The evasion of income tax in India is rampant. What are the administrative solutions? How can evasion of income tax and capital gains tax in India be reduced to US/European/Japanese level or lesser, without creating any harassment on an honest tax-payer?
I do NOT see any one single remedy. I have proposed several small changes, each small change reduces the income and capital gains tax-evasion by a fraction, but togather they add up, and make tax evasion as less as it is in the West. At the same time, NO procedure I proposed increase hardship to ANY honest tax payer. Perticularly, not even one procedure I propose increase "search and seizure" powers of IT-officers, or even his power to send notices. Not even one procedure I propose increase discretionary powers of IT-officers. The burden of book-keeping DOES certainly increase, but it is something that can be easily automated, and will NOT create any problem to an honest tax-payer.
Most of my suggestions are copying the laws/procedures used in US and extending them.
What is universal ID system? A system where CENTRAL Govt has issued one and ONLY one ID to every person, every company, every firm, every bank, every bank account and as many peices of of property such as share, bond, land plots, flats etc. AFAIS, it is nearly impossible to reduce tax evasion in India to Western level without a universal ID system. And it would TRIVIALLY easy to bring tax evasion to western level once we have a enacted universal ID System. And it is TRIVIALLY easy to create a universal ID system for covering ALL entities such as individuals, companies, associations and major peices of property.
An ID system for individuals can be created using procedure ID.03. An ID-cum-ownership system for land/plots can be created by procedure ID.05. The Registrar of Companies already has a procedure to issue IDs to companies, which should be extended to cover partnerships. And the properitorships should be required to carry name and tax-ID of the owner. The banks have two flaws :- registration of tax-ID is NOT required to run a bank account and banks re-cycle bank account numbers and so there is no one-one relation. Once these two flaws are fixed, the bank accounts will have a universal ID. The shares/bonds have IDs and so do share accounts (so called deemat accounts) but again the system is incomeplete.
Preferably, ID should be 12-14 digit number, with digits only and no letters, and first digit should be non-zero. ID MUST not be recycled. I will show that by merely creating ID systems and improving them, tax-evasion in India can be reduced to as low as it is in west without increasing powers of IT-officers.
Proposal TX.01.0002 - Reporting interest reciever's tax-ID to Income Tax Dept
If a bank, post office savings or a private company gives interest on FDs or any account to any person, it MUST report the amount, date on which interest was paid, and the reciever's tax-ID to Income Tax Dept at the end of the quarter as well as end of the year.
Benefit of TX.01.0002 :
Say a person has 100 FDs of Rs 50,000/- totalling Rs 50 lakhs in 100 DIFFERENT banks at say 8% each. So interest is Rs 4000/yr per FD totalling Rs 400,000/-. Now the banks will NOT deduct taxes on this interest as TDS i.e. tax deduction at source in case of bank interest is ONLY when interest on FD is above Rs 5000/yr. So as of today the person can just evade all the taxes due on this interest income of Rs 400,000/- simply by NOT reporting this income !!!
And the situation in postal savings bank is truely hilarious. In case of postal savings, the administrative details are managed by Department of Posts. But it is the Finance Ministry which pays interests on postal savings. And the other department inside Finance Ministry, namely income tax dept, fails to collect taxes on that interest !!! So the right arm of Finance Ministry pays interest, and left arm of Finance Ministry doesnt even come to know about evasion ! Today, lakhs of individuals collect interest from post offices, and simply DO NOT show the interest income in their returns, and evade taxes.
The proposed procedure TX.01.0002 will stop this. Once each citizen has an ID, and once banks are required to register and report IDs of ALL interest recievers, such evasion will stop. Say the person's ID is #700897. Then each of the 100 banks will report that person #700897 has been paid an interest of say Rs 4000/-. Hence when person #700897 files return, and if he does NOT report the interest income of Rs 4000/- from each of this bank, the ITO can easily note that the person is under-reporting his interest incomes. Hence the person has NO option but to report his interest income of Rs 400,000/- and hence pay the taxes on it
Also, consider postal savings banks. Once each citizen has an ID, and ALL post offices register the ID on EVERY postal savings and every interest payments to Income Tax dept, the interest earners will NOT be able to evade the income tax due in the interest.
