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Tax practitioners are unfamiliar with tax theory. Tax economists remain unfamiliar with tax law and tax administration. Most textbooks relate mainly to the US, UK or European experiences. Students in emerging economies remain unfamiliar with their own taxation history. This textbook fills those gaps. It covers the concept of taxes in regards to their rationale, principles, design, and common errors. It addresses distortions in consumer choices and production decisions caused by tax and redressals. The main principles of taxation—efficiency, equity, stabilization, revenue productivity, administrative feasibility, international neutrality—are presented and discussed. The efficiency principle requires the minimisation of distortions in the market caused by tax. Equity in taxation is another principle that is maintained through progressivity in the tax structure. Similarly, other principles have their own ramifications that are also addressed.

A country’s constitutional specification of tax assignment to different levels of government—central, state, municipal—are elaborated. The UK is more centralised than the US and India. India has amended its constitution to introduce a goods and services tax (GST) covering both central and state governments. Drafting of tax law is crucial for clarity and this aspect is addressed. Furthermore, the author illustrates different types of taxes such as individual income tax, corporate income tax, wealth tax, retail sales/value added/goods and services tax, selective excises, property tax, minimum taxes such as the minimum alternate tax (MAT), cash-flow tax, financial transactions tax, fringe benefits tax, customs duties and export taxes, environment tax and global carbon tax, and user charges. An emerging concern regarding the inadequacy of international taxation of multinational corporations is covered in some detail. Structural aspects of tax administration are given particular attention.

Inhaltsverzeichnis

Frontmatter

1. Introduction to Taxation

This chapter summarises the concepts, practices and experiences in taxation history, theory, law and administration covered in this book. It reviews the market behaviour of consumers and producers prior to the introduction of a tax and how a market equilibrium is achieved. It addresses what happens to the pre-tax equilibrium when a tax is introduced, and its impact on that market and on the economy as a whole. It provides reasons why governments impose taxes and what principles should be adhered to when structuring a tax system. It addresses the area of tax legislation regarding how a country’s constitution assigns taxes to different levels—central, state, local—of government, and how the language of tax law should be formulated, and by which professional branch. It addresses the structures and experiences with a comprehensive list of globally prevalent taxes—both direct and indirect—on consumption, production and forms of income. It continues to an issue in international taxation that has recently emerged in the form of challenges to adequately tax multinational enterprises. It addresses how tax administration should be structured in all its aspects and provides country experiences. Finally, in a nutshell, it recounts what should comprise an ideal tax design.

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Selected History of Indian Taxation

Frontmatter

2. Taxation in Ancient India

Taxation has existed as long as human civilisation has been documented. It is important for the interested student of taxation to familiarise himself with the earliest thoughts and practices of governance, and taxation in particular. Taking India as a case study, this chapter covers evidence of taxation in ancient India, beginning with the earliest written texts. It is found that the Indian tradition of Brahmanic and Buddhist scholarship is full of references to governance, tax and expenditure policy of which selected instances are provided. It covers the writings of various experts and advisers, and edicts of rulers during those early kingdoms and empires in both north and south India. Examples from other parts of the world in the annals of history, from China to the early Greeks, are also cited. What emerges is a rich background to the ancient history and practices in global including, in particular, Indian taxation.

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3. Taxation Under the Mughals

This chapter covers the history of taxation from the Mughal dynastic era (1526–1858) in India. There are many scholarly studies on taxation during Mughal rule over three centuries from which a summary of impositions and conclusions therefrom may be drawn. The chapter takes up the third and sixth emperors, Akbar, the most effective, and his great-grandson Aurangzeb, the most controversial. For the Mughals, taxation was perceived as the monarch’s reward for governance and the protection of their subjects. Land comprised the main tax base, along with a few other taxes including import and export duties, and tributes from states controlled by the Mughals. Indian history emphasizes the imposition of jizya, a progressive income tax on non-Muslims with an exemption for minimum wagers. Akbar was uncomfortable with religious segregation and abolished it. Aurangzeb reinstated it. Nevertheless, beyond jizya, Mughal revenue administrations have a lot to offer to a scholar of taxation. As the empire declined, however, regional governors assumed self-governance and diminished revenue transfers to the emperor and, with the rise of the British East India Company, the right to trade in salt, opium, tobacco and betel nut without paying customs duties was transferred to them by the 1720s.

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4. Taxation in Early British Period

This chapter covers taxation during the East India Company administration in India, focussing on Robert Clive, Warren Hastings and Charles Cornwallis as designers of tax policy from mid-1700s to early 1800s, followed by British sovereign rule from 1857. Heavy impositions began in 1757 with the victory of Clive in a battle with the Nawab of Bengal, continuing replacements on the throne and war reparations therefrom. Taxation pressure was not any lighter during famine when, in 1770, under Warren Hastings, half the labouring and working people had died. The Company rigorously enforced tax collection while increasing revenue assessments. Hastings commented that tax collections ‘violently kept up to their former standards’. A Permanent Settlement on land was introduced by Cornwallis in 1793 whereby absolute rights were given to landowners provided they paid a pre-designated land tax in perpetuity. Unless paid punctually, the land was sold to someone else, with half the estates changing hands in the ensuing decades. After 1857, the Indian economy functioned to ensure an Indian market for British manufacturers, remittances to Britain and high returns on British investment. GDP stagnated. Per-capita income declined. Under such conditions, extraction of heavy taxes overburdened all producers—agricultural and non-agricultural—in the economy.

