Abstract
This Selected Issues paper paints a picture of the Indian economy that has made great strides, but has more to do to accelerate growth and reduce poverty. The paper assesses empirically whether India has entered a new phase of higher trend growth. Two alternative methodologies are used to disentangle underlying structural growth trends from shorter-term cyclical fluctuations around this trend. The paper focuses on a number of the reforms required to ensure that needed high growth can be achieved on a sustained basis.
IV. The Tax System in India: Could Reform Spur Growth?1
A. Introduction and Overview
1. While the average tax intake in India is low by international standards, marginal rates are high. High tax rates are thought to depress employment, investment, and growth. The empirical evidence is mixed. Cross-country studies generally confirm the negative impact of taxation on economic activity, but results are not robust. Firm-level evidence and simulation results are more conclusive, supporting the view that high tax rates have an adverse effect on growth and distort financing and investment decisions (Box IV.1). High tax rates may also contribute to the growth of the “shadow economy,” carrying costs in terms of foregone tax receipts and lower productivity growth (Farrel, 2004; Schneider and Klinglmair, 2004).
2. To improve the tax intake and savings and investment rates, which are low by regional standards,2 a series of tax reforms have been considered in India. 3 Their main thrust is to combine lower statutory rates with base broadening, to realize more revenues while lowering the marginal tax burden and removing distortions. This in turn should foster growth, leading to an “expansionary” fiscal adjustment.
3. This chapter assesses the potential impact of India’s tax system on growth. Section B establishes stylized facts about the tax system: (i) a high dependence on indirect taxes, (ii) low average effective tax rates (AETRs) and tax productivity, and (iii) high marginal tax rates and tax-induced distortions on marginal investment and financing decisions. Section C finds that the proposed tax reforms would improve tax productivity and lower the marginal tax burden and tax-induced distortions. But firms that rely on internal sources of funds or face problems borrowing would continue to face high marginal tax rates.
Empirical Evidence on Taxation and Growth
High labor taxation can negatively impact employment and growth by pushing up labor costs. In the presence of strong and decentralized labor unions, labor taxes are shifted into real wages, reducing labor demand; this in turn leads to substitution away from labor and downward pressure on the marginal product of capital, reducing investment and growth. Empirical evidence for European Union (EU) countries confirms this view.1 High marginal effective tax rates (due to the combination of tax and benefit systems) can also affect labor supply decisions by affecting the choice between additional work and leisure.2
Consumption taxes do not affect savings and investment decisions since future and current consumption are treated equally, and they remain neutral with respect to various sources of income. Empirical evidence is mixed, however. Some studies find that such taxes indeed have no impact on employment and growth,3 but others find that—like income taxes, although to a lesser extent—they have a negative impact on growth by distorting the choice between labor and leisure, and also could depress savings.4
Corporate taxes raise the required rate of return on investment and depress investment. In addition corporate taxes tend to favor debt over equity financing or retained earnings, potentially leading to an inefficient allocation of resources, higher insolvency risks, and discrimination against smaller companies that face more difficulties borrowing. Corporate taxes are also non-neutral given the widespread use of rebates, exemptions and special regimes for specific sectors or regions. This also benefits large companies which can bear a lower tax burden through tax planning and fiscal engineering.5 Cross-country studies confirm a negative link between the tax burden and growth for high-income countries. However, the result does not hold for low- and middle-income countries, perhaps reflecting measurement problems. 6Firm-level empirical results, as well as simulation results using computable general equilibrium models, in contrast support the view that higher taxes negatively affect growth.7
Taxation of capital income—even when at a low level—as is the case in most EU countries, appears to have a distortionary effect on savings. Although there is little evidence for the EU that taxes affect the aggregate level of savings, they appear to influence its composition and location. Many EU countries tend to grant favorable treatment to specific savings instruments, such as retirement schemes and housing investment. Moreover, they generally apply a preferential treatment to non-residents, thus distorting saving flows and potentially enhancing tax evasion possibilities associated with cross-border investment.8
1 See Daveri, F., and G. Tabellini, 2000, “Unemployment, Growth, and Taxation in Industrial Countries,” Economic Policy, Vol. 30, pp. 48–104.2 For example, see OECD, 2001, Tax and the Economy: A Comparative Assessment of OECD Countries, (Paris: Organisation for Economic Co-operation and Development).3 See Daveri and Tabellini, 2000; and Kneller, R., M. F. Bleaney, and N. Gemmel, 1999, “Fiscal Policy and Growth: Evidence from OECD Countries,” Journal of Public Economics, Vol. 74(2), pp. 171–190.4 For example, see Milesi-Ferretti, G. and N. Roubini, 1995, “Growth Effects of Income and Consumption Taxes: Positive and Normative Analysis,” NBER Working Paper 5317; and Tanzi V. and H. Zee, 2000, “Taxation and the Household Saving Rate: Evidence from OECD Countries,” Banca Nazionale del Lavoro Quarterly Review, Vol. 53, pp. 31–43.5 See Rao, S., and J. Lukose, 2002, “An Empirical Study of the Determinants of the Capital Structure of Listed Indian Firms,” unpublished (Mumbai: Indian Institute of Technology); OECD, 2001; and Joumard, I., 2001, “Tax Systems in European Union Countries,” OECD Economic Studies, Vol. 34, pp. 91–151; and Nicodeme, G., 2002, “Sector and Size Effects on Effective Corporate Taxation,” Economic Papers No. 175 (Brussels: European Commission).6 See Blankenau, S., S. Nicole, and M. Tomljanovich, 2004, “Public Education Expenditures, Taxation, and Growth,” unpublished (Kansas: Kansas State University). Such studies typically use the tax revenue to GDP to proxy for the tax burden instead of the marginal or effective tax rate on corporates, which ideally should be used.7 See Fishman, R. and J. Svensson, 2000, “Are Corruption and Taxation Really Harmful to Growth? Firm Level Evidence,” unpublished (New York: Columbia University); and Feltenstein, A. and A. Shah, 1995, “General Equilibrium Effects of Investment Incentives in Mexico,” Journal of Development Economics, Vol. 46, pp. 253–69.8 See OECD (2001).B. The Indian Tax System: Stylized Facts and Issues
The Tax System 4
4. India has a well developed tax structure, with the authority to levy taxes divided between the central government and the state governments. The central government levies direct taxes such as personal income tax (PIT) and corporate tax (CIT), and indirect taxes such as customs duties, excise duties, and central sales tax. The states levy state sales tax and various local taxes. Since 1991, the tax structure has been substantially rationalized. Changes include reducing customs and excise duties, lowering CIT rates, extending a form of VAT to some industries, and broadening the tax structure to some services.5
5. The principal direct taxes include PIT and CIT, state taxes on agricultural income, wealth tax, and various withholding taxes. The PIT is levied on non-agricultural income at rates of 10 percent–31.5 percent. It applies to Indian residents and foreigners, on income earned in India. The exemption threshold of Rs. 50,000 (US$1,111) results in a relatively narrow tax base of about 34 million taxpayers.6 States levy some taxes on agricultural income (land revenue tax and agricultural income tax), but their combined incidence is considerably less than that of the PIT. A wealth tax is levied on net assets in excess of Rs. 1.5 million. The corporate income tax (CIT) is levied at a basic rate of 35 percent, but with significant exemptions. Other corporate taxes include a dividend distribution tax (DDT), a minimum alternative tax on profits, and various withholding taxes on interest, royalties, etc.
6. The main indirect taxes are the sales tax, custom and excise duties, and service tax. A state sales tax is levied on intrastate trade and a central sales tax (CST) on interstate trade, at a rate that varies depending on the type of transaction and the rate of the state sales tax. The center also levies custom duties and a basic excise duty (modified VAT or CENVAT) on goods manufactured or produced in India. The CENVAT base is truncated to manufacturing and eroded by a complex and extensive system of exemptions, including for small-scale industries and Special Economic Zones. Special excise duties are levied on specific items. In 1994, a selective turnover tax on services was introduced on three specified services. The base was gradually widened to cover 58 services.7 Other minor taxes and duties imposed at both center and state level include stamp duty, taxes on land and buildings, and taxes on motor vehicles.
7. As in other developing countries, tax incentives feature prominently in India. They are used to encourage new industry to locate in “backward” regions; to promote exports; and to promote investment in sectors including hotels, power, telecommunications, and infrastructure. The question remains whether tax incentives are decisive factors in the decision to invest. They may be important for some companies to offset other costs of doing business in India—such as still relatively high import duties, cascading sales taxes, and inadequate public infrastructure—but an unfortunate outcome has been to thin out the overall direct and indirect tax bases (Shome, 2004). Tax holidays, which are the preferred form of incentives in India, have the most serious shortcomings (Tanzi and Zee, 2001).
Stylized Facts
8. India’s general government tax revenue has declined since the 1990s, to under 14 percent of GDP in 2002/03. This is more than 5 percentage points below the average for selected non-OECD countries and 2 percentage points below the Asian average. The decline in revenue during 1992–2002 contrasts with the increase in tax intake observed in other large Asian countries (Indonesia, China, and Korea) over the same period. It occurred as major tax reforms were implemented, aimed at improving the buoyancy of revenues and increasing the share of direct taxes in total revenues. Direct tax revenues increased, but indirect tax collections declined, mainly due to tariff reductions (Figure IV.1).
India: Tax Burden, 1974/75–2003/04
(In percent of GDP)
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Sources: Indian authorities; and staff projections.India: Tax Burden, 1974/75–2003/04
(In percent of GDP)
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Sources: Indian authorities; and staff projections.India: Tax Burden, 1974/75–2003/04
(In percent of GDP)
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Sources: Indian authorities; and staff projections.9. The most recent reforms (2002-04) were moderately successful in reversing the declining trend of revenues. The peak tariff reduction for non-agricultural imports advocated by the 2002 Kelkar committee reports (Box IV.2) was fully implemented and the revenue loss was more than offset by buoyant corporate tax collections. However, excise and PIT revenues rose only marginally, reflecting the extension of further exemptions, deductions, and rebates (against the recommendation of the Kelkar reports). The states succeeded in raising sales tax collections, but the introduction of a VAT was postponed.
Kelkar 2002 Reports Proposals
As part of its overall reform agenda, the government in 2002 set up a tax reform task force (Kelkar task force) to propose a far-reaching reform agenda for direct and indirect taxes. 1 Proposals centered around the following elements:
A change in the exemption level and rate structure of the personal income tax and broadening of the base, as well as minimizing exemptions and replacing allowances by credits. A constitutional device would allow the government to tax agricultural income. The general exemption would be increased, the number of brackets reduced, and the highest marginal rate reduced to 30 percent. A range of special deductions would be eliminated and some would be converted into credits. The report also proposed changes to the taxation of capital income, specifically exempting dividends from Indian companies and long-term capital gains on equity.
A reduction in the rate and in the large number of deductions and exemptions of the corporate income tax. The rate would be reduced to 30 percent for domestic companies and 35 percent for foreign companies. The minimum alternate tax would be eliminated.
A rationalization of the import tariff structure and export promotion schemes. The existing 20 tariff rates, ranging up to 182 percent, were to be reduced to a range of 0 percent-20 percent for most goods, with higher rates—up to 150 percent—for certain agricultural products and “demerit” goods, with the new schedule to be adopted as of 2004/05. Exemptions would be significantly narrowed.
Broadening the base of the central excise tax (CENVAT) and moving it further toward a VAT.
10. Despite reforms, the tax structure remains dominated by indirect taxes. State taxes on commodities and services are the prominent source of general government revenue (representing more than a third of the total tax intake), followed by central government excises (one-fifth of the total) (Table IV.1). The share of revenue from indirect taxes is more than three quarters, compared to half in the average non-OECD country (Table IV.2).
India: Structure of General Government Tax Revenue, 2003/04
Mostly service tax.
Staff estimates based on projected GDP growth and historical elasticities.
