Tag: Income Tax Act | Vivek Kaul

6 April, 2017

Of Section 269ST and Black Money-The More Things Change, the More They Remain the Same

In the budget speech made on February 1, 2017, the finance minister Arun Jaitley had said: “The Special Investigation Team (SIT) set up by the Government for black money has suggested that no transaction above Rs 3 lakh should be permitted in cash. The Government has decided to accept this proposal.” Black money is basically money earned through legal or illegal means but on which tax has not been paid.

In the Finance Bill (which is what the budget is) that was finally passed on March 30, 2017, this limit was reduced to Rs 2 lakh. This has led to the addition of Section 269 ST in the Income Tax Act. This is how the Section 269 ST reads: “No person shall receive an amount of two lakh rupees or more— (a) in aggregate from a person in a day; or (b) in respect of a single transaction; (c) in respect of transactions relating to one event or occasion from a person, otherwise than by an account payee cheque or an account payee bank draft or use of electronic clearing system through a bank account.”

Basically, the introduction of Section 269ST into the Income Tax Act does not allow transactions of greater than Rs 2 lakh in value to be carried out in cash. On the face of it, like many other government moves in the past, this seems like a good move. Indeed, this seems like a move with noble intentions given that it intends to move people towards digital transactions. And as people move towards digital transactions, the number of transactions carried out in black will come down.

In fact, the history of the Indian government (and I don’t just mean the current one) is littered with examples of decisions carried out with noble intentions. But in the end these decisions either do not make a material difference or go against the people they are supposed to benefit. Much of my new book India’s Big Government—The Intrusive State and How It is Hurting Us deals with this basic issue.

Getting back to the issue at hand. What does the Rs 2 lakh limit on cash transactions really mean? You cannot receive more than Rs 2 lakh in cash from a single person in cash in a day. So, if you receive Rs 3 lakh from the same person during a single day, even for two or more different transactions, then a penalty will be levied on you.

As the newly inserted Section 271DA of the Income Tax Act points out: “If a person receives any sum in contravention of the provisions of section 269ST, he shall be liable to pay, by way of penalty, a sum equal to the amount of such receipt.” This basically means that in the above example, the penalty shall work out to Rs 3 lakh.

Further, the penalty shall also apply in other situations. Let’s say there’s a single transaction of Rs 3 lakh and cash payments are made on three different days. Even in this case, the receiver of the payment will be liable to pay a penalty.

The third situation is the most tricky of the lot. It limits cash payments of greater than Rs 2 lakh relating to one event or occasion from a person. The words event and occasion have not been defined. Now let’s consider a marriage. In case of a marriage, this would mean that any payment of more than Rs 2 lakh in cash cannot be made to one of the suppliers. If such a payment is made, then the suppler is liable to pay a penalty.

One could also interpret this section with regard to cash gifts that are received during the course of a wedding. One interpretation of this can possibly be that a cash gift of more than Rs 2 lakh cannot be received from a single person. This would also include gifts from “relatives” as defined by the Income Tax Act, who are allowed to gift any amount of money.

So far so good. As I said the intentions are very noble indeed. Nevertheless, the first question is how will the government and more specifically the Income Tax department figure out that cash transactions of greater than Rs 2 lakh are taking place? Typically, such large cash transactions are carried out only if the two parties do not want the government to know about it, and in the process avoid paying tax on the transaction.

How does Section 269ST change that in anyway? Let’s say you go to buy a luxury good which costs more than Rs 2 lakh. The shopkeeper may not want to take cash for an amount greater than Rs 2 lakh. Then the Section 269ST becomes fully useful. But one always has the option to go over to another shopkeeper who is willing to accept cash and fudge his books of account. My point is that this new section will not have a major impact on black money in India, its noble intentions notwithstanding.

Also, the Section 269ST and or any other move of the government, doesn’t do anything regarding the demand for cash as a form of payment. This was and continues to remain the main problem when it comes to black money. Take the case a real estate builder. If you want to buy a flat, the builder will more likely than not demand cash from you. What will you do in such a situation? Tell him that under Section 269ST he is liable to pay a penalty if he receives a payment of greater than Rs 2 lakh?

