Addressing revenue-bias in tax agencies

Consider a few news items about the goods and services tax (GST) from recent days. The Directorate General of GST Intelligence (DGGI) has claimed to have detected 6323 cases involving the evasion of duty of Rs 1,98,324 Cr in 2023, a whopping 119% increase in detection. They also made 140 arrests. The DGGI also raised a demand of Rs 402 Cr on Zomato and Rs 350 Cr on Swiggy. The Commercial Taxes Department of Maharashtra government recently raised a demand of Rs 806 Cr on LIC, and of Tamil Nadu, Uttarakhand, Gujarat, and Telangana have raised total demands of Rs 996 Cr on the same company. Hindustan Lever has been slapped with demands of Rs 447 Cr from five state GST units, and LTIMindtree got a demand of Rs 206 Cr. The CBIC recently claimed to have detected Rs 1.36 lakh Cr in GST evasion, which was further increased to Rs 1.51 lakh Cr. It’s also reported that GST notices of Rs 1.45 trillion have gone to about 1,500 businesses in December alone.

The unfortunate reality is that very few of these eye-popping demands will result in any actual realisation. Debashis Basu writes,

A media report says GST authorities believe in general, tax recovery based on earlier demand notices has been weak. It quotes GST officials saying that about only Rs 18,541 crore was recovered from notices aggregating Rs 1.51 trillion while the internal “target” was Rs 50,000 crore… It is hard to believe that these blue-chip companies, with the best tax and legal expertise and multiple layers of compliances mandated by the market regulator, would indulge in tax evasion of this magnitude. They are all aware of the reputation damage and financial dent that would follow, along with directors’ liability (given the draconian GST laws). One tax expert says, “The GST law is so loosely and hurriedly drafted that every officer can take a new view and put penalties beyond capacity of assessees.”

There are certain well-intentioned and understandable reasons behind such high-pitched demands. One, tax administrators tend to have a revenue bias that inclines them to interpret any assessment with the widest possible scope in terms of revenue. Two, tax administrators often view new assessments as a game of bargaining. They feel that a large initial demand would frame the revenue expectations from the taxpayer at a sufficiently high level and increase the likelihood of them settling for a lower but significant enough final demand. Unfortunately, this same logic also drives harassment and rent-seeking settlements.

Three, since GST is a new law, its base is still in the process of being fully discovered. Newer interpretations and types of tax lines are continuously detected and demands are being raised. And new assessments suffer from an inherent upward revenue bias, besides being applied to multiple previous years. Four, once a demand is raised on a new tax line, it’s only natural for more demands on similarly placed taxpayers to get generated. If the tax administrator does not raise demand on all taxpayers with the newly detected taxable item, it becomes a possible audit objection.

Five, the new law also means that clarifications on several areas under dispute or confusion by way of court judgments, executive instructions, and legislative amendments are yet to be issued. Six, the repeated extensions of time to raise demand has allowed tax units to raise demands on filings from even 2017-18. This naturally leads to demands and penalties for five or six years being raised at a time on the taxpayer.

Finally, there are the audit paragraphs of the CAG that highlight omissions. In such cases, even where the Department does not agree with the paras, the default position has been to issue show cause notice and keep the revenue protected, even while pursuing with the CAG for resolving the paras through replies and discussions.

All this has meant that central and state tax units have generated massive demands since the inception of GST, as has been the case with VAT Act before. But the true test of a demand is its collection. It’s here that tax demands made by central and state tax units have been put in perspective.

Much like the tiny conversion rate of the MoU’s signed in state government organised investors’ meets, only a very small percentage of the large demands raised are ever realised. Like with the former, these high demands have unfortunately come to be seen as virtue signalling.

In the seven years of GST, there are only a few cases of even low double digit crores of realisations from a single case of demand raised on revenue loss detected from investigations and enforcement actions. A disproportionately tiny share of the demands raised, a fraction, have translated into actual realisations. It would be interesting to know whether there is any case of realisation of hundred crore plus such demand from across the country. I’ll be surprised if there are any.

In this context, it’s important to make the distinction between tax evasion and newly detected potential revenue channels. The former has to be dealt with strictly without any leniency whereas the latter should be tested and gradually expanded. The expansion of tax base should be done both prospectively and with sufficient advance notice so that businesses and consumers are able to absorb the increment in the cost and price. For example, there are instances of GST demands being raised on taxpayers on transactions where GST was neither levied nor collected. Businesses cannot be expected to absorb large newly identified tax demands that are suddenly raised and with retrospective effect, even if they are legitimate.