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5. Taxation in Pre-Independence Period: The Salt Tax

This chapter addresses the inter-twining of tax resistance with India’s independence movement. In December 1916, Mohandas Karamchand Gandhi courted arrest reflecting extractions by British landlords in Champaran village from ‘every home and every marriage, even levying special taxes to pay for their own hunting or holidays’. Conditions of Indians deteriorated. Independence became the objective of India’s Congress party. Gandhi planned mass refusal to pay taxes in Bardoli in February 1922, then reinvented it in 1927. Eighty-four thousand peasants refused to pay taxes for six months. Government reduced taxes, compensating losses from seizure of goods. On 26 January 1930, Gandhi published a declaration of complete independence, picking salt tax as his instrument. On 6 April, he picked up salt in Dandi, Gujarat, without paying tax. Sushil Dhara did likewise in Tamluk, Bengal. Electrified, officials resigned; villagers made salt at home; soldiers refused to fire on demonstrators. Retaliating, Brigadier General Michael O’Dwyer ordered the shooting of peaceful demonstrators in Jalianwallah Bagh, Punjab, on April 13, killing 379 people and wounding 1100. Tax-free salt manufacture was allowed for personal use. English analysts commented the salt tax march was among the last nails on the British colonial coffin. India gained independence on 15 August 1947.

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Theory of Taxation

Frontmatter

6. Principles of Taxation

The theory of taxation rests on the shoulders of economic theory of the market. When a tax is introduced, market prices of products and inputs change, shifting the allocation of inputs—labour and capital, for example—distorting their pre-tax ‘efficient’ allocations among various products. A second effect could be unequal distribution or incidence of tax burdens on those resources. A third effect comprises uncertain effects on the stabilisation of an economy, and on savings and investment that may, in turn, affect capital formation and economic growth. Tax design should, therefore, recognise principles that minimise such adverse ramifications. Fourth, revenue buoyancy or productivity of tax revenue is an important concern of tax administrations. Fifth, clarity of tax law determines the ease of taxpayer compliance. Sixth, simplicity of tax structure is important because complexity leads to challenges of interpretation. Seventh, structuring a tax administration such that tax law is applied transparently and impartially has emerged as a crucial principle. The fact that some principles may conflict with one another under selected circumstances has to be contended with. Finally, a question that is addressed is, once a reformed tax structure adhering to essential principles is introduced, how long is it likely to last.

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7. Market Behaviour of Consumers and Producers

In a world without taxes, how consumers and producers are assumed to behave in a perfectly competitive economy is addressed in this chapter. Consumers express their demands for products in the marketplace reflected in their ‘utility functions’. Producers use engineering technology and associated costs to construct factories and warehouses that comprise their fixed cost for their production structure. They also use machinery, raw materials and labour and obtain their input prices from the market. They combine fixed cost with the variable costs, the former remaining constant and the latter varying with the quantity they choose to produce. In turn, that determines their supply in the market revealing how much they will supply at each price faced by their product. Thus, all consumers combine to generate varying market demands at different market prices and all suppliers combine to generate changing market supplies at different market prices. An equilibrium price–quantity combination occurs where the schedules or curves of market demand and supply of a commodity intersect. At the equilibrium, the ‘marginal rates of substitution’ among consumers equal the ‘marginal rates of transformation’ among producers. These foundational concepts of market equilibrium are elaborated through figures and explanations in this chapter.

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8. Introduction of a Tax in the Market

Reflecting their need for public expenditure, governments impose taxes on the production or consumption or incomes (or on some or all of them) that prevail at a market equilibrium. A tax taken from consumers modifies their demand away from taxed goods and towards untaxed goods, a decision made entirely due to the tax. Therefore, their pre-tax, free-market choice gets distorted and a new post-tax choice emerges. A tax taken from producers or the factors of production—comprising investors, wage earners and owners of land—that go into making a product, modifies their decisions to produce and supply, and a different, post-tax supply will be established in the market. The relationship between the pre- and post-tax equilibria reflects how consumers, producers and owners of factors of production react to the tax. These reactions depend on various elasticities of substitution between products, and elasticities of factor substitution across various factors of production. The impact of moving the original to another equilibrium results in an ‘excess burden’ of tax reflecting the fact that some consumer satisfaction is lost forever as a result of the tax. Some taxes cause more excess burden than others. These matters are the subject of analysis in this chapter.

