Tax evasion is a crime. Tax avoidance is a .... ?

In the good old days, this was an easy cliche. Tax evasion (breaking the law) was a crime. Tax avoidance (minimising paying the tax within the law) was something you were duty bound to do. Whether you are an individual, company, whatever. Period. Now it isn't so clear cut an answer.  And that says something about our times.

Witness the case of Apple. It does aggressive tax planning (all within the law). It has a big subsidiary in Ireland and has done a deal with the government there for a low tax rate. It does not bring overseas profits into the US, because it is double taxed then; so it leaves all its overseas profits overseas. All very legitimate. And yet there has been a huge outcry and a Congressional hearing where Apple is accused of not paying "its fair share of taxes".

Similar accusations are levied on Amazon, Google and Starbucks in the UK and indeed in many other countries. Nowhere are the authorities claiming they broke the law. They are just angry that these companies pay a low or zero tax despite large businesses in those countries.

From a public's point of view, there is no difference between evasion and avoidance. The expectation is that all companies must pay lots of taxes irrespective of the law and facts. Equally all rich people must pay big amounts of tax even if the law does not require them to do so. But for each individual himself, it is perfectly OK to evade tax (breaking the law). Queer set of values.

Almost everybody in India breaks the law when it comes to taxes. And before you protest too much, please answer if you have disclosed your savings bank interest as income in your tax return and if you have done no cash transactions above Rs 10,000. The less said about professions like lawyers, doctors and the like, the better. The salaried class is one of the worst offenders - their salaries are caught by the taxman under the withholding tax regime. Everything else, in the eyes of the salaried man or woman is not to be disclosed as after all they are paying "lots of tax" on their salaries.

Why does this work like that. Why is it OK for us to evade tax, but not for others even to avoid it. Is it just pure jealousy against the rich ? Is it just one law for everybody else and one law for us ? What is going on ?

For corporates and rich individuals, there is an expectation of  social responsibility at play here. It is not enough to follow the law. It is now required to be seen as "being fair to society" everywhere. This is a woolly concept ; after all what is the concept of fair.  But each company has to make its own "contract" with society. The more successful you are, the more demanding the contract.

Social responsibility has gotten an altogether new meaning, A far more challenging meaning. Companies have to be seen as "good citizens, whatever that means. Notice that the public's definition of a good citizen is "I break the law, but you shall do over and above the law". "

Its a tough world out there.

Everybody bashes the Taxman

If you have been following the news in the US, you might have noticed an almighty hullabaloo over the the IRS (their tax man) having targeted Tea Party and Conservative groups. Much hot air and righteous indignation is being spouted and Obama has fired the IRS chief yesterday. Almost everybody on earth loves to bash the taxman (rightfully so !) and this is all good fun.

Except that I believe that in this case the bashing is wrong. Or at least much exaggerated.

What happened is this. The IRS admits that it subjected groups which bore the name tea party, or patriot to extra scrutiny. The fact that such groups are exclusively Republican and that the President is a Democrat seems to indicate political targeting. That is, of course, against the law. Hence all this noise.

But why did the IRS do this - after all, they are not fools. If you try and answer this question, a different picture emerges.

The problem all started with, in my view,  the appalling judgement by the US Supreme Court in the Citizens United case in 2010. In layman terms the Supreme Court decided that organisations were people and had the same right of free speech as you and me. Therefore there could be no curbs on their political activities and donations.

Overnight, all sorts of action groups sprung up and the money started being being poured into US elections of all kinds.  Many of these outfits do not want to disclose who really gives them money. The way to achieve this is to register as a social welfare organisation under the tax code which then grants you tax exempt status - something called Sec 501(c)(4) exemption !! You are not prohibited then from indulging in political activity - its just that the primary activity has to be social welfare in nature. The main purpose of these groups is not to avoid tax (for they do not really seek to make a profit). The primary purpose is to avoid disclosing who is giving all the money.

It is probably a safe bet to say that the majority of these groups (Republican or Democrat) have zero interest in social welfare and are primarily there for  political activity.

From 2010 to 2012, the number of such organisations doubled to some 3400. A large number of them were "tea party" or "patriots". Do you really expect the IRS to sit tight and watch all this. After all, it is their job to check whether these outfits really were primarily involved in social welfare. 

The IRS did not prosecute them or withdraw their status. All they did , in true Ramamrtiham style, is to harass them with lengthy requests for information, do audit reviews, delay decisions on their applications and commence painstaking procedures. In this my sympathies are entirely with the said groups as we all know what the incredible capabilities of Ramamritham are.

