In a brilliant introduction to his book, The
Law Book – 250 Milestones in the History of Law, Michael H. Roffer begins
with the statement: “The Law surrounds us. It affects the food we eat, the
water we drink, and the air we breathe. It travels with us. It defines our
relationships with the people with whom we live, work, and share space. It
affects our homes and schools, our offices and stores. The law touches every
aspect of our lives and even our deaths.” I am inclined to think, in a
lighter vein, that the author had the tax law in his mind more than any other
law, for the tax law (direct & indirect) touches every aspect of life which
he has listed! That is perhaps why Oliver Wendell Holmes Jr., made the famous
statement that “Taxes are the price we pay for civilization. I like to pay
my taxes”. But the question as to how the taxes are imposed and collected,
and upon whom they are levied, and in what manner and how they are quantified – these questions seem to
have always troubled the tax administrator, the tax payer, the tax lawyer and
ultimately the government.
Taxes have been looked upon, traditionally, as the government’s share in
the prosperity of the breadwinner. That is one of the main reasons why
income-tax paid is not allowed as a deductible expense; it has been held to be
the “Crown’s share in the profits”, there being other reasons, too. It would appear
that before the development of “money” as representing the purchasing power of
a person, the taxes were collected in kind, through commodities, even hard
work. Customs duty and taxes on owning of lands are said to be two of the
earliest taxes netting huge revenues for the countries. Only in the year 1798,
William Pitt the Younger, who was the Prime Minister of Great Britain those
days, first proposed a legislation to tax the citizens “upon all the leading
branches of income”. This law is generally believed to be the first formal
income-tax in history. This tax is believed to have been imposed to replenish
the treasury of that country which had been drained because of its war with
Napoleon Bonaparte. The tax was known as “The Triple Assessment” because
its measure was three times the expenditure which a person had incurred in the
preceding year. There is good reason to believe that the levy succeeded,
because it was followed up by a proposal that a general income-tax be charged
on all leading branches of income. This resulted in a tax legislated for the
first time in history in January, 1799, and it called for a progressive rate of
tax on annual income above 60 pounds; the rate began with 1% and went up to 10%
on incomes above 200 pounds. But it was a disaster, and the public protested
strongly and resisted payment. It was criticised as a “monstrous law” and “an
indiscriminate rapine”; experts claimed that the public received it with
nothing but “disdain and distrust”. Eventually the tax was repealed in 1802,
after a short life of just three years, but the trend had set in, and the law
had caught the eye of governments all over. In the very next year, England
enacted a new income-tax law and this law became the basis for all subsequent
enactments in that country and became the bedrock of that country’s fiscal
policy. Soon, Germany and America adapted the law, resulting in the passing of
several enactments for the levy and collection of income-tax.
In America, several short-lived attempts had been made in this behalf
and in the law passed in 1894, a tax of 2% was imposed on annual income over
4,000 dollars the object stated being “to address economic inequalities”. But
what happened was that in a decision of the Supreme Court of America, Pollock
vs. Farmers’ Loan & Trust Co., this levy was struck down as
unconstitutional; it was held that the taxes on real and personal property were
direct taxes and in the absence of apportionment among the states they were
unconstitutional. Chastened by this judgment, Howard Taft, the President of
America, wanted to levy income-tax in 1908 after an amendment to the
Constitution to expressly permit the levy. It was the sixteenth amendment and
after being passed by the Senate and the House of Representatives and the
required number of states, it became law in 1913. It was called the Revenue
Act, 1913 and it imposed tax on net income at rates ranging from 1% to 6%.
Beginning with William Pitt’s levy in 1798, taxes have been imposed to
recover monies lost on account of warfare, impliedly as a fee for protecting
the citizens against external aggression. In India, the Sepoy Mutiny in 1857
saw the British rulers imposing a tax in 1860 as a temporary measure for 5
years. In 1867, a licence tax on all trades and professions was imposed. In
1868, it became a ‘certificate tax’ and in both licence tax and certificate
tax, agricultural income was excluded. From 1869 to 1873, for a period of 4
years, there was an income-tax including agricultural income. The tax got
revived due to famine and other reasons in 1877, but it was the Act of 1886
which saw the first landmark of income-tax law of India. It remained in force
till 1918, in which year a comprehensive recasting of the income-tax law was
attempted with a measure of success. Inequalities and inconsistencies in the
earlier law were sought to be redressed. The heads of income such as property,
salaries, business earnings and professional income, other sources of income
were introduced in this law. It applied to income under these heads which arose
in British India.
