Income Tax Compliance Cost of Corporations in India, 2000–01

Abstract

This is the first study of compliance costs of income taxation of corporations in India. Compliance costs are the costs of meeting obligations under the income tax law and in planning to save taxes. Opportunity costs such as when tax refunds are delayed are also included. Social compliance costs, gross versus net private costs, and mandatory versus voluntary cost can be distinguished. Gross private compliance costs include both legal and illegal expenses (such as bribes paid), employee costs, the cost of tax advice, and also other non-labour expenses. Estimates in this paper are for the year 2000-01 based on a postal survey of 45 companies throughout India in August-September 2001. Estimated gross compliance costs, excluding bribe costs, are between 5.6 and 14.5 per cent of corporation tax revenues. These are similar to estimates for other countries near the lower limit but are a cause for concern near the upper limit. Tax deductibility of legal expenses and cash flow benefits from the timing difference between taxable income and payment of tax result in net compliance costs between minus 0.7 and plus 0.6 per cent of corporation tax revenue. Both gross and net compliance costs are regressive. Among other findings, five are noteworthy: First, around 25 per cent of sampled companies knowingly paid excess tax (median value: 46%) since tax evasion penalty cannot be levied under Indian law if assessed taxes have already been paid. Second, 70 per cent of companies, especially small companies, used external assistance to prepare tax returns accounting for 39 per cent of the legal compliance costs. Third, voluntary costs associated with tax planning contribute 19 to 43 per cent of total compliance costs. Fourth, the average sample company had 10 to 11 assessment years locked in disputes for tax or penalty in addition to around two years for which assessments were incomplete. Statistical analysis suggested that one extra disputed assessment year raises legal compliance costs by 5.7 per cent. Fifth, it was found to be fairly common for incorrect application of tax laws by tax officials in areas where they have high discretion to cause tax assessments to be revisited. Among reform suggestions is streamlining of 22 legal and procedural �hot spots� which add to compliance costs. Since the response rate was a disappointing 1.15 per cent, the stratified random sample design degenerated into a convenience sample with over-representation of large firms and under-representation of loss-making and zero-profit companies. Therefore, results should be viewed as preliminary and tentative. Other problems are that there were only qualitative questions about in-house cost components; assumed opportunity cost of funds to value cash flow benefits were used; and, as in earlier studies, there can possibly be a bias due to incorrect apportionment of fixed costs and the value of time of company management