Sucheta Dalal :Getting incomes into legitimate tax net
Sucheta Dalal

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Getting incomes into legitimate tax net  

Dec 29, 2004

A large section of the Indian population successfully evades income tax   

Ever since the primary market collapsed under the onslaught of dubious companies in 1993-94, no public meeting on capital markets is complete without debating ways to ‘restore investor confidence.’ Imagine my surprise then on finding out that lakhs of Indian investors still prefer the dangerous and illegal cash markets simply to avoid any detection by tax authorities. Last week, a senior stock exchange executive narrated his conclusions after a series of investor interactions across the country, especially in smaller towns and stock exchange centres. This is an informed assessment that will never emerge out of investor surveys.

He says there are potentially large investor populations in smaller cities such as Goa, Jaipur, Mangalore, Rajkot with substantial earnings from tourism, plantations, trade and agriculture. However, these people are emphatic about avoiding official investment channels, to avoid being sucked into the tax mechanism.

Interestingly, they don’t hoard cash at home, but make good use of the banking system. They say that bank deposits are safe and anonymous if their accounts are spread across multiple banks and branches. That’s because there is no central database that allows the tax authorities to track individual accounts across banks by matching addresses. The post office is another preferred avenue. Since the over-riding consideration is to avoid a trail, some accounts are routinely closed and new ones opened.

Anecdotal evidence by rural marketing experts suggests that there are indeed significant pockets of rural wealth. They recount stories of simple farmers in small towns who can casually fish out enough cash from their kurta pocket to pay the full price of a motorcycle. There is also substantial income earned by police and government officials through bribes and unaccounted wealth generated by doctors, traders and businessmen by evading taxes. This money is usually channelled into property, fixed deposits or illegal trading systems. No wonder then that official estimates of the investor population haven’t crossed two crore in over a decade.

• There is no central database to allow the tracking of individual accounts

• Business is flourishing for dabba traders even in smaller cities

My sources say that fears about the securities trading tax (STT) has also given a fillip to illegal trading (bucket shops or dabba traders), because it threatens a clearer audit trail. Business is booming for dabba traders and they are now opening branch offices in smaller cities. One large dabba operation is carried out in Mumbai in the building next to the Sebi office.

About the only legal investment made by such investors is in IPOs. That too, because there is no alternative and the gains on listing have been substantial in recent months.

Now consider this incongruity. A large chunk of India’s population firmly believes in avoiding income disclosure and successfully does it. Tax evaders are routinely offered amnesty every four or five years if they choose to turn legitimate. On the other hand, honest taxpayers are punished with higher taxes. Further, the government has empowered tax officials to attach assets of suspected evaders. The finance minister insists this power will be sparingly used, but given rampant corruption, there is bound to be abuse by enforcement authorities and politicians.

A top banker says it is imperative for India to break out of this tax evasion logjam, if the government wants to find money for infrastructure development. He suggests drastic action on two fronts. A significant carrot for honest taxpayers who have diligently paid their dues, which will also bring all the borderline evaders into the tax net;and a scheme to flush out existing hoards of black money.

His suggested carrot is a modification of the Vijay Kelkar proposal— a flat 10% tax for an income of upto Rs 5 lakh per annum and 20% above that, with no exemptions, accompanied by a highly simplified payment mechanism. He suggests the launch of Infrastructure Bonds with no questions about the source of money. Again, the government would be foolish to ask the middle class taxpayer to suspend moral judgement if this class is not rewarded, for once, through a drastic cut in tax rates.

Is the government courageous enough to take this risk? If not, an amnesty scheme will cause outrage and land up in court. Especially as finance minister P Chidambaram, during his earlier stint, had not only offered the biggest ever bonanza for tax evaders, but also promised the court that it would be the last such amnesty for evaders.

-- Sucheta Dalal