The recommendations of the All India Tax Committee formed the basis of
the Indian Income-Tax Act, 1922 which tax lawyers of repute commend as a
well-drafted, precise legislation with about 60 sections. In this law, the tax
rates were not prescribed in a schedule as was done previously, and the rates
were left to be prescribed by the annual Finance Acts. This has endured till
now. Notable features of the Act were the adjustment of past losses and
inter-head and intra-head losses, liability of the successor to the business to
pay taxes of the predecessor, etc. The Act received wholesale amendments by the
1939 Amendment Act. Notable features of this amending Act were: introduction of
a category of “resident, but not ordinarily resident”, taxation of income
accruing outside British India even if it is not brought into British India,
introduction of provisions to prevent avoidance of tax by creating trusts,
transferring property to relatives (spouse, minor children),
dividend-stripping, bond-washing, introduction of closely-held companies to
avoid dividend income, etc.
The working of the 1922 Act led to certain situations which were thought
by the government to be not in the interests of the growth and development of
income-tax law in India, and a series of recommendations were sought with a
view to bringing about a legislation with more teeth and which was more
comprehensive. Substantial changes were made in the 1947 Taxation of Income
(Investigation Commission) Act, in 1952,
1953 and 1955 (Dr. John Mathai Committee). More importantly, the Act was
referred to the Law Commission in 1956 in order to make it “on logical lines
and to make it intelligible and simple, without at the same time affecting the
basic structure”. The recommendations of the Law Commission and the committee
headed by Mahavir Tyagi set up in the meantime formed the basis of the present
1961 Act.
The Income Tax Act, 1961 today is a maze no doubt, but to call it “a
national disgrace” (Nani Palkhivala, preface to the 8th edition
of his treatise on income-tax law) would be unfair, in my humble opinion.
Government has the right to set right distortions practised by the tax payers
to “evade” (not avoid or mitigate or plan) income-tax, and it is also well
established that this can be done even retrospectively. This is particularly so
in modern days when multi-national enterprises indulge in multi-layering and
multi-structuring of the corporate entity, and locate them in different places
around the world and in different tax jurisdictions. The government of the day
must be conceded the right to combat such moves if it feels due taxes are not
being paid and the right to plug the loopholes, if necessary, by making the
amendments retrospective. It cannot be lost sight of that it is always a
running battle between the government and the tax payers, particularly the
multi-national juggernauts, and each side tries its best to outdo the other!
But to be fair to the tax payers, it must also be said that some of the
amendments in the recent past, say in about 10-12 years, have been startling,
upsetting the traditional and well-accepted notions of what is “income”. A
different concept of “taxation of benefits” has come to stay, where the
notional difference between the market value of an asset, movable or immovable,
and the price paid is roped in as income.
It is hard to believe that a provision in the Act which was read down to
make it workable, equitable and fair to both the citizen and the government, by
the Supreme Court in K.P. Varghese (131 ITR 597) (SC) has been
introduced through “the back door”, giving a go-by to the acclaimed principles
of taxation vis-à-vis the power under the Constitution of India explained
lucidly and forcefully, if I may say so with respect, in the judgment. There
are also recent instances of what is not income or even a receipt, being taxed
under some pretext or the other. We have all so far understood the pay-out of
dividend by a company as its expense (though not tax-deductible in the
company’s hands, being appropriation of profits), but we are now told that it
will be taxed as the income of the company, a proposition which is baffling.
The constitutional validity of this tax has undoubtedly been upheld by the
Supreme Court in the recent Tata Tea case and therefore the levy has come to
stay. But one shudders to think of the consequences that may follow in the
coming days. A citizen can be mulcted with taxes both on his income and his
expense, to put it crudely, taking umbrage under the ever-elastic Entry 82 of List
I (Union List) which permits the central government to levy “taxes on income
other than agricultural income”.