India: Structure of General Government Tax Revenue, 2003/04
| Billions of Rupees | Percent of GDP | Percent of Total | ||
|---|---|---|---|---|
| Central government | 2,544.4 | 9.2 | 61.0 | |
| Corporate tax | 636.1 | 2.3 | 15.2 | |
| Income tax | 414.4 | 1.5 | 9.9 | |
| Excises | 907.6 | 3.3 | 21.8 | |
| Customs | 486.3 | 1.8 | 11.7 | |
| Other 1/ | 100.0 | 0.4 | 2.4 | |
| States and union territories 2/ | 1,626.7 | 5.9 | 39.0 | |
| Taxes on income | 25.7 | 0.1 | 0.6 | |
| Taxes on property and capital transactions | 177.5 | 0.6 | 4.3 | |
| Taxes on commodities and services | 1,423.4 | 5.1 | 34.1 | |
| Total | 4,171.0 | 15.0 | 100.0 | |
Mostly service tax.
Staff estimates based on projected GDP growth and historical elasticities.
India: Structure of General Government Tax Revenue, 2003/04
| Billions of Rupees | Percent of GDP | Percent of Total | ||
|---|---|---|---|---|
| Central government | 2,544.4 | 9.2 | 61.0 | |
| Corporate tax | 636.1 | 2.3 | 15.2 | |
| Income tax | 414.4 | 1.5 | 9.9 | |
| Excises | 907.6 | 3.3 | 21.8 | |
| Customs | 486.3 | 1.8 | 11.7 | |
| Other 1/ | 100.0 | 0.4 | 2.4 | |
| States and union territories 2/ | 1,626.7 | 5.9 | 39.0 | |
| Taxes on income | 25.7 | 0.1 | 0.6 | |
| Taxes on property and capital transactions | 177.5 | 0.6 | 4.3 | |
| Taxes on commodities and services | 1,423.4 | 5.1 | 34.1 | |
| Total | 4,171.0 | 15.0 | 100.0 | |
Mostly service tax.
Staff estimates based on projected GDP growth and historical elasticities.
Non-OECD Countries General Government: Tax Revenue, 2001
(In percent of total)
Non-OECD Countries General Government: Tax Revenue, 2001
(In percent of total)
| Taxes on Payroll or Workforce | Taxes on Social Security Contributions | Taxes on International Trade and Transactions | Indirect Taxes on Domestic Goods and Services | Taxes on Property | Direct Taxes on Corporates | Direct Taxes on Individuals | Total | |
|---|---|---|---|---|---|---|---|---|
| Albania | … | … | … | … | … | … | … | … |
| Argentina | … | 15.1 | 2.8 | 23.8 | 11.2 | 8.3 | 15.2 | 100.0 |
| Azerbaijan | … | … | … | … | … | … | … | … |
| Belarus | 2.2 | 26.3 | 4.2 | 44.1 | 3.3 | 6.6 | … | 100.0 |
| Bolivia | … | 10.4 | 5.0 | 58.0 | 9.6 | 6.9 | … | 100.0 |
| Brazil | … | … | … | … | … | … | … | … |
| Bulgaria | … | 27.1 | 2.3 | 42.3 | 1.2 | 8.6 | 12.5 | 100.0 |
| Chile | … | 7.3 | 6.0 | 55.8 | 3.7 | … | … | 100.0 |
| Croatia | … | 32.3 | 6.3 | 45.0 | 1.3 | 3.0 | 10.4 | 100.0 |
| Estonia | … | 33.8 | 0.1 | 39.4 | 1.4 | 2.4 | 22.9 | 100.0 |
| India | … | … | 12.8 | 60.3 | 4.2 | 11.6 | 11.1 | 100.0 |
| Israel | 2.8 | 16.9 | 0.7 | 33.4 | … | 10.2 | 32.5 | 100.0 |
| Kazakhstan | … | … | … | … | … | … | … | … |
| Kyrgyz Republic | … | … | … | … | … | … | … | … |
| Latvia | … | 31.2 | 1.1 | 37.4 | 3.3 | 7.0 | 20.1 | 100.0 |
| Lithuania | 0.1 | 27.2 | 1.0 | 41.5 | 2.1 | 1.9 | 26.1 | 100.0 |
| Moldova | … | 27.5 | 4.9 | 48.8 | 4.1 | 2.5 | 7.2 | 100.0 |
| Mongolia | … | 18.3 | 8.1 | 49.4 | 0.5 | 8.3 | 6.2 | 100.0 |
| Peru | 0.1 | 9.2 | 10.2 | 58.3 | … | 13.2 | 11.3 | 100.0 |
| Romania | … | 39.6 | 2.9 | 35.8 | 1.8 | 6.9 | 11.8 | 100.0 |
| Russia | … | 21.3 | 11.4 | 35.2 | 3.8 | 7.4 | 8.8 | 100.0 |
| Slovenia | 4.6 | 34.8 | 1.6 | 37.3 | 1.8 | 3.8 | 10.4 | 100.0 |
| South Africa | 1.0 | 1.8 | 2.9 | 33.5 | 5.1 | … | … | 100.0 |
| Thailand | … | 3.3 | 11.3 | 52.6 | 1.6 | 17.0 | 11.8 | 100.0 |
| Unweighted average | 2.4 | 23.3 | 4.2 | 41.7 | 2.9 | 6.6 | 14.5 | 100.0 |
Non-OECD Countries General Government: Tax Revenue, 2001
(In percent of total)
| Taxes on Payroll or Workforce | Taxes on Social Security Contributions | Taxes on International Trade and Transactions | Indirect Taxes on Domestic Goods and Services | Taxes on Property | Direct Taxes on Corporates | Direct Taxes on Individuals | Total | |
|---|---|---|---|---|---|---|---|---|
| Albania | … | … | … | … | … | … | … | … |
| Argentina | … | 15.1 | 2.8 | 23.8 | 11.2 | 8.3 | 15.2 | 100.0 |
| Azerbaijan | … | … | … | … | … | … | … | … |
| Belarus | 2.2 | 26.3 | 4.2 | 44.1 | 3.3 | 6.6 | … | 100.0 |
| Bolivia | … | 10.4 | 5.0 | 58.0 | 9.6 | 6.9 | … | 100.0 |
| Brazil | … | … | … | … | … | … | … | … |
| Bulgaria | … | 27.1 | 2.3 | 42.3 | 1.2 | 8.6 | 12.5 | 100.0 |
| Chile | … | 7.3 | 6.0 | 55.8 | 3.7 | … | … | 100.0 |
| Croatia | … | 32.3 | 6.3 | 45.0 | 1.3 | 3.0 | 10.4 | 100.0 |
| Estonia | … | 33.8 | 0.1 | 39.4 | 1.4 | 2.4 | 22.9 | 100.0 |
| India | … | … | 12.8 | 60.3 | 4.2 | 11.6 | 11.1 | 100.0 |
| Israel | 2.8 | 16.9 | 0.7 | 33.4 | … | 10.2 | 32.5 | 100.0 |
| Kazakhstan | … | … | … | … | … | … | … | … |
| Kyrgyz Republic | … | … | … | … | … | … | … | … |
| Latvia | … | 31.2 | 1.1 | 37.4 | 3.3 | 7.0 | 20.1 | 100.0 |
| Lithuania | 0.1 | 27.2 | 1.0 | 41.5 | 2.1 | 1.9 | 26.1 | 100.0 |
| Moldova | … | 27.5 | 4.9 | 48.8 | 4.1 | 2.5 | 7.2 | 100.0 |
| Mongolia | … | 18.3 | 8.1 | 49.4 | 0.5 | 8.3 | 6.2 | 100.0 |
| Peru | 0.1 | 9.2 | 10.2 | 58.3 | … | 13.2 | 11.3 | 100.0 |
| Romania | … | 39.6 | 2.9 | 35.8 | 1.8 | 6.9 | 11.8 | 100.0 |
| Russia | … | 21.3 | 11.4 | 35.2 | 3.8 | 7.4 | 8.8 | 100.0 |
| Slovenia | 4.6 | 34.8 | 1.6 | 37.3 | 1.8 | 3.8 | 10.4 | 100.0 |
| South Africa | 1.0 | 1.8 | 2.9 | 33.5 | 5.1 | … | … | 100.0 |
| Thailand | … | 3.3 | 11.3 | 52.6 | 1.6 | 17.0 | 11.8 | 100.0 |
| Unweighted average | 2.4 | 23.3 | 4.2 | 41.7 | 2.9 | 6.6 | 14.5 | 100.0 |
11. The tax system is characterized by extremely low AETRs. The AETR on labor, at 2 percent in 2001, is much lower than in the European Union, United States, or Japan, which range from 21–36 percent (Table IV.3). This reflects India’s narrow tax base and the lack of social security system.8 The AETR on capital income is also low, reflecting the wide coverage of tax incentives, low personal taxes on capital income, and a large informal sector.9 Korea in the mid 1970s had similar low AETRs, but they have since risen significantly (Figure IV.2). Finally, the AETR on consumption is broadly average despite a tax base that largely excludes services. As in Korea, it has declined over time.
India: Average Effective Tax Rates Comparison, 1990–2000
(In percent)
Combined effective tax rate on labor and consumption.
Average 1993–2000, based on data availability.
India: Average Effective Tax Rates Comparison, 1990–2000
(In percent)
| Average Effective Tax Rate | Total Tax Wedge on Labor 1/ | |||
|---|---|---|---|---|
| Labor | Capital | Consumption | ||
| India 2/ | 1.6 | 5.2 | 15.0 | 15.9 |
| Australia | 20.9 | 30.7 | 12.1 | 30.5 |
| Austria | 39.6 | 24.3 | 16.2 | 51.2 |
| Belgium | 41.3 | 32.7 | 15.0 | 51.7 |
| Canada | 29.6 | 36.8 | 13.9 | 39.4 |
| Czech Republic | 41.5 | 21.6 | 13.0 | 47.2 |
| Denmark | 39.9 | 39.5 | 20.6 | 56.0 |
| Finland | 45.0 | 26.0 | 18.7 | 58.0 |
| France | 40.5 | 33.2 | 15.1 | 51.3 |
| Germany | 35.0 | 21.2 | 13.4 | 44.9 |
| Greece | 34.9 | 12.9 | 15.5 | 46.5 |
| Hungary | … | 14.7 | 22.2 | … |
| Ireland | 26.3 | … | 21.2 | 41.9 |
| Italy | 37.7 | 31.0 | 13.9 | 47.9 |
| Japan | 24.1 | 27.9 | 6.4 | 29.4 |
| Korea | 9.9 | 16.7 | 15.8 | 24.2 |
| Netherlands | 36.4 | 32.7 | 18.0 | 47.9 |
| New Zealand | 25.1 | … | 18.5 | 38.9 |
| Norway | 36.2 | 24.7 | 25.7 | 52.5 |
| Poland | … | 20.9 | 17.1 | … |
| Portugal | 23.9 | 17.6 | 19.9 | 39.0 |
| Spain | 30.7 | 20.0 | 14.5 | 40.8 |
| Sweden | 49.6 | 35.7 | 19.8 | 59.6 |
| Switzerland | 30.9 | 27.1 | 9.3 | 37.3 |
| United Kingdom | 22.6 | 34.0 | 15.7 | 34.8 |
| United States | 23.4 | 27.3 | 6.4 | 28.3 |
| Unweighted average | 32.4 | 26.5 | 15.9 | 43.4 |
| EU15 average | 38.0 | 28.7 | 17.8 | 48.9 |
Combined effective tax rate on labor and consumption.
Average 1993–2000, based on data availability.
