A Happy New Proposal for Micro enterprises- Progressive Tax Code for Enterprises

Proposal for Budget 24-25

By V Vaidyanathan, MD and CEO, IDFC FIRST Bank

Proposal: To introduce a Progressive Tax structure for corporates, partnerships, proprietorships, and Self-employed people.

The proposal is to make Income Tax for corporates, partnerships, LLPs, proprietorships, and self-employed in India on a Progressive Basis, starting at ZERO percentage Tax at PBT of say Rs. 25 lacs, and progressively going up to 25% after say, Rs. 5 crores of PBT.? This could benefit millions of small and micro-entrepreneurs and self-employed people.

Background: Our nation needs to encourage entrepreneurship. We need to reward job creators and self-employed more than job seekers. MSMEs for instance, have a difficult life with more handicaps including low scale, lesser ability to attract talent, to implement technology, higher interest costs (15-24%), higher per unit cost because of lower lot sizes, lower negotiating power with suppliers, low access to capital markets, low access for foreign borrowings. Millions of existing small entrepreneurs and start-ups will benefit from this. This includes self-employed people, who too live an uncertain economic life as compared to salaried people.

A suggestive, indicative progressive slab could be as follows. We could evaluate fiscal implications based on various slabs.

? PBT up to Rs. 25 lacs = 0% of PBT

??PBT between Rs. 25 lacs to Rs. 50 lacs = 10% of PBT exceeding Rs. 25 lacs

? PBT above Rs. 50 lacs to Rs. 1 Crore = 15% of?PBT exceeding Rs. 50 lacs

? PBT above Rs. 1 Crore to Rs. 5 crore = 20% of PBT exceeding Rs. 1 Crore

? PBT above Rs. 5 Crores = 25% of PBT exceeding Rs. 5 Crores

?I suggest we don’t have a turnover-based cut-off for implementing this structure as turnover can be a misleading indicator of profitability. In one industry, say consulting, Rs. 20 crore Turnover may result in a PBT of Rs. 10 crores, while a trader with the same turnover may make a PBT of say Rs. 20 lacs. In the structure mentioned above, the benefit will be based on PBT so we can be agnostic to the industry and the margins they may have.

A progressive tax structure for business income can have the following benefits:

1. We can promote entrepreneurship: A Zero tax regime for income up to say Rs. 25 lac can hugely encourage the youth of our country to start businesses rather than looking for employment. This can be a big breakthrough in the long run. Conceptually, there is a power of Zero. Zero Tax in Middle East countries attracts millions of people to employment there. At Zero tax, and low tax slabs up to say Rs. 5 crores of PBT, the youth who has completed his or her education could be highly motivated to start a business rather than look for employment.

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1. There will be no reason for self-employed people and small entrepreneurs to deal in cash, they will show income in the bank account. Our government has reduced the parallel economy in the country through various initiatives. Yet, even at 25%, entrepreneurs avoid taxes if they can and often deal in cash. Gym trainers, tuition teachers, music teachers, carpenters, architects, etc., and such self-employed people too, often take revenue in cash and use up the cash for their personal expenses, and the exchequer never gets to know. At 0% up to a small threshold say Rs. 25 lacs, they will disclose every income of theirs on the books as they have no reason to deal in cash, and will have better balance sheets.

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1. Our GDP growth rate will go up, as the informal business will become formal business.

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1. Levelling the playing field for small entities vs their larger counterparts: Large corporates borrow at 8-10%, have better negotiating power, better unit cost economics, and can hire better talent. On the other hand, micro/small enterprises have significant handicaps including low scale, higher interest costs, higher unit-cost of everything, lower negotiating power, limited access to capital markets, limited access to foreign borrowings, and so on.? Hence, for small enterprises, squaring up with larger entrepreneurs is an uphill task, so the big becomes bigger. This progressive method of taxation will partially make up for some of their handicaps, and give them a shoulder. It will improve their retained earnings vis. a vis. the larger ones to an extent.

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1. Easier access to credit: Since low progressive tax rates will encourage SMEs to correctly report their income it in turn will bring more of them to the formal economy and give them better balance sheets. This will fit in well with the government’s intention to make credit available to small and micro enterprises.

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1. Employment creation at the Micro Level: Small Entrepreneurs could be encouraged to expand. They usually employ the less skilled or less educated people and this could boost employment at the micro level.

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1. Concerns:? One concern could be entity-splitting to avail lower rates. However, this is now difficult because if an entrepreneur splits the entity, they will have higher compliance costs, like separate GST numbers for IGST, and CGST, separate income tax filings, separate PAN numbers, creation of separate bank accounts, brands, separate Company Secretaries for each entity, and other formalities will be deterrence for this purpose. If they were to float different companies, they must get more board members etc. with their attendant costs.

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1. Support with an educational campaign: Armed with such a tax regime favoring micro and small business entities, the government can launch a massive educational campaign explaining how paying their taxes is their responsibility, tax rates are ZERO, how it makes them eligible for bank credit, and so on.

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1. Laffer Curve effect: Such a progressive structure, starting at low rates, may even increase tax collections, because of better compliance, as there will be a reduced tax burden.

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1. In summary, the introduction of a progressive tax structure for self-employed, self-employed, partnerships, partnerships, etc. and all forms of businesses will provide a big relief to small entrepreneurs, formalize the economy at the grassroots, improve retained earnings for small entrepreneurs, improve their ability to compete with larger peers, make them credit-eligible, spur the economy and create jobs at the bottom of the pyramid. Such structures exist in Australia, South Africa, Singapore, and Sri Lanka, though the slabs may be different. We can make our slabs based on the above concept, one that will benefit small and micro-entrepreneurs and give them a helping shoulder.

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Finally, if a salaried person were to argue why they should pay tax for income while a self-employed person with the same income would pay low taxes under the above slabs, the nation has an equally engaging argument that self-employed people, MSMEs, and corporates create jobs. We need to encourage those who create jobs over job seekers, though we do appreciate that both categories add value to the economy in their own way.