The real culprit is the political donations sloshing around consequent to that awful Supreme Court verdict.  In true US politics style, this will not be addressed - instead the IRS will be hauled over coals. Yuk !

I never thought I would ever write a post in defence of Ramamritham, but there you go ... !

47% vs 97%

Mitt Romney is in a  soup over his 47% remark. In some remarks he made at a private meeting he said that 47% of Americans do not pay income tax (fact) and implied that these were scroungers (rubbish). But he was factually accurate in that 47% of Americans do indeed not pay income tax - although to be fair about that half of that lot do pay payroll taxes which is a form of income tax meant for funding social security and Medicare.

The purpose of this post is not to wade into the political controversy. But simply to point out the fact that if Romney were in India, he would say 97% of the population does not pay income tax. That's right - only 2.8% of Indians pay any income tax .

That's not to say 97% of the population does not pay any tax at all. Indirect taxes like VAT, Sales Tax, Octroi and a whole host of devilish taxes are levied on everything. Even a beggar buying beedis is paying all these taxes. But income tax, the largest revenue earning component of the budget is paid by only 2.8% of Indians.

Of course, this is a headline grabbing statistic that somewhat obscures the facts. India is a young country with a large number of children. They obviously are not meant to pay taxes (although I am somewhat loath to mention this as Ramamritham might pounce on the idea and design a tax for them). But clearly there is something very wrong in the Indian taxation system.

Surely so much of India is not dirt poor. The fact is that lots of people dodge taxes. Perhaps the true number of those who should be paying taxes is three times this number. Still, even if you say by rigorous enforcement of the law the number of tax payers would rise to say 9% - three times the current number, even then this is awfully small. How can a country which wants freebies and subsidies for everybody be financed largely by just 10% of its population.

Three things are blindingly obvious

- Economic growth for everybody should be the single most important priority of the government and society ; millions must be given the opportunity to earn enough income that they pay taxes. If ever there was a case for learning from the China model, this is it. Get rich first; then worry about income distribution.

- Tax evasion is clearly rampant. Here Ramamritham is indeed trying hard, but the scale of the problem beggars belief

- Tax exemption for agricultural income and long term capital gains has to go. If you earn sufficient income, whatever the source may be, you have to pay income tax.

You can only soak the 3% so much.

Pranabda ko gussa kyon aata hai

Statutory Warning - This post has language which may be offensive to some. Reader discretion is advised !

Why is the  Finance Minister  an angry old man  - approximate translation of the title of this post for non Indians. He is one of the most mature and level headed politicians in India. And yet, these days, he is behaving like an "old f&*% with that perpetual scowl on his face" - you can see zillions of this category in any apartment owners' association in India. Either he has gone a bit batty or has let Ramamritham loose - both of which are awful developments for India

I am referring to their collective antics relating to the tax laws in India. The Vodafone story is now well known and is the subject of an earlier post of mine. Pranabda is simply being extremely churlish and petty in pursuing this. I continue to be amazed that they are going after Vodafone (which was the buyer in this transaction and made no capital gain) rather than the seller, Hutchison Telecom, which is really the company they should go after. If Ramamritham has any b*&@$, he should take on China.

But they haven't stopped there. They are loudly defending the retrospective changes they have brought into the Income Tax law . In this process, they are also overriding bilateral tax treaties with many countries. Nonsense regarding sovereignty and the right of Parliament to enact any law it pleases is being spewed. They are seeking to impose GAAR (General Anti Avoidance Rules). In layman's language, GAAR  simply means that you as a tax payer have to prove your innocence (the taxman is simply going to assume that you are guilty). Fantastic. Grrrr.

I can understand the pressing need to raise revenue - given that they are spending money like water on doles and giveaways and simply borrowing their way to nirvana. Even grant for a minute that curtailing expenditure is a non option (wow).  But is this the way to raise money ?

Only 35m Indians pay Income Tax. That's 3% of the population. Is really 97% of India poor ? How about getting some more people to pay instead of screwing those who do ?? Just look at the fantastic (and mostly ill gotten) wealth in property most of which is in suitcases. How about tightening the noose on those. Even today you can earn Rs 10000000000 crores as "agricultural income" and not pay any income tax at all. Why not tax that ?