India: Average Effective Tax Rates Comparison, 1990–2000
(In percent)
| Average Effective Tax Rate | Total Tax Wedge on Labor 1/ | |||
|---|---|---|---|---|
| Labor | Capital | Consumption | ||
| India 2/ | 1.6 | 5.2 | 15.0 | 15.9 |
| Australia | 20.9 | 30.7 | 12.1 | 30.5 |
| Austria | 39.6 | 24.3 | 16.2 | 51.2 |
| Belgium | 41.3 | 32.7 | 15.0 | 51.7 |
| Canada | 29.6 | 36.8 | 13.9 | 39.4 |
| Czech Republic | 41.5 | 21.6 | 13.0 | 47.2 |
| Denmark | 39.9 | 39.5 | 20.6 | 56.0 |
| Finland | 45.0 | 26.0 | 18.7 | 58.0 |
| France | 40.5 | 33.2 | 15.1 | 51.3 |
| Germany | 35.0 | 21.2 | 13.4 | 44.9 |
| Greece | 34.9 | 12.9 | 15.5 | 46.5 |
| Hungary | … | 14.7 | 22.2 | … |
| Ireland | 26.3 | … | 21.2 | 41.9 |
| Italy | 37.7 | 31.0 | 13.9 | 47.9 |
| Japan | 24.1 | 27.9 | 6.4 | 29.4 |
| Korea | 9.9 | 16.7 | 15.8 | 24.2 |
| Netherlands | 36.4 | 32.7 | 18.0 | 47.9 |
| New Zealand | 25.1 | … | 18.5 | 38.9 |
| Norway | 36.2 | 24.7 | 25.7 | 52.5 |
| Poland | … | 20.9 | 17.1 | … |
| Portugal | 23.9 | 17.6 | 19.9 | 39.0 |
| Spain | 30.7 | 20.0 | 14.5 | 40.8 |
| Sweden | 49.6 | 35.7 | 19.8 | 59.6 |
| Switzerland | 30.9 | 27.1 | 9.3 | 37.3 |
| United Kingdom | 22.6 | 34.0 | 15.7 | 34.8 |
| United States | 23.4 | 27.3 | 6.4 | 28.3 |
| Unweighted average | 32.4 | 26.5 | 15.9 | 43.4 |
| EU15 average | 38.0 | 28.7 | 17.8 | 48.9 |
Combined effective tax rate on labor and consumption.
Average 1993–2000, based on data availability.
12. Reflecting the low AETRs, India’s tax productivity is also lowr elative to both OECD and non-OECDcountries.10 For example, CIT tax productivity is much below average (Table IV.4a) and (table IV.4b).11While this is unwelcome in a static sense, it is attractive if considered dynamically: by expanding the taxpayer net, broadening the tax base, or stepping up tax administration, revenue can be raised without rate increases. During the period 1993–2001, India increased AETRs on labor and capital despite reductions in statutory rates and a declining CIT tax base 12 This suggests that improved tax administration and compliance was the main factor underlying the improvement in tax productivity.
India: Revenue Productivity of the Corporate Tax, 2001
(In percent)
Ratio of effective CIT rate to statutory CIT rate.
As of 2000.
India: Revenue Productivity of the Corporate Tax, 2001
(In percent)
| Statutory CIT Rate | Effective CIT Rate | Revenue Productivity 1/ | |
|---|---|---|---|
| India | 35.9 | 3.5 | 9.7 |
| France | 33.3 | 8.9 | 26.8 |
| Germany | 38.9 | 2.1 | 5.3 |
| Italy | 37.0 | 6.7 | 18.2 |
| Japan | 40.9 | 8.7 | 21.2 |
| Korea | 29.7 | 9.6 | 32.4 |
| United Kingdom | 30.0 | 9.9 | 32.9 |
| United States 2/ | 45.8 | 5.3 | 11.6 |
| OECD average | 32.3 | 9.6 | 29.7 |
Ratio of effective CIT rate to statutory CIT rate.
As of 2000.
India: Revenue Productivity of the Corporate Tax, 2001
(In percent)
| Statutory CIT Rate | Effective CIT Rate | Revenue Productivity 1/ | |
|---|---|---|---|
| India | 35.9 | 3.5 | 9.7 |
| France | 33.3 | 8.9 | 26.8 |
| Germany | 38.9 | 2.1 | 5.3 |
| Italy | 37.0 | 6.7 | 18.2 |
| Japan | 40.9 | 8.7 | 21.2 |
| Korea | 29.7 | 9.6 | 32.4 |
| United Kingdom | 30.0 | 9.9 | 32.9 |
| United States 2/ | 45.8 | 5.3 | 11.6 |
| OECD average | 32.3 | 9.6 | 29.7 |
Ratio of effective CIT rate to statutory CIT rate.
As of 2000.
The Burden of Taxation on Investors
13. This section assesses to what extent the Indian income tax code affects incentives to invest. We calculate two standard indicators, the marginal effective tax wedge (METW) between the pre- and post-tax return on capital, and the marginal effective tax rate (METR), defined as the ratio of the METW to the real required pre-tax rate of return.13 By summarizing various tax effects, including the statutory CIT rate, depreciation allowances, inventory valuation method, and personal taxes, the METW measures the potential cost of taxation to investors, which in turn affects their decision to invest.14 Comparable estimates have been published for OECD countries.
India and Korea: AETRs on Labor, Capital, and Consumption
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Source: Staff estimates.India and Korea: AETRs on Labor, Capital, and Consumption
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Source: Staff estimates.India and Korea: AETRs on Labor, Capital, and Consumption
Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004
Source: Staff estimates.India: Revenue Productivity of the Corporate Tax, 2003
(In percent)
As of January 1, 2004.
Used as proxy for the effective CIT rate. For 2003, unless otherwise indicated.
Ratio of corporate tax/GDP to statutory CIT rate.
India: Revenue Productivity of the Corporate Tax, 2003
(In percent)
| Statutory CIT Rate 1/ | Corporate Taxes/GDP 2/ | Revenue Productivity 3/ | |
|---|---|---|---|
| India | 35.9 | 2.3 | 6.4 |
| Argentina | 35.0 | 2.7 | 7.7 |
| Bolivia | 25.0 | 1.8 | 7.2 |
| Chile (2001) | 17.0 | 4.6 | 27.2 |
| China | 33.0 | 2.5 | 7.5 |
| Colombia | 35.0 | 4.7 | 13.4 |
| Hungary | 16.0 | 8.0 | 49.8 |
| Indonesia | 30.0 | 1.7 | 5.5 |
| Mexico (2000) | 33.0 | 5.0 | 15.3 |
| Pakistan | 35.0 | 3.6 | 10.2 |
| Peru | 30.0 | 3.4 | 11.4 |
| Philippines | 32.0 | 2.6 | 8.2 |
| Poland | 19.0 | 4.9 | 25.6 |
| Russia | 24.0 | 4.0 | 16.6 |
| Singapore (2001) | 22.0 | 8.0 | 36.5 |
| South Africa | 37.8 | 5.5 | 14.4 |
| Thailand | 30.0 | 3.0 | 10.0 |
| Turkey | 33.0 | 2.5 | 7.6 |
| Ukraine | 25.0 | 5.0 | 20.0 |
| Uruguay | 35.0 | 2.6 | 7.4 |
| Venezuela | 34.0 | 14.7 | 43.1 |
| All: Mean | 29.0 | 4.5 | 17.2 |
As of January 1, 2004.
Used as proxy for the effective CIT rate. For 2003, unless otherwise indicated.
Ratio of corporate tax/GDP to statutory CIT rate.
India: Revenue Productivity of the Corporate Tax, 2003
(In percent)
| Statutory CIT Rate 1/ | Corporate Taxes/GDP 2/ | Revenue Productivity 3/ | |
|---|---|---|---|
| India | 35.9 | 2.3 | 6.4 |
| Argentina | 35.0 | 2.7 | 7.7 |
| Bolivia | 25.0 | 1.8 | 7.2 |
| Chile (2001) | 17.0 | 4.6 | 27.2 |
| China | 33.0 | 2.5 | 7.5 |
| Colombia | 35.0 | 4.7 | 13.4 |
| Hungary | 16.0 | 8.0 | 49.8 |
| Indonesia | 30.0 | 1.7 | 5.5 |
| Mexico (2000) | 33.0 | 5.0 | 15.3 |
| Pakistan | 35.0 | 3.6 | 10.2 |
| Peru | 30.0 | 3.4 | 11.4 |
| Philippines | 32.0 | 2.6 | 8.2 |
| Poland | 19.0 | 4.9 | 25.6 |
| Russia | 24.0 | 4.0 | 16.6 |
| Singapore (2001) | 22.0 | 8.0 | 36.5 |
| South Africa | 37.8 | 5.5 | 14.4 |
| Thailand | 30.0 | 3.0 | 10.0 |
| Turkey | 33.0 | 2.5 | 7.6 |
| Ukraine | 25.0 | 5.0 | 20.0 |
| Uruguay | 35.0 | 2.6 | 7.4 |
| Venezuela | 34.0 | 14.7 | 43.1 |
| All: Mean | 29.0 | 4.5 | 17.2 |
As of January 1, 2004.
Used as proxy for the effective CIT rate. For 2003, unless otherwise indicated.
Ratio of corporate tax/GDP to statutory CIT rate.
14. The total tax wedge on capital income in India is broadly average, but tax-induced distortions tend to be high. Firms that rely on internal financing are particularly penalized (Table VI.5a, IV.5b, and IV.6):
The tax wedge on capital (1.4 percent) is slightly lower than the OECD average. This reflects low personal taxes and the indexation option available for long-term capital gains.
The standard deviation of the tax wedge across investment assets is three times higher than the OECD average. Inventory investment is treated more harshly than investments in machinery and buildings, so that firms that need to carry more inventories are penalized, more so than in other countries.15
The standard deviation of the tax wedge across financing sources is twice as high as the OECD average. The large negative tax wedge enjoyed by debt financing means that the government is effectively subsidizing marginal debt-financed investments, more so than in other countries. Investments financed by new equity face a below average tax wedge, thanks to low dividend taxation. However, investments financed by retained earnings face a tax wedge of nearly 3 percent (compared to the OECD average of 2 percent). Smaller firms that face problems in borrowing and tend to be more dependent on internal sources of funds are thus disadvantaged compared to larger firms (Rao and Lukose, 2002; Joseph et al., 1998). The relatively large tax advantage of debt finance may also have contributed to relatively high financial leverage in India, exacerbating firms’ vulnerability.15
India: Marginal Effective Tax Wedge by Investment Type 1/
(In percent)
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor can earn a 4 percent real rate of return on a demand deposit. The estimates shown refer to 2004 for India, 1999 for other countries.
The standard deviation across investment vehicles provides an indicator of the neutrality of the tax system towards corporate investment decisions. The lower the standard deviation, the more neutral the tax system.
India: Marginal Effective Tax Wedge by Investment Type 1/
(In percent)
| Standard | Weighted | Investment Type | |||
|---|---|---|---|---|---|
| Deviation 2/ | Average | Machinery | Building | Inventories | |
| India | 1.5 | 1.4 | 0.7 | 0.5 | 3.2 |
| Canada | 1.0 | 3.6 | 2.7 | 4.1 | 5.1 |
| Germany | 0.4 | 1.2 | 0.9 | 1.4 | 1.9 |
| Japan | 1.0 | 2.0 | 1.0 | 3.1 | 2.8 |
| United Kingdom | 0.5 | 2.2 | 1.9 | 2.2 | 3.1 |
| United States | 0.4 | 1.9 | 1.5 | 2.5 | 2.0 |
| OECD average | 0.4 | 1.6 | 1.2 | 1.7 | 2.3 |
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor can earn a 4 percent real rate of return on a demand deposit. The estimates shown refer to 2004 for India, 1999 for other countries.
The standard deviation across investment vehicles provides an indicator of the neutrality of the tax system towards corporate investment decisions. The lower the standard deviation, the more neutral the tax system.
India: Marginal Effective Tax Wedge by Investment Type 1/
(In percent)
| Standard | Weighted | Investment Type | |||
|---|---|---|---|---|---|
| Deviation 2/ | Average | Machinery | Building | Inventories | |
| India | 1.5 | 1.4 | 0.7 | 0.5 | 3.2 |
| Canada | 1.0 | 3.6 | 2.7 | 4.1 | 5.1 |
| Germany | 0.4 | 1.2 | 0.9 | 1.4 | 1.9 |
| Japan | 1.0 | 2.0 | 1.0 | 3.1 | 2.8 |
| United Kingdom | 0.5 | 2.2 | 1.9 | 2.2 | 3.1 |
| United States | 0.4 | 1.9 | 1.5 | 2.5 | 2.0 |
| OECD average | 0.4 | 1.6 | 1.2 | 1.7 | 2.3 |
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor can earn a 4 percent real rate of return on a demand deposit. The estimates shown refer to 2004 for India, 1999 for other countries.
