Economy Part III

TAXATION
3.1 Introduction
Tax is a financial charge or levy imposed by a government on individuals, businesses, or other entities to fund
public expenditures and government functions. It is a compulsory contribution that citizens and businesses
are required to pay, and it is a crucial source of revenue for the government.
 3.2 Classification of Taxes
❖One way is to classify them in progressive, proportional and regressive way:
❖ Progressive Tax: Tax percentage increases with increase in income
❖ Proportional Tax: Tax percentage remains same/constant irrespective of income
❖ Regressive Tax: Tax percentage decreases with increase in income

❖Another way of classification is Specific tax and Ad-valorem tax:

❖ Specific tax is the tax which is fixed as per each unit of good or service rather than based on its
value.
❖ Ad-valorem tax is levied as a percentage of value of the item it is imposed on, and not on the
item's quantity, size, weight or other such factor.

❖Another way of classification is production and consumption-based tax. (This classification

is only for indirect taxes).
❖ Production tax (or origin-based tax) is levied where goods & services are produced.
❖ Consumption tax (or destination tax) are levied where goods & services are consumed.

❖Another way of classification is direct and indirect taxes:

❖ Direct taxes are those which are paid directly by an individual or organization to the imposing entity
i.e., the government. For example, a taxpayer pays direct taxes to the government for different
purposes like income tax, property tax etc.
❖ An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who
bears the ultimate economic burden of the tax (such as the consumer). For example, taxes levied on
goods and services.
 3.3 Direct Taxes
❑Personal income tax is imposed by combining all sources of the individual's income like
salary, rental income, interest income etc. Presently there are two tax regimes, new tax
regime and old tax regime and individuals are free to choose either the old or new tax regime
for tax payment but the new tax regime is the default one.
❑Corporate income tax (CIT) is imposed on the profits of the corporates/ companies/
entities. All profit-making companies need to pay a flat rate of corporate income tax. Presently
two structures of CIT exist and the companies can opt anyone. If a company does not claim
any tax exemptions, then it needs to pay 25.17 % CIT, but if a company claims tax exemptions,
then it needs to pay 34.94% as CIT.
❑Minimum Alternate Tax (MAT): At times it may happen that a taxpayer, being a company,
may have generated income during the year, but by taking the advantage of various provisions
of exemptions under the Income tax law (like depreciation, etc.), it may have reduced its tax
liability or may not have paid any tax at all (zero tax companies). Due to increase in the
number of zero taxpaying companies, MAT was introduced by the Finance Act, 1987. The
objective of introduction of MAT was to bring into the tax net "zero tax companies" which in
spite of having earned substantial book profits and having paid handsome dividends, do not
pay any tax due to various tax concessions and incentives provided under the Income tax Law.
 3.3 Direct Taxes
❑Capital Gain Tax: Capital gains tax is a tax on capital gains i.e., the gain/profit realized on the sale of an asset
that was purchased at a cost amount that was lower than the amount realized on the sale. The most
common capital gains are realized from the sale of shares/stocks, bonds, precious metals, artwork and
property.
❑Dividend Distribution Tax (DDT): Dividend is the distribution of a portion of company's profits/earnings to
its owners/ shareholders. When a company announces dividends, it has to pay tax (DDT) on the dividend
which is to be distributed to the owners and the owners also pay tax (as per their income tax slab) on the
dividend received. DDT was abolished in the budget 2019-20 and dividend was made taxable in the hands of
the shareholders.
❑Securities Transaction Tax (STT) is a tax levied at the time of purchase and sale of securities like shares,
bonds, debentures, mutual funds etc. listed on stock exchanges in India. The rate of STT differs based on the
type of security traded and whether the transaction is a purchase or a sale. Purchaser and seller both pay
STT. For example, while buying or selling an equity share purchaser and seller both need to pay 0.1% of share
value as STT.
❑The Equalization Levy, also known as “Google Tax,” was introduced in India in 2016 to address taxation
challenges posed by the digital economy. The Equalization Levy is distinct from income tax and was
introduced as an independent levy through the Finance Act of 2016. It covers various digital services and
became effective at different dates. Initially, it was applied to the “sale of digital services (ads),” and
subsequently, from April 1, 2020, it also extended to e-commerce firms.
 3.3 Direct Taxes
❑Land Revenue is levied as per the different State Govt. Acts. Generally, the fixation of land revenue is done
on the basis of classification of different types of land and cash value of the average yield of the land. Factors
affecting productivity in value terms are taken into account. The land revenue tax is levied as Rs. per
acre/hectare of land.
❑Property tax in India is paid on “real property”, which includes land and improvements on land, with the
government appraising the monetary value of each such property and assessing the tax in proportion to its
value. This tax amount is used to develop local amenities including road repairs, maintenance of parks and
public schools, etc. Property tax varies from location to location and can be different in different cities and
municipalities. Urban local bodies like municipal boards/ municipal corporations/ town area committees levy
property tax under the relevant Acts.
❑Global Minimum Corporate Tax (GMCT): Big Technology companies shift their profits to such countries
where the corporate tax rate is less. The companies do not shift the actual business but mostly financial
transactions are involved. As the competition among the countries is increasing, to attract more
business/investment, countries also resort to reduction in corporate taxes. This has led to the loss of tax
revenue to the home country government. That is why countries have agreed to implement a Global
Minimum Corporate Tax. Once the 'Global Minimum (Corporate) Tax' kicks in, India may have to abolish the
'Equalization Levy' which it imposes on multinational technology companies such as Google, Facebook etc.
