‘Capacity To Pay’, ‘Ability To Pay’ Govt’s New Rates Question Tax Principles

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By 2017-09-17

By Paneetha Ameresekere

A standard statement by tax consultant N.R. Gajendran when addressing tax seminars, used to be, that the Government's tax policy should be based upon the principle of the taxpayer's 'ability to pay' and the 'capacity to pay'.

In this context, the Government's move, led by Premier Ranil Wickremesinghe to reduce indirect taxes from the current 80% to 60%, while doubling direct taxes from the present 20% to 40%, is a good move.

The logic behind this move, as one of my bosses put it to me succinctly the other day was, why should a man earning
Rs 25,000 a month pay Rs 50 for a loaf of bread, whereas another earning four times that salary at Rs 100,000, also be paying Rs 50 for that same loaf of bread?

His reasoning was that should not the man earning a higher income be made to pay higher or more taxes and thereby reduce the indirect tax burden such as those levied on a loaf of bread, thereby reducing the price of bread and making it more affordable to the low income earner making only Rs 25,000 a month?

It may be impractical to have a two tier or multiple tier tax regime for consumables such as bread vis-à-vis their retail prices, by making the rich pay more for a loaf of bread and the poor, a lesser price. How is the trader to identify who's a rich or a poor customer to levy the 'appropriate' tax rates?

But what may be done, is to either reduce or take off the tax completely on bread, while at the same time increasing the direct tax on those, in Gajendran's words, who have 'the ability to pay' and the 'capacity to pay.'

It is in this context that one has to look at the increase of two direct taxes in the new Inland Revenue Act that was passed in Parliament recently, which questions the fact that when those new taxes percolate down to the end user, whether the taxpayer (either direct or indirect), has the 'ability to pay' and the 'capacity to pay'.

One of those two controversial taxes is the carte blanche Withholding Tax (WHT) of 5% to be levied on interest earned on fixed income instruments such as fixed deposits (FDs), i.e. a doubling of the current WHT rate of 2.5%, to 5% once the new Inland Revenue Act comes into force in April 2018.

The other, is the increase of the Standard Tax regime for companies in the Healthcare Sector, from 12% to 28%.

Therefore, the proposal to hike the tax in the healthcare sector from the present 12% to 28%, is a 16 percentage point or a 133.33% increase. This new tax too will be effective from April next year. In fact, all of the tax proposals under the new Inland Revenue Act will be effective from April 2018.

On the subject of the increase in WHT on interest earned on instruments such as FDs, there may be a question of fairness in levying such a tax, carte blanche, vis-a-vis a person who lives off from such an income, say, an earning of Rs 25,000 per month of interest income and another person who is earning four times that amount, i.e. Rs 100,000 per month.

Such a scenario may be similar to the aforesaid example of a person earning a salary of Rs 25,000 having to pay Rs 50 for his loaf of bread, while another person earning Rs 100,000, also having to pay 'only' Rs 50 for that same loaf of bread, instead of being taxed more.

It's not that this newspaper is advocating that bread should be taxed on an ascending or sliding scale depending on a person's income, where a person earning 'less' would be charged a lower tax on his loaf of bread, while the person who is earning a 'higher' income should be charged a higher tax on his bread, that way ensuring that Government suffers no revenue loss due to a sliding/ascending tax rate applied to an essential commodity like a loaf of bread. Such a scheme, as explained above, is not viable.

WHT on such interest receipts was first introduced by the cash starved Mahinda Rajapaksa regime, where such a WHT first became effective from 1 April 2011. However, at the time, an individual earning a maximum of Rs 500,000 as interest income didn't come under this particular WHT regime.

Initially, when this taxation scheme was introduced, i.e. effective from the financial year 1 April 2011, the minimum rate applicable was 2.5% for individuals earning an interest income of between Rs 500,000 and Rs 1.5 million annually. Anyone earning a higher interest income was subjected to a WHT of 8% on such earnings.