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9. Incidence of a Tax

A tax may be levied on a firm or individual but its final burden—what economists term ‘incidence’—may be shared by another economic entity. Thus, a tax on the supply of Laptops may be shifted partially to consumers if consumer demand is less than fully elastic if Laptop is a relative necessity, not a luxury. Incidence analysis of a product market alone is referred to as ‘partial incidence’ of a tax. The Laptop supplier may pass on some burden to the labour he hires, in other words, to inputs he uses in production. When all actors in the production process—inputs and output—are considered together, the final distribution of the burden among them is called ‘general incidence’ of a tax. This has been analysed in the context of the corporation income tax. It is a ‘partial’ tax collected from the income of capital in the corporate sector alone. Resource use decreases in the sector and they move out from it. They will be absorbed in the non-corporate sector though the relative returns—wages and rental of capital—to factors will change in the entire economy reflecting various product and factor substitution elasticities. These incidence outcomes are analysed here.

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10. Equity Effects of Taxation

Entities equally placed prior to the imposition of a tax may find themselves to be unequally affected by the imposition of the tax. Thus, a tax could be inequitable across different consumers and producers in the economy, that is, it may suffer from ‘horizontal inequity’. Also, a tax may exacerbate the inequity that already exists in the income distribution in the economy. This indicates that the tax suffers from ‘vertical inequity’. The design of taxes should prevent worsening the prevailing distribution of income in the population. There are alternative criteria behind how taxes are imposed. One is the benefit principle, that is, a tax should be collected from a taxpayer in reflection of the benefit he derives from a public service. It does not recognise equity as a principle but has certain advantages such as transparency. Another method is taxing according to the ability to pay of a taxpayer that results in higher taxation as incomes rise. Yet another method is optimal taxation that emphasises the efficiency criterion with built-in subsidies for the poor primarily through the expenditure side of the budget. This chapter considers these principles and concludes that the ability to pay criterion is the most widely used.

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11. Tax and Stabilisation of the Economy

One of the government’s roles is to maintain aggregate demand in the economy which is consistent with stability in employment. When the economy is in recession, government should bolster it by taxing less; and, when the economy’s demand outpaces supply, government should cut the excess demand back by taxing more. This is called counter-cyclical tax policy. A progressive tax structure achieves this objective and is called an automatic stabiliser. The objective of this chapter is to examine the economic stabilisation capability of a tax structure. Relatedly, it examines the concepts of ‘buoyancy’ and ‘elasticity’ of tax structures that measure the revenue response to rises in income. It analyses the impact of progressivity of taxes in an inflationary environment when it is possible for nominal incomes to rise, though not real incomes. Nevertheless, higher nominal incomes would drag taxpayers to higher tax brackets. This phenomenon is termed ‘fiscal drag’. To alleviate it, some inflation adjustment in tax payments is called for. On the other hand, during inflationary times, any slowness or lags in revenue collection deplete the real value of revenue collected. Tax administrations should structure revenue flows to guard against it. These aspects are considered in this chapter.

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Tax Law

Frontmatter

12. Tax Assignment and Revenue Sharing

A decentralised economy comprises different levels of government with independent fiscal powers. A crucial issue is the design of appropriate assignment of taxes and expenditures to different levels of government. The rationale for decentralising fiscal responsibility derives from the premise that the welfare generated by providing public goods and services is maximised by reflecting, as closely as possible, the preferences revealed by the population at the subnational levels of government. Accordingly, governments that comprise several levels assign different expenditure responsibilities to each level. Tax assignment also follows a stratification of objectives. A central government function is achieving appropriate redistribution which should be assigned to it since, otherwise, people bearing any resultant burden of local redistribution policies would emigrate to another state or province or local jurisdiction. The central government must also remain ultimately responsible for overall macroeconomic stabilisation since local attempts at stabilisation policies would have spillover effects across jurisdictions. Subnational—state and local—governments, on the other hand, are assigned taxes that do not adversely affect the efficiency of resource allocation. The mix of tax and expenditure responsibilities of different levels of government is referred to as fiscal federalism. This chapter focuses on the taxation side of fiscal federalism.

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13. Tax Legislation

Once tax economists have deliberated on a tax matter and proposed a tax structure, they tend to take little continuing interest in the formulation or interpretation of subsequent law. The intensity of this separation is possibly diminishing with time. In that vein, this chapter illustrates the process of introducing tax law, who designs it, who writes it and who ensures its adherence to the rule of law. Broadly, tax law is enacted by the legislature, implemented by the executive and interpreted by the judiciary. If tax law is not designed well, for example if retrospective taxation is introduced to suit government’s will, taxpayers will eventually express dissatisfaction and, if the judiciary is unbiased, courts are likely to interpret the law in the taxpayers’ favour, with taxpayer rights and charters increasingly appearing in tax statutes. Conversely, if taxpayers, in particular multinational enterprises, indulge in sustained tax avoidance by using loopholes available in different tax statutes across the world, global tax authorities will intervene and install cumbersome reporting requirements and mechanisms for the exchange of information amongst themselves. These aspects, together with cross-country experience of tax legislation and a short recounting of India’s pre- and post-independence tax legislative history comprise this chapter.

