JUNE 08, 2009

BUDGET 2009-10

By Sukumar Mukhopadhyay, Former CBEC Member

THE 2009-10 Budget is the first Budget of the New Government. The Finance Minister has already announced that the priorities are two. The first is to ensure growth, which is to come out of the recession and catch up with the growth path which the economy had already aligned itself to. The second priority is to bridge the fiscal deficit which is very near to an alarming percentage if both Central and State deficits are added together. Both the priorities, however, are mere statement of the goal. The means to achieve this end are what we are going to discuss now from the angle of indirect taxes. I remember that when the NDA Government was in power in the year 2000, it announced the aim of achieving the double digit growth rate. To make it possible it was felt necessary that the structure of indirect taxes and direct taxes be reformed and rationalised so that the revenue realisation becomes optimum. That would generate enough savings in the hands of the government for further investment at the same time leaving enough funds in the hands of private investors. The Planning Commission set up an advisory group consisting of different experts and gave its report in May 2001 advising on how to mobilise resource for the 10 th Plan to make double digit growth possible.

The suggestions that were made at that time in the Report of the Advisory Group on Tax Policy and Tax Administration have been implemented only to some extent but very many suggestions have not been implemented on the indirect tax side even now. Had they been implemented the present tariff and the tax laws would have been far more resilient to the needs of the Budget making that the present Finance Minister is faced with.

Now coming to the actual proposals I propose to begin with the Central Excise Tariff. The Central Excise Tariff is supposed to have been simplified. That is the current impression given in the last few Budgets. In reality the tariffs remain quite complicated which can be understood only if you go through all the notifications and the alternative rates of duties. Even now, long winding circulars are being issued by the Central Board of Excise and Customs on whether coconut oil in packs of 200 ml should be taken as hair oil or as ordinary coconut oil. This has been the reason for ongoing battle for at least two decades that I can clearly remember. All this is because of different rates of duty even now prevailing. This is not the end of the battle on coconut oil because the moment the circular mentions “200ml”, manufacturers will start packing the oil in 225ml. These controversies can be solved only by making the rates of duty equal. Right now there are so many rates. A comparison is given below:

Rates of Central Excise Duty:

Table

Some of these rates have been changed after the 2008-09 Budget (for example, 14 has become 10 temporarily) but the structure remains the same.

The exemptions have also remained as plentiful as they were several years back. A comparison of the last three years based on only the main exemption for all tariff items is given below:

Budget 2005 2006 2008

From the tables above one can easily see that in the last 10 years there has not been any substantive improvement in the number of rates, the number of exemptions and the complications therefrom. In fact if one sees the total volume of the tariff book, one would find that it is almost double the tariff of 1995-96. It is only a myth that the rates have now gravitated to 16% or 14% or 10% temporarily. It is true that majority of the items that attracted 16%, are now charged14%. In fact the number of items attracting 8% has increased. It is widely accepted now that 8% has become almost as important as 14%. All textiles have become 8% in place of 14%. It does not simplify matters at all. When in most of the chapters the choice before the assessing central excise officer is to resort to the duty rates of 14% or 8% or nil depending on the conditions and the lists in the exemptions, one can hardly draw any comfort from the fact that the 14% and 8% are two major rates. Some of the chapters such as chemicals, textiles, machinery, vehicles and instruments have become so riddled with exemptions and conditions etc that simplification seems to be the last thing in the minds of the Budget makers. In the wake of a looming GST it is better to keep this 10% rates universal for all the goods so that the service tax rate also can be the same.

Now let me come to some specific cases where exemptions can be abolished either immediately or gradually.

(i) There is extreme populism involved in geographical exemptions. These exemptions are utilized used mostly for making peripheral activities such as packing, labelling, etc., which are technically manufacture but in effect they hardly involve any investment and they also hardly increase employment. They are mostly misused to evade duty. There are many instances where the expansions in the factory are taking place in the exempted areas. So the growth in the exempted area is at the cost of growth in the non-exempted area which is the bulk of the country. Whatever else may be done to promote investment in the underdeveloped places, excise relief is certainly not the one. A neutral tax is universally regarded by the Economists as a desirable tax system. A sun set clause could be introduced on the geographical exemptions saying that it will lapse now except where firms have already availed of the exemption by making substantial investment.