Given the new law and the lack of awareness among taxpayers coupled with inadequate expertise among tax administrators, it’s only appropriate that tax demands in the initial stages be done with caution and benefit of doubt given to the taxpayer. Further, demands on new tax lines be tested carefully and gradually on 2-3 cases before being scaled up across taxpayers.

Public commentators who blame tax units of tax terrorism have little to offer by way of constructive suggestions. This is a wicked problem. There are no easy or magic pill solutions involving legislations and diktats or digital solutions. The challenge is to issue guidance that can both discourage against raising of unreasonable demands and also prevent abuse of such guidance to cause revenue loss and indulge in corruption, without creating incentives to low-ball or avoid demands. This will require a combination of measures all done diligently and with seriousness to change the culture of revenue-bias within GST units.

In light of the above here are a few suggestions to contain high-pitched or frivolous or vexatious demands:

1. Foremost, it’s required to define what constitutes a high-pitched or vexatious or frivolous demand assessment. There should be a set of principles on signatures of such demands. It should be accompanied with a few illustrative examples.

2. Some of the commonly observed instances of such high-pitched and vexatious demands should be specifically called out with guidance and executive instructions. An important step would be to issue clear guidance that articulate with illustrations to eschew unreasonable demands.

For example, there could be a set of exclusion principles to be used by adjudicating officers to exercise restraint. It should cover those exclusions or types of cases where demands should not be raised and restrictions on the amounts that can be raised, both with appropriate qualifications to prevent their abuse. For tax administrators whose default position is a revenue bias, exclusions can serve as powerful cognitive reminders and checks against raising excessive demands. This guidance will require some form of statutory basis so as to be credible. It may therefore have to be discussed and approved by the GST Council.

Consider a few. One, in cases of a newly detected revenue loss channel, where it’s established that the taxpayer has himself not levied and collected GST. Two, where it can be established that the industry practice has been not to levy and collect GST. Three, where the GST levied is more than X% of the total revenue or profit before tax. Four, where the issue is partially covered by a judgment of a High Court, even when it has not been settled by the Supreme Court. 

Ideally, these principles should evolve from judicial clarifications. And they will over time as the GST law matures. But we should also explore whether this process can be expedited from the executive side.

3. One approach on the executive side would be to have a mechanism to be able to respond to clarifications raised by different tax units clearly and quickly. Fortunately, the GST Council already has its Law and Fitment Committees. Tax units could be encouraged to formally refer such matters to these Committees, which in turn could examine and issue clarifications or place before the Council for decision. For the first decade or so of any law like the GST, these Committees have a critical role in issuing clarifications.

If these Committees are clear and quick in their responses, the tax units can be advised to refrain from hair-trigger demand raising and can act based on the guidance from them.

Similarly, in case of CAG paras, if they border on policy measures or on interpretation of law, it is suggested that instead of every State CTD contesting such paras, it should be left to the wisdom of GST Council to make out an explanation and present to CAG so that divergent views are not projected by different states on policy matters or on interpretation of law. There are however formidable challenges to achieve the co-ordination required to do this.

4. Newly identified revenue loss channels are particularly vulnerable to high-pitched demands. Once such an instance is detected, it’s not uncommon for the assessing officers to start investigations on similar taxpayers and raise demands for previous years. Such accumulated demands can sometimes run into large amounts compared to even the turnover of the companies. This should be curbed and expansion into more cases should happen only with higher level approvals. It’s therefore useful to have clear guidance and protocols on test investigations and adjudications on those cases.

5. Internal deliberation and taxpayer consultation should be encouraged to contain unreasonable demands, especially those beyond certain threshold or certain kinds of new demands. The deliberative mechanism can be differentiated based on administrative levels to cover demands based on monetary thresholds and nature of cases.

Periodic formal meetings may be conducted with departmental representatives before the tribunal, tax counsels for government, tax consultants and advocates on those demands to solicit areas of concern and pain points perceived to be unfair and unjust by the taxpayers. This will also improve the image of the department as a responsive tax administration.

6. A most important reform is to make officers accountable for the demands raised. Currently, there is neither any accountability nor any administrative cost borne by the officer raising the demand. In fact, their incentives are completely misaligned. The incentives of the investigative arms like the DGGI and the investigation wings in the State units are aligned to maximising demand raising without any concern whatsoever on whether they get realised or not. This must change.