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14. Drafting Tax Law

Drafting tax law falls within the specialisation of drafting any law. In the case of tax law, particular factual considerations of how to organise sections, the type of language to be used that is comprehensible to the tax community, considerations of how simple the law should be to read without sacrificing necessary detail and more normative considerations regarding whether the law has achieved effectiveness in conveying the proper message to taxpayers and tax officers alike, all come into play in determining its usability domestically and quotability in the international sphere. Given the prevalence of some cross-country variation in definitions, there is little doubt that a domestic legislative drafting style with suitable definitions is preferred over blindly borrowing from international quarters. This is notwithstanding the awareness with which globally available styles have to be mastered by a drafter of any tax law. We consider some of these matters in this chapter.

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Prevalent Taxes

Frontmatter

15. Income Taxes—Design and Evidence

The design of the income tax is embedded in defining its base—what deductions, allowances or credits are allowed, rate structures—the degree of its progressivity, as well as the basis of payroll taxes—pay as you go (PAYG) or fully funded (FF). Many countries use withholding to facilitate tax compliance on interest and dividend or other incomes which comprise deductions in income tax returns. Taxing wealth was historically important though the quality of implementation receded and countries began abolishing it. With increasing need for fiscal resources, it has re-entered academic discussion. The scaling back of taxes on inheritance, gifts and estates are also being reconsidered. Other taxes include a minimum tax on the well-off, and a presumptive tax on hard-to-tax taxpayers based on the observed standard of living for an individual or, for a small factory owner, his floor space, number of employees and electricity use. At the local level, the most prevalent is the property tax. Some countries have taken time to appropriately structure a property tax for want of a cadastral survey though it is now common to find it at least in large cities in emerging economies. These taxes, and variations thereof, are considered in this chapter.

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16. Taxation of Income from Interest, Dividends and Capital Gains

Interest earnings and dividends earned are comparable for tax purposes in that the taxation of interest and dividends is usually viewed as taxing nothing other than ordinary income. Dividends and interest on selected types of savings may be taxed less than individual income to encourage capital investment and savings. However, such incentives cause inefficiencies by encouraging taxpayers to invest and save in lower-taxed segments that could effectively favour higher-income taxpayers since they tend to have higher capital income. On the payments side, interest payments may be fully or partially deductible, while dividends paid out may be partly deductible or may not be recognized in the calculation of taxable profits. Tax treatment of earnings that are retained by businesses and do not comprise dividend payments are usually treated differently for tax purposes. Selected country experiences are illustrative. Taxing capital gains is subject to greater debate and discussion. It is a complex area of income tax design; hence some countries choose to tax it in a scheduler manner, that is independently of the regular income tax schedule. Its rationale, concept and design structure deserve particular attention. These perspectives on the taxation of interest, dividends and capital gains are examined in this chapter.

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17. Taxation of Individual Income—India Case Study

India’s individual or personal income tax has become complex over the years. It comprises various elements and branches thereof including the taxation of payroll or salaries, interest, dividends and capital gains, estate and wealth tax, inheritance and gifts. Some have been repealed. Several of them are linked to other taxes. For example, the tax on dividends has been linked to a tax on securities transactions, the wealth tax was linked to a minimum tax, though at present the wealth tax stands abolished. There also were components of presumptive tax on agricultural holdings several of which have not survived. Thus, many income-oriented taxes have been experimented with over the decades since the Income-tax Act was introduced in 1961 and implemented from 1962. Several of those experiments did not last, for example, attempts to tax fringe benefits through a tax specifically on them, and a tax on bank transactions to control the black economy had to be repealed reflecting popular demand. In the 2000s, several attempts to reform the income tax into a consolidated direct tax code have not succeeded, more often than not due to the inaction of successive governments. The hope for reform survives, however, in the present day.

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18. Corporate Income Tax—Design and Evidence

The corporate income tax has become increasingly complex across the globe. This reflects the complexity in measuring business income, divergence of tax law from accounting law, designing rules to depreciate capital assets or make inflation adjustments to ensure a correct tax base. The financial sector has particular characteristics that render it difficult to be taxed in a congruent manner with other sectors, so that special rules are needed to tax it. A narrowing of tax base has led countries to legislate different minimum taxes to avert revenue depletion from tax incentives and tax avoidance. Incentives distort equilibrium resource allocation in the economy. Protecting the tax base from becoming too distorted by measuring the marginal effective tax rate becomes a necessity so that subsequent corrective structural improvements can be made. Other considerations include the relationship between corporate and individual income taxes. Some countries attempt to integrate them. However, most countries tax individuals and corporations separately. Countries have considered alternatives to taxing corporate income such as taxing their cash flow, though the narrowness of the cash-flow tax base has obviated its introduction anywhere. Elaboration of some of these considerations is the subject matter of this chapter.