Why does a builder take a portion of the payment when he sells a flat or a house, in cash? I think it is very important to understand this. He takes a payment in cash because he needs to make payments in cash. He needs to pay his suppliers in cash. But more importantly he needs to pay politicians and bureaucrats in cash.

Unless a builder has politicians and bureaucrats in his pocket, it is very difficult for him or her to be in the business of real estate, given how complicated the regulations governing the sector are. The speed money paid to politicians and bureaucrats essentially helps builders stay in the game. And this speed money cannot be paid in cheque or through NEFT/RTGS/IMPS and so on. It has to be paid in cash.

And this cash can only come from the buyer who is buying the flat or the homes that the builder has built. Unless this nexus between politicians and builders is struck down, the government can keep coming up with all the new sections and all the new changes, the demand for cash is not going to go anywhere.

As I keep saying, this can only happen if the system of electoral financing in India is cleaned up. Given the high cost of elections in India, the politicians need cash. And the builders and the corporates provide this cash. And there is nothing that the government has done on this front till date.

The column originally appeared in Equitymaster on April 6, 2017

4 May, 2016

Here’s a Good Joke: New Income Tax Data Shows India Has Only 20 Lakh Landlords

In yesterday’s column I had mentioned that only around 26 lakh Indians (to be precise the number is 26,01,777) filed for income from house property under the individual category, for the assessment year 2012-2013.

During the assessment year 2012-2013, income tax returns for the income earned during the year 2011-2012 had to be filed. A total income of Rs 29,927 crore was declared under this category.

Of this around 6.06 lakh individuals showed an income of less than zero from house property. This would primarily include people who have taken on a home loan to buy a house and are repaying it. During the financial year 2011-2012, an interest of up to Rs 1.5 lakh, paid on a home loan, in case of a self-occupied house, could be set off while calculating taxable income.

This meant that an individual repaying a home loan on a self-occupied house, could show a negative income of up to Rs 1.5 lakh when it came to income from house property. These are the individuals showing negative income against their house property. This negative income could be set off against taxable income and the taxable income could bethus brought down.

Further, the limit of Rs 1.5 lakh applied only to self-occupied property and not on other homes that a tax payer may choose to buy by taking on a home loan. Any amount of interest paid on such home loans can be claimed as a deduction as long as a “notional rent” is added to the income.

We all know that over the last few years the “rents” have been very low in comparison to the EMIs that need to be paid in order to repay the home loan. The rental yield (rent dividend by market value of the home) is in the region of 2-3%.

Even after deducting a notional rent, the interest component tends to be massive during the initial years. Hence, the difference between the notional rent and the interest paid is negative. This essentially means income from house property is negative. Such individuals who own more than one home financed through a home loan, also earn a negative income from their house property. This negative income helps people with two or more homes, claim huge tax deductions.

This “deduction” has been used over the years by well-paid corporate employees to bring down their taxable income. Further, individuals who use this deduction benefit on two fronts—tax deduction as well as capital appreciation.

Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling and thus prevent a faster fall in home prices.

Getting back to the point, there were only 6.06 lakh individuals in the assessment year 2012-2013 who had an income of less than zero or a negative income from house property. As I said, these are people essentially repaying their home loans. The interest they pay on their home loans can be set off against taxable income.

It is worth asking here that does India have less than 6.06 lakh individuals living in self-occupied homes on which home loans are being repaid? Something just doesn’t add up here. Honestly, this is bizarre.

As a newsreport in The Economic Times points out: “In 2011, the number of accounts was 47.32 lakh, which went up to 47.78 lakh in 2012, with the disbursed amount also increasing from Rs 2.5 lakh crore to Rs 2.6 lakh crore.”

If the banks had close to 47-48 lakh home loan accounts in 2011 and 2012, why are only around 6.06 lakh showing up in the income tax data?

Also, around 19.95 lakh people declared an income from house property in assessment year 2011-2012. This is another extremely low number. What does this mean? It means that the number of individuals in India who are earning a rental income from their homes (real as well as notional) is around 20 lakh. How is that possible? It means is that there are around 20 lakh landlords in the country, if the data from the Income Tax department is to be believed.