The power to tax income, and the general power to levy taxes, is
traceable to Article 246 of the Constitution of India which says that Parliament
has exclusive power to make laws with respect to any of the matters specified
in List I of the 7th Schedule to the Constitution. It is also
necessary to note Article 248 which reiterates that Parliament has exclusive
power to make any law with respect to any matter not enumerated in the State
List or the Concurrent List and such power shall include the power to legislate
for the levy of tax not mentioned in either of these Lists. It is in this
background that we need to now look at Article 265, which occurs in the Chapter
titled “Finance, Property, Contracts and Suits”. It is a single-liner, and one
of the most powerful one-liners; one cannot also help noticing that the
marginal head of the article consists of 10 words, and the article itself
contains 12 words, only 2 more than the marginal head!
“ARTICLE 265. Taxes not to be imposed save by authority of law.—No tax
shall be levied or collected except by authority of law”.
The government therefore requires the authority of law not only to
“levy” taxes but also to “collect” them. The consequence is that a collection
machinery which is tyrannical or arbitrary or out of proportion with the
gravity of the situation or circumstances can also be held to be
unconstitutional, being in violation of the article. Since an entry includes
all subsidiary and ancillary matters, the power to tax would include the power
to enact law for the effective implementation and collection/recovery of the
tax levied. It can determine the procedure to collect the tax and provide for a
machinery and also make provision for evasion of taxation: Orient Paper
Mills Ltd. vs. State of Orissa (AIR 1961 SC 1438). It was, however, held
that the power to seize and confiscate the goods moving from one state to
another, which were not meant for sale, and also levy penalty was not
incidental to the power to levy tax under Article 265 (C.P. Officer vs. K.P.
Abdulla, (1970) 3 SCC 355).
In a federal set-up like ours, the inter-relationship between the
government at the centre and the state governments is very critical. According
to M.P. Jain, the author, inter-governmental financial relationship “touches
the very heart of modern federalism, as the way in which this relationship
functions affects the whole content and working of a federal polity”. Since
taxation is part – a very substantial and significant part – of the finances,
the allocation of the taxing powers is considered important in Constitutions.
The scheme of allocation of taxing powers is broadly based on the principle
that the taxes which are of a local nature are legislated upon by the states
and taxes which have a tax-base extending over more than one state, or which
should be taxed uniformly throughout India, or which can be more conveniently
collected by the centre, are allocated to the centre. The drawing up of a
Union List, State List and Concurrent List has by and large said to have
prevented the problem arising out of overlapping taxes being levied causing
hardship to citizens, though the Concurrent List has now and then caused some
problem or the other. There are some other federations in the world where this
problem (of overlapping taxes) has manifested itself more acutely.
I had earlier referred to the entries in the three Lists in the 7th
Schedule to the Constitution being “elastic” and being the subject of a wide
interpretation. Here, there is a clear distinction between a tax entry and a
non-tax entry. A tax entry, it has been held in several judgments of the
Supreme Court, has to be construed or interpreted broadly and liberally. In Tata
Iron & Steel Co. vs. St. of Bihar (AIR 1958 SC 452), this principle of
broad and liberal interpretation of the tax-entries was extended to include the
power to tax retrospectively. An important principle in this context is the
doctrine of “pith and substance” which means this: the true character of the
legislation in question has to be ascertained by having regard to it as a
whole, to its objects and to the scope and effect of its provisions, and if
according to its “true nature and character” the law substantially relates to a
topic assigned to the legislature, which enacted it, then it is not invalid
merely because it incidentally trenches or encroaches on matters assigned to
another legislature. The fact of incidental encroachment does not affect the vires
of the law even as regards the area of encroachment; incidental encroachments
are not forbidden. The law in question has to be read as an organic whole and
not as a mere collection of sections; it should not be disintegrated into
pieces and each piece examined whether it fits into the Constitutional scheme
or division of legislative powers. The classic observations of the Supreme
Court in State of Bombay vs. Balsara (AIR 1951 SC 318) are these:
“It is well-settled that the validity of an Act is not affected if it
incidentally trenches on matters outside the authorised field and, therefore,
it is necessary to enquire in each case what is the pith and substance of the
Act impugned. If the Act, when so viewed, substantially falls within the powers
expressly conferred upon the legislature which enacted it, then it cannot be
held to be invalid merely because it incidentally encroaches on matters which
have been assigned to another legislature”.
