Direct Tax Reforms

Direct tax is one of the types of tax by which government earns

revenue. Direct tax includes Income tax, wealth tax etc. Income tax
included taxes paid by individuals as well as organisations and is
governed by the Income tax act, 1961. The IT act is complex and
provides scope for tax evasion. Government has brought about
different modifications in the direct tax system like reducing the
corporate tax, introducing presumptive taxation scheme etc. The
government is working on introducing a new direct tax code to replace
the IT act. DTC is aimed to simplify the taxation laws and increase the
tax payer base.

Tax refers to an involuntary and compulsory financial charge or fee that is levied by government on
individuals or groups like organisations. Tax is collected by the government in order to be used as funds for
different expenses. Taxes are of two types based on their mode of collection- Direct tax and Indirect tax.
Direct taxes like Income tax, corporate tax, wealth tax etc are levied on income or profits and paid directly
to the government by the person or organisation on which it is levied. Indirect taxes like GST, excise duty,
custom duty etc are paid on goods and services by the consumer indirectly as it is levied on supplier or
manufacturer who in turn shifts it onto the final consumer.

Taxes play major role as a source of revenue for the government. Government collects tax in order to use it
for public services like health, education, transport etc, redistribute income so as to reduce inequality of
income and wealth, prevent undesirable behaviour like accumulation of wealth and resources by
individuals or groups, generate employment, pay off its debts, bring about overall economic development
etc. Taxes are collected as per the rates decided by the government taking into account different factors
like for income tax, the amount of income earned decides the tax rate, for GST, the type of product i.e
either essential or non-essential is used to decide the tax rate.

Direct Tax and its relevance

Direct tax is the tax paid by an individual or organisation directly to the government. Direct tax is
progressive in nature and the rate of direct tax to be collected is decided on the basis of capacity to pay. An
individual or organisation with higher income has to pay more tax compared to an individual who has less
income. Direct tax is non-transferable and has to be paid by the individual or organisation on whom it is
levied and its burden cannot be shifted onto others. Direct taxes are paid after the income or earning
reaches a person or organisation. Direct taxes are certain to some extent as the payee is sure about the
amount of tax to be paid based on income and adjacent tax rate. Further it is elastic as the rate varies in
accordance to the need of the government. If government has to increase its revenue, it increases tax rate
and vice versa.

Direct tax is a huge source of income for the government. It is productive because with increase in
economic condition of the society direct tax collection increases thereby increasing government revenue.
Direct tax is sometimes used by the government to control inflation. When inflation increases, government
increases the tax rate as a result individuals are left with lesser money to spend (decreased purchasing
power) that in turn reduces the consumption demand and finally results in reduction of inflation. Direct tax
helps to prevent accumulation of wealth by people as the more they earn the more they pay which is
redistributed among all.

Direct taxes in India

Some of the direct taxes imposed in India are Income tax, corporation tax, property tax, gift tax, capital tax
etc. Income tax levied on the income of a person is one of the most important taxes levied in India. Income
tax is progressive in nature and the rate of income tax depends on the income and its percentage increases
with the increase in income. Income tax is collected by the central government but the proceeds collected
are shared between the centre and the state as per recommendations of the finance commission. Income
tax is governed by the Income tax act, 1961. Corporation tax is levied on the profit of companies and is paid
by domestic companies and even those foreign companies whose income arises from India. Property tax is
the tax an individual has to pay based on the value of property in possession. It is usually collected by the
local governing authority of the area where the property is located. Gift tax is the tax to be paid by an
individual if he/she receives a gift worth more than the prescribed limit. Gift tax was repealed from 1998
until its reintroduction in 2005 under the Income tax act, 1961 so as to end tax evasion that had increased
under the disguise of gift exchange after repeal of the gift tax. Capital tax is another direct tax levied in
India. Capital gains tax is the tax levied on the profit earned by sell of any asset. Owner of asset pays a tax
on the difference between purchase price of asset and sale price of asset.

The Central Board of Direct Taxes under the department of revenue of finance ministry is responsible for
regulating and monitoring the collection of direct taxes. Among the direct taxes, Income tax is the major
source of revenue for the government. Agricultural income as defined in the Income tax act, 1961 is
exempt from income tax along with certain other list of deductions like public provident funds, life
insurance premiums etc as mentioned in the Income tax act.