It is worth recounting here something that Akhilesh Tilotia writes in The Making of India based on the 2011 Census data: “India’s households increased by 60 million to 247 million from 187 million between 2001-2011. Reflecting India’s higher ‘physical’ savings, the number of houses went up by 81 million to 331 million from 250 million. The urban increases is telling: 38 million new houses for 24 million new households.”

This means India had 331 million or 33.1 crore houses in 2011. Now compare this with the fact that there are around 20 lakh individuals earning a rental income from their homes. This comparison clearly tells us how low the 19.95 lakh number, really is.

There are two things that become clear here. One, is that many individuals are just buying up homes as an investment and not putting it up on rent. Anshuman Magazine, chairman and managing director of CBRE South Asia Pvt. Ltd., in a 2015 article wrote that “around 1.2 crore completed houses” are “lying vacant across urban India”.

Further, this is a clear indication of the fact that most landlords are getting their rents paid in cash and not paying any income tax on it. It also leads to the question where did these people earn the money to build these houses in the first place?

Here is another interesting data point—Of the 19.95 lakh who have some rental income, around 14.55 lakh have an average rental income of around Rs 60,000 per year or Rs 5,000 per month. This number is very low as well.

The point being a major part of the black money in India continues to be generated in the real estate sector. The general impression we have had up until now is that black money is generated when real estate is bought and sold. Nevertheless, with this new data it is very clear, that black money is generated even when real estate is rented out.

The column originally appeared on the Vivek Kaul Diary on May 4, 2016

10 February, 2015

One thing that Jaitley can do to control speculation in real estate

In response to yesterday’s column I got an interesting email from a reader. The email has prompted me to write another column on real estate.
Talking about the budget presented by the Narendra Modi government in July 2014, the reader said: “The most detrimental thing that the government did was hike the deduction limit from Rs 1.5 lakh to Rs 2 lakh!!!”
The finance minister Arun Jaitley had said in his budget speech: “Housing continues to be an area of concern for middle and lower middle class due to high cost of financing. Therefore, to reduce this burden, I propose to increase the deduction limit on account of interest on [home] loan in respect of self occupied house property from Rs 1.5 lakh to Rs 2 lakh.”
This should not have been done the reader suggested, as it leads to more speculation in real estate. As he wrote in his email: “ Even in Vasai or Virar or any other distant suburb from where people come to Mumbai to work, flats are not cheap.” What makes the situation worse is the fact that “people with high incomes living in Mumbai invest in such distant suburbs to avail tax benefits and capital appreciation.”
What the reader was basically saying is that individuals who already own flats and are living a comfortable life in Mumbai, buy “cheaper” flats in suburbs to avail tax benefits. I am sure something similar must be happening in other cities as well.
At the same time such individuals hope to make capital gains from the purchase in the years to come, as real estate prices keep going up. With more money chasing the same number of flats, prices go up. This makes flats more expensive for people who want to buy and live in them.
While the reader has got the speculation bit right, he has got the tax part of it wrong. It doesn’t make any sense for an individual to buy a flat for the sake of investment, so that he can get a deduction of Rs 2 lakh on it and save Rs 61,800 in the process (assuming he comes in the top tax bracket and pays a total tax of 30.9%).
The amount is too small to be taking on the headache of owning a flat in a distant suburb. Further, chances are that the individual would be already repaying a home loan for the flat that he lives in. Hence, he can’t take the same deduction for two flats.
Nevertheless, it would still make sense for an individual looking to buy a flat(and this need not be limited to just one flat) for investment purposes to go ahead and save money in the process.
In fact, the Income Tax Act actually encourages people to speculate in real estate. There is no restriction on the number of homes against which a tax payer 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 2 lakh can be claimed as a tax deduction.
This limit applies only to the self-occupied property and not on other homes that a tax payer 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. This was the point that the reader who sent in an email was trying to make, even though he got the tax deduction part wrong.
This “deduction” has been used over the years by well paid corporate employees to bring down their taxable income. Further, individuals who use this deduction benefit on two fronts—tax deduction as well as capital appreciation. Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling.
While offering a tax deduction on a self occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “deduction” needs to be plugged immediately as it encourages speculation.
Arun Jaitley has an opportunity to do a huge favour to the people of this country by removing this deduction in the forthcoming budget. Whether he goes around to do that will only become clear once the budget is presented on February 28, later this month.

