IMPORTANT EVENTS 1946-61

Revenue

• 1945-46 : Rs.57.12 Crores(As per IT Reports returns for 1945-46)
• 1960-61 : Rs.287.47 Crores

AN ERA OF NEW DIRECT TAXES Period 1946-1961

 

Introduction

 

The period 1946-61 was one of the intense creativity. A black or parallel economy emerged both in the wake of the Second World War and the expansion of the economic activity in the post-independence period. Incentives were provided through the taxation laws to promote savings and investment ; this made the tax laws more complex. Then, there was the need for larger revenues to finance the plans of economic development. Thorough investigations were, therefore, conducted into the structure of taxation not only with a view to widen the base of income-tax but also to look for new taxes and to prevent tax evasion and avoidance. The Income-tax administration came under heavy strain due to the increase in the volume and complexity of its work.

 

Several new taxes were levied notably the Business Profits Tax (1947), Capital Gains Tax (1946-48 and from 1956), the Estate Duty (1953), Wealth-Tax (1957), Expenditure-Tax (1957) and Gift-Tax (1958). To curb the evil of the black or parallel economy, high-denomination notes were demonetised in 1946 ; an Investigation Commission was set up in 1947 and a Voluntary Disclosure Scheme for disclosing concealed income was introduced in 1951. The Income-tax Department was strengthened by an increase in its personnel and a Class-I service was introduced. The income-tax law was re-written and based on the draft of the Law Commission, the 1922 Act was replaced by the Income-tax Act, 1961.

Investigation into taxation structure and tax administration.

During the period, the taxation structure and the tax administration were investigated by several experts individually or through Committees and Commissions notably the following :-

1. Income-tax Investigation Commission (1947-48)
2. Taxation Enquiry Commission (1953-54)
3. Prof. Nicholas Kaldor’s Report on Indian Tax Reform (1956)
4. The Direct Taxes Administration Enquiry Committee (1958-59) ; and
5. Law Commission of India – 12^th Report – Income-tax Act, 1922 (1958).

The recommendations made by each of them, particularly the important ones are described below. These had far reaching effect on the set up and working of the department.

Income-tax Investigation Commission (1947-48)

 

The Income-tax Investigation Commission under the Chairmanship of Sir Srinivasa Varadachariar, ex-judge of the Federal Court, was constituted under the Taxation on Income (Investigation Commission) Act, 1947. It was to –

1. investigate and report to the Central Government on all matters relating to taxation of income, with particular reference to the extent to which the existing law and procedure was adequate to prevent tax evasion ; and
2. Investigate and report to the Central Government any specific cases referred to it.

The Commission gave its report in December, 1948 and made a number of recommendations to plug loopholes for preventing tax evasion and tax avoidance and also to simplify various provisions of law and procedures. Based on the Commission’s recommendations, a comprehensive Income-tax (Amendment) Act, 1953 was passed.

 

Specific cases on tax evasion could also be referred by the Central Government to the Commission U/s 5(1) of the Taxation on Income (Investigation Commission) Act, 1947 ; the Commission could also call for the cases of tax evasion U/s 5(4) of the said Act. On 28^th May, 1954, the Supreme Court held that section 5(4) was a piece of discriminatory legislation offending Article 14 of the Constitution w.e.f. 26^th January, 1950 i.e. the date on which the Constitution came into force. To meet the situation created by the Supreme Court judgment, Ordinance, No. 8 of 1954 was promulgated by which section 34 of the Indian Income-tax Act, 1922 was amended. The amendment empowered the I.T.Os to take action, with the prior approval of the Board, in all the cases called for by the Commission for investigation provided the concealment relating to the period 1^st September, 1939 to 31^st March, 1946 was Rs.1 lakh or above. By another judgment delivered in October, 1954, the Supreme Court held that the Commission could not proceed even with the cases referred to it U/s 5(1) and pending on 17^th July, 1954 i.e. the date when the above ordinance amended the Indian Income-tax Act, 1922. On 19^th November, 1958 the Supreme Court in Bisheshar Nath’s case invalidated the settlements with the assessees U/s 8A of the Investigation Commission Act.

 

At the time of the Supreme Court’s judgement of October, 1954 the position of the Commission’s work was as under :-

Section 5(1) Section 5(4)

(a) No. of cases referred 1312 369

(b) No. of cases disposed of 823 224

(c) Balance pending for disposal 489 145

(d) Amount of tax involved in

respect of cases under (b) Rs.20.23 Cr. Rs.5.81 Cr.

(e) Amount Collected Rs. 7.51 Cr. Rs.2.42 Cr.