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19. Corporate Income Tax—India Case Study

A corporation is a separate and independent legal person from its shareholders. Corporate tax is paid on the net profit made from business by corporations. Corporate income is taxed at a specific rate prescribed under the Indian Income-tax Act (the law). Indian and foreign companies are both liable to pay corporate tax. An Indian company is registered under the Indian Companies Act and includes corporations established under central or provincial acts. A domestic company includes private and public companies. A foreign company is one which is incorporated in any foreign country. Companies are taxed based on their residential status. A company is resident for tax purposes if it is incorporated in India or if its place of effective management (POEM) is in India during the relevant fiscal year. POEM is a place where key management and commercial decisions for the conduct of business are made in substance. A resident company is taxed on its global income. A non-resident company is taxed on Indian income accrued or received in India. The scope of Indian income is defined under the law. These matters are addressed in this chapter. Deductions, amortisation, maintenance of accounts and audits, and presumptive taxation are also examined.

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20. Minimum Alternate Tax—India Case Study

India’s corporation income tax has been beset with tax incentives that reduce the tax base, adversely affect neutrality in the tax system, and reallocate resources between industry sectors and commerce. They also reduce revenue collection as is evident in the government’s annual calculations of revenue loss from tax incentives in its annual budget, an exercise that began in 2006. Continuing depletion of the revenue base generated an early interest in a minimum alternate tax (MAT) in India. In this chapter, we study the emergence, trajectory and behaviour of the Indian MAT. MAT was introduced in 1987, while an AMT was introduced in 2012 on entities other than companies. The MAT itself underwent many changes including removal and rate changes. Its time series relationship with the corporation income tax is estimated and analysed. While the chapter shows in some detail how the Indian MAT has to be calculated by a taxpayer, it also proposes an alternative MAT base that combines a stock and a flow concept, that is an asset and an income combination. That would amplify the minimum revenue contribution behind a MAT by closing possible gaps that enable taxpayers to minimise their revenue contribution to the corporation income tax.

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21. Consumption and Production Taxes

Two types of indirect taxes prevail, first, on selected commodities called selective excises on ‘demerit’ goods like alcoholic beverages and tobacco products, on non-renewable resources like petroleum products, and luxuries like furs and yachts. Collected at the factory gate, they are called production taxes. Excises are narrowly based, and their rates are higher than for widely based consumption taxes including retail sales tax (RST), value-added tax (VAT), and goods and services tax (GST). The United States, one among few, uses RST at the state level. Collected exclusively at the retail level, RST is prone to evasion. The GST or VAT collects tax at every stage of production and distribution including retail while giving input tax credit for taxes paid in earlier stages. This eradicates ‘tax on tax’ or cascading. Thus, if the retail stage is missed, tax is nevertheless collected at earlier stages. Some developing countries have VAT on the supply of goods though not on services. However, VAT or GST should include goods and services in the base. Only then cascading is eliminated comprehensively from the supply chain, though some cascading remains in most structures due to exemptions. Exemptions also erode the base. Production and consumption taxes are studied in this chapter.

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22. Environment Taxes and User Charges

Market failure occurs when the social cost of producing and supplying certain commodities is not reflected in market pricing. This results in excess market supply and consumption. It could reflect pollution from factory smoke and actual cost of clearing the pollution not being factored into product price. The impact of pollution is a negative social cost or ‘externality’ that should be captured in market prices. Correct pricing should ‘internalize’ social cost of production and supply. Irretrievable proof has emerged that the atmosphere is being damaged through greenhouse gases punching holes in the earth’s ozone layer, leading to global warming or ‘climate change’ with significant inter-generational ramifications. Corrective measures include regulation, user charges, permits and taxes that attempt to equate, at the margin, the social cost of a supply with its social benefits, with relative advantages and disadvantages to using them. As the atmosphere becomes increasingly recognised as a global resource and, reflecting the rise in the use of mineral resources such as coal and petroleum products, the most prominent instrument is a global tax on carbon emissions. However, such taxes to mitigate global pollution have not met final success. These and related issues comprise the subject matter of this chapter.

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23. Indirect Taxation Prior to GST: India Case Study

Reflecting the constitution’s tax assignment, India’s indirect tax history began with state-level sales taxes on goods and a handful of services and central level excises on manufacturing. Both suffered from rate dispersion and cascading. In 1985–1986, the central government—centre—allowed input tax credit (ITC) in its excise structure though not comprehensively, calling it Modified VAT (MODVAT). In 1994, the centre introduced a tax on three services—insurance, telecommunications and stockbroking—at 5%. Gradually, more services were taxed, and the rate increased to 15% by 2017. Services as a category were not mentioned in the constitution; the centre used an assigned ‘residual’ category to tax services. In 2005, states introduced their own VAT on goods with the centre providing financial compensation for 3 years. The state VAT slashed the number of rates and had the same VAT base for all states with few exemptions. Using a constitutional amendment, India consolidated its indirect tax structure with a Goods and Services Tax (GST) in 2017 covering central and state governments and including both goods and services. Though somewhat flawed in structure, it was an achievement for a fiscally federal country. India’s experience before the GST comprises this chapter.