The standard deviation across investment vehicles provides an indicator of the neutrality of the tax system towards corporate investment decisions. The lower the standard deviation, the more neutral the tax system.
India: Marginal Effective Tax Wedge by Financing Source 1/
(In percent)
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor an earn a 4 percent real rate of return on a demand deposit. The representative investor is supposed to be a resident person, taxed at the top marginal income tax rate (see OECD, 1991). The estimates shown refer to 2004 for India, to 1999 for other countries.
The standard deviation across financing instruments provides an indicator of the neutrality of the tax system towards corporate financing decisions. The lower the standard deviation, the more neutral the tax system.
Weighted average across available countries (weights based on 1995 GDPs and PPPs).
India: Marginal Effective Tax Wedge by Financing Source 1/
(In percent)
| Sources of Financing | ||||
|---|---|---|---|---|
| Standard Deviation 2/ | Retained earnings | New equity | Debt | |
| India | 2.0 | 2.9 | 2.8 | -0.6 |
| France | 2.9 | 3.6 | 7.7 | 0.7 |
| Germany | 0.7 | 0.9 | 2.5 | 1.3 |
| Italy | 0.4 | 1.3 | 1.3 | 0.4 |
| Japan | 2.3 | 3.3 | 5.5 | -0.1 |
| Korea | 0.5 | 0.6 | 1.6 | 1.6 |
| United Kingdom | 0.5 | 2.9 | 2.4 | 1.6 |
| United States | 1.5 | 1.7 | 4.8 | 1.4 |
| OECD average 3/ | 0.9 | 2.0 | 3.2 | 1.0 |
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor an earn a 4 percent real rate of return on a demand deposit. The representative investor is supposed to be a resident person, taxed at the top marginal income tax rate (see OECD, 1991). The estimates shown refer to 2004 for India, to 1999 for other countries.
The standard deviation across financing instruments provides an indicator of the neutrality of the tax system towards corporate financing decisions. The lower the standard deviation, the more neutral the tax system.
Weighted average across available countries (weights based on 1995 GDPs and PPPs).
India: Marginal Effective Tax Wedge by Financing Source 1/
(In percent)
| Sources of Financing | ||||
|---|---|---|---|---|
| Standard Deviation 2/ | Retained earnings | New equity | Debt | |
| India | 2.0 | 2.9 | 2.8 | -0.6 |
| France | 2.9 | 3.6 | 7.7 | 0.7 |
| Germany | 0.7 | 0.9 | 2.5 | 1.3 |
| Italy | 0.4 | 1.3 | 1.3 | 0.4 |
| Japan | 2.3 | 3.3 | 5.5 | -0.1 |
| Korea | 0.5 | 0.6 | 1.6 | 1.6 |
| United Kingdom | 0.5 | 2.9 | 2.4 | 1.6 |
| United States | 1.5 | 1.7 | 4.8 | 1.4 |
| OECD average 3/ | 0.9 | 2.0 | 3.2 | 1.0 |
These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor an earn a 4 percent real rate of return on a demand deposit. The representative investor is supposed to be a resident person, taxed at the top marginal income tax rate (see OECD, 1991). The estimates shown refer to 2004 for India, to 1999 for other countries.
The standard deviation across financing instruments provides an indicator of the neutrality of the tax system towards corporate financing decisions. The lower the standard deviation, the more neutral the tax system.
Weighted average across available countries (weights based on 1995 GDPs and PPPs).
India: Statutory and Effective Tax Rates on Corporations
(In percent)
As of January 1, 2004.
Based on investment in plant and machinery, financed by equity or retained earnings (but not debt). Taxation at the shareholder level is not included (hence no distinction between new equity and retained earnings). Other assumptions: real post-tax required rate of return fixed at 10 percent. The estimate is for the current tax system for India, the 1999 tax system for all other countries.
India: Statutory and Effective Tax Rates on Corporations
(In percent)
| Statutory Corporate Tax Rate, 2004 1/ | Statutory Corporate Tax Rate, 1999 | Marginal Effective Tax Rate 2/ | |
|---|---|---|---|
| India | 35.9 | … | 26.1 |
| Australia | 30.0 | … | … |
| Austria | 34.0 | 34.0 | 17.4 |
| Belgium | 34.0 | 40.2 | 25.6 |
| Canada | 36.1 | 34.6 | 24.0 |
| Czech Republic | 28.0 | … | … |
| Denmark | 30.0 | … | … |
| Finland | 29.0 | 29.0 | 19.5 |
| France | 34.3 | 36.4 | 29.9 |
| Germany | 38.3 | 38.3 | 28.3 |
| Greece | 35.0 | 37.5 | 27.7 |
| Hungary | 18.0 | … | … |
| Ireland | 12.5 | 10.0 | 6.6 |
| Italy | 37.3 | 40.3 | 9.2 |
| Japan | 42.0 | 40.9 | 31.8 |
| Korea | 29.7 | … | … |
| Luxembourg | 30.4 | … | … |
| Netherlands | 34.5 | 35.0 | 24.3 |
| New Zealand | 33.0 | … | … |
| Norway | 28.0 | … | … |
| Poland | 19.0 | … | … |
| Portugal | 27.5 | 35.2 | 20.3 |
| Spain | 35.0 | 35.0 | 29.5 |
| Sweden | 28.0 | 28.0 | 16.1 |
| Switzerland | 24.1 | … | … |
| United Kingdom | 30.0 | 30.0 | 20.3 |
| United States | 40.0 | 39.3 | 23.8 |
| Unweighted average | 30.3 | 33.6 | 22.0 |
| EU15 average | 32.2 | 34.4 | 22.3 |
As of January 1, 2004.
Based on investment in plant and machinery, financed by equity or retained earnings (but not debt). Taxation at the shareholder level is not included (hence no distinction between new equity and retained earnings). Other assumptions: real post-tax required rate of return fixed at 10 percent. The estimate is for the current tax system for India, the 1999 tax system for all other countries.
India: Statutory and Effective Tax Rates on Corporations
(In percent)
| Statutory Corporate Tax Rate, 2004 1/ | Statutory Corporate Tax Rate, 1999 | Marginal Effective Tax Rate 2/ | |
|---|---|---|---|
| India | 35.9 | … | 26.1 |
| Australia | 30.0 | … | … |
| Austria | 34.0 | 34.0 | 17.4 |
| Belgium | 34.0 | 40.2 | 25.6 |
| Canada | 36.1 | 34.6 | 24.0 |
| Czech Republic | 28.0 | … | … |
| Denmark | 30.0 | … | … |
| Finland | 29.0 | 29.0 | 19.5 |
| France | 34.3 | 36.4 | 29.9 |
| Germany | 38.3 | 38.3 | 28.3 |
| Greece | 35.0 | 37.5 | 27.7 |
| Hungary | 18.0 | … | … |
| Ireland | 12.5 | 10.0 | 6.6 |
| Italy | 37.3 | 40.3 | 9.2 |
| Japan | 42.0 | 40.9 | 31.8 |
| Korea | 29.7 | … | … |
| Luxembourg | 30.4 | … | … |
| Netherlands | 34.5 | 35.0 | 24.3 |
| New Zealand | 33.0 | … | … |
| Norway | 28.0 | … | … |
| Poland | 19.0 | … | … |
| Portugal | 27.5 | 35.2 | 20.3 |
| Spain | 35.0 | 35.0 | 29.5 |
| Sweden | 28.0 | 28.0 | 16.1 |
| Switzerland | 24.1 | … | … |
| United Kingdom | 30.0 | 30.0 | 20.3 |
| United States | 40.0 | 39.3 | 23.8 |
| Unweighted average | 30.3 | 33.6 | 22.0 |
| EU15 average | 32.2 | 34.4 | 22.3 |
As of January 1, 2004.
Based on investment in plant and machinery, financed by equity or retained earnings (but not debt). Taxation at the shareholder level is not included (hence no distinction between new equity and retained earnings). Other assumptions: real post-tax required rate of return fixed at 10 percent. The estimate is for the current tax system for India, the 1999 tax system for all other countries.
15. A related result is that corporates that rely mainly on internal financing face a high marginal tax rate. The METR for investments financed by retained earnings is 26 percent, compared to the OECD average of 22 percent, reflecting a relatively high CIT rate.17
C. Priorities for Reforms
16. The facts highlighted above suggest that a tax reform combining lower statutory rates with base broadening is likely to enhance growth prospects in India. AETR and tax productivity estimates suggest ample scope for raising revenue through base-broadening and improved tax administration. These measures in turn would create room for lowering statutory rates, reducing the METR and raising investment. These broad directions for tax reform were highlighted in the FRBMA roadmap (Ministry of Finance, 2004).
An Assessment of the FRBMA Roadmap Tax Proposals
17. The roadmap proposes the introduction of a national VAT on goods and services and a number of changes to corporate and personal income taxation: reduction of the statutory CIT rate to 30 percent and elimination of the surcharge; reduction of the general depreciation rate to 15 percent; elimination of the withholding tax on distribution of dividends; and elimination of the long term capital gains tax. The reforms also envisage lifting most exemptions and incentives to expand the tax base and increased reliance on IT to improve tax administration and compliance.
18. The proposals implemented as a package would imply a significant increase in tax productivity. For example, the corporate tax to GDP ratio is projected to nearly double from 2.3 percent of GDP in 2003/04 to 4.2 percent of GDP by 2008/09, despite a lower CIT rate (Ministry of Finance, 2004). CIT tax productivity would more than double to 14 percent by 2008/09 (nearing the non-OECD average). The proposed extension of the CENVAT to services should also help enhance its revenue productivity.
19. The reforms would also decrease the METW on capital income and reduce tax-induced distortions. The METW would be nearly halved thanks to lower personal taxes (Table IV.7). Neutrality with respect to sources of financing would improve, but firms that rely on internal finance would remain relatively penalized.18 Neutrality with respect to investment patterns would improve by a third, thanks to the lower depreciation rate, but remain more than double the OECD average, suggesting scope for further improvements. Replacement of the sales taxes and excise duties by a national VAT should also help reduce distortions, with favorable effects on investment and exports (Ministry of Finance, 2004).
20. To mitigate potentially excessive reliance on debt finance and help further improve the neutrality of the tax system, additional tax measures can be considered. These include (IMF, 2004): limiting the deductibility of interest to a percentage of net taxable income; limiting debt for the purposes of income tax (e.g., debt-to-equity ratios in Canada are limited to 2, in Germany to 1.5, and in Japan to 3); limiting interest to a referential rate (e.g., in Portugal, the 12-month Euribor plus 1.5 percent); or introducing an allowance for corporate equity.19
India: Tax Wedges Under Current Tax System Versus Reformed Tax System
(In percent)
The standard deviation measures the neutrality of the tax system with respect to corporate financing and investment decisions. The lower the standard deviation, the more neutral the tax system.
Corresponding marginal effective tax rates are reported in italics.