1 April 2011 was the genesis of the WHT regime vis-à-vis interest earned on deposits by individuals. Four years later, on 8 January 2015, the present regime was elected to power, bringing in political and economic changes to the old order, for better or for worse.

The new Government, similar to the previous regime, has also been strapped for cash. While the former government restricted the application of the WHT on deposit interests of those earning more than Rs 500,000 per annum, the present regime, carte blanche, made it applicable to any value earned vis-à-vis deposit interest, doing away with Rajapaksa's minimum deposit interest income threshold.

If an individual earned a deposit interest income of Rs 1,000 per annum, that income was also subjected to a 2.5% WHT under the new regulations, effective from 1 April 2015. Similarly, if a person who earned a Rs 1,500,000 interest income per annum, that person too was subjected to a 2.5% WHT.

Though the WHT may be construed as a direct tax, the carte blanche application of the WHT on interest income, regardless of the value of such an income, however, brings to question, whether such a blanket application of the WHT on deposit interest income, may violate the tax principle of the taxpayer's 'ability to pay' and the 'capacity to pay.'

Matters have been made worse where, under the new Inland Revenue Act passed by Parliament this month, this WHT on deposit interest has been doubled to 5%. The seeming saving grace is that seniors, which the Inland Revenue Department defines as those who are above 60 years of age, earning an interest income of a maximum of Rs 1.5 million per annum, are however not subjected to this new 5% WHT regime.

The retiring age in public service is 55 years, with extensions, such a person may work up to 60 years. A public servant therefore is cushioned by the fact that he can be employed till he's 60 years of age, thereby being assured of a monthly salary till he reaches the 'actual' retirement age of 60 years.

Therefore, whatever gratuity he may get as a retired public servant, he may place it in the form of a deposit such as an FD, which would provide him with an annual interest income. If such an annual interest income is below Rs 1.5 million, that individual is not liable to pay a WHT on such interest earned on an FD. In addition, a retired public servant also earns a monthly pension.

But, in the case of the private sector employee, the retirement age is 55 years. Such a retired individual's FD, made after collecting his retirement benefits, whether such interest earned is a 'low' Rs 100,000 per annum or a higher rate of more than Rs 1.5 million, will, under the new tax regime, be subjected to a WHT of 5% until he reaches 60 years of age.

Even though that individual may be considered a senior citizen according to the Monetary Board's (MB's) definition, where, an individual is over 55 years thereby being entitled to a higher deposit rate, all those gains may be negated due to the ascendancy of the higher WHT regime of 5% from 1 April.

28% Healthcare Tax

Likewise, the Healthcare Company Tax, which stood at 12% even during the former regime, will be hiked up to 28% to be on par with the standard company tax regime, with effect from April next year.

Passing tax liabilities to the end user is an economic reality in the marketplace. Whereas company taxation is a form of a direct tax, passing down such taxes is an indirect cost to the consumer, in this instance, the patient.

Therefore, there is a likelihood of patients' bills going up after 1 April due to the higher healthcare company taxes operable from then onwards. Such increases, however, in the case of doctor's channelling charges, have an upper limit of Rs 2,000 by law. Similarly, in the case of certain drugs, there is a price ceiling.

But the market, whether it be the healthcare sector, or any other sector, knows how to circumvent such price caps. They may levy higher charges for other healthcare services offered in order to recoup the extra costs or alternatively, they may not import those drugs whose prices are controlled by the Government, or may import cheaper drugs of inferior quality.

Former UN Conference on Trade and Development (UNCTAD) Secretary General Supachai Panitchpakdi, speaking at a forum organized by the Retailers' Association in Colombo last week, said that rising income disparities were more worrying to the UN than 'climate change.'

He said that the effect of these inequalities was that those who invest in real estate, bonds and equities, find their income levels rising faster than the rest of society.

Panitchpakdi may provide a solution to the Government's low tax revenue, thereby avoiding taxing carte blanche, on those who live off interest income, while at the same time ensuring that patients don't end up with higher hospital bills due to the current regime's higher tax policy for the health sector.

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