[Aside : The Income Tax code needs to be modified in case of FD interests. Say a person takes FD of Rs 100,000/- @10%/pa compounded annually for 3 years. Say he takes accumulation option. So the person gets interests as Rs 10000, Rs 11000 and Rs 12100 in 1st, 2nd and 3rd year respectively. But the person gets NO interest in his hands for 1st and 2nd year. But nevertheless, he is asked to pay income tax on this "income". Such "income tax" law is counter intuitive. There are valid reasons to keep it, but still it should be made optional. Basically, the person should have OPTION of specifying at the time of buying FD if he wants to pay tax every year or at the maturity. If the option is every year, the person should pay the tax every year. If the option is "tax at maturity", the bank should withheld X% of interest as TDS, and there should be no tax in the intermediate years. And the bank can charge interest as expense ONLY in the year it actually gives the interest. ]
The IT-Dept will instruct the state govts and municipalities to freeze the sale of land/plots till IDs of the owners of land/plots are registered, and owners have disclosed seller's name and address, purchase price and year in which they had purchased the plot/flat.
The IT-dept will obtain a list of ALL flats/plots from local municipalties along with the tax-ID of the owners. For every plot/flat whose tax-ID of the owner is unknown, the IT-dept will send a notice to the owner to pay an additional tax of 0.5% of land value per quarter, till he registers the seller's name address and tax-ID and the date/year of purchase.
Benefits of TX.01.0007 :
This will enable the IT-Dept to ensure that every person is correctly reporting his real estate wealth in his asset statement. In addition, it will also enable IT-dept to trace the those sellers who have evaded capital gains tax in past seven or fewer years. It will stop capital gains evasion henceforth, and would also improve collection of wealth tax.
Even though laws related to check bounce are quite tough, the burden of serving notice, summons and warrants lie on complainer. In many cases, if the accused may be untraceable, in which case serving him summons also becomes difficult. The police/courts MUST assume the responsibility of brining the accused before the court. Solution? We need to improve summon sending system. How? Please see procedure RN.12 for details.
CCs charge 2% to 4% surcharge. This is too high in may cases. Solition? Improve telecommunication so that cost redcues. How? Please see COMM.01 ,
COMM.02 ,
COMM.03 and
COMM.04 for details.
Recently, a court declared that if a person gives a bank check on a ceratin day, but he had closed his account BEFORE THAT date (on which he had given the check), the law related to check bounce (so called section-138 of Negotiable Instrument Act) will NOT apply. The regular law of defrauding (IPC section 420 etc) may apply. But it is difficult to prove conviction under regular fraud cases, as in such case, the accused can say that there was no payment due, and the burden of proving that a payment was due lies on check reciever. IOW, the check reciever is at disadvantage. This has further reduced the use of bank checks. Solution? The procedure TX.01.0010 will partly solve the problem.
Procedure TX.01.0010 : A following type of check may improve the use of checks and thus increase accountability in commerce and thus reduce tax evasion :
A bank can issue a special type of check, called self-expiring checks, which will have the name, address, the tax-ID and the date on which the check book was issued. This will be PRINTED. The bank, upon the request of account holder, may also print "below Rs X" note. These checks will be considered expired six months after they are printed, used or unused.
A person who has opened such an account CANNOT close the account for 8 months after he had last issued a check book.
If a check issued by such a person bounces, and if same check is presented again, and it bounces again, the check-owner would ONLY need to present the check before the court. The court shall write the notice to the check-writer at the address specified on the check. It would be responsibility of court/police to arrest him subsequently.
If the person is NOT traced for 2 months, the court will instruct ALL banks in India to freeze the bank accounts if the account has that specific tax-ID. This can be implemented by courts sending a note to RBI's main office in Mumbai, and then RBI sending memo to ALL banks.
If and when the accused is traced, the Jurors will decide the case.
Benefits of TX.01.0010 :
The sellers will be willing to put more and more faith in checks, and checks will gain acceptance. When certain sellers start using checks, other sellers too will be pressurized to accept checks, or else buyers may flee to them. In such cases, checks will gain wider and wider acceptance. And the increase in payments by cheks will reduce tax-evasion.
Proposal TX.01.0012 : Accounting for bad debt and unpaid expenses
If payment is NOT recieved within 3 months, the person should be allowed to take the payment off the income from the final return (NOT the quarterly returns).
Removing an expense : If payment is NOT made within 3 months, the person MUST be required to take expense off his books for the current year in the final return (NOT the quarterly returns).
Proposal TX.01.0013 : Gift Tax to fund Military
Gift tax for Military : All gifts, except gifts from close relatives should be taxed (close relatives would mean spouse, sibblings, parents, children ONLY and not even in-laws).
The gift reciever must report gifts in excess of say Rs 20000/- in a year, except gifts received from close relatives, and bracket it as income, and pay tax on it.
The gift tax will be equal to highest marginal tax rate. The money from gift taxes will be used strictly for defense.
Benefits of TX.01.0013 :
Will increase funds for military.