India: Tax Wedges Under Current Tax System Versus Reformed Tax System
(In percent)
| Mode of Financing | |||||||
|---|---|---|---|---|---|---|---|
| Type of Investment | Retained earnings | New equity | Debt | Weighted average | Standard Deviation 1/ | ||
| Tax System, 2003/04 2/ | |||||||
| Machinery | 2.2 | 2.1 | -1.1 | 0.7 | 1.9 | ||
| 41.2 | 40.0 | -56.8 | 18.5 | ||||
| Buildings | 2.1 | 1.9 | -1.4 | 0.5 | 2.0 | ||
| 39.8 | 38.5 | -82.1 | 14.2 | ||||
| Inventories | 5.0 | 4.9 | 0.9 | 3.2 | 2.3 | ||
| 61.8 | 61.2 | 22.3 | 50.6 | ||||
| Weighted average | 2.9 | 2.8 | -0.6 | 1.4 | 2.0 | ||
| 48.6 | 47.6 | -25.0 | 30.3 | ||||
| Standard deviation 1/ | 1.7 | 1.7 | 1.3 | 1.5 | |||
| Tax System, FRBM Roadmap 2/ | |||||||
| Machinery | 2.1 | 1.8 | -0.2 | 1.0 | 1.3 | ||
| 39.7 | 36.1 | -8.0 | 24.4 | ||||
| Buildings | 1.2 | 0.9 | -1.0 | 0.2 | 1.2 | ||
| 27.6 | 22.5 | -47.5 | 5.6 | ||||
| Inventories | 3.4 | 3.1 | 0.8 | 2.2 | 1.4 | ||
| 52.0 | 49.4 | 21.2 | 41.6 | ||||
| Weighted Average | 2.3 | 2.0 | -0.1 | 1.2 | 1.3 | ||
| 41.9 | 38.4 | -3.0 | 27.4 | ||||
| Standard deviation 1/ | 1.1 | 1.1 | 0.9 | 1.0 | |||
The standard deviation measures the neutrality of the tax system with respect to corporate financing and investment decisions. The lower the standard deviation, the more neutral the tax system.
Corresponding marginal effective tax rates are reported in italics.
India: Tax Wedges Under Current Tax System Versus Reformed Tax System
(In percent)
| Mode of Financing | |||||||
|---|---|---|---|---|---|---|---|
| Type of Investment | Retained earnings | New equity | Debt | Weighted average | Standard Deviation 1/ | ||
| Tax System, 2003/04 2/ | |||||||
| Machinery | 2.2 | 2.1 | -1.1 | 0.7 | 1.9 | ||
| 41.2 | 40.0 | -56.8 | 18.5 | ||||
| Buildings | 2.1 | 1.9 | -1.4 | 0.5 | 2.0 | ||
| 39.8 | 38.5 | -82.1 | 14.2 | ||||
| Inventories | 5.0 | 4.9 | 0.9 | 3.2 | 2.3 | ||
| 61.8 | 61.2 | 22.3 | 50.6 | ||||
| Weighted average | 2.9 | 2.8 | -0.6 | 1.4 | 2.0 | ||
| 48.6 | 47.6 | -25.0 | 30.3 | ||||
| Standard deviation 1/ | 1.7 | 1.7 | 1.3 | 1.5 | |||
| Tax System, FRBM Roadmap 2/ | |||||||
| Machinery | 2.1 | 1.8 | -0.2 | 1.0 | 1.3 | ||
| 39.7 | 36.1 | -8.0 | 24.4 | ||||
| Buildings | 1.2 | 0.9 | -1.0 | 0.2 | 1.2 | ||
| 27.6 | 22.5 | -47.5 | 5.6 | ||||
| Inventories | 3.4 | 3.1 | 0.8 | 2.2 | 1.4 | ||
| 52.0 | 49.4 | 21.2 | 41.6 | ||||
| Weighted Average | 2.3 | 2.0 | -0.1 | 1.2 | 1.3 | ||
| 41.9 | 38.4 | -3.0 | 27.4 | ||||
| Standard deviation 1/ | 1.1 | 1.1 | 0.9 | 1.0 | |||
The standard deviation measures the neutrality of the tax system with respect to corporate financing and investment decisions. The lower the standard deviation, the more neutral the tax system.
Corresponding marginal effective tax rates are reported in italics.
Annex I.
India: Main Features of the Tax System (June 2004) 1/
Taxes are administered and levied by the Central government, unless otherwise specified.
India: Main Features of the Tax System (June 2004) 1/
| Tax | Nature of Tax | Exemptions and Deductions | Rates |
|---|---|---|---|
| 1. Direct Taxes | |||
| 1.1. Taxes on Income and Profits: 1.1.1. Business income 1.1.1.1. Corporate income tax (CIT): | Companies are taxed based on the residing principle. CIT applies to net profits determined after business expenses and depreciation allowances. Inventories are generally valued at the lower of cost or market price. Normally, there is conformity between tax and book reporting. FIFO and average cost are acceptable, provided they are consistently applied. Short-term capital gains are taxed at the CIT rate. They arise on the sale of an asset within three years of its acquisition (one year in the case of shares). Other capital gains (called long-term gains) are determined after increasing the cost by prescribed inflation factors. Sort-term capital losses can be set off against any capital gains. Long-term capital losses can be set off only against long-term capital gains during the year. Gins and losses (computed under “Depreciation”) arising on the sale of depreciable assets are classified as short-term capital gains/losses. Stock dividends may be distributed and are not taxed at the time of receipt in the hands of the recipient equity shareholders. | CIT exemptions: (a) agricultural income (b) foreign companies and nonresident individuals under an agreement between the central government and a foreign government or an international organization; (c) business income arising from specified sources (see “Tax Incentives”); (d) undistributed foreign income of a nonresident subsidiary; (e) long-term capital gains on sales of shares in a government approved enterprise wholly engaged in specified infrastructure sectors, subject to fulfillment of prescribed conditions. Double taxation of foreign income is avoided through treaties that generally provide for deduction of the lower of foreign tax or Indian tax on the doubly taxed income from tax payable in India in the case of residents. Similar relief is allowed unilaterally where no treaty exists. Net operating losses may not be carried back. Loss carry forward is allowed as follows: Unabsorbed depreciationunlimited Other business and capital losses8 years | CIT (including surcharge of 2.5 percent): -firm 35 percent -domestic company35.875 percent -co-operative societies Rs. 0 – Rs. 10,00010.25 percent Rs. 10,000 Rs.20,00020.5 percent Rs. 20,000-above35.875 percent -foreign company 41 percent Tax on capital gains : -short-term CIT rate -long-term 20.5 percent |
| Depreciation: depreciable assets are grouped in blocks, and each block is eligible for depreciation at a prescribed rate on the opening written-down value plus acquisitions less deletions during the year (declining-balance depreciation). Power generating or distributing companies can opt for straight-line depreciation. | Deductions: Allowed under general rule: accountancy fees and costs, legal expenses, guarantee payments, and partially deductible expenditures (e.g., entertainment, travel, advertising, head office expenses). Allowed under specific rule: scientific research expenditure; payments for intellectual property; bad debts; exchange rate fluctuations; rents, rates, taxes, repairs and insurance for buildings; repairs and insurance of machinery, plant and furniture; bonus paid to employee; premiums for covering risks to stocks and stores of the business; interest; employer contributions to provident funds; medical insurance premiums; payments made to approved organizations for approved projects, rural development programs and conservation projects; promotion of family planning among employees; allowance in respect of an animal used for business purposes which has died or become useless; expenditure incurred in 1999/2000 in respect of a non-Y2K compliant computer system to make it compliant. All taxes relating to business (other than income and wealth tax) incurred during the fiscal year are deductible in that year, provided they are paid by the following October 30. Otherwise, they are deductible in the year of payment. Intercompany dividends can be deducted for domestic companies that receive dividends from other domestic companies, to the extent, such dividend is redistributed by the recipient domestic company on or before the due date of filing the return of income. | Depreciation rates: Buildings - residential 5 percent -non residential10 percent - hotels/units20 percent -temporary structures100 percent Furniture10–15 percent Machinery and plant -general25 percent - some sub-items20–100 percent Intangible assets25 percent Additional depreciation of 15 percent on new machinery and plant (other than ships and aircraft) acquired and installed after March 31, 2002, is allowed to a new industrial undertaking in the year of manufacture and to existing industrial undertakings which achieved an increase in installed capacity of 25 percent or more in that year (Finance Act 2002). | |
| 1.1.1.2 Minimum alternative tax (MAT) | Both resident and nonresident companies are liable to pay tax on their book profits where the tax liability of the year is less than 7.5 percent of the adjusted book profits | (a) sick companies (b) export profits of undertakings set up in free-trade zones and 100 percent export-oriented undertakings (during the tax holiday period) (c) nontaxable profits from the export of goods and software. | 7.688 percent (including 2.5 percent surcharge) |
| 1.1.2. Withholding taxes 1.1.2.1. Residents | Income earned from designated sources (including dividends, interest, royalty, rent, and capital gains) is subject to withholding tax at a variety of rates. The tax is withheld by the person making payments to the recipient of the income. | Residents (in percent): Interest domestic company 21 other residents 10.5 Income from: lottery, crossword puzzles 31.5 horse races 31.5 insurance commission 10.5 fees for selected services 5.25 mutual funds and UTI units 10.5 Lottery ticket sales commissions 10.5 Non insurance commissions 10.5 Dividends 10.5 Payment to contractors: 1–2 Rent 15.75–21 Any other income 21 | |
| 1.1.2.2. Nonresidents | Income earned from designated sources (including dividends, interest, royalty, and rent) is subject to withholding tax at a variety of rates. The tax is withheld by the person making payments to the recipient of the income. | Some tax treaties provide for lower withholding rates from certain types of income (dividends, interest, royalties, technical service fees). | Nonresident company: General rates (in percent): Royalties from an agreement concluded between 1961–197652.5 Technical service fees from an agreement concluded between 1954–197652.5 Other income 42 Specific rates (in percent): Dividends other than dividends from Indian companies 21 Interest on foreign currency loans 21 Long term capital gains 21 Income distribution from foreign currency units held in approved mutual funds or the UTI 10.5–21 Income distributions from bonds or Global Depository Receipts purchased in foreign currency 10.5 Income received by specified foreign financial institutions from listed securities: Short-term capital gains 31.5 Long-term capital gains 10.5 Other income 21 Royalties/technical service fees in respect of an approved agreement concluded between: 1976–1997 31.5 After 1997 21 |
| Other nonresidents: Interest 21 Long term capital gains 21 Income distributions arising from Global Depository Receipts 10.5 Rent 15.75 Any other income 31.5 | |||
| 1.1.3. Individuals 1.1.3.1. Individual income tax (IIT) | Residents are taxed on their worldwide income, except for those who are not ordinarily resident in India. Such a resident is taxed like a nonresident but is also liable to tax on income accruing abroad if it is from a business controlled or a profession set-up in India. Nonresidents are taxed only on income that is received in India or that accrues or is deemed to accrue in India. Employee gross income An individual’s entire remuneration (including benefits in kind valued as per the tax rules) received from an employer is taxable. Income tax is withheld from salaries. Capital gains and investment income: Short-term capital gains are aggregated with taxable income, which is taxed at the applicable rates. Long-term capital gains are determined after adjusting costs by prescribed inflation factors. Long-term capital losses can be set off only against long-term capital gains. Short-term capital losses can be set off against long-term as well as short-term capital gains. | Exemptions: Employee gross income: a. The tax paid by the employer on nonmonetary perquisites provided to the employee in the hands of the employee (Finance Act, 2002). b. Regarding employees stock option plans or schemes, if the plan/scheme is in accordance with government guidelines, the taxable event will occur only at the time of sale of shares. Any gains are taxed as capital gains at the time of exercise. c. leave passage within India, reimbursement of medical expenses and certain retirement benefits. d. foreign employees of a foreign enterprise who are not present in India for more than 90 days in a year for remuneration received from the foreign employer for services performed in India, provided the foreign enterprise is not engaged in any trade or business in India and provided the remuneration is not deductible in computing the employer’s taxable income in India. e. Specified income of a foreign citizen and a person who is not ordinarily resident, if he/she is engaged with the approval of the prescribed authority to render technical services under an agreement entered into by an international organization with the government of India and funded by the government of a foreign state. f. agricultural income Capital gains and investment income: Income from specified investments is exempt, up to certain limits. | Income brackets and IIT rates: Rs. 0-Rs. 50,000 Nil Rs. 50,000-Rs. 60,000 10 percent Rs. 60,000-Rs. 150,000 Rs. 1,000 plus 21% of income in excess of Rs. 60,000 Rs. 150,000-and above Rs. 19,000 plus 31.5% on income in excess of Rs. 150,000 The highest marginal rate for individuals with agricultural income however can differ. However, if an individual has agricultural income exceeding Rs. 5,000 in addition to total income, and total income excluding agricultural income exceeds the annual exemption, agricultural income is taken into account to determine the highest marginal rate. A 5% tax surcharge of the tax liability applies for residents whose taxable income exceeds Rs. 60,000. Tax on capital gains: - short-term IIT rate - long-term 21 percent |