(ii) Pan Masala: Reducing the duty on pan masala from the general rate of 14% to 8% has been against all economic norms and also against consideration of health. To put it precisely, the Government has reversed the Sin Tax. A tax that is imposed on products or services that is seen as vice or sin such as alcohol, tobacco and gambling is called a sin tax. These types of taxes are levied by government to discourage an individual from partaking in such activities without making the use of the product illegal. The additional advantage is that these taxes provide a source of government revenue. Governments favour sin taxes because they generate an enormous amount of revenue. They are usually accepted by the general public because they are indirect taxes and affect those people who consume them. They do not affect the general populace who would even be prompted to stay away from such products as far as possible. In fact, these heavy taxes on sin prevent people at least to some extent to commit those sins. Sin tax is considered as one of the traditional means of bringing a modicum of market forces to economic situations where externality problems exist. And thus it results in better market efficiency. The generic name for such taxes levied to correct negative externalities of a market activity is Pigovian tax. This tax is named after the economist Arthur Pigou who also developed the concept of economic externalities. In the working of the Pigovian tax the key problem is that of calculating what level of tax will counter balance the negative externality.

So my suggestion is that the latest initiative taken to reduce the Sin Tax has not been on economic consideration but on external considerations. This Budget should put an end to such “externalities”.

(iii) One of the most litigated subjects in Central excise is the use of machine or power for the manufacture of some of the goods which are usually made in small scale. Cheap shoes, aerated water, furniture, fireworks, gas mantles, cheap soap, mica, and last but not the least, the poor man's biri are some of the examples of such distinction being made over a period of time in regard to the rates of duty. There have been extreme cases where the use of light in the room to sort out mica or the use of power to lift water from the ground floor to the first floor for using such water for mixing raw materials have been the subject matter of court cases. These small little items have lent a rich legacy of literature behind them before some of these distinctions are now being abolished but some still continue. The distinction regarding biri is still continuing. Such controversies will never be over and poor small-scale manufacturers will run from adjudication to appeal to tribunal to courts, inspite of all the clarifications by the Board, until the exemptions based on the use of power or machine are abolished.

(iv) How much of exemptions are to be continued – General comments

Some exemptions are to be continued but if we want to remove inspector raj, we have to remove most exemptions. Exemption should be economically viable, not populist. The best tax is neutral tax. Exemption is an antithesis of neutrality.

Exemptions from taxation have attained a certain amount of disrepute amongst economists and fiscal analysts. This is mainly because many of them have been given due to lobbying and many others are for the sake of populism. Vanity bag, bindi , kumkum , writing ink — these are a few of the favourite things which enjoyed exemption from excise duty.

Does it mean that all exemptions can be removed? Not really. Export-oriented exemptions cannot all be removed because the mechanism of zero-rating the exports is by exempting the outputs (which are exported) and also inputs used in exports. Throughout the world exports are zero-rated. India has to do the same to remain competitive. But our export-oriented exemptions have gone far more than the simple zero-rating. Umpteen schemes have been devised by the government to encourage exports in such complicated exemption mechanisms, which open the floodgate to grand misuse. It is imperative to examine all such schemes in their totality to ensure the zero-rating and nothing more. The second most important exemption is for the small scale industry. From the point of employment, potentiality of export and mass base, the small scale must be encouraged. An extreme view cannot be taken that the small-scale exemption should be abolished. But it should be limited to a turnover of rupees two crore and not four as it is now.

So the conclusion is: (i) If we want to remove inspector raj, remove exemption; (ii) Exemption should be economically viable, not populist; and (iii) Best tax is neutral tax. Exemption is an antithesis of neutrality.

CENVAT

Today the Cenvat procedure and implementation have become so complicated that the bulk (or at least a high percentage) of the litigation on the Central Excise side. Table below was compiled by me from reported cases in ELT upto 2004 but the situation is even worse now.

In order to improve the situation, my suggestions are the following:

(a) The suggestion of the Planning Commission report of May 2001 that the distinction between capital goods and inputs should be abolished has to be implemented. It is truer now because we have to make the excise tax structure compatible with service tax structure to form GST.

(b) Reference to manufacture should be replaced by reference to use in the factory.

(c) It should be laid down that all goods and services should be allowed to avail of Cenvat credit excepting those in the banned list.

(d) Inter-changeability of inputs from service tax and central excise should be met completely without any restriction.

(e) The different types of rates of duty should be abolished.

(f) Cess should be abolished. It is a great drag on Cenvat Procedure.