The pending cases with the Commission were referred to a newly set up organisation namely, Directorate of Inspection (Special Investigation) for the expeditious completion of the proceedings. In addition, 78 settlements spread over 560 cases which were affected by Bisheshar Nath’s judgement were also taken over by the said Directorate. In some cases, action was not possible as they did not satisfy the technical requirements of section 34(1)(a) of the 1922 Act. Proceedings were started in 914 cases, most of which were disposed of by the Directorate by 30^th November, 1960 when it was wound up. In 808 cases disposed of till October, 1959, the Directorate had settled concealed income of Rs. 32.04 crores involving tax of Rs.15 crores.

Although the powers of the investigation Commission were seriously curtailed by the Supreme Court’s judgement, its powers to investigate the cases referred to it under the Travancore Taxation on Income (Investigation Commission) Act, remained unaffected since the Supreme Court held that the provisions of that Act were valid. For this purpose and also for the purpose of certain residuary and administrative and legal functions relating to the cases already disposed of, the Commission’s term was extended from time to time till 31^st December, 1958 when it was ultimately wound up. While the Commission could not function effectively due to Supreme Court’s judgement, it made significant contribution by its report submitted in 1948 in which it made valuable recommendations for changes in law and procedure. Its contribution in individual cases was no less significant, it discovered a concealment of Rs.48 crores (1940-46) on which tax evaded was Rs.32 crores. Largely as a result of the investigation conducted by the Commission, the Directorate of Inspection (Special Investigation) was able to settle concealed income involving tax of Rs.15 crores. This was in addition to the cases finally settled by the Commission and tax recovered thereon.

Taxation Enquiry Commission (1953-54)

Taxation Enquiry Commission was appointed in 1953 not only to review the structure of taxes on income but also to carry out an in-depth study of the central taxes and their administration. The Commission carried out a very comprehensive study and made a number of recommendations of far reaching consequences, the more important ones were

1. The distinction between agricultural and non-agricultural income should be done away with, and both the incomes should be treated as one eventually for the purpose of taxation.
2. The incomes of both husband and wife, and, indeed, of the whole family, should be aggregated ; that it was not only equitable but also necessary for the effective administration of the Income-tax Act.
3. The following receipts of a capital nature should be chargeable to Income-tax by spreading them to certain number of years.
   1. premium on leases ;
   2. sale proceeds of patent rights and copy rights ;
   3. compensation received for termination of managing agency agreements or similar business agreements ; &
   4. compensation for loss of employment except when it is in the nature of damages awarded by a court in consequence of the repudiation of service agreement by an employer or for wrongful discharge of dismissal of an employee.
4. The exemption limit in the case of an individual should be reduced from Rs.4,200 to 3,000 and the maximum marginal tax rate on slab of income above Rs.1.50 lakhs, should be raised from 82 to 85 per cent. The tax rate for upper middle income brackets should also be raised.
5. Development rebate at 25 per cent, of the cost of new plant and machinery should be allowed for investment in selected industries. It should be in lieu of the initial depreciation allowance. The assessees could alternatively opt for complete holiday for six years from the year in which the manufacture of production begins.
6. The Commission also made a number of recommendations to check tax evasion and plug tax avoidance and for improving the machinery of tax administration. It suggested a departmental enquiry for finding out ways and means of completing the assessments expeditiously and making tax administration more effective and purposeful.

The major recommedations of the Commission regarding taxation on agricultural income and treating the family as a unit of assessment were not found acceptable by the Government. However, its recommendations for reducing the exemption limit, increasing the tax rates and introduction of development rebate were duly implemented. A departmental enquiry was also made and a number of measures were taken to strengthen the machinery in the Income-tax Department as a result of that enquiry

Prof. Nicholas Kaldor’s report on Indian Tax Reform (1956)

Although the Taxation Enquiry Commission had examined the structure of Indian Taxation, a review by Prof. Nicholas Kaldor was desired by the Government in late 1955 "in view of the larger dimensions assumed by the problem of resources for the plan since the Commission reported."

Prof. Kaldor recommended the "broadening of the tax base through the introduction of an annual tax on wealth ; the taxation of capital gains ; a general gift-tax; and a personal expenditure tax." For reducing the scope of tax evasion, he suggested the introduction of the institution of a comprehensive tax return for all direct taxes and the introduction of a comprehensive reporting system on all properties transferred and other transactions of a capital nature. He also recommended breaking of vicious circle of charging more and more on less & less. According to him, rates should be lowered so that maximum rate of Income tax is 45%.

The recommendations of Prof. Kaldor for introduction of new taxes was accepted. His advice was however, revised, adapted and added both as to the scope and definition as well as to the schedule of rates for various new taxes. His suggestions for reducing the tax evasion and tax avoidance were referred for consideration to the Direct Taxes Administration Enquiry Committee.