Proposal TX.01.0014 : Taxes on income from agriculture
If a farmer has only agricultural income, and net income from agriculture is below Rs 100000/yr, there will be no tax. The income above that will be taxed at normal rate. If he has non-agricultural income of Rs X, the exemption on agricultural income will be only (Rs 100000 - Rs X).
For the purpose of deduction of farm expenses such as electricity, labor, fertilizer etc, if the farmer has more than 50 acres and/or total (total, not just agricultural) income of any of the past 5 years is above say Rs 200,000/yr, he MUST maintain the books. If the land holding is below 50 acres and his income of all the past 5 years is below Rs 200,000/yr, he has two options:
he may maintain books OR
take x% deduction from his total sales of farm output as expense where x will be the amount decided by the Income Tax Dept and Argricultural Ministry. OR
may deduct Rs X per acre of land he owns as expenses, where X will be the amount decided by the Income Tax Dept and Argricultural Ministry, and may be based on the crop he sells. If the farmer takes this option, he must disclose the plot numbers and sizes of the plots he used for agriculture. And if a plot has more than one owner, he must disclose his %-ownership of the plot, and can take ONLY proportionate amount of Rs X as deduction. eg say IT-dept allows to deduct Rs 20,000/acre as expenses from gross reciepts. And the farmer has 40% share on the plot of 50 acre. Then he can deduct Rs 20000 * 50 * 40/100 = Rs 20000 * 5 * 4 = Rs 400,000 as total expenses from the gross reciepts.
The money from taxes from agricultural income will be used strictly for defense.
Benefits of TX.01.0014 :
Will increase funds for military.
Proposal TX.01.0015 : Abolishing HUFs
All properties owned by HUFs should be bracketed with properties of "karta" of HUFs.
The Income Tax dept will ask the banks to close ALL bank accounts/FDs in the name of HUFs, and would ask the banks to return the funds to the karta of HUF using payee-ac checks.
The Income Tax dept will ask state govts to freeze ALL lands/flats in the name of HUFs, till HUF's karta transfers them in the name of himself. The wealth tax will be twice till the karta transfer this property.
The Income Tax dept will ask ALL companies and its registrars, to freeze ALL shares and withhold dividends in the name of HUFs, till HUF's karta transfers them in the name of himself. The DPs will be asked to freeze all shares in HUF accounts till HUF's karta transfers account in his name.
Likewise, ALL loans given to or taken from HUFs will be become liability or property of the HUF's karta.
The Income Tax dept will void ALL tax-IDs issued to HUFs.
Benefits of TX.01.0015 :
Thus incomes of HUF will become income of karta, and thus income tax collection will increase.
Proposal TX.01.0016 : Abolishing deductions and rebates
All deductions, except those necessary to run businesses, should be abolished. In short,
no rebate/deductions for donating to charities
no rebate/deductions for any kind investments including retirement investment including provident funds and private provident funds
no rebate/deductions against education fees
no rebate/deductions on buying houses
no rebate/deductions on interest payments on personal loans, car loands, house loans, education loans etc
no rebate/deductions for being a women (rebate for senior citizens may continue)
no rebate/deductions on incomes from salaries (i.e. so called standard deductions should be cancelled).
no deductions/rebate on incomes from dividend or interest incomes from banks or LIC etc.
No deductions for incomes from exports
No deduction/rebate from income from software export
Benefits of TX.01.0016 :
Rebates and deduction only increase relative net taxes on lower income group. eg Consider Rs 5000/- rebate to females. Obvuously, a women who is earning Rs 40000/yr will get ZERO benefit of this, while maximum benefit goes to someone earning say Rs 90000/-. IOW, reducing tax rate and cancelling rebated deduction give LARGER benefit to those in lower income groups.
Besides, rebates and deductions divert investments to less efficient areas from more efficient areas. eg say a person gives loan of Rs 100,000 to a another private person who is willing to pay interest of 15% i.e. Rs 15000/yr. And say highest bank interest is 12% i.e. Rs 12000/yr. Then also person will give money to bank. Why? Becuase bank interest of upto Rs 12000 is tax free. So when bank gives Rs 12000 of interest, the tax due is zero, while in first case the person will have to pay tax on ALL Rs 15000. Such rules prompt a person to make LESS efficient choices.
Also, the way things work, the finance ministry's officers/ministers just extract bribes when in comes to creating categories for deduction/rebates. eg CEOs of some top companies gave HUGE bribes to Finance Ministers, their officers and PM in year 2003, and we saw a strange law -- if a person invests in shares of some top 500 companies (called A scrips), the long term capital gains tax was ZERO. But capital gains tax was applicable in OTHER companies' shares and also applicable in case of GoI bonds !!! Such selective deductions, rebates or ANY other type of exemptions ONLY increase corruption and erode efficiency.
