Seven Decades of Independent India

by Vinod Rai

  The board has to satisfy itself about the existence of a succession plan.

  The evaluation criteria of independent directors shall be laid down and disclosed in the annual report.

  Finally, in order to strengthen enforceability of these provisions SEBI moved the corporate governance norms from the listing agreement to a new regulation—the Listing Obligations and Disclosure Requirements Regulation, 2015. Besides, stock exchanges have been empowered to regularly review and analyse the mandatory and time-bound disclosure by companies and take penal action. Delegating powers to exchanges to monitor corporate governance compliance and to penalize the corporations have been extremely successful.

  Global Developments and Demand Side Interventions

  In social and political life across the world, perceptible movements towards challenging authority, asserting individuals’ rights, mass action, spontaneous reactions and wider protests are being noticed over the last decade. Regimes are being challenged, continuous and comprehensive evaluations are being demanded, authorities are being recalled before time, and the concept of fixity of tenure in institutional positions is being challenged successfully. From Turkey to Cairo, from Mexico to Brazil, small incidents, such as construction in a park or a rise in bus fare, is able to mobilize hundreds of thousands of people on the streets. It is also true that many in the crowd are not unemployed youth but decently employed/self-employed, well-educated persons who are indignant at their voices not being heard. Technology, of course, is helping generate a stronger momentum.

  It stands to reason that if such sentiments are increasingly being demonstrated in political and social life then the same would also drive behaviour in dealing with authorities in charge of running corporations—where these ‘ordinary’ people have placed their hard-earned money. Therefore, it is hardly surprising that small stakeholders are challenging decisions by corporate boards. Even a hint of suspicion of conflict of interest or wrongdoing on the part of the companies is able to evoke strong reactions from shareholders. Shareholder activism is on the rise. Between 2014 and 2015 almost one-fourth of CEOs of Fortune 500 companies who were removed pre-maturely were due to shareholders’ demand. Compensation and bonuses to CEOs are increasingly being questioned and in many cases, even national political leaderships have awakened to this disquiet amongst the shareholders. This is reflected in the British Prime Minister Theresa May’s disapproval of the widening gap in the pay ratios of top executives and those of younger employees. Lack of gender diversity is another area attracting serious scrutiny.

  Sensing these developments across the world, SEBI came out with a policy asking institutional investors to have voting policies, publish the policies on their websites and publicly disseminate their voting histories. The requirements began with mutual funds; pension funds and insurance companies followed suit. It is noticeable that even schemes of arrangements are being questioned by the institutional investors, who are often coming together before voting in order to take common stands that might reflect their disgruntlement. These demand side interventions have not only forced rethinking among corporate boards and managements, but have also generated a wider public debate.

  Proxy Advisory Firms

  Proxy advisers provide advice and analysis to institutional investors and other clients on the shareholder proposals brought to vote at Annual General Meetings (AGMs). They also execute votes in accordance with the instructions of their clients and engage in record keeping, and enabling a platform for voting. In addition, they provide recommendations on public offers. Further, proxy advisers provide consulting services to corporate clients on issues related to corporate governance, conduct corporate governance research and develop scores on corporate governance. Over the last five years, these firms have gained momentum and multiplied in numbers. SEBI regulations seek to provide that such analytical services and recommendations/advices are unbiased, independent, objective, and there is no conflict with other activities. Proxy advisers are to be registered and regulated under SEBI (Research analyst) Regulations, 2014. All the provisions of SEBI (Research analyst) Regulations, 2014, such as qualification and certification, capital adequacy, management of conflicts of interest and disclosure requirements, maintenance of records, code of conduct etc., also apply to the proxy advisers. SEBI has also placed certain restrictions on the conduct of experts who express their opinion in the media. The idea is to ensure disclosure and to avoid conflict of interest.

  It is not surprising that the efforts taken by India have received universal recognition. The World Bank Report on ease of doing business has a component on minority investors’ protection, where India’s ranking jumped up from forty-nine in 2012 to thirty-four in 2013 and seven in 2014. In the latest report of the World Bank released in October 2017, India’s ranking has further gone up to four.5 This particular criterion in the World Bank ranking includes extent of shareholder governance and transparency, extent of director liability, extent of shareholder rights and extent of disclosure.

  Emerging Trends and New Challenges

  With governments increasingly withdrawing from commercial activities and even corporatizing traditional services like road, rail, water supply and sewage, the impact of private firms and corporations on society and environment is getting more and more substantial. Major multinational corporations have grown large, to the extent of exerting substantial influence over commercial and economic prospects all over the world. The risks arising from such influence were demonstrated by the global financial crisis that brought to light how the lack of good corporate governance and risk mitigation by companies can affect the lives of ordinary citizens across the world.

  The emerging emphasis is now on risk mitigation, impact on environment and on the social fabric of society, and how sustainable the business model is. The fact that large institutional investors like pension funds or sovereign funds have significant holdings in the corporations they invest in has given further momentum to the demand on corporations to assess and report on parameters other than solely financial ones. The Oil Fund of Norway, which is close of USD 900 million in size and is equivalent to 1.3 per cent of all listed companies, has been forceful in its demand for close scrutiny of CEOs. It has, during the last two–three years, been successful in rejecting pay rises to many CEOs and demanded stricter accountability on performance.

