ECONOMIC & SOCIAL

DEVELOPMENT
(PRE-CUM-MAINS, 2020)

Under The Guidance Of

M K YADAV

Both Online & Offline Classes Available

BOOKLET # 4
TAXATION & PUBLIC FINANCE (PART I OF II)
INDEX
1 TAXATION: Basic Concepts, Classification of Taxes 1
2 TAX EVASION, TAX AVOIDANCE, & TAX PLANNING 3
3 METHODS OF TAX AVOIDANCE: Round Tripping, BEPS, Transfer Pricing, Shell Co.s etc. 3
4 IMPACT OF TAX EVASION & TAX AVOIDANCE ON INDIA 5
5 STEPS TAKEN TO CURB TAX EVASION 5

* We took all care in preparing this document. If you still find any discrepancy in the information provided, please inform us
at info@theiashub.com

Published by: www.theiashub.com

theIAShub © 2019 | All Rights Reserved
 ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020
Under the Guidance of M K YADAV

UNIT 3: TAXATION & PUBLIC FINANCE

3.1 TAXATION

• Taxes are the compulsory payments to the government (local, regional or national), made by individuals
or corporations, without any quid-pro-quo.

3.2 CLASSIFICATION OF TAXES

3.2.1 ON THE BASIS OF TAX RATES
• Progressive tax - Marginal tax rate increases
with increase in Taxable Income. Eg. Personal
Income Tax.
• Proportional tax - Tax rate remains same
irrespective of taxable income Eg. Corporate
Income Tax.
• Regressive tax - Marginal tax rate decreases
with increase in taxable income.
• Degressive Tax - A type of progressive tax in
which the marginal tax rate increases with
increases in taxable income and then becomes
constant.

3.2.2 ON THE BASIS OF POSSIBILITY OF SHIFTING OF TAX BURDEN

• Direct Tax
- It is usually imposed on the income and wealth of individuals and Tax incidence – on whom
firms. the tax is imposed.
- The burden of the tax and the incidence of tax fall on the same person. Tax burden – one who
- The tax burden can’t be shifted. actually pays tax.
- Generally progressive in nature.
- Eg. Personal Income Tax, Corporate Income Tax, Wealth Tax, Securities transaction tax, Property
tax, Capital Gains tax etc.

Minimum Alternate Tax (MAT)

• MAT is a tax introduced in India by the Finance Act of 1987, to facilitate the taxation of ‘zero tax companies’
i.e., those profit making companies which show zero or negligible income to avoid tax, by taking advantage of
the various deductions & exemptions allowed under the Act.
• Under MAT, such companies are made liable to pay to the government, by deeming a certain percentage of
their book profit as taxable income.
• In India MAT is levied under Section 115JB of the Income Tax Act, 1961.
• It is levied at the rate (recently revised) of 15% of the book profits (normal corporate tax rate applicable to an
Indian company is about 25%)
• It is applicable to all corporate entities, whether public or private, Indian or foreign, including companies in
Special Economic Zone (SEZ).

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

1
https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

Alternate Minimum Tax (AMT)

• The corresponding tax similar to MAT, but imposed on individuals or non-corporate entities, who claim certain
deductions under the IT Act, is known as Alternate Minimum Tax (AMT).
• The rate of AMT is also at 18.5%.

• Indirect Tax
- It is usually imposed on production and distribution of goods and services.
- The impact and incidence of tax is usually on different persons.
- The tax burden can be partially or fully shifted on others.
- They are regressive in nature.
- Eg. Excise, Customs, Service tax, VAT, GST

3.2.3 ON THE BASIS OF IMPOSITION

• Ad Valorem Tax
- Ad valorem means – according to value. It is imposed on the basis of value of output or value
added of a good or an asset. For eg. property taxes.
- It is expressed in terms of a percentage (%).
- As the value of the good/asset increases, the tax amount increases. Thus, it is likely to be more
progressive than a specific tax.

• Specific Tax
- It is imposed on the basis of specific criteria like weight, length etc. of commodity sold, regardless
of its price. Thus, it is called ‘per unit tax’.
- For example, a fixed tax of Rs. 100 on per litre of petrol.

3.3 OTHER TERMS RELATED TO TAXATION

• Tax Terrorism
- It refers to the adversarial or the overly aggressive approach adopted by the tax authorities
- It has adverse consequences esp. for honest taxpayers and creates ambivalence in the overall
investment climate
- It was used in the context of retrospective taxation in Vodafone-Hutch case
• Tax Expenditure
- Tax expenditure is also termed as ‘revenue forgone’. It refers to the sum total of the amount of
exemptions given to the tax payers.
- It measures the difference between the actual tax collected and the tax that would have been
collected if there were no such exemptions.
- But it does not necessarily imply that this quantum of revenue has been waived by the government.
It should be interpreted as targeted incentives for the promotion of certain sectors that may not,
in the absence of such incentives, have come up.
- High tax expenditure or exemptions can make the tax system unduly complex. Thus, Government
is taking deliberate steps to phase it out.