The relationship between the taxman and taxpayer is one of extreme confrontation in India - anybody who has been at the receiving end of attention from Ramamritham knows this. Laws are draconian and the concept of guilty until proven innocent is well engrained. Dispute resolution in a sensible way is non existent - everything is confrontation. With the latest scowl on Pranabda's face, its only going to get worse.

When will we ever learn that making laws simple and fair , keeping tax rates reasonable and letting economic activity boom is the surest way for governments to increase revenues. Pranabda knows all this - he is a wise and extremely experienced minister. And yet, look at what he has become.

Will the Pranabda of old resurface please ?

For a more level headed and saner piece on this issue, read here.

Sack Ramamritham

Ramamritham must be sacked - plain and simple. He is usually just a nuisance and a pain in the posterior, but otherwise a good man. But recently he has crossed the barrier and is now a genuine danger. He must be read the riot act and told to go.

I am referring to his contortions and nonsensical behaviour in the Vodafone case. For those not familiar with this saga - here's a short summary.

Some years ago Vodafone bought a 67% stake in Hutchison Essar. Vodafone's Dutch company bought the shares from Hutchison Telecom which is a Hong Kong company. Neither the buyer, nor the seller was an  Indian company although the shares they bought were of a company whose operations are in India. Under ordinary tax laws in most countries in the world, including India, the place where the selling company is and the buying company is dictates where tax would be paid on the gains from the sale of shares (in this case neither was in India). This should have been a straightforward matter.

But Ramamritham decided to put his grubby fingers in. He levied a demand on Vodafone that capital gains tax was to be paid in India as the underlying asset was in India. Specious argument, but then Ramamritham is not exactly renowned for cold logic. The judicial process being what it is, Vodafone had to cough up a substantial amount (Rs 2500 crores of the total demand of Rs 12,000 crores ), before it could go on appeal.

The case duly went to the Supreme Court which told Ramamritham to *$%& off. That should have been it.

But Ramamritham decided that he would not return the money he had expropriated from Vodafone (you see he had spent it on giving free colour TVs to all and sundry). So he amends the law with retrospective effect in the latest budget to say that Vodafone has to pay. He has excelled himself - he has amended the law with retrospective effect dating back to 1962 !!!!! He can now open every sale or purchase of shares from 1962 and go after everybody. His justification - government will lose a lot of money if it has to refund Vodafone. The mind boggles - next he can simply rob you and me of all our money and then refuse to return it on the grounds that government will lose revenue.

It does not matter to him that the Supreme Court has ruled time and again that the law cannot be amended retrospectively. Ramamritham is trying to get away in this case by claiming that he is not amending the law but the notes to the law !

Have you noted that the blighter is going after Vodafone, which was the buyer and made no capital gain - it was Hutchison Telecom as the seller which made the gain. The simple reason is the Vodafone is in India and unfortunately in Ramamritham's grasp. Ramamritham can always find logic for his tantrums ( in this case the grounds are that Vodafone did not deduct tax at source). Hutchison Telecom does not exist in India; so he cannot go after them. They exist in China which of course has told Ramamritham where he can go and stuff it.

No sensible businessman can do business in India if Ramamritham continues to get away scot free. He must be sacked,  banished to Dhanushkodi and told never to return.

PS - For newbies to my blog, here's an introduction to this frustrating character called Ramamritham.

The taxman and Windows 7

If you are in India and wanted to buy a Windows 7 box, you could not do it legally. Never mind that Windows 7 was released globally about 2 weeks ago. Never mind that much of Windows 7 development happened in India. Why ? Because the babus (pedantic officer) at Customs wanted to tax the stuff twice !!

This is an example of the nonsensical complexity that abounds in India’s taxation law and the missionary zeal with which the babu wants to implement them – methinks the ultimate frustrated guy is the Indian babu and his only source of pleasure in life is from creating and implementing mind boggling complexity.

Take the Windows 7 situation. The product is the standard software box with a CD and a manual in it. Because it’s a box, it’s a physical product. Therefore customs duty on the “product” is to be levied. Then the box contains a CD which gives you a license to use the software. Giving the license to use is a “service”. So they want to again charge service tax on the same box. Tax the same stuff twice - once as a product and once as a servie. Only the warped mind of an Indian babu can come up with such logic. Boxed software sales in India have fallen by 40% as the boxes gather dust in the customs warehouse. Furious lobbying, intricate clarifications from the mandarins in Delhi, millions of manhours of intense activity and the boxes seem to be ready to leave the shipyard now.