  The demand is also for disclosures keeping in mind not only the interests of shareholders, but all the stakeholders; workers, customers and society. Integrated reporting has now become a movement that has gained worldwide acceptance. SEBI first mandated a business responsibility report for the top 100 companies in 2012 and extended it to the top 500 companies. Finally, in early 2017, it has mandated integrated reporting. Some Indian companies have already started IR on a voluntary basis.

  In mid-2017, SEBI recently proposed further strengthening of the corporate governance framework, for which a committee was set up. The committee has submitted its report recently where the focus is on ensuring further independence of independent directors and strengthening transparency, disclosures, board evaluation and improving safeguards against related party transactions. The effort to continuously strengthen governance and accountability is on.

  XXIV

  Tax Policy Design and Development: The Indian Story

  Pinaki Chakraborty

  Tax structure and the levels of taxation differ across countries based on their economic systems, public service delivery needs and the capacity to administer taxes. The primary objectives of a tax policy are to increase revenues irrespective of the forms of government, raise revenues equitably and fairly, minimize cost of raising taxes, encourage (or discourage) a particular economic activity, group and region.1 Calibrating tax policy in a complex federal system like India has its own challenges. This essay discusses critical dimensions of India’s tax policy reforms since Independence and evaluates its progress.

  Levels and Structure of Taxes in India

  A long-run trend in tax t
o GDP ratio is presented in Figure 11. India’s tax to GDP ratio is often criticized as being low. There is no denying of the fact that further increase in tax to GDP ratio is possible and is the most desirable public finance option for an emerging market economy like India. However, if we take a long-run view, India’s tax to GDP ratio (taking Centre and states together) was around 6 per cent of GDP in 1950–51. As per the 2015–16 budget estimates (or BE), it is now around 17.14 per cent of GDP. As evident, the relative importance of direct taxes has increased in recent years. This is attributed to major reforms in taxation post 1991. As evident from Figure 12, the share of direct tax was as low as 16 per cent of the total tax collections in 1991. This has increased to 34 per cent in 2015–16 (BE) (Figure 12). Since almost the entire direct collection is at the Union level, the share of direct taxes in total collection of the Union taxes will be even higher. As estimated for the year 2015–16, the share of direct tax collection in total tax collection was 50.14 per cent. This progressive change in tax structure away from direct to indirect taxes were due to the reduction and rationalization of direct tax rates, simplification of the tax structure and the introduction of technology in tax administration.

  Figure 11: Tax to GDP Ratio: 1951-52 to 2015–16

  Source: Indian Public Finance Statistics, 2015–16.

  Figure 12: Share of Taxes in Total Taxes: 1951–52 to 2015–16

  Source: Indian Public Finance Statistics, 2015–16.

  Although combined tax-revenue as a percentage of GDP showed more or less an increasing trend till the last half of the eighties, it had started declining thereafter (more on this in the next section). The decline in tax to GDP ratio during the nineties was due to the drop in both customs duty and Union excise duty as a percentage of GDP. However, during the nineties, the direct tax effort increased sharply. It should be noted that as the Indian tax structure is heavily dependent on indirect taxes, the increase in the direct tax revenue effort could not compensate for the resultant revenue loss arising out of the decline in the tax effort of the indirect taxes. The peak rate of income and corporation tax also has declined sharply. In case of indirect taxes, the significant reforms have been the introduction of the VAT (Value Added Tax) in the fiscal year 2005–06 and the Goods and Services Tax (GST) on 1 July 2017.

  Tax Reform Initiatives in India

  India’s journey towards a modern tax system began with tax reforms in the fifties, based on the recommendations of the report of the Taxation Enquiry Commission chaired by John Matthai. The commission placed emphasis on enhancing the role of taxation, and the role of borrowings in financing development programmes of the public sector. It also recommended progressive direct taxation with effective tax enforcement. The commission recommended the setting up of the All India Taxation Council under Article 263 of the Constitution of India. The need to generate additional resources for financing the Second Five Year Plan invited celebrated public finance expert Nicholas Kaldor2 to recommend further measures for Indian tax reforms. Kaldor suggested the introduction of wealth tax, taxations on capital gains, a general gift tax, and a personal expenditure tax. However, expenditure tax was withdrawn in 1957 as it fell short of expectations on additional revenue generation as envisaged in the report.

  The challenges of tax evasion as a consequence of very high marginal rates and inefficient tax administration forced Indian policymakers to attempt a series of reforms through the establishment of the Direct Taxes Enquiry Committee (DTEC)3 headed by K.N. Wanchoo, and subsequently, the Indirect Taxes Enquiry Committee (ITEC)4 headed by L.K. Jha. The major recommendations of the DTEC included measures to curb black money and tax evasion, reconstitution of the Central Board of Direct Taxes (CBDT) and introduction of a system of Permanent Account Numbers (PAN) for taxpayers. The most important recommendation of the ITEC was to introduce VAT in the country. The ITEC, however, took note of the limitations of the then prevailing tax administration structure and recommended a VAT system at the manufacturing level.