So SAY NO to all deductions, rebates and selective exemptions.
Proposal TX.01.0017 : Abolishing tax-exempt status of ALL charities, temples, educational trusts, health trusts etc
The charities should be required to pay taxes on ALL its incomes such as incomes on interests, income from its businesses etc. just like regular companies.
If the charity has recieved donations by check from an entity in India, it must report it to IT-dept with the tax-ID and account number of the donor.
if the donation giver was in highest marginal tax rate bracket in the previous year, then the charity will need to pay NO tax.
In case donor was in a lower tax rate bracket, the charity will need to pay the difference as tax. eg say donor was in 20% gift bracket when highest tax rate is 30%. Now if the donor gives a donation of Rs 100,000/-, the charity will need to pay a tax of 10% on THAT donation i.e. Rs 10000/-.
In ANY case, the donation giver will get NO deduction in his taxes from this donation.
If the charity has recieved donation by cash, or by DD/check from an unknown source or if the donor's previous year's marginal tax bracket was unknown or donation (or transfer payment) was from a foreign country including UN or charity registerd in a foreign country, the charitable institution MUST pay highest marginal tax rate on the donation as tax within 90 days after it recieves the donation.
There will be no tax on money transferred from one charity to another as long as both are in India.
the money recieved from this tax will be used strictly for defense and nothing else.
Benefits of TX.01.0017 :
Military will have more funds. And tax evasion in the name of charities will reduce.
Proposal TX.01.0018 : Reducing "tax evasion via ghost salaries"
What is tax evasion via ghost salaries?
Consider existing (Apr-2004) tax laws/rates in India. Consider following scenario
As of Apr-2004, in India, income tax due on a man with salary income below Rs 75000/yr i.e. Rs 6300/mo is zero. And on a woman with salary income below Rs 120000/yr i.e. Rs 10000/mo is zero.
Now say the employer is ACTUALLY paying his employee Rs 2500/mo i.e. Rs 30000/yr.
Say employer's net income after ALL deductions including salary is Rs 400,000/yr i.e he is in highest marginal tax i.e. 30% bracket.
Now how can employer reduce his taxes without reducing income?
Welcome to the world of GHOST SALARIES.
How is ghost slary implemented
The employer can pay the employee a salary of Rs 6000/mo and then ask the employee to repay Rs 3500/- back. Or just pay the employee Rs 2500/- and ask him to sign on a voucher that "salary of Rs 6000/- has been paid."
IOW, official salary stated in income tax return would be Rs 6000/mo, of which Rs 2500/mo is REAL and Rs 3500/mo is GHOST salary.
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So employer's "official" income will reduce by Rs 3500/mo i.e. Rs 42000/yr. And the employer evades a tax of 30% * Rs 42000 = Rs 12600/yr.
If the employee is female, the employer can even officially state the salary as say Rs 10000/mo i.e. about Rs 120,000/yr on paper, while in reality it may be just Rs 30000/yr. And thus employer can "save", rather evade, taxes of about 30% of Rs 90000 = Rs 30000.
So Rs 12000 to Rs 3000 of evasion is per employee is possible/ Most employees will NOT go that far, they will evade say Rs 5000 to Rs 10000 per employees. But this is per employee. An employer with 5-10 employees can easily evade similar amounts for every employee.
Now why would employee also agree to report such WRONG ghost salary? There are three reasons
Employee has nothing to lose : The taxes due on employer are zero whether salary is shown as Rs 30000/- or shown as Rs 75000/- (or Rs 120000/- in case of females). So the employee has NO real reason to refuse employer's demand to show an additional ghost salary.
Fear of getting fired : These days, unemployment runs so high that employees have no option but to treat employers like God, and it is impossible to turn down such zero cost requests.
In addition, the employee too has one advantage --- by showing inflated ghost salary incomes, he qualifies for a larger bank loans. In India, where interests on loans from private street lenders are 3% to 5% to 7% per MONTH i.e. 36% to 80% per YEAR, while bank loans are 8% to 12% per year, the salary earners are always eager to get bank loans for house, furniture, personal expenses etc. Now maximum amount a bank will loan will depend on income reported in past 3 years income tax return -- higher the ghost salaries -- more the low interest loans banks would give and thus lesser the loans they will need to take from loan sharks --- lesser their TOTAL income burden. So sometimes, you see employees requesting employers to over-report salaries !!
Here is another way businessmen use ghost salaries to evade taxes
Say there are two businessmen A and B.
