Tracking spending, taxing income

Cash flow means the tax authorities also want to know the outflow, or the expense.

By Rohit Saranand Narayan Krishnamurthy | Print Edition: January 25, 2007

Q. What is income tax? A. Tax on income. Q. What is it levied on? A. A tax payer’s income. Q. To tax income, what is it that the government needs to know? A. The tax payer’s income, from all sources.

This is how we all see income tax. This is how the world defines of income tax. But beginning June 2006, the Central Board of Direct Taxes (CBDT) has begun to think of income tax as something more. A means to force you to disclose your expenditure.

In a new tax return form called 2F, introduced from 1 June 2006, it has added a schedule called cash flow statement (see graphic below). Till now tax return forms were concerned with only one kind of flow— the inflow or the income. The cash flow means the tax authorities also want to know the outflow, or the expense. This intrusion by the tax department is historically and geographically unprecedented.

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Though right now furnishing cash flow statement is optional and is demanded from only salaried income earners (who don’t have income from business, agriculture or capital gains and do not own more than one house), the intent is to make the expense statement obligatory for all categories of taxpayers in the next financial year. That is, if the income tax department has its say. Already the Parliament’s Standing Committee on Finance in its November 2006 report found “it absolutely unnecessary to include cash flow statement in the return forms”.

The objections to the demand for details of expenses are both philosophical and practical. To determine the income tax liability of an individual, the government should go to any extent in asking his sources of income. But that is where it should stop. Having got details of income, and collected tax on that income, it has no business to ask what the taxpayer does with the income he has already paid tax on.

Large-scale tax evasion—over 65% taxpayers (about 20 million out of total 30 million taxpayers) are believed to under-report their income—means CBDT is unable to get to all the sources of income and tax it. This is even after it set up an elaborate tax information network (TIN) in 2004. The TIN has so far generated information about 1.8 million high-value expenditures valued at over Rs 13,00,000 crore.

To act on this information the income tax department needs to verify how many of these transactions were done with undeclared income. Right now it can only verify by sending notices to a small fraction of people who made the 1.8 million transactions. Surely many of the notices it sends are to honest taxpayers and who have done the purchases out of “white” money. To increase the effectiveness of TIN in catching tax evaders the department needs a filtering mechanism that can weed out honest taxpayers and generate a list of expenses that are most likely to have been undertaken from unreported income. In asking people for cash flow, tax authorities feel they have found an easy and effective filter.

They can match the expense details generated by the TIN with that filed by the taxpayer in their returns and then go after people whose expenses declared in cash flow do not reconcile with the expenses shown by TIN. But the CBDT’s convenience is at the expense of the taxpayers’. Every taxpayer will have to maintain records of their annual expenses to fill out the cash flow details in the form. Though the statement does not ask for a break up of expenses beyond three broad categories, people will still have to work back some kind of accounts to be able to arrive at a figure to fill. This is particularly true of clause (vi) b and (vi)c.

Tax authorities point out one fringe benefit though. Filling the cash flow details will encourage some sort of financial planning among people. That will undoubtedly lead to a more disciplined approach to financial planning.

Cover Story"Once the income is taxed, utilisation of the taxed income shouldn’t be the concern of the income tax department"-B.C. KHANDURI, Chairman, Standing Committee on Finance

"Asking for cash flow means inconvenience to all taxpayers in order to net just a few tax evaders"-VED JAIN, Income Tax Expert

Right. But instinctively most people don’t like to be forced into financial planning by the government, particularly when it comes from a department that’s far from being a model of efficiency and honesty.

That brings us to the biggest fear from the disclosure of spending details in tax returns. Won’t the details be misused by corrupt income tax officials to harass taxpayers and demand explanations— and bribes? Sure, an honest taxpayer need not fear any explanation call or give in to any demand for bribes. But that’s easier said than done. Pressed for time and short on knowledge on how to deal with tax officials, a majority of taxpayers would rather go for a small “settlement fee” than spend hours gathering documentary support and make the rounds of income tax offices. More than filling government coffers by cutting evasion, the cash flow statements is likely to fatten the wallets of a few unscrupulous tax officials.

 Honest Taxpayer's charter
 I. Income tax is tax on income, why ask for expense
 II. If that helps nab big evaders we are willing to cooperate
 III. But only if expense details are kept to the bare minimum
 IV. Guarantee is given that the details won’t become tools for
harassment in the hands of corrupt taxmen.
 V. Inform us of the additional tax collections made through
this disclosure
 VI. Cut rates of income tax to compensate us for the hassle
and tension
 VII. Besides if evasion comes down, rates can be cut without
affecting collections
 VIII. Keep expense disclosure a temporary requirement, scrap
it after 5 years
The CBDT, however, has another scenario in mind. Admitting that the cash flow statement will inconvenience honest taxpayers for no fault of theirs, the department feels it’s a small price to pay for helping catch big tax evaders. Moreover, tax evaders actually feed on honest taxpayers. People under-reporting incomes usually use all their white income to do savings and black money to meet expenses. The official expenses shown in their tax returns are only a fraction of their income. By forcing such people to declare expenses, the department hopes to cut the scope of evasion. If 20 million taxpayers who under-report their income each declare just Rs 10,000 more as annual expense (Rs 833 a month), that’s an additional disclosure of Rs 20,000 crore (black turning white) and an additional revenue of about Rs 5,000 crore.

What about the harassment of honest taxpayers who help the government get this pot of gold? The CBDT’s assurance that no notice on the basis of cash flow statement will be issued without the express approval of the income tax commissioner doesn’t sound very convincing. A department that is unable to process PAN card requests for years, whose office brazenly ask for bribes before dispatching refunds—even when the taxpayer has given his bank account number for electronic credit— should think twice about undertaking such a commitment.

So should CBDT and honest taxpayers give up hopes of catching tax evaders? Maybe one way out is to introduce a cash flow provision for a limited period, say five years, to unearth some hidden income. Make an upfront announcement of this. Also commit to reduce the income tax rates if, and as, revenue gains accrue (see Honest Taxpayers’ Charter).

And introduce some concrete, demonstrable initiatives to cut harassment and corruption in the income tax department. Tax collectors should be made just as accountable as taxpayers.

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