| Deductions are allowed up to certain limits. | Deductions: a. Business-connected expenses, depending on salary drawn: less than Rs. 150,000 33.33 percent of the salary or Rs. 30,000, whichever is less Rs. 150,000-Rs. 300,000 Rs. 25,000 Rs. 300,000-Rs. 500,000 Rs. 20,000 Rs. 500,000-above Nil b. approved charitable contributions, medical insurance premiums, and to a limited extent, children’s’ education/hostel allowance received from the employer (up to certain limits). c. certain allowances in connection with a posting in specified hilly, border, remote, or tribal areas (up to certain limits). d. professional taxes imposed by certain states. | ||
| Tax rebates are allowed on specified investments from the gross tax up to a maximum of Rs. 20,000 (Rs. 15,000 if gross total income is between Rs. 150,000 and Rs. 500,000), out of which the rebate in excess of Rs. 14,000 (Rs. 10,500 if gross total income is between Rs. 150,000 and Rs. 500,000) must be out of investment in infrastructure. | Specified investments include: amounts paid for life insurance premiums, specified schemes, contributions to specified provident funds, long-term investments, amounts spent on construction/purchase of a residential house, or repayment of certain loans, and subscriptions to specified infrastructure bonds. | Tax rebate rates: Gross total income Rs. 150,000 or less 20 percent Rs. 100,000 or less in specified circumstances 30 percent Rs. 150,000–Rs. 500,000 15 percent | |
| 1.1.3.2. Local taxes on income | Professional taxes imposed by certain states are minimal and are deductible in computing taxable income. | ||
| 1.2. Tax incentives: 1.2.1. Inward investment | An initial period of tax holiday, followed by rebates at a decreasing percentage in later years, is allowed to Indian companies. The full tax exemption period, as well as the number of initial and later years varies from sector to sector. Export concessions are also granted to specified companies. | a. New industrial undertakings located in specific “backward” states and districts. Districts are classified in category A or B depending on level of infrastructure development. b. Hotels satisfying prescribed conditions. c. Undertakings engaged in developing and building a housing project, scientific research, commercial production, or refining of mineral oil or setting up and operating a cold chain for agricultural produce or engaged in the integrated business of handling, storage, and transportation of food or grains, subject to fulfillment of prescribed conditions. d. Undertakings engaged in building, owning, and operating a multiples theater or convention center satisfying prescribed conditions (extended under the Finance Act, 2002) e. Power generating or distributing companies, enterprises providing telecommunication services, or developing or operating and maintaining a notified infrastructure facility or an industrial park or special economic zone f. Export profits of new industrial undertaking satisfying prescribed conditions established in a free- trade zone, software technology park, or electronic hardware technology park, or 100 percent export-oriented undertaking g. Exports of new undertakings engaged in the manufacture or production of articles or computer softwares in any special economic zone. | Share of profits exempt from tax (in percent): a. for companies: Category A districts: First 5 years of operation 100 Next 5 years 30 Category B districts: First 3 years of operation 100 Next 5 years 30 b. Same as a. c. First 5–10 years 100 Following years 30/50/100 Later years 30 d. First 5 years 50 e. Any 10 consecutive years falling with in the first 15 years of operation (20 years in the case of infrastructure projects except ports, airports, inland waterways, and inland ports) 100 f. First 10 years 90 This exemption is only available until taxpayer’s financial year 2008-09 g. First 5 years 100 Following 2 years 50 |
| 1.2.2. Other tax incentives | Other exemptions and deductions are allowed to Indian companies and other residents. | Exemptions: a. Export of goods (other than mineral oils, specified minerals, and ores) and computer software (including technical services provided outside India for its development or production), where proceeds are received within a specified time in convertible foreign exchange or exports of film, television, music, television news, software or telecasting rights, subject to fulfillment of prescribed conditions. | Exemption rates (in percent): a. These concessions are only available until financial year 2003-04 in a phased-out manner: prior to FY2000-01 100 FY2000-01 80 FY2001-02 70 FY2002-03 50 FY2003-04 30 Following years Nil b. First 10 years 100 |
| b. Profits of new industrial undertakings set up in notified development centers located in the North- East region Deductions: c. Income received in convertible foreign exchange from foreign governments or foreign enterprises for the use outside India of any patent, design, or registered trademark. d. Profits derived from the construction of any building, dam, road, bridge, or other structure outside India, or the assembly or installation of machinery or plant outside India, if the proceeds are received in convertible foreign exchange within a specified time. In the case of approved hotels, profit from services to foreign tourists that are earned in convertible foreign exchange, subject to prescribed conditions. | Rates of deduction (in percent): c. FY2002-03 20 FY 2003-04 10 Following years Nil d. Same as c. | ||
| 1.3. Other taxes on capital and property | |||
| 1.3.1. Land tax | Imposed by the states on the value of land. The local authorities can impose a surcharge (“land cesses”). | Methods of valuation and rates vary from state to state. | |
| 1.3.2. Tax on land and buildings | Imposed by the local authorities based on the annual rental value. | ||
| 1.3.3. Betterment taxes | Imposed by local authorities based on increases in land values caused by town planning and town improvement. | ||
| 1.3.4. Taxes on the transfer of immovable property | Levied by local authorities based on the value of property. | ||
| 1.3.6. Tax on motor vehicles | Imposed by the states Based on the residing principle. | The first Rs. 1.5 million of net wealth is exempt. | 1% of the value of specified net assets exceeding in the aggregate Rs. 1.5 million. |
| 1.4. Wealth tax | |||
| 2. Indirect Taxes 2.1 Customs duty | Specific rate and/or ad valorem duties are imposed on exports and imports. Import duties: - basic customs duty, levied on items listed in the First Schedule of the Customs Tariff Act 1975. - additional duty of customs (“countervailing duty”), equivalent to the excise duty imposed on goods produced or manufactured in India. - other duties (anti-dumping, safeguard duty to restrain excessive imports that may affect local industries) Export duties: - custom duty, levied on items listed in the Second Schedule of the Customs Tariff Act 1975. | Exemptions: (a) Goods in transit or being transshipped via India (b) Warehousing facility (allows imported goods then used in the manufacture of export goods to be exempt for a specific period of time) (c) Export promotion schemes (allow for goods which will be used in a manufacturing activity to be imported free from customs duty, provided the manufactured product is exported). | Basic customs duty : varying rates for different goods Additional duty of customs: same as corresponding excise duty rate The customs value is the transaction value. |
| 2.2. Excise tax | Levied on goods produced or manufactured in India as: - a basic excise duty known as the central value added tax (CENVAT); and - a special excise duty, in addition to CENVAT, on specified goods. The tax is administered by the central government, via the Central Board of Excise and Customs. The duty must be paid by the manufacturer at the time of removal of goods from his factory premises or warehouse, the taxable base being the wholesale price of the goods manufactured. CENVAT credit: A modified value added tax (MOD VAT) was introduced in 1986 to prevent cascading of excise duty and double taxation. Under this scheme, a manufacturer of excisable goods receives a credit for the duty paid on specified inputs and capital goods under conditions specified in CENVAT Credit Rules 2002. Credit is also available for additional customs duty (countervailing duty) paid on imported capital goods and inputs. | Exemptions: (a) Small scale industries up to the specified value of goods cleared. (b) Goods produced or manufactured in Special Economic Zones. No credit of excise tax is available on inputs if the related final products are exempt unless they are exported. | Basic excise duty (items listed in the First Schedule of the Central Excise Tariff Act 1986): General 16 percent Specified items “Nil” or 8 percent Special excise duty (levied on items listed in the Second Schedule of the Central Excise Tariff Act 1986): General 8 percent Separate rates are applicable for petrol, diesel, and tobacco products. Cess (surcharge): varying rates |
| 2.2. Sales tax | All states impose sales tax on virtually all sales of goods. Each state has its own sales tax act. State sales taxes are generally single-point taxes. In most states, the tax is imposed on the first point of sales. In certain states, the tax is levied at the point of last sale of goods. In certain other states, the tax is a multi-stage tax. The central government imposes a central sales tax (CST) on interstate sales, which is levied in the state in which the movement of goods commences (CST Act, 1956). The revenue is administered by the state in which it is levied. Every dealer liable to pay tax under the CST Act must be registered. The CST payable is determined by applying the appropriate tax rate to the dealer’s turnover. | State sales tax: (a) export sales (b) goods specified under the local Act of the state CST exemptions: (a) goods unconditionally exempt from tax under the local Act of the state. (b) any subsequent sale (after a taxable interstate sale) of the same goods during the movement in interstate trade. (c) consignment/branch transfers. (d) sales of immovable property, newspapers, shares, stock, securities, and actionable claims. (e) sales of goods from domestic tariff area to units located in special economic zones. | CST rates: (a) Sale to the government: the lower of 4% or the prevailing state sales tax (b) Sale to registered dealers of goods included in the registration certificate: the lower of 4 percent or the prevailing state sales tax rate (c) Sale of declared goods to unregistered dealers: double the rate of state sales tax applicable to similar goods (d) Sale of goods, other than declared goods to unregistered dealers: the higher of 10 percent or the prevailing state sales tax. |
| 2.3. Service tax | Service tax is levied on certain types of services rendered (year when the tax became applicable in brackets): (a) brokerage fees (1994) (b) insurance premiums (1994, 2001 for life insurance) (c) telecommunications (1994) (d) advertising, pagers, and couriers (1996) (e) customs house agents (1996) (f) air travel agents (1997) (g) real estate agents (1998) (h) engineering consulting (1997) (i) management consultants (1998) (j) banking and other financial services (2001) (k) broadcasting (2001) (1) ports (2001) (1) ports (2001) (m) beauty, health and fitness (2002) (n) dry-cleaning (2002) (o) storage and warehousing (2002) and so forth. | Indian states of Jammu and Kashmir are exempt. Other exemptions: (a) services paid for in convertible foreign exchange (b) broadcasting services provided by cable TV operators (c) consulting engineer services in respect of computer software (d) video tape production (e) life insurance services other than premiums (f) specified insurance schemes (g) specified accounting and auditing services (h) various services rendered to diplomatic missions, the UN, international organizations. The Service Tax Credit Rules 2002 allow the utilization of credits within the same category of services. | A uniform 8 percent. |
| 2.4. Expenditure tax | Levied on hotel accommodation on payments made to the hotel in respect of food, drinks, or any other services. | Expenditure of less than Rs. 3,000 is exempt. | 10 percent of chargeable expenditure. |
Taxes are administered and levied by the Central government, unless otherwise specified.