 3.4 Indirect Taxes
❑Excise duty used to be applied to manufactured goods, with taxation occurring when the goods left the
factory premises
❑Customs duty is imposed on the import and export of commodities.
❑Service Tax was levied on the provision of services.
❑Central Sales Tax (CST) was imposed by the Central government on the sale of products between
different states. However, the tax revenue was collected and retained by the state where the transaction
originated, which is why it was referred to as an origin-based tax.
❑Value Added Tax (VAT) was applied to the sale of goods within a state. The Central government did not
have the authority to tax intrastate sales, and VAT was only imposed on the value added at each stage of
production. Under the VAT system, every entity in the value chain was required to remit taxes to the
government based on their respective value additions.
❑Entry Tax, previously enforced by Indian state governments, applied to the inter-state movement of
goods. It was imposed by the receiving state to safeguard its tax revenue base.
❑Stamp Duty is a tax that pertains to all legal property transactions. It required the affixing or imprinting of
a physical stamp on the document to signify payment of the stamp duty. As it is imposed by individual
states, the tax rate varies from one state to another.
 3.5 Goods & Service Tax
❑Goods and Services Tax (GST) was introduced on July 1, 2017, based on the principles of value-added tax
and applies to the supply of goods and services across the nation.
❑Multiple Tax Levels: India’s GST system consists of multiple tax rates, with four primary tax rates (5%,
12%, 18%, and 28%), Additionally, there is a “zero rate” for certain essential goods and services.
❑Destination-Based Tax: This means that the revenue generated from GST is collected by the state where
the goods or services are consumed, rather than where they are produced.
❑Input Tax Credit: Under the Indian GST system, businesses can claim input tax credit for the GST they paid
on their purchases. This helps eliminate the cascading effect of taxation and ensures that taxes are levied
only on the value added at each stage of the supply chain.
❑Compliance and Reporting: Registered businesses in India are required to file regular GST returns,
including details of their sales, purchases, and tax liabilities, through an online portal provided by the
Goods and Services Tax Network (GSTN).
❑Dual GST Model: It implemented a dual GST model, which means that both the Centre and the States will
simultaneously levy GST on a common tax base.
❑GST Council: The amendment led to the formation of the GST Council, a joint forum of the Centre and the
States. This council is tasked with making recommendations on various issues related to GST, such as the
tax rate, exemption list, and threshold limit.
 3.5 Goods & Service Tax
❑Integrated GST (IGST): The act also introduced the concept of Integrated GST, which is levied on interstate
transactions of goods and services and is shared by both the Centre and the States.
❑Compensation to States: It provided for compensation to states for any revenue loss due to the
implementation of GST for a period of five years.
❑The Electronic Way Bill (E-Way Bill) is an important component of the Goods and Services Tax (GST)
system in India. It’s a digital document generated on the GST portal, evidencing the movement of goods.
An E-Way Bill is required when the value of the consignment of goods transported exceeds ₹50,000.
3.6 Tax Related Terms
❖Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies used by multinational
enterprises (MNEs) to exploit gaps and mismatches in tax rules across different jurisdictions. The
goal of these strategies is to artificially shift profits from higher-tax jurisdictions to lower-tax
jurisdictions or tax havens, where there is little or no economic activity by the company. This
shifting results in eroding the tax base of the higher-tax jurisdictions and leads to minimal
overall corporate tax being paid globally.
❖Transfer pricing in taxation refers to the rules and methods for pricing transactions between
enterprises under common ownership or control. These transactions could involve the trade of
goods, services, or intangible assets.
❖The primary goal of transfer pricing rules is to ensure that the transactions between related
parties are conducted at arm’s length – that is, as if the transactions were between unrelated
parties.
3.6 Tax Related Terms
❖Tax buoyancy is defined as the ratio of the percentage change in tax revenue to the percentage
change in GDP. It indicates how tax revenues increase or decrease in response to changes in
economic activity.
❖Tax Buoyancy = (Percentage change in tax revenue) / (Percentage change in GDP)
 3.7 Non-Tax Revenue
❖Fees and Charges: Revenue earned from providing services or issuing licenses and permits. This includes fees for
government services like passport issuance, driving licenses, court services, and administrative services.
❖Fines and Penalties: Money collected from penalties imposed for violations of laws and regulations. Examples
include traffic fines, environmental violation penalties, and other legal penalties.
❖Profits from Public Enterprises: Earnings from businesses owned or operated by the government. These can
include profits from public utilities, transport companies, and other state-owned enterprises.
❖Interest and Dividends: Income generated from investments held by the government, such as interest from bank
deposits or dividends from shares in companies.
❖Royalties and Licenses: Payments received for the use of government resources or property. This often includes
royalties from natural resource extraction (like oil, gas, and minerals) and fees for broadcasting and
telecommunication licenses.
❖Grants and Donations: Funds received from other governments, international organizations, or private entities,
as well as donations from individuals and organizations.
❖Property Income: Revenue from the rent, lease, or sale of government-owned property and assets.
 3.8 Disinvestment in PSUs
❖The disinvestment process in India is managed by
the Department of Investment and Public Asset
Management (DIPAM), a department within the
Ministry of Finance.
❖DIPAM’s main goal is to oversee and handle the
government’s investments in public sector
enterprises, including the process of disinvesting
government shares in these entities.
❖In 2005, the Indian Government established the
National Investment Fund (NIF). The funds obtained
from the disinvestment of Central Public Sector
Enterprises are directed into this fund.