India needs to win over taxpayers, not tyrannise them

By Mihir Sharma

Indians have long had a confrontational relationship with the nation’s tax office, whose adversarial approach has crushed countless small businesses and international investors. This was meant to be the year the government fixed all that and repaired relations with taxpayers.

A few weeks ago, the federal budget cut taxes for many middle-class Indians. It also promised to present a new law that would drastically simplify how income taxes were calculated and paid.

When the new bill was eventually made public, however, it was a disappointment. As has happened too often in the decade-plus that Prime Minister Narendra Modi has run India, good intentions have been undermined by half-hearted implementation.

Expectations were high. The tax office proudly said that it had put 150 officials on the job, and they had spent 60,000 hours redrafting regulations. The new law is about half as voluminous as the old one.

Yet the general public and tax lawyers both seem to view this as a missed opportunity. If the government wanted more people to enter the tax net, they needed to completely reform the system. They didn’t. Some parts of the rules have been simplified, but the basic structure remains the same. It does nothing to ease Indians’ basic concern: That the taxman will send them a demand for an arbitrary sum when they least expect it. If the government intended a new compact with taxpayers, this isn’t it.

The state needed to promise, through a new legal code, that it would take a less adversarial approach. Distrust and confrontation is at the heart of how the Indian tax system works, and it is both nerve-racking and inefficient.

This hostile mindset means that compliance costs are too high and disputes too frequent. The burden is so troublesome, in fact, that it renders the country’s small businesses globally uncompetitive. Consider the unnecessarily wide-ranging “withholding” system: Every time someone is paid, the payer has to spend too much time calculating the fraction of that amount to be sent to the government. Essentially, withholding shifts the cost of administration from the state, where it belongs, to the private sector.

Then there is the inevitability of disputes. Almost a year’s worth of tax collections are currently stuck in various disagreements. In 2021, the amount being contested was almost six times as much as it was in 2010.

Average citizens feel that most of these attempts by authorities to go after taxpayers are to meet some arbitrary collection targets, instead of being based on careful investigation. The numbers partly justify this suspicion: When these disagreements go to court, the government wins less than 8% of the time.

The problem isn’t just that a tax demand might be arbitrary. Even if you eventually win, it takes a long time for the dispute to be settled. In India’s higher courts, a case can take six years to conclude – and those are far more efficient than the lower judiciary. And the tax office almost always appeals a negative verdict, even for relatively tiny amounts.

Anecdotally, these fears have led to high-net worth Indians fleeing the country for Singapore or Dubai. But companies and investors are put off as well. Your capital can get tied up in India even when you want to exit. For example, tax litigation forced Finnish cellphone company Nokia Oyj to exclude its considerable Indian assets from the $7.2 billion deal it struck with Microsoft Corp in 2013. If you think the tax authorities will stop you from exiting an investment, you don’t want to make it in the first place.

Many in government think taxpayers are being ungrateful. There is a lot that has been done in the last decade to make things easier, after all. Digital payments and filing have been introduced, as well as new procedures designed to prevent outright extortion by officials. And, of course, tax rates have been cut.

Yet Indians still feel locked into an antagonistic relationship with authorities. Political rhetoric about tax evasion and constant news about raids and random audits don’t help. They have interpreted this code not as the harbinger of a new age of cooperation between assessee and official, but as a pause to clarify the rules for an eternal battle. The law still centers the revenue needs of the state, not the rights and liberties of the taxpayer.

The government really needs to change its attitude to income taxes — and not out of compassion, but necessity. For investment and growth to take off, taxes need to be reliable, uniform and predictable. India’s system is instead designed to be combative, and it’s a big reason why the broader economy keeps underperforming.