One way to address this is to have investigations and adjudications done by the same officer, as is the case in some states. But this too has its pros and cons, like with the prevailing system. A second way would be to have an executive mechanism to examine what appear to be high-pitched demands. In this context, the review mechanism currently available under Section 108 of the GST Act 2017 is limited only to revenue protection, thereby allowing only upward revisions. Additional safeguards may be necessary to allow for downward revisions in review. Such upward revision powers may also be limited to cases with demands above a certain threshold. In order to make this practical, such downward revision power can be with a Committee of officials drawn from both the State and local CBIC units. 

7. All this must be complemented with disciplinary action against those adjudicating officers who have raised high-pitched demands. Some of the principles discussed above could form the basis for such actions. For example, such action should be initiated in cases of any demand, especially but not only high-pitched ones, raised with perfunctory invocation of suppression of facts, wilful misstatement, etc., and where there is neither any evidence for these nor when there was no intent on the part of taxpayer to evade.

Similarly, there should be a periodic review of the orders set-aside by the appellate authorities to know the repeated mistakes committed by the adjudicating authorities in cases of high-pitched demands. If they are found to be bad in law and without application of mind, disciplinary action should be initiated and mention of the same made in the assessment reports of the officer concerned.

8. The GSTN or the GST Council should consolidate and publish information about the quality of investigations undertaken by different state and central tax units. This information should contain measures of the audit and adjudication effectiveness, the final demands raised on each of scrutiny, audit, and inspections, the respective amounts collected, and the cases that have gone to litigation (and their progress). Shining light on this and evaluating tax units and proper officers on these parameters is critical to start creating the conditions for more responsible adjudications and raising of demands. 

The Council Secretariat should also be continuously issuing guidance to all tax units on emerging developments in GST case laws. The current mechanism of such guidance issued by CBIC should be expanded to include state units too.

9. Oversight and investigative agencies like the CAG and CBI should be given clear and explicit directions to make the distinction between genuine and conscious omissions and malafide actions. Admittedly, operationalising this by changing cultures and practices is difficult. But it’s an essential requirement to help officers overcome the fear of subsequent disciplinary actions and avoid high-pitch demands. 

In particular, there should be highest level care to ensure that adverse administrative actions are not triggered against officers who have avoided raising large unreasonable demands on bonafide and well-reasoned cases. It’s important that adjudicating officers are suitably assured of the backing of senior officers so that they do not succumb to revenue bias to raise demands mechanically only on the ground that the demands arose based on audit objections or due to inspections or to achieve revenue targets.

10. Public debates on issues like tax terrorism must expand from blame games and become constructive by creating the conditions for officers to have the confidence in restraining their revenue-bias instincts and adjudicating responsibly. Opinion makers, commentators, tax experts, researchers etc., have been unfair and populist in this regard. They have excoriated tax officers for high-profile high-pitched demands while ignoring the conditions that result in such demands.

11. There are also competency and work management factors that contribute to such aggressive demands. Tax officers are often not conversant with the law and its application, do not have the expertise to read company account statements, have superiors breathing down their necks with aggressive revenue targets, and are over-burdened and have limited time to deliberate and for serious application of mind in adjudication. These factors should be addressed through administrative actions like extensive case study-based trainings. 

As more demands get issued, work burden increases sharply and entraps the system in a bad equilibrium. This must be addressed by having some benchmarks on allocation of cases for investigations and adjudications. The allocations should be staggered such that the officers don’t get swamped with bursts of demand issuance and their workload can be managed. The Proper Officers (POs) should have adequate time to gather evidence, examine the case, and apply their mind in investigation and adjudication, and in writing clear and well-reasoned orders.

12. The most important driving force behind such high-pitched demands is the near universal practice of targets-based tax administration. This cannot be avoided to some extent. But the widespread tendency among officers and units to take such targets-based administration to its extremes should be curbed. 

Instead, the targets should be realistic and confined to the realisation of arrears and dues that have been generated from investigative and enforcement actions. Ideally, tax administration should veer towards monitoring of business processes, business intelligence and its analysis, and completion of investigations with quality and within stipulated times.Those are the only things within their control.

13. Finally, there’s no sustainable way to address the problem of high-pitch demands except to reform the excessively revenue-biased culture of these departments. This would require long-drawn moral suasion and repeated reinforcement. High pitched demands which do not conform to the principles and law, and remain unrealised should be stigmatised.

Update 1 (08.04.2024)

CBIC has issued instructions that cover some of the points raised above.