Both have earned say Rs 300,000/- in their business incomes, and say their wives' actual incomes are nil.
Then A will report a ghost salary paid of Rs 120,000/- to B's wife, so tax liability of B's wife will still be zero, while A's tax liability will reduce by 30% * 120000 = Rs 36000/-.
Then B will report a ghost salary paid of Rs 120,000/- to A's wife, so tax liability of A's wife will still be zero, while B's tax liability will reduce by 30% * 120000 = Rs 36000/-.
SOLUTION
TX.01.0018 : Collecting refundable excess tax can partly reduce the problem.
The salary returns should be filed every quarter
If the annual salary of a person is above Rs 24000/yr, the payment over Rs 24000/- MUST be by payee-ac checks ONLY. As time passes, the limit should be further reduced. The employer pays a salary of above Rs 24000/- in a month, he will need to pay a charge of 20% of the salary above Rs 24000 paid.
Salary expenses MUST be expensed on CASH basis, i.e. the employer can take the expense ONLY when the check was deducted from his account, NOT when the check was given.
The tax on salary above Rs 2500/mo or Rs 30000/yr should be deducted at highest marginal tax rate, and the difference will be repaid to the wage-earner a certain number of years, along with PLR interest.
eg1.
say marginal tax rate is 30%
if salary of a person is Rs 2500/mo i.e. Rs 30000/yr, the tax deducted will be zero.
if salary is Rs 4000/mo, then on salary above Rs 2500 i.e. Rs 1500 the tax rate will be 30% i.e. tax of Rs 2500 * 30% = Rs 750 will be deducted by the employer and deposited with IT Tax dept same quarter. The employee will get Rs 4000 - Rs 750 = Rs 3250
The employee will get this amount back after certain number of year, along with PLR returns.
How do the above procedures reduce ghost salaries? If an employer wishes to over-report salary, he will still need to pay the highest marginal tax rate. And the refund will go to the employee, and when employee gets the excess tax back, there is no guarantee that employee will return the money back to the employer. So the employer is unlikely to enter into such deal
Benefits of TX.01.0018 :
The reduces tax evasion by ghost salary.
Proposal TX.01.0019 : Flat income tax
Both, the progressive and regressive taxes are unethical.
If any activity's cost is to be borne by the society, it is MUST that everyone bears the cost in the SAME proportion to their incomes. There is NO ethics in saying that he who earns more should pay higher taxes. If not flat, I would propose following tax rate based as of 2004 level
Income below 50000 : 0%
Income between 50001 and 10,00,000 : 10%
Income above 10,00,000 : 20%
Such flat taxes will reduce tax evasion by ghost salaries.
In US, if one takes employee as well as employer side social security tax into account, income tax is a flat tax. Which is why one would never see ghost salaries in US.
Benefits of TX.01.0019 :
Flat taxes reduce evasion, and if coupled with wealth tax, there is NO decrease in total tax collection. In fact, the tax collection will increase. Also, flat tax may increase income/wealth inequality, but it DOES not increase poverty.
Improving administration of Income tax dept
Following procedures will improve internal functioning of Income Tax dept
The PM should appoint Finance Minister, who should appoint Income Tax Dept's Chairman (which is the case today).
The citizens should have powers to replace IT Chairman by RLPP. What is RLPP? It is fast/inexpensive procedures
Proposal TX.01.0020 : Compulsory payments by checks
Income tax dept should ask certain companies to take certain payments strictly by tax-ID stamped check/CCs, and report the reciept from each tax-ID.
Some examples can be :
electricity bill
phone bills
gold
insuarnce policy payments
and so forth
Advantages :
This will ensure that a person can spend only the money on which he had paid income tax.
Draft of the act to create procedure TX.01
There is NO one single draft to enact TX.01.
I have proposed 3 drafts to enacts some parts of TX.01.
To bring RLPP/Jury over employees of Income Tax dept and to bring Jury System in Income Tax trials, the citizens would need to pass a law in the Parliament.
To create ID-based reporting of expenses, the Parliament first needs to pass a draft that would ensure that every person indeed has an ID. Please click here for the description of ID system. Once ID system is enacted, the citizens need to pass a draft that would make reporting of ID compulsory.
To implement other proposals related to improving collection of income/capital gains taxes, a draft for each is needed in the Parliament.
Now citizens can ask MPs to pass this Act. But IMO, it will be wiser for citizens to first enact procedure LM.03, and then use LM.03 to pass these drafts WITHOUT any help from MPs. To know about procedure LM.03, please click here .
If you have any other question, please mail it to MehtaRahulC@yahoo.com. Thousand thanks in advance.
