Taxation in the post-Covid era

Covid -19 has thrown the world economy into disarray. “The worst recession in three centuries,” said British Prime Minister Boris Johnson. The Covid lockdown has meant a spike in joblessness and a drop in labour force participation. A 10 per cent contraction in global GDP would push 170 million more people into extreme poverty and India will account for half the additional poor. About 75 million Indians will have to live with earnings less than $1.90 per day.

India lifted 271 million people out of extreme poverty between 2005 and 2017. That achievement is now under threat. The Union government realised the seriousness of the situation and announced a fiscal package of ₹20 lakh crore to provide stimulus, especially in the rural areas. The Chief Economic Adviser has opined that the stimulus must be in line with the tax GDP ratio. The tax-paying public in the US is about 40 per cent of the population; but in India, it is less than 10 per cent.

In a ruling on May 27, the Delhi Bench of the ITAT upheld the claim for tax exemption for the NIIT Foundation, engaged in educational activity. The Bench pointed out that now the world is experiencing a new normal in all spheres of activity. Interestingly, the Gujarat High Court in a recent ruling upheld the claim for deduction of CSR funds despite the bar placed on the same from 2015 onwards.

Covid-specific tax issues

The Finance Ministry has come up with prompt responses with regard to problems posed by Covid. Tax deadlines have been extended upto November 30. Taxpayers were allowed to invest in the PPF, the NSC and other tax-saving instruments upto July 31 and claim credit in the income tax returns for the financial year ending March 31, 2020. Tax audit reports can also be filed by October 31.

The deadline for filing applications for settlement of tax disputes related to obtaining waiver of penalty and interest has been extended upto December 31.

Non-corporate assessees: While relaxations have been announced in respect of individual taxpayers, major problems arise for non-corporate assesses. The number of days one must stay in India to be considered a resident was reduced from 180 days to 120 days by the Finance Act. Cases have come up where individuals are forced to stay in India beyond the prescribed time because of Covid restraints. The government has been quick to announce that in respect of individuals, such forced stay in India will not be counted for residential status.

Problems arise when such individuals happen to represent companies abroad. A stranded employee of a foreign enterprise working in India is capable of creating a permanent establishment for the foreign entity here. Employees habitually conclude contracts on behalf of a foreign enterprise and create a dependent-agent PE. If such an employee is forced to stay in the country, will he be considered a PE for the foreign enterprise?

Questions also arise about place of effective management. The company can become a resident in India if its place of effective management happens to be here. In that event, the foreign company can be taxed at the steep 40 per cent tax rate with applicable surcharge and cess.

FPIs: Foreign portfolio investors figure in India’s stock markets as trusts or association of persons (AOPs). They earn dividends. At present, such dividends can be taxed at 43 per cent. If they happen to be taxed at their home jurisdictions, they can avail of treaty benefits. The US, Singapore, Mauritius and Ireland do not consider trusts and AOPs as taxable entities. Since they are not taxed there, they will be liable for Indian taxation. They have the option of availing treaty benefits. Dividends are taxed at 40 per cent-plus surcharge for FPIs. If they avail of DTEA benefits, they can get away with a tax rate of 5-10 per cent. If the FPI is not taxable in its home country, it will not be eligible for treaty benefits. Overseas subsidiaries are often treated as domestic entitites for tax purposes if the control and management is in India.

OECD guidelines: OECD guidelines for framing tax policies in the light of the challenges posed by Covid-19 take note of the need for multilateral collaboration to address the economy. The expansionary fiscal policy should focus on reducing harmful tax categories and encourage inclusive growth. Containment and recovery policies can coexist. Carbon pricing tax should be introduced. Introducing new taxes will be less difficult at a time of major policy reform. Companies suffering heavily from the crisis will have to be helped.

The OECD also raises the issue of tax problems concerning cross-border workers stranded in a country that is not their country of residence; these issues will have an impact in the tax treaty between the countries.

Tax rates

The perennial question of an optimum tax rate becomes more relevant today because of the economic slowdown. Indian companies face competititve disadvantages because of high cost of capital, poor infrastructure, difficult business environment, cumbersome legal system, rigid labour laws, high cost of power and real estate. Reduction in corporate tax rate has still meant an effective rate of 34.9 per cent for companies. Even after they avail exemptions the effective rate stands at 27.8 per cent. Companies can opt for foregoing exemptions and pay a rate of 25.1 per cent. New manufacturing units, will get a lower rate of 15 per cent and inclusive of surcharge, it will go up to 17.1 per cent. Just look at the tax rates from neighbouring jurisdictions (see Chart).

It has therefore been suggested that a uniform tax rate of 15 per cent for all companies will make India an attractive destination because of the large domestic market. India can become a regional manufacturing hub. Opportunities will be provided to attract companies looking to diversify post Covid-19.

Of course, there will be a revenue loss of approximately ₹2.5 lakh crore. This loss can be made up by personal income tax collections and consumption taxes because of greater job generation.

Exports will get a boost. Tax compliance will increase.

Covid 19 is an unprecedented pain, but such situations provide opportunities for new ideas to emerge, and India should be ready to come up with a new policy framework to successfully deal with the crisis.

Ramanujam is a former Chief Commissioner of Income-Tax. Sangeetha is a Chennai-based advocate