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials

https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

3.4 TAX EVASION, TAX AVOIDANCE, & TAX PLANNING

3.4.1 TAX EVASION, TAX AVOIDANCE, & TAX PLANNING

Sno. Tax Evasion Tax Avoidance Tax Planning

1 Where the payment of tax is Where the payment of tax is Where the payment of tax is
avoided through illegal avoided by complying with the avoided by making use of
means or fraud provisions of law but defeating legitimate deductions &
the intention of the law exemptions provided explicitly
by government.
2 It is legally wrong It is morally wrong, as main It is morally & legally correct.
intention is to avoid paying taxes

3 It is carried out after the tax carried out before the tax carried out before the tax
obligation has arisen obligation has arisen obligation has arisen

4 Methods - Concealment of Methods - Round tripping, Methods - Availing Sec 80C by

income, manipulating Transfer pricing, Treaty shopping investing in tax saving
accounts, making false etc. instruments like PPF, Mutual
statements etc. Fund, Insurance etc.

What is Black Money?

• While there is no legal definition of black money, it is most commonly understood as money which is generated
through illegitimate means or by bypassing taxation system (ie. Tax evasion)
• A 2015 FICCI report estimated black money in India to be as high as 75 per cent of the GDP.

3.4.2 WHAT ARE VARIOUS METHODS OF TAX AVOIDANCE?

• Round Tripping
- A process where Black Money leaves the country throu gh various channels – Payments to shell
companies, inflated invoices, hawala route – and returns to same country as investment (FDI,
participatory notes etc,), through offshore jurisdictions, to avoid taxes.
- This investment route is layered with multiple entities and companies (shell companies) to conceal
real identity of investors, who in many cases invest in their own companies.

• Base Erosion & Profit Shifting –

- BEPS refers to tax planning strategies used by multinational enterprises that exploit gaps and
mismatches in tax rules to avoid paying tax.
- It involves artificially shifting profits to low or no-tax locations, where there is little or no economic
activity, and shifting losses and high expenditures to high tax jurisdictions, resulting in little or no
overall corporate tax being paid.
- Sources of BEPS
✓ Abuse of tax treaties - Taking advantage of loopholes in bilateral tax treaty to escape taxation
in both countries ie. “Double Non Taxation”.

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials

https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

✓ Problems in deciding Place IMPACT OF BEPS

of Effective Management
(PoEM) or Permanent
Establishment (PE) Status to
arrive at tax liability.
✓ Rise of digital economy and
problem in its taxation.
✓ Abuse of Transfer pricing
rules and tax avoidance
arrangements with
Subsidiaries.
- Not all BEPS strategies are
illegal as they just take
advantage of current rules
governments have put in place.
• Loss of Tax Revenues - As per OECD estimates, BEPS practices
cost countries USD 100-240 billion in lost revenue annually.
• Distorts competition - businesses that operate cross-border
may profit from BEPS opportunities, giving them a competitive
advantage over domestic enterprises.
• Impact on Developing countries - Developing countries’ higher
reliance on corporate income tax (esp. from MNCs) means they
suffer from BEPS disproportionately.
• Lead to inefficient allocation of resources by distorting
investment decisions towards activities that have lower pre-
tax rates of return, but higher after-tax returns.
• Issue of fairness - when taxpayers (including ordinary
individuals) see multinational corporations legally avoiding
income tax, it undermines voluntary compliance by all
taxpayers.

• Double Taxation Avoidance Agreement (DTAA)

- A DTAA is a tax treaty signed between two or more countries. It applies in cases where a tax-payer
resides in one country and earns income in another.
- Its key objective is that tax-payers in these countries can avoid being taxed twice for the same
income.
- For eg. India’s DTAA with Singapore, Mauritius and Cyprus used to give full exemption on capital
gains to investors as there was no cap gains in contracting countries. These agreements were
misused for round tripping black money.
- India has now revised treaties with these countries to curb revenue loss and check the menace of
black money.

• Transfer pricing - Lowering or increasing the prices of goods and services between parent and subsidiary
companies to take advantage of different tax rates charged in different jurisdictions to minimise the
groups’ tax liabilities. Thus using transfer pricing practices to shift profit from high-tax jurisdictions to
low-tax jurisdictions.