Another aspect of Article 265 is that it is open to the legislature to
pass a validating Act to remove the infirmity in the law pointed out by the
judgment, and make the law effective from the date of its enactment and retain
the collections of the taxes under the law invalidated by the court. The
important condition, however, is that the government must have the power to
levy the tax, for in the absence of the power the tax must ever remain invalid:
M.P. Cement Manufacturers Association vs. State of M.P. (2004) 2 SCC 249.
The validation by a validating Act can however be done only by removing the
grounds of illegality (Rai Ramkrishna vs. State of Bihar) (AIR 1963
SC 1967), or by removing the basis of the decision and not merely by
disregarding or disobeying or “reversing” the judgment: Ahmedabad
Municipality vs. New Shorrock Spg. & Wvg. Co: (1970) 2 SCC 280.
Legislative competence (in addition to Constitutional validity) is the
deciding factor in examining the validity of a tax. In judging the legislative
competence – which has to be adjudicated at the threshold before any other
challenge is examined – the nature and character of the tax constitute a
significant element. The following aspects are irrelevant: (a) motive in imposing
the tax; (b) wrong reasons given in the statement of objects and reasons; (c)
the form and manner in which the power is exercised; (d) nomenclature of the
tax. In Jullundur Rubber Goods Manufacturers Association vs. UoI (1969) 2
SCC 280, it was held that so long as the doctrine of “pith and substance”
is satisfied and the “real nature and character of the levy” test is answered
in the affirmative, with reference to the taxable event and the incidence of
the levy, the law imposing tax cannot be invalidated. It cannot also be argued
that the tax under a particular entry shall be levied in a particular manner;
it is open to the legislature to adopt such method of levy as it chooses so
long as the character of the levy falls within the four corners of the particular
entry: Twyford Tea Co. vs. State of Kerala (1970) 1 SCC 189. The pithy
observations of the Supreme Court in Rai Ramkrishna (supra) are
noteworthy:
“The objects to be taxed, so long as they happen to be within the
legislative competence of the legislature can be taxed by the legislature
according to the exigencies of its needs. ……..the quantum of the tax levied by
the taxing statute, the condition subject to which it is levied, the manner in
which it is sought to be recovered are all matters within the competence of the
legislature”.
In Jain Bros. vs. UoI (1969) 3 SCC 311 and Avinder Singh vs.
State of Punjab (1979) 1 SCC 137, it was held that Art. 265 does not
prohibit double taxation of the same person twice over if the legislature
evinces a clear intention to do so and that the vice of double-taxation cannot
be spun out of the said article. But without an express provision in the law to
impose tax twice over on the same subject, there can be no double-taxation by
implication.
The question of sharing the revenues between the centre and the states
is crucial, not the least due to political reasons. In the USA, there is no
provision in their Constitution for sharing revenues between the centre and the
states, but in actual practice a system of conditional grants has come to be
under which the centre financially supports the states. Moreover, in that
country the power of the states to impose taxes is vast. The situation in
Australia and Canada is more or less the same, and there is a system of
tax-sharing. The Constitution of India also contains provisions to ensure
financial equilibrium in the distribution of collection by way of taxes. It may
be noted that most of the lucrative tax levies, such as corporation tax,
income-tax, goods and services tax, customs duty are within the domain of the
centre. On the other hand, the states require plenty of money for their welfare
and development schemes and they are mostly left with taxes by way of octroi,
entry tax, land revenues, etc. There are, however, political compulsions in
imposing land revenues, as well as considerations such as hardships to the
agriculturists to be taken note of. The makers of the Constitution did
recognise that the revenues of the states were thus inadequate to fulfill their
needs. In the Report of the Expert Committee on Financial Provisions, this was
highlighted. The Constitution therefore provided for sharing of the finances
between the centre and the states.