India: Main Features of the Tax System (June 2004) 1/
| Tax | Nature of Tax | Exemptions and Deductions | Rates |
|---|---|---|---|
| 1. Direct Taxes | |||
| 1.1. Taxes on Income and Profits: 1.1.1. Business income 1.1.1.1. Corporate income tax (CIT): | Companies are taxed based on the residing principle. CIT applies to net profits determined after business expenses and depreciation allowances. Inventories are generally valued at the lower of cost or market price. Normally, there is conformity between tax and book reporting. FIFO and average cost are acceptable, provided they are consistently applied. Short-term capital gains are taxed at the CIT rate. They arise on the sale of an asset within three years of its acquisition (one year in the case of shares). Other capital gains (called long-term gains) are determined after increasing the cost by prescribed inflation factors. Sort-term capital losses can be set off against any capital gains. Long-term capital losses can be set off only against long-term capital gains during the year. Gins and losses (computed under “Depreciation”) arising on the sale of depreciable assets are classified as short-term capital gains/losses. Stock dividends may be distributed and are not taxed at the time of receipt in the hands of the recipient equity shareholders. | CIT exemptions: (a) agricultural income (b) foreign companies and nonresident individuals under an agreement between the central government and a foreign government or an international organization; (c) business income arising from specified sources (see “Tax Incentives”); (d) undistributed foreign income of a nonresident subsidiary; (e) long-term capital gains on sales of shares in a government approved enterprise wholly engaged in specified infrastructure sectors, subject to fulfillment of prescribed conditions. Double taxation of foreign income is avoided through treaties that generally provide for deduction of the lower of foreign tax or Indian tax on the doubly taxed income from tax payable in India in the case of residents. Similar relief is allowed unilaterally where no treaty exists. Net operating losses may not be carried back. Loss carry forward is allowed as follows: Unabsorbed depreciationunlimited Other business and capital losses8 years | CIT (including surcharge of 2.5 percent): -firm 35 percent -domestic company35.875 percent -co-operative societies Rs. 0 – Rs. 10,00010.25 percent Rs. 10,000 Rs.20,00020.5 percent Rs. 20,000-above35.875 percent -foreign company 41 percent Tax on capital gains : -short-term CIT rate -long-term 20.5 percent |
| Depreciation: depreciable assets are grouped in blocks, and each block is eligible for depreciation at a prescribed rate on the opening written-down value plus acquisitions less deletions during the year (declining-balance depreciation). Power generating or distributing companies can opt for straight-line depreciation. | Deductions: Allowed under general rule: accountancy fees and costs, legal expenses, guarantee payments, and partially deductible expenditures (e.g., entertainment, travel, advertising, head office expenses). Allowed under specific rule: scientific research expenditure; payments for intellectual property; bad debts; exchange rate fluctuations; rents, rates, taxes, repairs and insurance for buildings; repairs and insurance of machinery, plant and furniture; bonus paid to employee; premiums for covering risks to stocks and stores of the business; interest; employer contributions to provident funds; medical insurance premiums; payments made to approved organizations for approved projects, rural development programs and conservation projects; promotion of family planning among employees; allowance in respect of an animal used for business purposes which has died or become useless; expenditure incurred in 1999/2000 in respect of a non-Y2K compliant computer system to make it compliant. All taxes relating to business (other than income and wealth tax) incurred during the fiscal year are deductible in that year, provided they are paid by the following October 30. Otherwise, they are deductible in the year of payment. Intercompany dividends can be deducted for domestic companies that receive dividends from other domestic companies, to the extent, such dividend is redistributed by the recipient domestic company on or before the due date of filing the return of income. | Depreciation rates: Buildings - residential 5 percent -non residential10 percent - hotels/units20 percent -temporary structures100 percent Furniture10–15 percent Machinery and plant -general25 percent - some sub-items20–100 percent Intangible assets25 percent Additional depreciation of 15 percent on new machinery and plant (other than ships and aircraft) acquired and installed after March 31, 2002, is allowed to a new industrial undertaking in the year of manufacture and to existing industrial undertakings which achieved an increase in installed capacity of 25 percent or more in that year (Finance Act 2002). | |
| 1.1.1.2 Minimum alternative tax (MAT) | Both resident and nonresident companies are liable to pay tax on their book profits where the tax liability of the year is less than 7.5 percent of the adjusted book profits | (a) sick companies (b) export profits of undertakings set up in free-trade zones and 100 percent export-oriented undertakings (during the tax holiday period) (c) nontaxable profits from the export of goods and software. | 7.688 percent (including 2.5 percent surcharge) |
| 1.1.2. Withholding taxes 1.1.2.1. Residents | Income earned from designated sources (including dividends, interest, royalty, rent, and capital gains) is subject to withholding tax at a variety of rates. The tax is withheld by the person making payments to the recipient of the income. | Residents (in percent): Interest domestic company 21 other residents 10.5 Income from: lottery, crossword puzzles 31.5 horse races 31.5 insurance commission 10.5 fees for selected services 5.25 mutual funds and UTI units 10.5 Lottery ticket sales commissions 10.5 Non insurance commissions 10.5 Dividends 10.5 Payment to contractors: 1–2 Rent 15.75–21 Any other income 21 | |
| 1.1.2.2. Nonresidents | Income earned from designated sources (including dividends, interest, royalty, and rent) is subject to withholding tax at a variety of rates. The tax is withheld by the person making payments to the recipient of the income. | Some tax treaties provide for lower withholding rates from certain types of income (dividends, interest, royalties, technical service fees). | Nonresident company: General rates (in percent): Royalties from an agreement concluded between 1961–197652.5 Technical service fees from an agreement concluded between 1954–197652.5 Other income 42 Specific rates (in percent): Dividends other than dividends from Indian companies 21 Interest on foreign currency loans 21 Long term capital gains 21 Income distribution from foreign currency units held in approved mutual funds or the UTI 10.5–21 Income distributions from bonds or Global Depository Receipts purchased in foreign currency 10.5 Income received by specified foreign financial institutions from listed securities: Short-term capital gains 31.5 Long-term capital gains 10.5 Other income 21 Royalties/technical service fees in respect of an approved agreement concluded between: 1976–1997 31.5 After 1997 21 |
| Other nonresidents: Interest 21 Long term capital gains 21 Income distributions arising from Global Depository Receipts 10.5 Rent 15.75 Any other income 31.5 | |||
| 1.1.3. Individuals 1.1.3.1. Individual income tax (IIT) | Residents are taxed on their worldwide income, except for those who are not ordinarily resident in India. Such a resident is taxed like a nonresident but is also liable to tax on income accruing abroad if it is from a business controlled or a profession set-up in India. Nonresidents are taxed only on income that is received in India or that accrues or is deemed to accrue in India. Employee gross income An individual’s entire remuneration (including benefits in kind valued as per the tax rules) received from an employer is taxable. Income tax is withheld from salaries. Capital gains and investment income: Short-term capital gains are aggregated with taxable income, which is taxed at the applicable rates. Long-term capital gains are determined after adjusting costs by prescribed inflation factors. Long-term capital losses can be set off only against long-term capital gains. Short-term capital losses can be set off against long-term as well as short-term capital gains. | Exemptions: Employee gross income: a. The tax paid by the employer on nonmonetary perquisites provided to the employee in the hands of the employee (Finance Act, 2002). b. Regarding employees stock option plans or schemes, if the plan/scheme is in accordance with government guidelines, the taxable event will occur only at the time of sale of shares. Any gains are taxed as capital gains at the time of exercise. c. leave passage within India, reimbursement of medical expenses and certain retirement benefits. d. foreign employees of a foreign enterprise who are not present in India for more than 90 days in a year for remuneration received from the foreign employer for services performed in India, provided the foreign enterprise is not engaged in any trade or business in India and provided the remuneration is not deductible in computing the employer’s taxable income in India. e. Specified income of a foreign citizen and a person who is not ordinarily resident, if he/she is engaged with the approval of the prescribed authority to render technical services under an agreement entered into by an international organization with the government of India and funded by the government of a foreign state. f. agricultural income Capital gains and investment income: Income from specified investments is exempt, up to certain limits. | Income brackets and IIT rates: Rs. 0-Rs. 50,000 Nil Rs. 50,000-Rs. 60,000 10 percent Rs. 60,000-Rs. 150,000 Rs. 1,000 plus 21% of income in excess of Rs. 60,000 Rs. 150,000-and above Rs. 19,000 plus 31.5% on income in excess of Rs. 150,000 The highest marginal rate for individuals with agricultural income however can differ. However, if an individual has agricultural income exceeding Rs. 5,000 in addition to total income, and total income excluding agricultural income exceeds the annual exemption, agricultural income is taken into account to determine the highest marginal rate. A 5% tax surcharge of the tax liability applies for residents whose taxable income exceeds Rs. 60,000. Tax on capital gains: - short-term IIT rate - long-term 21 percent |
| Deductions are allowed up to certain limits. | Deductions: a. Business-connected expenses, depending on salary drawn: less than Rs. 150,000 33.33 percent of the salary or Rs. 30,000, whichever is less Rs. 150,000-Rs. 300,000 Rs. 25,000 Rs. 300,000-Rs. 500,000 Rs. 20,000 Rs. 500,000-above Nil b. approved charitable contributions, medical insurance premiums, and to a limited extent, children’s’ education/hostel allowance received from the employer (up to certain limits). c. certain allowances in connection with a posting in specified hilly, border, remote, or tribal areas (up to certain limits). d. professional taxes imposed by certain states. | ||
| Tax rebates are allowed on specified investments from the gross tax up to a maximum of Rs. 20,000 (Rs. 15,000 if gross total income is between Rs. 150,000 and Rs. 500,000), out of which the rebate in excess of Rs. 14,000 (Rs. 10,500 if gross total income is between Rs. 150,000 and Rs. 500,000) must be out of investment in infrastructure. | Specified investments include: amounts paid for life insurance premiums, specified schemes, contributions to specified provident funds, long-term investments, amounts spent on construction/purchase of a residential house, or repayment of certain loans, and subscriptions to specified infrastructure bonds. | Tax rebate rates: Gross total income Rs. 150,000 or less 20 percent Rs. 100,000 or less in specified circumstances 30 percent Rs. 150,000–Rs. 500,000 15 percent | |
| 1.1.3.2. Local taxes on income | Professional taxes imposed by certain states are minimal and are deductible in computing taxable income. | ||
| 1.2. Tax incentives: 1.2.1. Inward investment | An initial period of tax holiday, followed by rebates at a decreasing percentage in later years, is allowed to Indian companies. The full tax exemption period, as well as the number of initial and later years varies from sector to sector. Export concessions are also granted to specified companies. | a. New industrial undertakings located in specific “backward” states and districts. Districts are classified in category A or B depending on level of infrastructure development. b. Hotels satisfying prescribed conditions. c. Undertakings engaged in developing and building a housing project, scientific research, commercial production, or refining of mineral oil or setting up and operating a cold chain for agricultural produce or engaged in the integrated business of handling, storage, and transportation of food or grains, subject to fulfillment of prescribed conditions. d. Undertakings engaged in building, owning, and operating a multiples theater or convention center satisfying prescribed conditions (extended under the Finance Act, 2002) e. Power generating or distributing companies, enterprises providing telecommunication services, or developing or operating and maintaining a notified infrastructure facility or an industrial park or special economic zone f. Export profits of new industrial undertaking satisfying prescribed conditions established in a free- trade zone, software technology park, or electronic hardware technology park, or 100 percent export-oriented undertaking g. Exports of new undertakings engaged in the manufacture or production of articles or computer softwares in any special economic zone. | Share of profits exempt from tax (in percent): a. for companies: Category A districts: First 5 years of operation 100 Next 5 years 30 Category B districts: First 3 years of operation 100 Next 5 years 30 b. Same as a. c. First 5–10 years 100 Following years 30/50/100 Later years 30 d. First 5 years 50 e. Any 10 consecutive years falling with in the first 15 years of operation (20 years in the case of infrastructure projects except ports, airports, inland waterways, and inland ports) 100 f. First 10 years 90 This exemption is only available until taxpayer’s financial year 2008-09 g. First 5 years 100 Following 2 years 50 |