Direct Taxes Administration Enquiry Committee (58-59)

This Committee was set up in June, 1958 to "advise Government on the administration organisation and procedures necessary for implementing the integrated scheme of direct taxation with due regard to the need for eliminating tax evasion and avoiding inconvenience to the assessees". It was chaired by Sri Mahavir Tyagi, M.P. and was popularly known as ‘Tyagi Committee’. It submitted its report in November, 1959 and made several recommendations notably :-

(i) The Committee did not favour one comprehensive return for all direct taxes and suggested that the existing position of administering various statutes should continue till the Department and the tax payer had gained sufficient experience.

(ii) It was recognised that the simplification of statutes was not an easy task. However, if changes in the statutes were reduced to the barest minimum and the provisions were arranged more logically and expressed in clear language, much of the ambiguity would disappear.

(iii) For expediting assessments, a scheme of summary assessment was recommended for small cases which could be subjected to detailed scrutiny once in four years.

(iv) Instead of allowing depreciation according to the months of use of an asset in a year, full depreciation was required to be allowed if the asset was used for more than 6 months; half depreciation if it was used for more that one month and less than 6 months; and nil depreciation if the asset was used for less than one month.

(v) Several other recommendations were made for simplification of the tax laws and improvements in the methods of work notably in the areas of bad debts, speculation losses, registration of firms, taxation of non-residents, collection and recovery of taxes, refunds, evasion and avoidance and tax administration.

(vi)The Committee suggested the taking over of the recovery work from the State Governments.

(vii) In the area of the administration, it recommended increase in the strength of the Department as well as improvement in the quality of officers by improving training facilities and adopting "merit and efficiency" as "the sole criteria for filling of selection posts in any cadre."

(viii) Audit of accounts in all non company cases of business, profession or vocation where the assessee’s total income in any of the last three years exceeds Rs.50,000 should be made compulsory by law and auditor should be required to give audit certificate in a prescribed form. Such an audit should also be compulsory in those cases of business, profession or vocation where returned income for the first time exceeds Rs.50,000/-.

Most of the recommendations of the Committee were accepted through legislation or through administrative measures.

Law Commission’s Report of Income-tax Act (1958)

The Government asked the Law Commission in 1956 to revise the Indian Income-tax Act, 1922. About the said Act, the Commission remarked, "there is hardly any Act on the Indian Statute Book which is so complicated, so illogical in its arrangement, and in some respects so obscure as the Indian Income-tax Act, 1922". The revised draft was prepared by a Committee of eminent jurists consisting of Svs. P. Satyanarayana Rao, G.N. Joshi and N.A. Palkhivala. The Commission submitted the draft in September, 1958. It rearranged and re-grouped the various sections of the Act and simplified the language mainly by splitting long sections into independent ones and converting the provisos into independent provisions. Apart from changes in form, some changes in the substance of the Act were also made.

The Commission’s draft was the basis for the enactment of the Income-tax Act, 1961 which repealed the earlier Act, of 1922.

Post Investigation Developments

As a result of investigations by various experts Committees etc. Into the taxation structure and the working of the tax laws, a number of legislative changes were made. Several new laws were enacted. Significant changes were made in the existing Income-tax Law. They were mainly designed to increase the revenues for financing the plans of economic development and to provide tax incentives for promoting savings and investment in private sector. To cope up with the work, the departmental machinery had to undergo substantial expansion & alteration. The various new laws framed during the period 1946-61 in the sphere of direct taxes are indicated in the following paragraphs :-

Business profits Tax Act, 1947

After the lapse of the Excess profits Tax in 1946, a Business Profits Tax was enacted in 1947. This covered the period from 1.4.1946 to 31.3.1949 and was designed to tax the excess business profits which continued to be made after the Second World War largely due to shortages of various commodities in the country.

Extension of Income-tax Act to States

The Indian Income-tax Act, 1922 was extended to the merged States in 1949 by the Taxation Laws (Extension to Merged States and Amendment) Act, 1949 and to the State of Jammu & Kashmir in 1954 by the Taxation Laws (Extension to Jammu & Kashmir) Act, 1954. Extension of the Income-tax Act to the States brought about considerable increase in the number of assessees and also raised problems of integration of the tax administration of these States with the all India tax-administration.

Estate-Duty Act.

For furthering the objective of building an egalitarian society, death duty was levied under the Estate Duty Act, passed in 1953. It came into force w.e.f. 15^th Oct., 1953. The Act was based on the law in United Kingdom on the subject. For facilitating its administration, training was imparted to the officers of the department both in India and in U.K., Separate Estate Duty Circles were set up in major cities; a panel of values was drawn up and literature on the new enactment was developed for the officers as well as for the public.