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24. Goods and Services Tax (GST): India Case Study

Evidence of a seamless fiscal federal goods and services tax (GST) with parallel centre–state channels is found first in a 2001 task force report for India’s Tenth Five-Year Plan. In his 2006 budget speech, the Indian finance minister announced his intention to introduce GST; a first expert report was submitted on 31 December 2007. A 13th finance commission subcommittee penned another report in 2009. Thus, experts played crucial roles. Subsequently, the parliamentary select committee on GST also issued a favourable report. On 20 December 2014, the then finance minister recognised GST as the ‘single biggest tax reform since independence’. A centre–state GST was introduced on 1 July 2017. Despite flaws, few countries have achieved a fiscal federal GST on this scale. This chapter analyses, on the policy side, Indian GST’s conceptual basis and design, revenue base, continuing evidence of cascading and needed corrections, and role and functioning of the GST Council, the centre–state policymaking body. On the administration side, it addresses GST’s success or lack to inculcate a customer focus, the management of inter-state trade under GST, the lack of much-needed software to auto-populate debit–credit links in the production chain, strategies to mitigate tax evasion and continuing incidence of litigation.

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25. Taxation of International Trade: Design and Experience

The advent of the World Trade Organization (WTO) resulted in lower customs tariffs globally. Greater international competition, which could be possible only with lower taxes on international trade, was perceived to improve economic links and transfer of technology and to result in improved products and diversification of output and exports. Protectionist policies would have the opposite effect. Countries that reduced average tariffs experienced rapid economic growth the most. Similarly, export duties on traditional commodities such as tea, coffee, rubber and minerals were reduced to improve international competitiveness. This chapter addresses customs policy concerns. They include selected conceptual issues together with the rationale and objectives of a customs regime, the role of the WTO in the reform of the structure of customs tariffs, expanded customs functions in recent years, revenue generation through customs tariffs in emerging economies, progressively reduced customs tariffs in the industrial sector and the diminishing role of customs as a revenue generator, changes in tariff structure in India, and anti-dumping duty on imports.

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26. Unusual Taxes

Countries occasionally introduce taxes to plug loopholes elsewhere in their tax systems and to enhance revenue generation. A tax on financial transactions has been contemplated at a global level though not successfully, but has been used in Latin America in different forms such as in Argentina and Brazil. Argentina removed it and Brazil kept it in the statutes at a zero rate. Subsequently, India too introduced a tax on bank withdrawals but then abolished it. The design, economic effects, revenue productivity and collection costs of this tax are analysed. A tax on fringe benefits has been used in Australia and New Zealand. There is some justification for this tax when fringe benefits are not voluntarily reported as a part of the income tax base and tax paid on it. India introduced a well-designed tax on fringe benefits though its administration proved challenging. Hence it was removed. This chapter examines the conceptual basis of these taxes and takes up India as a case study.

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International Taxation

Frontmatter

27. Double Taxation Avoidance Agreements

Taxation of productive factors involves balancing national against international considerations. National objectives concern revenue, allocative efficiency and equity effects of taxation. Tax systems have fundamental ramifications also on the volume and allocation of productive resources internationally because factor returns and underlying tax bases straddle national boundaries. To alleviate possible conflicts, adjustments to domestic taxation are needed. One set relating to direct taxation comprises residence and source principles. Another set for indirect or consumption taxes—GST or VAT—comprises origin and destination principles. In the prevailing globalised world, cross-border transactions are increasing and becoming more complex. At the same time, domestic resource mobilisation has gained greater significance as governments feel pressured to generate additional revenues for socio-economic programmes. Every country seeks to tax the income generated within its territory on the basis of one or more connecting factors such as the location of the source of income (source principle), residence of the taxable entity (residence principle) or presence of a permanent establishment (PE) in its territory for carrying out business activities which generate profits. To alleviate double taxation of the same productive activity in different jurisdictions, countries negotiate tax treaties with treaty partners. The concerns of tax treaties comprise this chapter.

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28. Specific Anti-avoidance Rules (SAAR)

Globalisation has resulted in greater multinational enterprise (MNE) operations. Emerging economy MNEs are also establishing or acquiring subsidiaries abroad. MNEs carry out complex international transactions involving intangibles and multi-tiered services. They tend to structure transactions such that intra-group prices—transfer pricing—are determined reflecting tax considerations. This includes shifting of profits from one jurisdiction to another in a way that their global tax contributions are minimised. MNEs view such behaviour as ‘tax efficiency’. Tax administrations view it as comprising artificial means to avoid tax worldwide, that may be strictly legal but unintended in the law. Therefore, they have introduced anti-avoidance measures in their tax laws to minimise the shifting of the tax base abroad by MNEs to low-tax jurisdictions. Some rules against such ‘tax planning’ target specific identifiable means of tax avoidance and are, therefore, termed specific anti-avoidance rules (SAAR) for both domestic and international tax avoidance. Such rules attempt to contain tax avoidance through transfer pricing including excessive payments among related businesses for mutual international transactions, questionable sources of funds received as share capital or loans, transactions that strip out dividends or bonuses and artificial arrangements in transfers of movable property. Selected prevailing practices are examined in this chapter.