There are two major methods by which the finances are shared:
Tax-sharing and Grants-in-aid.There are detailed provisions in our Constitution
in Article 268 onwards and it is beyond the scope of this article to dive deep
into them. The most important aspect of tax-sharing is the establishment of a
Finance Commission which can devise its own formula for the splitting of the
revenues between the centre and the states in a flexible manner and without
being rigid. The Commission is a non-political body and consists of a president
and four members appointed by the President of India. Article 280 makes
elaborate provisions for the powers and functions of the Commission. The
functions include (a) the distribution between the Union and the States of the
taxes can be divided; (b) to lay down the principles to govern the
grants-in-aid of the revenues of the States out of the Consolidated Fund of
India; (c) to lay down the measures to augment the Consolidated Fund of the
States in order to supplement the resources of the panchayats on the basis of
the recommendations of the State Finance Commission; and (d) to lay down
measures to augment the State Consolidated Fund to supplement the resources of
the municipalities on the basis of the recommendations of the State Finance
Commission.
A burning question which has exercised the minds of tax experts,
economists, jurists, tax lawyers and persons of eminence is whether there
should be justice in taxation. N.T. Wright, an author who wrote several
books on religion, remarked: “A sense of justice comes with the kit of being
human. We know about it, as we say, in our bones”. John Rawls, in his book A
Theory of Justice says that the ultimate purpose of a State is justice.
James Madison, the celebrated President of the USA, said “Justice is the end
of government. It is the end of civil society. It ever has been and ever will
be pursued until it be obtained”. It is believed that taxation and economic
or fiscal policy, which are subsidiary features of a government, do aim to do
justice first and foremost. Thomas Piketty, in his book The Economics of
Inequality says that a primary factor for the persistence of economic
injustice in this world is tax and fiscal policy, though there may be other
reasons, too. Injustice in taxation has many facets, the main facet being
complexity due to lack of systematic theories which provide general guidance as
to how taxation does function in society, and the difficulty in reasoning it
out; according to David F. Bradford who wrote Untangling the Income Tax,
taxation “can be understood (if at all) by only a tiny priesthood of lawyers
and accountants”! Judge Learned Hand scathingly described tax law as a
“meaningless procession of cross-reference to cross-reference, exception upon
exception – couched in abstract terms that offer no handle to seize hold of….”.
Moreover, taxation or tax law takes note of and incorporates other disciplines
in it, such as economics, philosophy, at times even politics. In India, if one
has to understand the Income-Tax Act, one has to have more than a working
knowledge of other branches of law – Civil and Criminal Law, Partnership Law,
Hindu Law or Mohammedan Law, Company Law, Intellectual Property Law and so on.
This certainly makes the tax law more interesting, but also complex. In
contemporary tax jurisprudence, we often hear of horizontal and vertical
equity. Horizontal equity requires two persons similarly situated to be treated
similarly. Vertical equity requires two persons differently situated to be
treated differentially to a degree. These are probably different names given to
what is basically understood as fairness. Fairness in tax law, as presently
advised, seems to be a distant goal. Adam Smith must be turning in his grave!
Is there morality in taxation? This question has troubled many tax
jurists and lawyers over the years. We have a fascinating jurisprudence in
India on the subject. The debate will go on forever and jurists will keep on
saying that the two are poles apart, and that everything is fair in war, love
and taxation. The morality aspect is relevant not only in the means which the tax
payer adopts in “arranging his affairs in such a manner that he pays the least
amount of tax”, but it also applies to governments, particularly in the matter
of retrospective taxation. How moral is it to tax the results of a transaction
which, when it was put through, did not attract taxation but which has been
made subject to tax at a future point of time with back-effect? People may have
arranged their monetary affairs on the basis of the earlier law, and if they
are told after ten years that the earlier law is being withdrawn
retrospectively, it does cause enormous financial strain, mental agony and
leads to distrust or mistrust on the government of the day. Today’s world of
globalisation of business and inter-country commerce and investment suffers most
because of retrospective taxation, as we have seen recently in our country. The
debate will go on, and ways and means will be found to tide over such difficult
situations.
A stable tax policy may be a dream, but that should not prevent
governments from adopting a rational and informed view of taxation principles
to be adopted to serve the needs of the country. For a long time we did not
have a “tax policy unit” in the administration of the Income-Tax Act, and if
tax pundits are to be believed, this has resulted in several skewed situations
which benefit neither the government nor the tax payer. Fortunately, we now
have a Tax Policy Unit which carries out a lot of research, both of local and
overseas conditions, and keeps advising the government which can input the
advice to shape its fiscal policy.