• Treaty Shopping - For eg. A resident of a third country (for eg. UK) invests by taking advantage of a fiscal
treaty (DTAA) between India and another contracting state (eg. Mauritius). (Vodafone-Hutch case).

• Off Shore Shell companies Tax Havens - The term is applied

- An offshore company is a company or corporation that is to countries and territories that
incorporated in a foreign territory. offer favourable tax regimes for
- A shell corporation is a corporation without active business foreign Investors, such as:
operations or significant assets. - Low or zero corporate tax
- These types of corporations are not necessarily illegal, but are rates.
sometimes used illegitimately, such as to disguise business - Low or zero withholding tax
ownership from law enforcement or the public. rates on foreign investors.
- Bank secrecy laws

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials

https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

- Companies can create shell companies in offshore tax havens like Panama, Cayman islands etc.,
siphon off their earnings to tax haven, and lower their tax bills at home.

• Non-profit organizations - Taxation laws which allow certain privileges and incentives for promotion of
charitable activities are being misused and manipulated to park funds of corrupt politicians and
businessmen.

3.4.3 IMPACT OF TAX EVASION & TAX AVOIDANCE ON INDIA

• Financial & Economic impact –

- Rise of parallel economy leading to underestimation of GDP.
- Tax evasion ➔ reduced tax collections ➔ reduced fiscal capacity of government ➔ impact on
developmental & welfare expenditures ➔ reduced economic growth + increased poverty.
- Diversion of productive resources to sterile investments such as real estate, gold, jewellery. Thus,
distorting saving and investment pattern.
- Increase in conspicuous consumption ➔ Increase in inflation ➔ increase in interest rate ➔ high
cost of borrowing ➔ lower investment ➔ decreased economic growth.
- Threatens financial stability of legitimate businesses who cannot compete with firms with higher
profits due to aggressive tax planning. Thus, undermines free enterprise.
- Combating tax evasion requires expenditure on tax administration, audit, prosecution, putting a
pressure on already limited government revenues .
• Social effects - Tax evasion leads to redistribution of income from the honest to dishonest leading to
breach of horizontal and vertical equity between members of the society
• Political consequences –
- Tax evasion ➔ Non- achievement of the state’s fiscal target ➔ voter’s dissatisfaction ➔ political
instability
• Corruption – bribery becomes rampant at all levels eg. politicians, bureaucrats, accountants, financial
institution, corporates ➔ crony capitalism + money power in election ➔ impacts democratic fabric.
• Threat to National Security - due to undisclosed money flow in economy which may be used to finance
criminal activities.
• Decrease in country’s reputation - Black money has resulted in transfer of funds from India to foreign
countries through clandestine channels which decrease country’s reputation globally.

3.4.4 STEPS TAKEN BY GOVERNMENT TO CURB TAX EVASION

• By Individuals
- Enactment of the Benami Transactions (Prohibition) Amendment Act, 2016 to amend the Benami
Transactions (Prohibition) Act, 1988 and enable confiscation of Benami property and prosecution
of benamidar and the beneficial owner.
- Income Declaration Scheme - a window to violators to come clean by paying taxes, cess, and
penalty amounting to 45% of total undisclosed income
- Black Money and Imposition of Tax (Undisclosed Foreign Income and Assets) Act, 2015 to
specifically deal with black money stashed away abroad.
• By Corporates & MNCs
- GAAR (General Anti-avoidance rule) – to check aggressive tax planning/treaty abuse
- DTAA amendments – with Singapore, South Korea, Cyprus, Mauritius
✓ To enable levy of taxes in the country where income is generated rather than the country of
residence of the company.

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials

https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

✓ Included ‘Limitation of Benefit’ clause – Deters treaty abuse and limits benefits to residents of
two countries only.
- Advance Pricing Agreements (APA) - Agreement between tax payer and tax authority on an
appropriate transfer pricing methodology over a fixed period.
- Base Erosion and Profit shifting – Union Cabinet recently approved the ratification of the
Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and
Profit Shifting ("Multilateral Instrument" or "MLI") (an outcome of the OECD / G20 Project).
- Place of Effective management (PoEM) - Income Tax Act was modified to provide that if ‘Place of
effective management” of a company is in India, it will be considered ‘resident of India’ and taxed
accordingly.
- 6% equalization levy (EL), imposed by the Finance Act, 2016, in lieu of specified digital services
(online advertising services) provided to residents in India by non resident companies.
- ‘Significant Economic Presence’ (SEP) concept, introduced by Finance Act, 2018, whereby
government can tax digital companies (like Facebook, Google etc,) even if they have a virtual
presence (ie. don’t have a permanent establishment (PE)) in India.