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29. General Anti-avoidance Rules (GAAR)

Tax avoidance began to be targeted through a widely applicable instrument that came under the rubric, general anti-avoidance rules (GAAR). While each SAAR targets a single tax avoidance behaviour, GAAR is designed to target a broad spectrum of tax avoidance. The popularity of GAAR increased with growing disappointment among policymaking authorities regarding low tax contributions by services sector multinational enterprises (MNEs), particularly in the e-commerce sector, during the global economic crisis of 2008–2009 when revenue needs for public expenditure were at an all-time high. This feeling redoubled as SAARs were considered insufficient to capture tax avoidance comprehensively. GAAR enables wider scrutiny of intra-group MNE structures that are considered unacceptable. Cross-country GAAR legislation is found in a number of jurisdictions. This chapter reviews examples of GAAR across countries ranging from advanced economies such as Australia, the European Union (EU), the United Kingdom (UK) and the United States (US) to the emerging economies of Brazil, China and South Africa. A case study of India is included, that explores the core tensions—between the justifiable elements and the overzealousness of the tax authorities—in the emergence of the Indian GAAR originally introduced in 2012, then put in abeyance, and finally legislated in 2017.

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30. Tax Base Erosion and Profit Shifting (BEPS)

The Group of 20 (G20) nations engaged the Organisation of Economic Cooperation and Development (OECD) to make recommendations for containing international tax base erosion and profit shifting (BEPS). This reflected perceived MNE behaviour of locating profits in low tax jurisdictions and contributing little to tax in proportion to their global pre-tax profits. In the rush for corrective measures, however, governments were quick to conclude that inappropriate tax behaviour of MNEs was endemic. Tax avoidance was not viewed as a phenomenon pertaining to selected sectors or individual enterprises, rather, as a phenomenon afflicting the entire MNE sector. In September 2013, the OECD adopted 15 Action Plans to address BEPS. In October 2015, 15 Actions in 13 final reports were released. In July 2020, the OECD publicly shared the outcomes of a stocktaking exercise of whether signatory countries were meeting minimum standards that they had signed on to for being a part of the BEPS process. It found that countries were collaborating and sharing best practices regarding fiscal policy and tax administration. The report pointed to how standards could be improved for countering BEPS. This chapter examines the success of the Actions in addressing BEPS and country reactions to the BEPS process.

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31. Taxation of Digital Economy

The digital sector has little physical presence in taxing jurisdictions, rendering its taxation challenging. The OECD’s October 2015 BEPS Action 1 Final Report observed that digitalisation exacerbated BEPS and identified ‘nexus, data and characterisation’ issues. The G20 asked that OECD’s Inclusive Framework (IF) of more than 100 members deliver a solution by 2020. A 2018 interim report analysed nexus and profit allocation rules but repeated the challenges of ring-fencing it for taxation. Nevertheless, the IF released a Policy Note in January 2019 grouping proposals into two pillars—one on nexus and profit allocation (Pillar One) and one on ensuring a minimum level of taxation (Pillar Two). Pillar One could not generate consensus though a ‘Unified Approach’ (UA) document was released in October 2019. Consultation occurred on Pillar Two in December 2019. In January 2020, a note, ‘Outline of the Architecture of a Unified Approach on Pillar One’ was released. The United Nations proposed a framework for digital economy taxation in August 2020 with little traction. In October 2020, the OECD admitted that Pillar One discussions were deferred. This chapter relates the nature of the digital economy, revealing why multilateral taxation has been impossible, with countries taking unilateral steps to tax it.

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Tax Administration

Frontmatter

32. Structure, Customers and People

For any tax administration, its objectives or targets should be defined in a vision statement. The vision may exhort staff productivity and customer satisfaction, while articulating a revenue strategy and minimising the tax gap. For example, should a young tax administration focus on developing traditional tools for enhancing revenue, rather than sharpening precision instruments for lowering tax evasion? The objective cannot be merely to collect revenue but its effect on equity and allocative efficiency may be equally, if not more, important. A menu of specific, measurable objectives and key performance indicators (KPIs) needs to be in place for the different branches of the administration while specifying the likely consequences for over- or underperformance. Accordingly, this chapter focuses on a tax administration’s integrated structure, customers and people or staff. It elaborates on governance, management, information generation, customer focus, taxpayer services, dedicated staff for services delivery, e-access to customers, e-filing, pre-filled tax returns, administrative effectiveness and customer surveys, erroneous objectives, tax gap as an appropriate criterion, cutting off any nexus between tax officer and taxpayer, preventive and punitive vigilance and cross-country advances.