  A comprehensive reform of the Indian tax system was first observed in mid-eighties in the Long Term Fiscal Policy (LTFP) statement of 1985. The LTFP recommended the introduction of VAT in line with the recommendation of the L.K. Jha committee. Though a modified VAT was tried at the manufacturing level, fundamental reform in the tax system in India was initiated in the early nineties based on the recommendations of the Tax Reforms Committee headed by Raja J. Chelliah. The Chelliah Committee focused on reforming both direct and indirect taxes as well the reforms in the tax administration and implementation of a modern tax system. With regard to the direct taxes, the committee recommended widening of tax bases and the moderation of the rates of direct taxes. For indirect taxes, the committee recommended introduction of VAT in place of central excise, and for customs duty, major recommendations were reduction in import tariff, reduction in the spread of rates, a simplified tax structure and abolition of many concessions and exemptions. It is noteworthy that the VAT was a consistent recommendation of various expert committees as an efficient restructuring of the indirect tax system in the country.

  VAT—The First Step towards Rationalization

  Post the Chelliah Committee recommendations, the rates of both direct and indirect taxes were reduced, processes simplified, and attempts were made to orient tax administration to a modern system. Though these reforms were particularly concentrated at the Union level, the domestic trade tax system remained complex and archaic. The transition to VAT from the pre-existing sales tax regime was a major reform in indirect tax as well as in the overall tax administration in India. The government decided in the year 1995 to introduce VAT to abolish multiple points of taxation and for rationalizing the overall tax burden. After protracted deliberation for almost ten years, most of the states replaced the age-old sales tax system with a VAT in 2005. Initially, a few states were reluctant to join the VAT system. By 2007, all the states were part of it. States’ concern in moving to a VAT system was particularly driven by uncertainties with regard to the revenue outcome of VAT. The Union government had to assure the states about compensation of revenue in case of any losses. Also some states had particular concerns about the revenue neutrality of VAT as the tax structure differed across states. Producing states were concerned about phased reduction of the rate of interstate sales tax/central sales tax (CST) with the introduction of a destination-based VAT. However, post VAT, revenue growth of states was significant and the Union government did not have to make huge compensation to states.

  Institutionally, VAT was one of the best examples of cooperation among Indian states in coordinating a consumption tax regime through the empowered committee of state finance ministers—a body which emerged not through enactment of law but as a necessity for coordination and implementation of a harmonized VAT system across states.

  The VAT system had two major limitations. (i) It was applied only on goods and not on services; and (ii) it was levied only on intra-state trade with the provision for input tax credit (ITC). In other words, a comprehensive consumption tax reform was still not complete. Since CST continued in a VAT regime, there was a peculiar combination of intra-state VAT (i.e. VAT levied on the movement of goods within the state) based on the destination principle of taxation and an interstate sales tax or CST based on the origin principle of taxation.5 This resulted in continuation of cascading of taxes and fragmented taxation of goods and services and significant tax on exportation from richer producing states to poorer consuming states.

  While the VAT negotiations among the states were in place, in 2001, an expert group on taxation of services was set up. Separate task forces on direct and indirect taxes were set up by the Government of India in 2002. Under the prevailing service tax net, the expert group on taxation of services made specific recommendations to cover the sector. Among others, it suggested (i) integration of tax on services to a comprehensive central VAT on goods and services; (ii) sharing of powers to tax services with states; and (iii) incorporating a well-defined negative
list of services relating to public utilities, health and education services, etc. The report of the advisory group on tax policy and tax administration for the Tenth Five Year Plan also provided a detailed roadmap for reforms in tax administration for direct taxes, customs duties, Union excises and more importantly for introducing VAT. The report of the task force on introducing the fiscal responsibility and budget management (FRBM) Act of 2003 made a significant recommendation of introducing an all-India goods and services tax (GST), with concurrent powers to tax services by the states. India has finally introduced the Goods and Services Tax (GST) on 1 July 2017. GST is considered as a landmark reform aimed at the unification of Indian markets. This reform is also cited as the best example of cooperation between the Union and the states in a federal setup.

  GST in a Complex Federal System

  While the original plan was to introduce the GST from 1 April 2010, the process got delayed by more than seven years. This delay is a reflection of the fact that political economy of tax reform is not an easy job in a complex federation like India. Indeed, the negotiations on VAT also had gone on for several years before it was finally implemented by states. Similarly, the GST was finally introduced after protracted negotiations between the Union government, twenty-nine state governments and seven centrally administered Union Territories and to an extent with other stakeholders. The 122nd Constitution amendment paved the way for the implementation of GST. GST is expected to subsume major indirect taxes to provide a simple tax regime to develop a common market for India. The ultimate benefit of GST, however, would depend on the design of the tax, which is dependent on various provisions of the GST Bill and functioning of the GST council.