• A flat rate of tax — that is — doing away with the slab system. This is prevalent in some countries like Czech Republic, Mauritius, Russia, etc. However, this system by itself can achieve only limited simplification unless it is accompanied with removal of exemptions and deductions.

• Make tax laws (like accounting standards) principle-based and not rule-based. In other words don’t try to solve every conceivable problem or plug every possible loophole, but instead enact a generalised statute that lays down principles and clearly indicates their purpose. Surely, in today’s complex business environment, this is a pipe dream. Even assuming such an approach were attempted it would necessarily have to rely predominantly on voluntary compliance. Advocates of this approach canvass that simplicity would promote voluntary compliance and thereby boost revenue collections.

• Social and political objectives for development of areas or special interest groups should be through direct subsidies and not through tax laws. Subsidies however have proved to be very costly and ineffective and experience now suggests that these should be introduced only under very special circumstances.

It is also undisputed that world over taxpayers are resorting to ever more complex tax structures to reduce their tax liability. Indeed, taxpayers (with the help of consultants) are blurring the line between tax evasion, tax avoidance and tax planning. Complex business structures, use of tax-friendly jurisdictions (tax havens), off balance-sheet transactions, interdealings with related enterprises, etc. are as much an integral part of the modern business as they are tools to minimise tax liability.

Indian laws are not any more complicated than in the US and many other European countries. Tax laws world over are complex and will unfortunately remain so, as they have to deal with businesses that are complex and intricate.

Besides, modern tax laws are not just about revenue collection. They are also fiscal tools to achieve social, economic and political objectives. Despite the rhetoric from businesses and Government that they prefer a free market economy as a vehicle for the desired distribution of economic resources, in practice there is little faith shown in unassisted market to deliver optimal economic and employment growth. Special interest groups as well as political groups regularly lobby, often successfully and often justifiably, in carving out exceptions to the tax laws and thereby adding to complexity. It is routinely touted that exemptions and deductions should be reduced. However, the reality is that many groups will have special problems and their appeal for special treatment will sound perfectly fair and justified.

The bottomline is that as long as we continue to use tax codes to achieve economic, social and political objectives beyond raising revenue for necessary government programmes, it is impossible to achieve true tax simplification.

To summarise, the primary reasons for tax laws being complex world over are :

• Complex nature of transactions and business structures.

• Multiple character of transactions.

• Diverse nature of business, local, national and transnational.

• Use of tax law as tools to achieve social, economic and political objectives, for example, education cess of 3%.

• Exemptions granted to special interest groups or areas for encouraging economic development, for example, tax benefits granted to north-eastern States and developers of residential real estate.

• Desire of every taxpayer to arrange his affairs in a manner that minimises his tax liability.

• Desire of every government to tax a part of profit arising out of a transnational transaction.

• Use of different languages in similar provisions, for example, some Sections in chapter VI-A use the term ‘attributable to’ as opposed to ‘derived from’ used in other Sections resulting in endless litigation.

• Desire to deny deduction to which the assessee is entitled, leading to prolonged litigation, for example, S. 80HHC.

• Bad drafting of laws. This is despite the fact that all members of the CBDT are from the field and are conversant with the problems faced both by the tax gatherer and the tax-payer.

• Desire of tax gatherer to collect the most rather than the correct share of tax.

This does not mean that no attempt should be made to rein in complexity. Complexity in itself creates opportunities for tax avoidance and also causes difficulties for honest taxpayers. It leads to confusion and mistakes that are often hard to distinguish from dishonesty. Consequently, penalties become a less appealing approach to enforcement, while simultaneously, detection becomes costlier. In other words, complexity not only increases the cost of compliance for the taxpayer, but it also increases the cost of enforcement for the Government. Therefore, before giving in to demands of special interest groups, one must think hard about whether the alleged equity or advantage resulting from each new exception (exemption, deduction, etc.) is really worth the added complexity and confusion.

Lessons can also be learnt from international best practices. For example, OECD and the United Nations have been incessantly working for reducing complexities in international taxation by drafting model treaties for avoiding double taxation.

Given the limited possibility of reducing complexity, the focus must necessarily shift from simplification of tax laws to simplification in tax administration. Greater attention should be paid to improving compliance through equity, improvement in taxpayer services, transparency and accountability. The last disclosure scheme was questioned and criticised on the ground that it rewarded the dishonest taxpayer. But its success also demonstrated quite effectively that simplicity coupled with a responsive administration works.

US President Lyndon Johnson said, "I do not suppose we will ever get to the point where people are pleased to pay taxes, but we owe it to them to see that the collection is done as efficiently as possible, as courteously as possible and always honestly."

The concept of good governance and fair treatment of stakeholder is not just applicable to the corporate world, but is with much greater force applicable to the Government, which has the primary duty to treat taxpayer with fairness and dignity.

The Citizens’ charter published by the tax authorities proclaims its commitment to excellence in providing service to the taxpayers. It is about time that the Tax Department is held accountable on this promise. Tax practitioners should also work in tandem in promoting voluntary tax compliance. The unfortunate experience of the taxpayer and the tax practitioner is that the general approach is to treat the taxpayer as a tax evader and tax practitioner as evader’s abettor.

Simplification of tax administration can be achieved through systemic changes, effective use of technology and by introducing transparency and accountability. If information is available electronically and the interface between taxpayer and Tax Department is minimised to only where absolutely essential, then it will not only reduce the scope for malpractice, but would also improve tax administration. Higher transparency will automatically also result in higher accountability. In the age of ‘Right to Information’ this is the need of the hour.

Innovative steps in this direction could be :

• Statistics of additions made at assessment level as compared to additions finally sustained, total successful appeals out of total appeals filed by each section of the Department, and so on can be made public through Depart-ment’s website.

• Broad and well thought out parameters and not just revenue collection, should be used as criteria to judge the performance of the tax officers. This would go a long way in improving tax administration and bring about a change in ‘mindset’.

• The bureaucrat, it is said is as good as his last mistake. This mindset results in paralysis of action, as mistakes are not forgiven, but non-performance is ignored and often (ironically) encouraged. Tax officers need to be rewarded for prompt decision and action and held accountable for inaction and delay.

• Focussed training along with systemic changes by introducing transparency and accountability can certainly trigger the process of change.

• The Department should discourage filing of frivolous appeals. Statistics establish that majority of the appeals are filed by the Department. The Courts should award ‘cost’ –nay – heavy costs to the assessee, in case it is of the opinion that the Department’s appeal is frivolous.

• Where an issue is pending before the Supreme Court, the lower appellate authority should pass an order to the effect that the matter will be dealt with according to the decision of the Supreme Court. This will obviate the filing of an appeal by the assessee.

It is well known that changes introduced in the name of simplicity cause the greatest confusion. Complexity in administration can also be reduced by avoiding frequent changes in laws and rules, as they only lead to fresh ground of litigations and confusion. Since amendments are often with retroactive effect, the complexity and uncertainty embedded in the laws are further compounded and sensible planning becomes impossible.

The biggest problem today is not that the law is complex, but that it is administered in a complex and unfriendly manner. Focus must therefore change from simplification of tax laws to improving tax administration.

It is the duty of the Government to create an environment where tax compliance is encouraged and every taxpayer is not considered guilty until proven innocent. As William Gladstone said, "it is the duty of the Government to make it difficult for the people to do wrong and easy to do right".

Though tax laws will never achieve the simplicity we desire, the challenge is to have a responsive and efficient administration which can to a large measure prove John Haye’s statement wrong. I quote :

‘Income Tax is capital punishment’.

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