Warren Buffett’s favourite business book tells us what is wrong with India’s tax system


Vivek Kaul

Business books are soporific. They put me to sleep.
Nonetheless, now and then, one does come across an excellent business book as well. These days I am reading John Brooks’
Business Adventures. The book is a collection of 12 long articles that Brooks wrote for the New Yorker magazine.
In July 2014, Bill Gates wrote a blog titled
The Best Business Book I’ve Ever Read. As he put it : “Not long after I first met Warren Buffett back in 1991, I asked him to recommend his favorite book about business. He didn’t miss a beat: “It’s Business Adventures, by John Brooks,” he said. “I’ll send you my copy.” I was intrigued: I had never heard of Business Adventures or John Brooks. Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.” This blog by Gates sent the book to the top of the best-sellers lists almost everywhere.
The third chapter of the book is called
The Federal Income Tax. Brooks makes several points in the chapter about the income tax system in the United States as it had prevailed in the fifties and sixties. Some of the points I feel are as applicable to the general tax environment in India today as they were in the United States back then.
As Brooks writes in the context of the federal income tax in the United States: “A good deal of the attention given to the income tax is based on the proposition that the tax is neither logical nor equitable. Probably, the broadest and most serious charge is that the law has close to its heart something very much like a lie; that is, it provides for taxing incomes at steeply progressive rates, and then goes on to supply an array of escape hatches so convenient that hardly anyone, no matter how rich, need pay the top rates or anything like them.”
Long story short: The rich were “supposed” to be taxed at a high rate, but at the same time enough loopholes were built into the income tax laws ensuring that they did not pay the highest tax rates in reality.
A similar sort of scenario prevails in India when it comes to the Income Tax Act in particular and taxes in general. Along with the budget every year, the government of India
puts out a statement of revenue foregone under the central tax system.
What is the purpose of this system? “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the latest statement of revenue foregone points out.
The deductions, exemptions and other measures lead to a loss of revenue for the government. As can be seen from the accompanying table the revenue foregone for the government during the year 2013-2014 has been estimated to be at Rs 5,72,923.3 crore.

Statement of Revenue Foregone

TaxYear(in Rs crore)
Corporate Income Tax68,720.076,116.3
Personal Income Tax33,535.740,414.0
Excise Duty209,940.0195,679.0
Customs Duty254,039.0260,714.0

A simplistic way of looking at it is that the revenue foregone number is greater than the fiscal
deficit of the government for 2013-2014, which stood at Rs 5,42,499 crore.
Nevertheless it needs to be pointed out that the statement of revenue foregone is based on certain assumptions. As the statement points out “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.”
So the revenue foregone figure needs to be looked at with these limitations in mind. Having said that, the government of India is losing out on revenue because of the exemptions and deductions. There is no denying that. As can be seen from the above table corporate India is a major beneficiary of the same, like the rich were in the United States, around the time Brooks wrote about the federal income tax.
Getting back to Brooks, he also points out that laws and the regulations were so vast that the critics thought it was an “undemocratic state of affairs, for only the rich can afford the expensive professional advice necessary to minimize their taxes legally”.
This is what is happening in India as well. Companies have an army of chartered accountants and lawyers, working towards legally minimizing taxes, whereas most individual tax payers find it difficult to afford the services of a good chartered accountant who can help them.
Brooks also talks about the favoured treatment of capital gains. This is something that really helps the rich because they are the ones primarily investing in stocks and bonds. In India short term capital gains on equity gets taxed at 15%. There is no long term capital gains tax on equity i.e. if you buy and then sell a share after one year, you don’t have to pay a tax on the capital gains you make when you sell the shares. Equity mutual funds are treated in a similar way.
In case of debt mutual funds, long term capital gains come into the picture if the investment is held for a period of more than three years. Long term capital gains are taxed at either 10% or 20% with indexation, whichever is lower. Indexation allows inflation to be taken into account while calculating the cost of purchase. This brings down the tax significantly.
Now compare this to the common man’s investment—the humble fixed deposit. In this case the interest earned is taxed at the marginal rate of tax. Why is there a favourable treatment for investing in equity? I have often been told that this is because the investor investing in stocks is taking on more risk than the fixed deposit investor, and hence needs to be encouraged through a favourable tax treatment.
This I guess is “bullshit” (pardon my French!) of the highest order perpetuated by those who invest in equity and do not want to pay any tax on it. The amount of risk that an individual wants to take on with investments, is his or her personal preference and should have nothing to do with the prevailing income tax system. Nevertheless that’s the way things stand. Equity gets preferential tax treatment all over the world.
Other than this, the Indian Income Tax Act has a very interesting provision for those taking on a home loan to buy a home. In fact, the Act encourages people to speculate in real estate. T
here is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income.
We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
In a country where a large number cannot afford to buy a home what is the logic in having a regulation like this one?
The Direct Taxes Code, which is supposed to be replace the Income Tax Act, in its original form simplified the income tax system. In fact, I remember reading a large part of it when it first came out and was very impressed by its simplicity.
But a simple tax code doesn’t benefit those who currently make money out of the Income Tax Act being as complicated as it is. These include chartered accountants, tax lawyers, corporates and the income tax officers. Over the years, the Direct Taxes Code has been revised and from what I am told by those in the know of such things, it has become more or less as complicated as the Income Tax Act currently is.
To conclude, the tax system in India currently favours those who need to pay more taxes. This is something that needs to be addressed in the days to come.

