indian corporate taxation

8/10/2019 Indian Corporate Taxation

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THE ECONOMIC WEEKLY December 12,1964

Book Review

Indian Corporate TaxationVinaykumar D Lall

The Taxation of Corporate Income in India by S Ambirajan. Asia Publishing House, 1964. Pp xv + 315.price Rs 26.

THE author set out "to study theevol ution, working , effects and

future prospects of the taxation ofcorporations in India". In the processhe examines whether the Indian corporate tax policy has been rationa l.The study is divided into five chap-ters. The titles of the chapters arerather misleading and the text is attimes over-loaded wi th superfluousquotations.

Basis of Taxation

The first chapter, "Economics ofCorporate Taxation", analyses themeaning of the term corporation andexamines the reasons for. and themethod of, taxation of corporationsand the consequences of such taxation.Half a century ago, corporate taxation was unheard of. But, today, it hasbecome a universal and almost indispensable feature of tax systems. Ambi-rajan examines the three possiblebases of corporate taxes: gross sales,capital stock and income or profits.The advantage of a tax on gross sales

(tota l earnings witho ut deductingcosts), at low rates, is the difficultyof evasion; but it fails to take intoaccount differences in the quality ofmanagement. A tax on capital stockcan be an 'annual capital tax' or anoccasional 'capital levy', both of whichhave long before been dealt withat length by Hic ks and Rostas.Income is of course, the most common base of corporate taxation. But,its computation leads to problems andAmbirajan enumerates the various definitions of 'income' by Haig, Hicks.

Fisher, Kaldor and others. Towardsthe end of the chapter, running intofifty-seven pages, Ambira jan takes upthe twin problems of shifting incidence,but is content with the now ancientColwyn Committee Report on NationalDebt and Taxat ion and the PigouRobertson controversy which followedit.

The second chapter, "Corporate Sector in India", running into 60 pages,contains an uncritical analysis of thestructure and growth of corporatemanagement and finance in Ind ia.

While the explanation of such concepts as fixed and working capital,share capital, authorised and paid-up

capital, etc, is lucid, it adds nothingto our understanding of the effect ofcorporate taxation on capital structureand cost trends, Ambirajan makes arapid historical survey of the growthof the corporate sector in India andhis study reveals that only after 1945di d the growth gather momentum,mainly due to the War, which in

creased the demand for goods at homeand abroad, and the 'Swadeshi' move-ment which gave a fillip to Indian in

dustries, He analyses two importantindicators of the growth of the corporate sectorpaid-up capital and notprofitbut fails to examine other indicators like output produced and productive capital employed due to alleged lack of relevant data.

Plough-back of Profits

The study of profits is enlightening.The fundamental determinants of corporate profits are the demand for goodsproduced, the competitive conditionsin the industry and the system ofcontrols. However, it is retained pro-tits which are of real significance forexpansion and Ambiraj an makes aninteresting study of it . Retention of ;profits is largely determined by thecompany's dividend policy, which isinfluenced by the tax liability of theshareholders, the size of the company,the company's programme of expansion, the situation in the capital market, the nature of the business andgovernment intervention. Generally,the plough-back is 50 per cent and attimes in certain American manufacturing companies it is as high as 90

per cent. In India, Central Board ofRevenue figures for 1958-59 and1959-60 reveal it to be 46 per centand 41 per cent, respectively; theTaxat ion Enquiry Commission's sample of 492 joint -stock public companies showed 40 per cent, which wasabout the same as the figure revealedby the Reserve Bank of India's sampleof 750 public limited companies. Thisis followed by the familiar reasoningthat excessive corporate saving reduces the economic function of thecapital market, leads to concentrationof economic power and creation oflarge monopolies, and results in sub-optimum use of capital.

The first two chapters having provided the "appropriate background"or, rather something in the nature oftextbook appeal, the author comes tothe heart of the matter in the thirdchapter on "evolution and structure ofthe taxation of corporate income". Hemakes a rapid survey of the evolutionof corporate taxation in India and examines its constituents, especially during the last two decades. The studyreveals that major changes in our tax

structure have taken place only sinceindependence, to meet the increasingneeds of a developing economy as alsoto check tax evasion.