The Indian government came out with proposals in 2016 to make use of
e-assessment procedures with the objective of transparency and speed, in
consonance with the “digital India” initiative. Measures are being taken to
showcase the Indian tax administration as an intelligent, sensitive and
non-combative system which will deal with overseas investors in India fairly
and honestly. The recent amendment to introduce a pilot-scheme where
assessments will be made without any interface between the tax officer and the
assessee is a step taken with the right intention and its success will drive
future amendments with a similar purpose. At the same time, the concern of the
tax payers about the unnecessarily aggressive and at times vengeful attitude of
the tax authorities cannot be said to be without basis and must be addressed.
It is very easy to make a deliberately excessive and high-pitched assessment,
create a demand and harass the assessees who will be forced to run from pillar
to post, spend huge amounts as legal expenses, suffer mental agony, run the
risk of assets and bank accounts being attached with consequent stoppage of
business, and so on and so forth. Tax compliance cannot be expected without
showing tax-sensitivity; to tax and to please is impossible, hence the need
today for a friendly and polite and at the same time objective approach, with
only the requirements of the law in mind. Collection of targeted amounts of tax
cannot be the sole objective and setting of targets must also be realistic;
assessments must be rooted to the law and should be in conformity with the
judicial precedents and not merely target-oriented. A target-oriented approach
tends to result in aggression and a flouting of the rule of law. Judicial
review of the assessments and decisions of the tax authorities should be viewed
as a corrective and not as criticism.
What is required from the tax administration is a broad-minded, professional
and impersonal approach. Computerisation has its place in the procedural
aspects of administering the law, but computers cannot be allowed to make
assessments!
Protracted and interminable tax disputes serve no purpose. The Act
provides for an excellent system of appellate and revisional remedies but of
late murmurs are being heard whether the appellate tiers, both the first and
the second, are discharging their duties impartially and without being
influenced by “oblique” considerations. There was a time when the Appellate
Assistant Commissioners used to write orders which were, quality and learning
wise, no less than those of judgments of High Courts or even the Supreme Court.
It is unfortunate that one does not get to see such orders these days. The tax
tribunal has always done an excellent job but of late one wonders if it can be
said to be immune to the “winds of change” sweeping the country and the mindset
of its people. Innovation and improvisation in the decision-making process is
welcome, but it should be within the framework of the judicial norms and discipline.
The decisions should be informed by objectivity and absence of bias – against
the Department of Income-Tax, against the tax payer and also against the
counsel! – and care should be taken to ensure that judicial adventurism does
not masquerade as judicial innovation or judicial creativity. I will say no
more.
A word about the emerging trends and issues in international taxation,
which has turned out to be a fascinating branch of the income-tax law. These
are mostly issues arising out of interpretation of tax treaties and
transfer-pricing issues. In both, the stakes are mind-boggling. The
jurisprudence is marvellous and provides excellent fodder for intellectual
acrobatics. The IRS has mastered these two branches of tax law; the tax
lawyers, with some unmatched original thinking, have made a huge contribution
to the growth of this branch of the tax law, supplemented by the learning
exhibited by the Tribunal in dealing with those issues. It is a matter of pride
for the profession that the highest number of decisions in this branch has
emerged from our country and it is believed that they are treated with great
respect in judicial forums across the world. This is a very good augury for the
tax administration of the country. It is further believed that this branch of
tax jurisprudence will govern the future tax litigation in our country.
To conclude, I can do no better than quote the learned author,
Padamchand Khincha, from his preface to the book Emerging issues in
International taxation: “Rightful tax is the price of social order. Tax
is that portion of a citizen’s property which he/she yields to the Government
in return for the benefits enjoyed from the society. Citizens feel that taxes
are (un)wantonly levied, that the pervasiveness of taxes is stifling.
Governments feel that the tax payers are short in discharging their
obligations……………..In this interaction of granting the benefits and demanding
the exaction, the equation is hardly ever balanced.” Well, very pithily
put. The goal of every tax administration is to find that ever-elusive balance!
JAI HIND!!!