The article originally appeared on www.equitymaster.com on Dec 2, 2014

Bill Gates’ favourite business book tells us why Tata Nano “really” failed


In July this year Bill Gates wrote a blog. He titled it The Best Business Book I’ve Ever Read. As he wrote “Not long after I first met Warren Buffett back in 1991, I asked him to recommend his favorite book about business. He didn’t miss a beat: “It’s Business Adventures, by John Brooks,” he said. “I’ll send you my copy.” I was intrigued: I had never heard of Business Adventures or John Brooks.” Gates got a copy of the book from Buffett. “Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read. John Brooks is still my favorite business writer. (And Warren, if you’re reading this, I still have your copy),” Gates added. The book is essentially a collection of 12 long articles (I don’t know what else to call them) that Brooks wrote for the New Yorker magazine, where he used to work. A chapter that should be of interest to Indian readers is The Fate of Edsel. A reading of this chapter clearly tells us why Tata Nano, the most hyped Indian car ever, has failed to live up to its hype. But before we get to that, here is a brief summary of the chapter. In 1955, the Ford Motor Company decided to produce a new car, which would be priced in the medium range of $2,400 to $4,000. The car was designed more or less as was the fashion of the day. It was long, wide, lavishly decorated with chrome, had a lot of gadgets and was equipped with engines which could really rustle up some serious power. The car was called the Edsel. It was named after Edsel Ford, the only son of Henry Ford who started the Ford Motor Company. In 1943, Edsel Ford had died at a young age of 49, of stomach cancer. In fact, even before the Edsel car was launched there was a lot of hype around it. As Brooks writes “In September 1957, the Ford Company put its new car, the Edsel, on the market, to the accompaniment of more fanfare than had attended the arrival of any other new car since the same company’s Model A. A model brought out thirty years earlier.” The company had already spent $250 million on the car, before it was launched. The Business Week called it more costly than any other consumer product in history. Given this huge cost, Ford had to sell around 200,000 Edsels in the first year, if it had to get its investment back. Nevertheless, two years, two months and fifteen days later, it had only sold 109,446 Edsels. This included cars bought by Ford executives, dealers, salesman, workers etc. The number amounted to less than 1% of the cars sold in America during that period. On November 19, 1959, it pulled the plug on the car. Estimates suggested that Ford lost around $350 million on the car. So what went wrong? Some of the feedback from trade publications was negative. Over and above that, some of the cars that were sent out initially were badly made. As Brooks writes “Automotive News reported that in general the earliest Edsels suffered from poor paint, inferior sheet metal, and faulty accessories, and quoted the lament of a dealer about one of the first Edsel convertibles he received: “The top was badly set, doors cockeyed, springs sagged.”” Some individuals who worked on making and launching the car liked to believe in later that it was the because of the Sputnik, the first artificial space satellite launched by the Soviets that led to the car not selling. As Brooks puts it “October 4th[1957], the day the first Soviet Sputnik went into orbit, shattering the myth of American technical pre-eminence and precipitating a public revulsion against Detroit’s fancier baubles.” Detroit was the city were the biggest motor companies in the United States were head-quartered back then. While these could have been reasons for the car not selling, the real reason for the car not selling was the hype that accompanied it. As Brooks