PoEM (Place of Effective Management)

• Taxation authorities need information on residential status of foreign companies for the purpose of assessing
tax liability. PoEM rules helps arriving at this.
• "Place of effective management" is defined in the Income Tax Act, 1961 (as amended by Finance Act, 2015)
to mean a place where key management and commercial decisions that are necessary for the conduct of the
business of an entity as a whole are, in substance, made.
• While the non-resident foreign company is generally taxed only on its Indian sourced income; a resident
foreign company is taxed for its global income ➔ more tax revenues.
• Concept of PoEM is recognised by OECD and in various international treaties for determination of residence
of a company as a tie-breaker rule for avoidance of double taxation.

• Other measures
- Constitution of SIT on Black Money
- Tightening KYC norms on Participatory Notes by SEBI
- Prevention of Money laundering act, 2002 and various amendments to strengthen it.
- Constitution of Multi-Agency Group (MAG) consisting of officers of Central Board of Direct Taxes
(CBDT), Reserve Bank of India (RBI), Enforcement Directorate (ED) and Financial Intelligence Unit
(FIU) to probe Panama papers leak.
- Special Combating Financing of Terrorism (CFT) Cell created in the Ministry of Home Affairs in
2011, to coordinate with the Central Intelligence/Enforcement Agencies & State Law Enforcement
Agencies.
- Demonetisation - It was the biggest blow to black money hoarders across the country.
- Linking bank accounts with Aadhaar & PAN: huge success in getting hold of fake or Ghost accounts
and tracking big and suspicious transactions.
- ‘Project Insight’- ICT based initiative for strengthening non-intrusive, information driven approach
for improving tax compliance.
- Operation Clean Money’ - using information on cash transactions & data analytics tools for e-
verification of suspect cases. Portal launched.
- Rationalisation of taxes - expansion of tax base and lowering of tax rates.

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials

https://telegram.me/pdf4exams ⬅ JOIN NOW ➡ https://telegram.me/pdf4exams

ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

• International Cooperation
- Financial Acton Task Force (FATF) - India has complied with all FATF requirements and Action Plan
items.
- G -20 – India played major role in developing international consensus for taking action against tax
havens
- Multilateral convention of Mutual Administrative Assistance in tax Matters.
- Proactive sharing of Financial Information known as Automatic Exchange of Information (AEOI) to
enable India to receive financial account information of Indian residents in other countries.
- Tax information Exchange Agreement (TIEA).
- Information sharing agreement with the USA under the Foreign Account Tax Compliance Act
(FATCA) of USA.
- Section 94A inserted in Income Tax Act to black list country as non-cooperating if there is lack of
effective exchange of information. E.g.: Cyprus was black listed in 2013.
- Setting up Income Tax Overseas units to unearth black money in Mauritius, Singapore etc.
• Institutions
- Economic Intelligence Council (EIC)
✓ Apex forum, chaired by Union Minister of Finance, responsible for oversight on government
agencies responsible for economic intelligence and combating economic offences in India.
- Financial Intelligence Unit (FIU) [under Department of Revenue, Ministry of Finance]
✓ FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC)
headed by the Finance Minister.
✓ Responsible for analyzing and disseminating information relating to suspect financial
transactions. It is not a regulatory body and only gathers and shares financial intelligence.
✓ Coordinates efforts of national and international intelligence, investigation and enforcement
agencies against money laundering and terrorist financing.
- Enforcement Directorate (ED) [under Department of Revenue, Ministry of Finance]
✓ Responsible for enforcement of 2 key acts: Foreign Exchange Management Act 1999 (FEMA)
and some provision of the Prevention of Money Laundering Act 2002 (PMLA)
- Directorate of Revenue Intelligence (DRI) [under Central Board of Indirect Taxes and Customs,
Department of Revenue, Ministry of Finance]
✓ It is an apex anti-smuggling agency of India. It enforces the prohibition of the smuggling of
items (drugs, gold, diamonds, electronics, foreign currency, and counterfeit Indian currency)
- National Investigation Agency (NIA)
✓ Statutory body formed in 2008 under the NIA Act to combat terror in India.
✓ Terror Funding and Fake Currency Cell set up in the National Investigation Agency to
investigate Terror Funding cases.
- Serious Fraud Investigation Office (SFIO) [under Ministry of Corporate Affairs (MCA)]
✓ Probes corporate frauds (including shell companies) in coordination with IT Dept. / CBI

==========================================================================================

Published by: www.theiashub.com I Contact: 9560082909, 9697888881

theIAShub © 2019 | All Rights Reserved

Google it➡ PDF4Exams UPSC Materials