| 1.2.2. Other tax incentives | Other exemptions and deductions are allowed to Indian companies and other residents. | Exemptions: a. Export of goods (other than mineral oils, specified minerals, and ores) and computer software (including technical services provided outside India for its development or production), where proceeds are received within a specified time in convertible foreign exchange or exports of film, television, music, television news, software or telecasting rights, subject to fulfillment of prescribed conditions. | Exemption rates (in percent): a. These concessions are only available until financial year 2003-04 in a phased-out manner: prior to FY2000-01 100 FY2000-01 80 FY2001-02 70 FY2002-03 50 FY2003-04 30 Following years Nil b. First 10 years 100 |
| b. Profits of new industrial undertakings set up in notified development centers located in the North- East region Deductions: c. Income received in convertible foreign exchange from foreign governments or foreign enterprises for the use outside India of any patent, design, or registered trademark. d. Profits derived from the construction of any building, dam, road, bridge, or other structure outside India, or the assembly or installation of machinery or plant outside India, if the proceeds are received in convertible foreign exchange within a specified time. In the case of approved hotels, profit from services to foreign tourists that are earned in convertible foreign exchange, subject to prescribed conditions. | Rates of deduction (in percent): c. FY2002-03 20 FY 2003-04 10 Following years Nil d. Same as c. | ||
| 1.3. Other taxes on capital and property | |||
| 1.3.1. Land tax | Imposed by the states on the value of land. The local authorities can impose a surcharge (“land cesses”). | Methods of valuation and rates vary from state to state. | |
| 1.3.2. Tax on land and buildings | Imposed by the local authorities based on the annual rental value. | ||
| 1.3.3. Betterment taxes | Imposed by local authorities based on increases in land values caused by town planning and town improvement. | ||
| 1.3.4. Taxes on the transfer of immovable property | Levied by local authorities based on the value of property. | ||
| 1.3.6. Tax on motor vehicles | Imposed by the states Based on the residing principle. | The first Rs. 1.5 million of net wealth is exempt. | 1% of the value of specified net assets exceeding in the aggregate Rs. 1.5 million. |
| 1.4. Wealth tax | |||
| 2. Indirect Taxes 2.1 Customs duty | Specific rate and/or ad valorem duties are imposed on exports and imports. Import duties: - basic customs duty, levied on items listed in the First Schedule of the Customs Tariff Act 1975. - additional duty of customs (“countervailing duty”), equivalent to the excise duty imposed on goods produced or manufactured in India. - other duties (anti-dumping, safeguard duty to restrain excessive imports that may affect local industries) Export duties: - custom duty, levied on items listed in the Second Schedule of the Customs Tariff Act 1975. | Exemptions: (a) Goods in transit or being transshipped via India (b) Warehousing facility (allows imported goods then used in the manufacture of export goods to be exempt for a specific period of time) (c) Export promotion schemes (allow for goods which will be used in a manufacturing activity to be imported free from customs duty, provided the manufactured product is exported). | Basic customs duty : varying rates for different goods Additional duty of customs: same as corresponding excise duty rate The customs value is the transaction value. |
| 2.2. Excise tax | Levied on goods produced or manufactured in India as: - a basic excise duty known as the central value added tax (CENVAT); and - a special excise duty, in addition to CENVAT, on specified goods. The tax is administered by the central government, via the Central Board of Excise and Customs. The duty must be paid by the manufacturer at the time of removal of goods from his factory premises or warehouse, the taxable base being the wholesale price of the goods manufactured. CENVAT credit: A modified value added tax (MOD VAT) was introduced in 1986 to prevent cascading of excise duty and double taxation. Under this scheme, a manufacturer of excisable goods receives a credit for the duty paid on specified inputs and capital goods under conditions specified in CENVAT Credit Rules 2002. Credit is also available for additional customs duty (countervailing duty) paid on imported capital goods and inputs. | Exemptions: (a) Small scale industries up to the specified value of goods cleared. (b) Goods produced or manufactured in Special Economic Zones. No credit of excise tax is available on inputs if the related final products are exempt unless they are exported. | Basic excise duty (items listed in the First Schedule of the Central Excise Tariff Act 1986): General 16 percent Specified items “Nil” or 8 percent Special excise duty (levied on items listed in the Second Schedule of the Central Excise Tariff Act 1986): General 8 percent Separate rates are applicable for petrol, diesel, and tobacco products. Cess (surcharge): varying rates |
| 2.2. Sales tax | All states impose sales tax on virtually all sales of goods. Each state has its own sales tax act. State sales taxes are generally single-point taxes. In most states, the tax is imposed on the first point of sales. In certain states, the tax is levied at the point of last sale of goods. In certain other states, the tax is a multi-stage tax. The central government imposes a central sales tax (CST) on interstate sales, which is levied in the state in which the movement of goods commences (CST Act, 1956). The revenue is administered by the state in which it is levied. Every dealer liable to pay tax under the CST Act must be registered. The CST payable is determined by applying the appropriate tax rate to the dealer’s turnover. | State sales tax: (a) export sales (b) goods specified under the local Act of the state CST exemptions: (a) goods unconditionally exempt from tax under the local Act of the state. (b) any subsequent sale (after a taxable interstate sale) of the same goods during the movement in interstate trade. (c) consignment/branch transfers. (d) sales of immovable property, newspapers, shares, stock, securities, and actionable claims. (e) sales of goods from domestic tariff area to units located in special economic zones. | CST rates: (a) Sale to the government: the lower of 4% or the prevailing state sales tax (b) Sale to registered dealers of goods included in the registration certificate: the lower of 4 percent or the prevailing state sales tax rate (c) Sale of declared goods to unregistered dealers: double the rate of state sales tax applicable to similar goods (d) Sale of goods, other than declared goods to unregistered dealers: the higher of 10 percent or the prevailing state sales tax. |
| 2.3. Service tax | Service tax is levied on certain types of services rendered (year when the tax became applicable in brackets): (a) brokerage fees (1994) (b) insurance premiums (1994, 2001 for life insurance) (c) telecommunications (1994) (d) advertising, pagers, and couriers (1996) (e) customs house agents (1996) (f) air travel agents (1997) (g) real estate agents (1998) (h) engineering consulting (1997) (i) management consultants (1998) (j) banking and other financial services (2001) (k) broadcasting (2001) (1) ports (2001) (1) ports (2001) (m) beauty, health and fitness (2002) (n) dry-cleaning (2002) (o) storage and warehousing (2002) and so forth. | Indian states of Jammu and Kashmir are exempt. Other exemptions: (a) services paid for in convertible foreign exchange (b) broadcasting services provided by cable TV operators (c) consulting engineer services in respect of computer software (d) video tape production (e) life insurance services other than premiums (f) specified insurance schemes (g) specified accounting and auditing services (h) various services rendered to diplomatic missions, the UN, international organizations. The Service Tax Credit Rules 2002 allow the utilization of credits within the same category of services. | A uniform 8 percent. |
| 2.4. Expenditure tax | Levied on hotel accommodation on payments made to the hotel in respect of food, drinks, or any other services. | Expenditure of less than Rs. 3,000 is exempt. | 10 percent of chargeable expenditure. |
Taxes are administered and levied by the Central government, unless otherwise specified.
Annex IV.II Average Effective Tax Rates (AETRs) Based on Macroeconomic Data
1. The AETR on labor is derived in two steps. First, the effective tax rate on total household income is calculated as the ratio of individual income tax and household income. including: operating surplus of unincorporated enterprises (OSPUE), property income (PEI), and wage income (CE). Second, the AETR on labor is calculated by dividing the sum of taxes paid on labor income (tax on wages and salaries—calculated by applying the household income AETR to wage income—,1 social security contributions, and other payroll taxes) by the sum of wages and salaries and employer-paid social security contributions.
2. The AETR on capital is obtained by dividing the sum of taxes paid by capital (corporate income tax, household taxes on capital income, and various property taxes) by the net operating surplus of the economy.
3. The AETR on consumption is calculated as the sum of domestic taxes on goods and services, export, and import duties, divided by the sum of private and government nonwage consumption, net of indirect taxes. Indirect taxes are excluded in the denominator to reflect the common practice of expressing indirect tax rates as a percentage of the price before tax.
4. More recent studies however have argued that it is preferable to express the consumption tax base in gross terms (i.e., including indirect tax rates in the denominator), to improve comparability with the tax ratios on labor and capital and facilitate calculating a combined AETR on labor and consumption (Carey and Rabesona, 2002). We therefore also present this alternative (revised) estimate together with the original Mendoza et al estimate.
Notes
Labor and capital income of households are assumed to be taxed at the same rate.
Annex IV.III Tax Parameter Data, June 2004
(In Percent)
A. Corporate Tax System
| Corporate tax rate on retained earnings | 35.875 | ||
| Inventory valuation | FIFO | ||
| Long term capital gains tax rate | 21 | ||
| Dividend distribution tax rate | 12.81 |
| Corporate tax rate on retained earnings | 35.875 | ||
| Inventory valuation | FIFO | ||
| Long term capital gains tax rate | 21 | ||
| Dividend distribution tax rate | 12.81 |
B. Personal Tax System
| Interest income tax rate | 21 | ||
| Dividend income tax rate | 0 | ||
| Short-term capital gains tax rate | 31.5 | ||
| Long-term capital gains tax rate | 21 | ||
| Proportion of assets realized each period | 10 |
| Interest income tax rate | 21 | ||
| Dividend income tax rate | 0 | ||
| Short-term capital gains tax rate | 31.5 | ||
| Long-term capital gains tax rate | 21 | ||
| Proportion of assets realized each period | 10 |
C. Tax Depreciation Rates
| Machinery | Buildings | ||
| Depreciation method | Declining balance | Declining balance | |
| Rate for declining balance | 25 | 10 |
| Machinery | Buildings | ||
| Depreciation method | Declining balance | Declining balance | |
| Rate for declining balance | 25 | 10 |
References
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Prepared by Hélène K. Poirson.
National savings during 1999–2004 in India reached 24 percent of GDP on average annually, compared to 43 percent in China, 34 percent in Malaysia, and 32 percent in Korea.
For a history of reforms, see Ministry of Finance (1982, 2001, and 2004), Patel (1995), Mulheisen (1998), Burgess, Howes and Sterne (1997), and Shome (2004).
As of June 2004. See Annex IV.1 for detailed provisions of the tax system.
The budget 2004/05 imposed a 2 percent education surcharge on all taxes.
The exemption threshold was raised to Rs. 111,250 (US$2,472) in the 2004/05 budget. An estimated 14 million taxpayers are expected to benefit, further narrowing the base.
The service tax net has been further widened in the 2004/05 budget to cover 71 services. The service tax rate was raised to 10 percent. Credit of service tax and excise duty was extended across goods and services.
Estimates for non-OECD countries are not publicly available.
The operating surplus of unincorporated enterprises (a proxy for the share of the informal sector) accounted for three quarters of the operating surplus of the economy in 2000/01.
Tax productivity measures the extent to which revenues that should be received—given the rate and base of the tax—are actually being realized. It is measured as the ratio of the effective to statutory tax rate (Kraemer and Zhang, 2004).
In Table IV.4a, following the Kraemer-Zhang approach, we use the operating surplus of the economy (from national accounts) as the potential tax base. In Table IV.4b, in the absence of such data for non-OECD countries, we use nominal GDP.
The operating surplus of the economy declined by 2.7 percent of GDP during 1993–2001.
See Annex IV.III for tax parameters used. See OECD (1991) and Poirson (2004) for further details on the methodology and parameters. Indirect taxes impose additional costs on investment, but the METR approach focuses on direct taxation, thus understating the tax burden on investors.
The AETR, although commonly used for this purpose, does not accurately reflect incentives, as it is backward looking. Moreover, international comparisons using this indicator are difficult to interpret due to differences in accounting definitions and the timing of tax payments. Further, it does not incorporate personal tax provisions.
The use of the FIFO method (first in first out) for inventory valuation also entails a higher tax burden, as increases in the value of inventories due solely to inflation are taxed.
The average debt-to-equity ratio for Indian companies is high relative to their counterparts in Asian countries and elsewhere, and has risen recently to 1.4 in 2002 from a low of 1.2 in 1996 (Topalova, 2004).
The METR calculated here follows the methodology of Devereux, Griffith, and Klem (2002) and ignores any personal taxes, focusing on the marginal tax burden at the firm level.
The METR on retained earnings (ignoring any personal taxes) would increase by 3 percentage points to 29 percent following reforms, due to the lower depreciation rate.
The notional rate of return on invested equity is deductible under the CIT in Croatia (1994–2001), and imputed equity return is taxed at a reduced rate in Austria and Italy (until 2001).