Need for reforms in direct taxes

India’s direct tax laws have been a matter of criticism for long. Despite of number of guidelines and other
rules they have failed to increase the tax base and have failed to eradicate tax evasion. Direct tax is a major
source of revenue for the government. However, India has been more inclined towards indirect taxes
compared to direct taxes. High levels of corruption among the tax evaders, inadequate exemptions and
complicacy of the direct tax system has not been successful in strengthening India’s direct tax base. Even
with a rapidly developing economy, too few of the Indians pay direct taxes which subsequently deteriorate
the direct tax system. India’s over dependence on indirect taxes like GST makes its tax system regressive
instead of being progressive. A well reformed direct tax code will help achieve tax stability, increase the
number of tax payers and thereby reduce the burden on the poor. Further it will also help to balance the
overall economic structure of the country and will create space for reducing the rates of indirect taxes like
GST. A modified tax system will also help in reducing the number of litigations that exist in income and
corporate tax collection which had resulted in blocking of around 8 lakh crores in the year 2016-17.

India’s direct taxes have a low contribution of about 52% to India’s total tax amount being collected. This
percentage has been decreasing from 2013-14 even though the number of tax returns being filed and the
direct tax to GDP ratio has been increasing. A better tax code will help to increase economic efficiency as
they help to reduce the fluctuating effect of indirect taxes like GST. Further, though the tax payers have
been increasing, it has been seen that the average income being reported by Indians has decreased which
displays that the government efforts like the Income Declaration Scheme, 2016 that have been adopted to
reduce tax evasion have failed to achieve significant results. The complexity of current laws leaves behind
scope of misuse by individuals as well as bigger organisations who easily evade paying tax by manipulating
the existing laws. A large number of companies show negligible profit in order to evade tax and the
exemptions outlined in the tax laws are thoroughly misused which makes the laws regressive. Also, India’s
taxation framework is skewed with the top end of corporate tax rate being 25% whereas the top end being
30% for personal tax rate. Lastly, the tax offenders are either not caught or adequately punished due to
limited deterrence power of the existing laws and the poor win rate of Income tax department in tribunals
and in court of law.

Recent reforms carried out by government

In the last few years government has brought about number of changes to improve the direct tax system.
The Presumptive Taxation Scheme was introduce to allow tax payers to take full benefit of tax evasion and
avoid scrutiny after paying a certain decided amount of turnover tax. This step saw a massive positive
response when the number of filers under this increased to around 1 crores in 2018 from about 15 lakhs in
2017. In 2019, government offered a full tax rebate to people who earned up to 5 lakh rupees along with
other exemptions like deductions in home loan interest, interest on education loans, exemption on capital
gains tax while buying second house etc. Besides these government also slashes the corporate tax rate to
about 22% for all domestic companies and to 15% for new manufacturing companies. Further,
implementation of e-assessments by use of artificial intelligence and other technologies has eased the
taxation system to certain extent and reduced the undesirable practises. Recently in 2020, the finance
minister introduced the Vivad Se Vishwas Bill which is aimed to solve the various pending litigations on the
matter of direct tax. Further, the government also put in place lower tax rates for individuals who gave up
the exemptions that they enjoy under the existing laws.

The attempts of the government though are aimed to simplify the taxation system however, fail to do so.
The removal of exemptions in case of home loans will adversely affect the economically weak people who
used to take benefit from the exemptions. Also, with new guidelines being issued it will further complicate
the matter for tax payer who will have to compare and choose between the new and old laws. The
government attempted to reduce the economic slowdown by reducing the corporate taxes. However,
reducing corporate taxes would fail to address supply-side issues faced by Indian economy though it will
attract foreign investment.

Indian government has been trying to modify and improve the Income tax act, 1961 over the past several
years. In order to bring about necessary modifications, the government has been striving to introduce
Direct Tax Code (DTC). DTC will replace the IT act due to the various complicacies associated with the act.
DTC will include personal tax, corporate tax and all taxes that come under the IT act. In 2017, the current
government set up an expert committee to draft DTC. The committee that has submitted its report to the
finance minister worked in order to simplify the tax code and to reduce ambiguity. DTC will help to reduce
the exemptions due to which litigations arise while dealing with cases of taxation. It aims to bring under its
ambit more number of tax payers, establish a better and equitable taxation system for different classes of
tax payers, simplify the personal income tax structure by rationalising the tax slabs, lowering the corporate
tax rate and providing a uniform tax system for both domestic and foreign companies etc.

Conclusion
Direct taxes play a crucial role in the economy. As a major source of revenue for the government and due
to their progressive nature, they help in stabilising the economy. India has for long depended more on
indirect taxes and as a result there has been distortion in the economy due to the fluctuating nature of
these taxes. India needs to focus more on direct taxes and increase the tax to GDP ratio which will help to
stabilise the economy. Also there is need for developing robust IT infrastructure so as to improve the e-
assessments. DTC if implemented will help to simplify the existing complex taxation laws. The numerous
loopholes existing in the IT act that allow tax payers to easily avoid tax will be addressed effectively. A new
tax system was needed for India in order to overcome the age old IT act and DTC can prove to be the
effective in addressing the lacunae in the existing law and can help to establish a simplified taxation system
that reduces tax evasion and helps maintain a balance between direct and indirect tax.