The definition and classification of

companies under the Indian income-tax laws is derived largely from theprinciple of 'division of dichotomy',by which the corporate form of organisation could be utilised to avoid certain types of tax liability. To preventthis, tax authorities differentiate between types of companies.

Complex Structure

The structure of tax rates in Indiahas evolved fro m a comparativelysimple to an increasingly complex one.After a period-wise analysis, Ambi rajan finds that tax rates have, on thewhole, been moving up. but rightlypoints out that, "whi le the formalrates look truly formidable, the actualrates are much less so" because various concessions and rebateswhichare briefly examinedeffectively re

duce tax liability. The 1955 FinanceAct reforms are considered and lightis shed on the tick lish problem of

whether 'bonus shares' are dividends.Towards the end of the chapter, Ambirajan examines the computation of in-come and allied problems. To talassessable income is calculated by deduc ting 'certai n' expenses from theassessee's receipts during the 12-monthperiod. The chapter is rounded upwith a survey of the various taxes onbusiness.

The fou rth chapter on "effects ofcorporate taxation" is the most interesting. Ambirajan makes an interesting point on the principle of "gross

ing", according to which income taxpaid by companies is refundable toshareholders to a certain extent and

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T H E E C O N O M I C W E E K L Y December 12, 1964

under certain conditions and so, it isgenerally held, the net burden on thecompany is reduced to that extent.Ambirajan shows that this may not bethe case, for the advantage of gross-ing is applicable "only to the amount

actually distributed"; the undistributedprofits still have to bear the wholeburden of the income tax.

Unequal Distribution of Burden

Another interesting point is thatwhile the number of companies operating in India has increased by over16,000 between 1940 and 1959, thenumber of assessees paying corporatetax increased by only 6,308 so that in1959 only 10,777 out of 27,479 (i e,about rd of operating companies)

paid taxes. This has very interestingimplications: it could mean that the

majority of companies sustain losses,or their profits are eaten up by depreciation allowances, development rebates, etc, or they enjoy a tax holiday, or simply that they accomplishplain evasion. Also, companies paying

taxes have increased by about 2 times,profits by about 6 times and taxes byabout 14 times, which indicates thata few companies really bear the majorpart of the tax burden.

Ambirajan's analysis of the effectswhic h he divides into psychologicaland physicalalso make good reading.

The psychological effects are signil i-cant for they can affect corporate acti

vitythey may induce people to shyaway from risky enterprises or distortthe direction of investment or productive activi ties. Analysis of thiseffect is diff icul t; Ambirajan's resortto the trends of security prices forthis purpose is open to the objectionthat market valuation of companies

often lags a good deal behind thechange in their earning power.

As regards the physical or econo

mic effects, much depends upon who

ultimately bears the burden. The final

word on this has not yet been said.

In the short run, it is generally be

lieved, the corporation tax cannot be

shifted, but actually much depends on

the prevailing conditions, the tax

rates and the sacrifices involved, A

corporation can shift its tax burden

to labour, consumers, or shareholders.

Ambirajan, therefore, studies empiri

cally the effects of corporate taxation

on wages and labour, prices and con

sumers, dividends and shareholders,

corporate savings, supply of capital

and the growth of the corporate sector. The statistics on the earnings of

factory workers, collected by the

Labour Bureau reveal an increasingtrend, in spite of increase in corporate taxes and profits. Also government regulations and trade union

pressures prevent shifting of corporatetaxes to labour. Shifting of corporate

taxes to the consumers is, however, anopen issue. The price level of manufactured goods in India has been continuously rising and so have corporate taxes. But, this cannot lead tothe conclusion that a high correlation

exists between the tw o. Increases indemand, production costs, administrative inefficiency, black marketing, andnot corporate taxes alone, may beresponsible for the rising price level.Ambiraja n, therefore, contends thattaxes must fall either on companiesdirect or on their shareholders, sothat a fall in retained profits or divi

dends, or both, results. He shows tha t inthe period 1939-51, a 'significant part'of the burden was borne by shareholders, but as dividends cannot bereduced below a certain minimum (say,5 per cent), without grave consequences, any rise in costs (whether by taxor any other factor) has to be borne,

in the short run, by companies in theform of reduced retained profits.