writes “It was agreed that the safest way to tread the tightrope between overplaying and underplaying the Edsel would be to say nothing about the car as a whole but to reveal its individual charms a little at a time—a sort of automotive strip tease…The Ford Company had built up an overwhelming head of public interest in the Edsel, causing its arrival to be anticipated and the car itself to be gawked at with more eagerness than had ever greeted any automobile before it.” C Gayle Warnock, director of public relations of the Edsel division of Ford, shares an interesting example, which provides the real reason behind the failure of the Edsel car. In 1956, a senior official working on the Edsel launch (in fact it wasn’t called the Edsel then, it was just the E-Car) gave a talk about it in Portland, Oregon. Warnock was aiming for some coverage regarding the event in the local press. But what he got was something he had not expected. The story got picked up by wire services and was splashed all across the country. As Warnock recounts in the chapter “Clippings [of the media coverage] came in by the bushel. Right then I realized the trouble we might be headed for. The public was getting to be hysterical to see our car, figuring it was going to be some kind of dream car—like nothing they’d ever seen. I said… “When they find out it’s got four wheels and one engine, just like the next car, they’re liable to be disappointed.”” And this is precisely the reason why the Edsel flopped. The hype was so much that the public expected something that was totally out of the world. But what Ford was basically giving them in the rephrased words of Larry Doyle, the head of sales at the Edsel division, “exactly the car that they had been buying for several years.” As Doyle put it “We gave it to them and they couldn’t take it.” Further, it did not help that the first lot of cars was not properly manufactured. “Within a few weeks after the Edsel was introduced, its pitfalls were the talk of the land,” writes Brooks. Now replace the word Edsel with Nano and the situation stays more or less the same. The hype around the car was huge. When the car was launched in 2009, the entire world media was in Delhi for the launch. In fact, before the car was launched the rating agency Crisil said that the car could expand the Indian car market by 65%. People who had cars were already worried about the traffic on the roads getting worse than it already was, because of the Nano. Before the car was launched in 2009, prices in the used car market fell by 25-30%, given Nano’s expected price point of Rs 1 lakh. Nonetheless, Nano could not live up to the hype. In a May 2014 newsreport, the Business Standard pointed out that Launched in 2009,Nano sales between 2010-11 and 2012-13 constituted 23-24 per cent of Tata Motors’ total sales. But Nano sales declined dramatically after peaking to 74,527 in 2011-12. The numbers came down by more than 70 per cent in two years to 21,129 in 2013-14. Tata Motors has set up a facility at Sanand in Gujarat to make 250,000 Nanos a year.” So, the car sold nowhere near the numbers it was expected to. What did not help was that when the car actually started hitting the market in 2010, some units caught fire. After all the hoopla around the Nano, this wasn’t what the public was ready to accept. Brooks’ sentence written for Edsel can be re-written for Nano as well: “After the Nano was introduced, its pitfalls were the talk of the land.” Further, the hype around the car was so huge that the people were expecting something totally out of this world. They did not know what they wanted, but they did not want, what they got. The question that remains is how much could you expect out of a car which was supposed to be sold at Rs 1 lakh? The article originally appeared on www.FirstBiz.com on Nov 18, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)