(g) A task force should be constituted to work out a simplification. The task force should constitute of economists and officers both.

Legal change

(i) The Central Excise law and tariff should be conceptually sound. At the moment it is not. Excise has been called Cenvat in Section 3(1 )( a) of the Central Excise Act by an amendment made in 2000, the amended section reads as flows:

The amended Section reads as follows: ¶(a) [a duty of excise is called the Central Value Added Tax (CENVAT)] on all excisable goods (excluding goods produced or manufactured in special economic zones)] which are produced or manufactured in India as, and at the rats, set forth in the First Schedule to the Central Excise Tariff Act, 1985 (5 of 1986);]¶

To call duty of excise as Central Value Added Tax (CENVAT) is conceptually incorrect. A 'duty of Excise' is not CENVAT. It is only when input tax credit is allowed on the Central Excise Duty that the remaining portion becomes CENVAT (duty). For example 16% of the value of the excisable goods is the excise duty on tyre and an input credit is allowed by a certain amount which comes to, say, 7% of the value. So 9% is actually the CENVAT. 9% is the tax which is the tax on value added on the inputs. 16% is the tax which is on the total turnover. So CENVAT is only a part of Central Excise. A whole cannot be equal to a part. So conceptually it is a misnomer to call excise duty as equal to CENVAT. The amendment which is misconceived should be deleted in this Budget.

(ii) The Central Excise Tariff also have conceptual anomalies since it contains many unmanufactured products and uses expression nil, blank, and free which created enormous legal complications. My suggestions are the following:-

(a) All entries in the Central excise tariff which are for unmanufactured goods must be removed from the Central excise tariff as they are not excisable.

(b) In the excise tariff only ‘Nil' should be there. All entries of ‘Blank' should be abolished. ‘Nil' and ‘Blank' should not be written interchangeably. ‘Nil' is the proper expression which means that the goods are basically excisable and the government at the present moment does not want to charge any duty on it. ‘Blank' should not occur anywhere because it is redundant and, therefore, it creates confusion and litigation. One expression which is good enough should prevail rather than other redundant expressions. ‘Nil' has an advantage over ‘Blank' because in exemption notification the expression ‘Nil' is there and not ‘Blank' such as the general exemption No.6/2006-C.E. dated 1 March 2006, as amended, which contains all ‘Nil' entries but no ‘Blank'. In the customs exemptions also the expressions are ‘Nil'.

In the customs tariff the expression ‘Free' should be replaced by ‘Nil'. That will bring symmetry between the expressions in customs and Central excise tariff.

( d ) Thus in place of three expressions, ‘Nil', ‘Blank', and ‘Free' there should be only one expression: ‘Nil'.

(iii) Law of unjust enrichment -

This law is legally valid. But it is economically undesirable firstly because of it is creating enormous amount of litigation at all levels and more importantly because it hinders the business man in India in competing with all other capitalist economies like Japan, Europe and America (and even China).

CUSTOMS:

Whatever I have written above in regard to Central Excise regarding complications in the tariff and exemptions also apply mutatis mutandis to Customs as well. My point about unjust enrichment also applies to Customs.

SERVICE TAX :

Comprehensive service tax should be introduced immediately as a preparation to the Central GST. The budget of (2009-10) is more significant from the point of view of service tax than previous budgets. The significance is for the following reasons:

a) The government is now very near the ultimate time limit of April 2010 when GST (reportedly dual GST) is supposed to come into effect. At the Central level it will be a combination of excise and service tax, whatever be the nature of the product mix. So a preparation is necessary to make the tax system as ready as possible towards the introduction of GST.

b) Over a period of nearly fifteen years since 1994 when service tax was first introduced, more than one hundred services have come under the tax net. There are not too many services left which will give substantial revenue. The only exception is transport services. Therefore, a time has come to consolidate whatever taxes have been imposed into a viable and more workable system where it is not necessary to issue circulars after circulars to clarify matters. Comprehensive service tax will put things into a more theoretical groove.

c) There was a demand from the service providers for a comprehensive Service Tax Act. This issue will be settled once for all if a comprehensive service tax is introduced now.

We have now reached the stage where Central GST (that is a tax on the combination of goods and services) is coming and we cannot have such a GST without a comprehensive service tax. Also in our neighbouring country Sri Lanka, there is a comprehensive GST with a negative list. At this stage in India, we should be able to make comprehensive service tax possible as a precursor to the introduction of Central GST in 2010–11.