Taxation and Incentives

Now since, as Ambi rajan opines,companies bear the brunt of the cor-porate taxes, what reaction has thison the progress of the corporate sec-tor? He lucidiy examines and demonstrates that the reaction is not as dele

terious as many laymen claim it to be.The present situa tion in our developing economy is such that "there is noquestion of lack of incentives" orlack of willingness on the part of individuals to undertake investment andentrepreneurial activities. If therate of industrial activity is not higherthan what it is, it is not due solely

to corporate taxes. Increased labourcosts and prices of raw materials

and machinery, heavy competitiveborrowings by the government, variousgovernmental controls and regulationsall interact with each other, so thatit is not possible to isolate the effectsof any particular factor. In fact, if we

take the tax structure as a whole,the disincentive part is more or lessneutralised by the positive incentive';to industries. Ambirajan's analysis ofthe data on capital issues thereforeshows, not surprisingly, that there is"no lack of enterprising producers andpromoters to float new companies".

The title of the fifth chapter "corporate taxation and economic develop

ment" is misleading. A better title

would have been 'Prospects of corporate taxation in India' or 'Rationalisation of Indian corporate tax structure".The early part of the chapter is pedestrian; later, however, it becomes interesting, though not always convincing.

Ambirajan examines corporate taxation as a means of reducing inequalities in income, encouraging savings,investment and economic progress, butfeels that in a developing economy corporate taxes are not the correct weapon and so he pleads for "lighteningof the present burden of corporatetaxation". He is not, however, clear

as to how this should be done. Infact, after having earlier shown thattax rates are not really very high oradverse in their effects, he yet contends that as all taxes (direct or in

direct) are paid by corporations, andsince government is now placing moreemphasis on excise duties and otherindirect taxes, which cannot be always

easily shif ted, the government "canafford to reduce the rates of corporate taxation."

Case for New Incentives

A critical examination of the variousincentive measures then follows andsuggestions for improvements are made.The trouble with the existing conces

sional measures, the author observes,is that "the more advantage is taken

of them, the nearer is the period offull-fledged taxation". This can hit thecorporate sector hard. He, therefore,suggests, for instance, the conversionof the five year tax holiday into a'partial working day', involving pay

ment of say 30 per cent of the taxliability and the tax gradually rising

to the full complement in 10 or more

years. But, such a 'partial workingday' would not serve the purpose, asmany of the new enterprises do notmake profits in the early years tobecome liable for taxation and thereby

enjoy the 'holiday'. The purposewould be better served if the 'holiday'is extended beyond 5 to 10 years. Also,by continuous reinvesting, a companycan enjoy the advantages of tax concessions for a longer period.

Ambirajan suggests other tax reform measures, such as, administrativeimprovement, prevention of evasion,simplification of the tax structure, eli

mination of 'nuisance' taxes and continuity in the tax structure for reason

able lengths of time. But. these arealready common knowledge, though

not fully implemented.In an appendix, the author has

an international comparison of the

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December 12, 1964 T H E E C O N O M I C W E E K L Y

percentage share of corporate taxes innational income and the percentage ofincome paid by corporations as direct taxes. This is informative, but itsutility would have increased had a comparison been made with countries in

a similar position, or had a balancebeen made for various concessions.

The total impression that a readerforms of this book, after ploughingthrough it, is that it could well havebeen much smaller in size. The sub

ject of corporate taxation has yet tobe fitted into the main body of eco

nomic literature in our country; andnothing concrete has emerged so far

on the shifting and incidence of corporate taxes. The major virtue of thisbook is that it sets out to fill thisgap. While the book cannot be saidto fully succeed in this objective, it is.nevertheless, informative and can serve

as a good introduction to corporateproblems.

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indian corporate taxation

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