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33. Key Administration Processes

A tax administration has some core functions. They include taxpayer registration, tax payments, filing tax returns for both direct and indirect taxes. They include, among others, taxpayer identification, registration and payment arrangements, audit and scrutiny and, in association, developing risk-based audit selection and protocols, training and placement of audit staff on the basis of competency and specialisation in carrying out audit and scrutiny, and combined audit of direct and indirect taxes such as income tax and GST or VAT. Core functions also include the application of tax deducted at source (TDS), carrying out refunds and foreign tax credit in a timely manner, installing self-assessment requirements and procedures thereof and using tax recovery when needed to minimise delinquency or eliminate stopfilers. What emerges is that processes can become quite complicated unless simplicity for ease of compliance and administrative convenience are preserved and nurtured as a strategy and an objective to be achieved. This chapter elaborates on those core functions of a tax administration.

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34. Dispute Management

The dispute management function should commence from policies and measures to prevent or minimize disputes to their efficient and satisfactory resolution. Advanced tax administrations have a dedicated organization for dispute management that functions with independence so that a taxpayer has confidence in the administration’s objectivity and fairness. It should ensure that avoidable disputes are not generated and only exceptionally, cases escalate to litigation. Operating procedures should be transparent and made available to taxpayers. Tax administrations may issue binding technical guidance to ensure clarity and consistency in interpretation and application of law and to enhance taxpayer understanding of it. Pre-dispute consultation and pre-filing support together with high-quality show cause notices and tax demands are complementary instruments. Advance ruling and mutual agreement procedures (MAP) prevent disputes. Alternative dispute resolution (ADR) methods are employed to resolve tax disputes out of court including settlement commissions and arbitration mechanisms. They should incorporate administrative and appellate level functions. For success, dispute resolution requires officers with relevant knowledge, expertise and maturity. Assigned officers should receive adequate induction and on-the-job training in the principles of law and jurisprudence, principles of statutory interpretation, theory of precedents and principles of evidence. These aspects comprise the subject matter of this chapter.

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35. Technology and Research

Information and communications technology (ICT) has allowed the transformation of data and information to knowledge that, in turn, has enhanced a tax administration’s operational efficiency and analytical capacity. The rapidity with which tax identification numbers (TIN) have been issued, electronic filing implemented, profiles of hard-to-tax individuals created, processing time reduced and economic ramifications of major tax changes analysed are cases in point. It has resulted in a surge in tax revenues in recent years. Administrations that are slow in using ICT have suffered taxpayer dissatisfaction and higher tax evasion. Risks from ICT use exist and include data security risks and problems with large-scale public procurement. They have to be managed through the sharing of experiences of best practices across jurisdictions. ICT has enhanced the use of modern algorithms in revenue analysis and projections, development and monitoring of key performance indicators, including reduction in compliance costs, improvements in taxpayer segmentation and profiling, containment of tax debt of taxpayers and impact of customer contact on compliance. Analyses have pointed to strategies to enhance compliance of taxes such as income tax, GST or VAT, selective excises and customs. This chapter focuses on the use of ICT in tax analysis and its impact on governance.

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36. Customs Administration

Customs administration fits into an overall tax administration structure in terms of customer focus, administration structure, people or personnel, analysis and strategy. It has to meet growing client expectations for higher service standards. In the process, the best practice customs administrations have radically transformed their structures and business processes, taking advantage of the opportunities that recent rapid advances in technology offer. Yet there are certain functions that are specific to a customs administration in its domestic activities and, in particular, in international liaison aspects. There is no doubt that customs should provide seamless service rather than becoming an impediment to international economic relations through bureaucratic approaches and that information and communications technology (ICT) is playing an increasing role in customs processes. However, there are growing complexities faced by border agencies in trade facilitation challenged by security, money laundering and smuggling with the spread of globalisation. The World Customs Organization (WCO) plays a role in bringing administrations closer in enhancing international economic relations. Specialised skills, competencies, tools and processes are needed, supported by adequate resources, to achieve a world-class customs administration. This chapter focuses primarily on those functions that comprise unique challenges in a customs administration.

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Ideal Tax Design

Frontmatter

37. A Good Tax System: A Rapid Review

This volume emphasised essential underpinnings comprising principles of taxation in tax design. Conversion to a comprehensible legal format that can be correctly interpreted by stakeholders is equally important. Increasingly, tax avoidance by multinational enterprise (MNE) taxpayers represents a formidable challenge to tax administrations and a new branch has developed that addresses this issue. Not only are taxation theory and law important, but its administration represents a third anchor for taxation to be successful in a country and an international context. Further, this volume has illustrated an important lesson in taxation, that of its history, taking India as a case study. It found that taxation has had an extractive characteristic over the course of history rather than one of willing participation in a social contract between the government and the people it should serve. Historical experience is a lesson for what modern governments should eschew in designing tax systems and administrations to achieve voluntary tax compliance rather than using severe extractive policies merely for revenue generation. This chapter comprises a rapid review of the major elements of an ideal tax design that a student of taxation should keep in mind when designing tax policy, writing tax law or administering a tax system.

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