Examples abound of such inanity. Many years ago, I knew of a case of a producer of jams. In one budget, the government decided that jams should be exempt from excise duty as an incentive to fruit farmers. The producer of jams heaved a sigh of relief. But the next day, the babus descended on the poor guy. They said that while manufacturing jam, he starts by dissolving sugar in water , the act of which was the “production” of sugar syrup. He doesn’t have to pay excise duty on jams, but would he please pay excise duty on sugar syrup. The producer protested that he wasn’t producing sugar syrup – he was just executing a step in the manufacture of jams. NO. The babus , with great glee, were “enforcing the law”. The producer asked that instead of dissolving sugar in water, if he first mixed the fruit pulp and then added sugar in the mix, would that be OK? Yes; that was absolutely fine to the babu. No “sugar syrup” was being “manufactured” and that was fine !!!

Needless complexity and zealotry in arcane interpretations bedevil our taxation system. One one hand it leads to misery for a guy who wants to follow the law. On the other hand, it provides myriad opportunities for corruption. We should simply exterminate the tax babu. Bring a common rate of taxation on everything. Make the damn thing simple . And then enforce it ruthlessly. If the system was simple, the rate of tax was reasonable, and the penalties for evasion harsh, most people will quietly pay their taxes. I am quite prepared for a special fund to be created out of my taxes to create an opulent bordello where we can banish the tax babus for them to get their kicks, and leave us poor folk in peace.

IT Industry - Stop begging for favours

One of the provisions of the Indian budget presented a couple of days back is to extend the income tax holiday to IT companies This is an annual ritual. The STPI scheme under which this tax holiday is enjoyed was supposed to expire sometime ago. Every year the industry clamours for its continuance. And the government accedes.

The Indian IT industry does not pay the full income tax in India. This is a completely wonky situation. They operate in many countries in the world, most notably in the US. The tax laws are such that they pay taxes in every country they operate in. The only country in the world where they don’t pay is India.

Businessmen have no shame when they clamour for sops from the government. Moral and ethical rationale have no place in this argument, it appears. The same businessmen bemoan the fact that the fiscal deficit is huge. Why will it not be huge when everybody wants tax sops.

Corporate income tax is the largest source of revenue for the government. And one of the most profitable of industries in India does not pay income tax. Now why do we moan about no tax on agricultural income. Why do we shout on the unsustainable fertilizer subsidy. There is no greater moral vacuum than the IT industry getting tax exemptions. The usual arguments are presented – its an export industry, it creates employment, it needs “support” against foreign competition, blah blah blah. I am not even going to dignify this with demonstrating the utter illogic of these as justification for sops.

The government should bite the bullet and treat the IT industry just like any other industry. And the industry should hang its head in shame for continuing to clamour for tax exemptions.

Global businesses, National Laws - the woe of taxation

Business are global, but the laws they have to follow are national. Nowhere is this conflict more severe than in the arena of taxation.

Every nation has the right to tax as it pleases. And businesses have to abide by the tax laws in every country it operates in. But when businesses go global, it causes a real problem. Its common these days for a company to buy materials from 10 countries, manufacture in 5 others, transport via 3 others, sell in 20, account for them in 3, have employees in 15, be headquartered in 4, - all completely different countries. The profit it makes is of course a composite one. Where does it get taxed ?

The answer is, in all of them ! Welcome to the world of a monster called transfer pricing. The only people who salivate on the very mention of this term are the accountants and the tax lawyers. Only one thing is for sure in transfer pricing - you will pay more tax collectively across all these countries than if you paid all your taxes in the country having the highest rate of tax. And you will be dragged to court irrespective of what you do.

Businessmen being businessmen, will try and find the lowest tax option out. Enter the world of tax havens. Countries you may have never heard of. And countries who use tax as a competitive advantage. Like Ireland in the past. Now Switzerland where many European supply chain operations are being headquartered. Singapore in Asia.

Is this all not simplifiable ? Actually the world has made huge progress in the area of indirect taxation, especially customs duty through the WTO. Likewise, it must surely be possible in income tax as well.

How's this for an idea ?

• Tax bands are globally agreed. Income tax on companies cannot be lower than x and cannot be greater than y by multilateral agreement
• Double Tax agreements are multilateral (through the WTO) and not bilateral between countries.

This will remove much of the pain global businesses face from the inevitable conflict of national tax laws.

Nobody can do justice to this area without writing a 1500 page PhD thesis. I have absolutely no intention of doing so ! All I am catalysing is a thought.

Tomorrow I'll post on another aspect of globalisation - why it seems to be dirty word in the minds of many.