Postscript: I had written in a column last week that I would be surprised if the economic growth for this financial year would be greater than 7%, as per the new method of calculating the GDP. Data released yesterday by the ministry of statistics and programme implementation suggests that the Indian economy is likely to grow by 7.4% during this financial year. Turns out I was wrong in writing what I did.
As per the old method of calculating the GDP the economic growth during this financial year was supposed to be at 5.5%. No reasonable explanation has been offered for this jump in growth. At the same time other high frequency data like bank loan growth, corporate profitability, stalled projects, massive slowdown in collection of tax revenues etc., seems to suggest that the economic growth should be more around 5.5% than 7.4%.
I will keep track of this and in the days to come will try and come up with a possible explanation for this huge difference in the two numbers.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 10, 2015

2 December, 2014

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

Tax	Year	(in Rs crore)
	2012-2013	2013-2014
Corporate Income Tax	68,720.0	76,116.3
Personal Income Tax	33,535.7	40,414.0
Excise Duty	209,940.0	195,679.0
Customs Duty	254,039.0	260,714.0
	566,234.7	572,923.3

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. There 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

18 June, 2014

India Inc. benefits from complex tax laws even as it demands simpler ones

The Narendra Modi government will be presenting its first budget in about a month’s time. It is that time of the year when business lobbies meet the finance minister and present him with their wish-list of what they expect from the budget. This year, among other things, the lobbies seemed to have asked for a simpler tax regime. “A simple, transparent and non-adversarial tax regime, bereft of complexities and ambiguities, would go a long way to strengthen business sentiment and restore faith of the foreign investor in the India growth story,” Ajay Shriram, president of Confederation of Indian Industries (CII) told the media. It’s hard to argue with that demand. But a closer examination will reveal that the companies represented by such industry bodies benefit the most from a complex tax system, which allows for a slew of exemptions and loopholes. Do do Indian businessmen really mean it when they say they want a simpler tax regime?
Along with the budget every year, the government of India releases the “statement of revenue foregone”. The statement for the financial year 2013-2014 provides some interesting information about the income tax paid by Indian companies during the 2011-12 fiscal.
The statement considered the tax expenditure of 4,94,545 companies for an interesting bit of analysis. While the statutory tax rate was 32.445%, the effective average tax for these companies came in at 22.85%. What explains this difference of ten percentage points? The complex tax regime. How? We shall see in a moment.

Interestingly, the greater the profits made by a company, the lower was its effective rate of income tax. As can be seen from the table above, companies which made a profit of between Rs 0-1 crore had an effective tax rate of 26.26%. For companies which made a profit of greater than Rs500 crore, the effective rate fell to 21.67%.
More than half the companies in the sample (around 53.2%) had an effective tax rate of up to 20% of their profits. “In other words, a large number of companies (263,315) contributed a disproportionately lower amount in taxes in relation to their profits,” the statement points out.
So, why is there such a huge difference between the statutory rate of income tax and the effective rate that the companies are paying? The only explanation for this is the huge number of deductions allowed by the Income Tax Act, 1961. Every deduction that has been added to this Act over the years has made it inherently more complicated, and less simple. And companies have been taking advantage of this complexity and ensuring that they do not have to pay tax at the statutory rate.
The revenue foregone, or the money that would have flown to the exchequer if all companies paid statutory tax rates, has been rising. The figure was Rs 81,214.3 crore for 2011-2012 and was expected to be at Rs 89,446.6 crore for 2012-2013.
The effective rate of income tax that companies pay has marginally risen over the years. It went up from 20.55% in 2006-2007 to 24.1% in 2010-2011 and fell to 22.85% in 2011-2012. The rate of increase in the effective rate of income tax paid by companies has been very slow.
When companies complain about the complex tax regime, what they mostly mean is that they want a less aggressive income tax department. The complexity in rules translate directly into more money for companies, and in general, they have not been known, anywhere in the world, to lobby hard so they could make less money.

The article originally appeared on qz.com on June 18, 2014