Development of integrated tax structure-Wealth-tax, Expenditure-tax and Gift-tax.  

The year 1957-58 was a water shed in the history of direct-taxes legislation. Major reforms were introduced in this year. A new integrated direct tax structure was put into operation. Based on the recommendations of Prof. Nicholas Kaldor, Wealth-tax and Expenditure-tax were levied. Gift-tax was introduced in 1958.
 

Wealth-tax  

The Wealth-tax was to be an annual levy payable by individuals who had wealth of more than Rs.2 lakhs, by Hindu Undivided Families which had wealth of more than Rs.4 lakhs, and by Companies which had wealth of more than Rs.5 lakhs. The Wealth-tax on companies was abolished from the asstt. Year 1960-61.  

Expenditure-tax  

The rates of tax were pitched fairly high on the excess over normal expenditure of Rs.36,000 per year. The object of this tax was to curb ostentatious expenditure on consumption. Several administrative difficulties were encountered in implementing this Act – the major one being, in maintaining reliable records of expenditure. The revenue from this tax was very poor. The collection in the year 1960-61 amounted to Rs.90.56 lakhs. The levy of Expenditure Tax was, therefore, discontinued w.e.f. the assessment year 1962-63 under a provision made in this behalf in the Finance (No.2) Act, 1962. The Act was revived from the asstt. Year 1964-65. While the rate of Expenditure-tax was reduced, certain exemptions and deductions which were hitherto admissible were removed. The collections from the revived Act also continued to be poor. The Act was finally repealed w.e.f. the asstt. Year 1966-67 by section 40 of the Finance Act, 1966.

 

Gift-tax  

As part of the process of installing an integrated tax structure, Gift-tax was introduced in 1958. It was applicable to gifts made after 1st April, 1957 and exceeding Rs.10,000 in a year. Such types of gifts as of immovable property outside India, gifts to Government, gifts to charitable institutions recognised under the Income-tax Act, bonafide gifts during the course of business etc. were exempted from levy. The object of this tax was to ensure that the base of tax on income and / or wealth was not eroded by transfers to one’s relatives and others.

Changes in the Income-tax Act  

Significant changes were made during the period 1946-61 in the Income-tax Act. Their major aim was to increase revenue collections, provide tax incentives for savings and investment, bring about simplification and rationalisation in the various provisions, plug loop-holes for prevention of tax avoidance and to strengthen the tax machinery. The major changes made during this period are as under :-  

1. 1. In 1948, abatement from tax for voluntary donations to approved charitable and religious institutions was provided. The abatement was equal to 50% of the donation and was applicable to donations exceeding Rs.250 but less than Rs.1 lakh during the year with the further restriction that they did not exceed 5% of the assessee’s income. The objective was to encourage activities for promoting relief to the poor, education, medical relief and other objects of public utility.

2. 1. In 1949, Section 15-C was introduced in Indian Income-tax Act, 1922 providing for tax holiday on profits of newly established undertakings set up after 1^st April, 1948. The exemption was to be equal to 6% per annum of the capital employed in the new industrial undertaking and was to be allowed for 5 assessment years beginning from the year in which the undertaking commenced manufacturing operation. Vide Finance Act, 1961, the concession was extended to the hotels also w.e.f. 1^st April, 1961.
   2. Section 23-B was inserted by the Taxation Laws (Extension to merged States and Amendment) Act, 1949 empowering the I.T.O. to complete a provisional assessment on the basis of returned income in advance of the regular assessment. The object was to recover the tax on the basis of the returned income without waiting for the completion of the regular assessment.
   3. With effect from the 1^st April, 1952, persons leaving India were required to obtain tax clearance certificate because of section 46-A inserted by section 22 of the Indian Income-tax (Amendment) Act, 1953.
   4. Capital Gains Tax was introduced w.e.f. 1^st April, 1946 by the Income-tax and Excess Profits Tax (Amendment) Act, 1947. It inserted section 12-B to the Indian Income-tax Act. The Capital Gains Tax was abolished w.e.f. 31^st March, 1948. It was reintroduced w.e.f. 1^st April, 1957 vide Finance (No. 3) Act, 1956.
   5. While the earlier Finance Acts had been making changes in the rates of tax, the most important changes in the Income-tax rate structure were introduced in the year 1957-58. They were –
   6. 1. The lowering of the exemption limit for personal Income-tax from Rs.4,200 to Rs.3,000.
      2. The increase of the first slab of exemption for married persons from Rs.2,000 to Rs.3,000 and the provision of further exemption of income up to Rs. 600 for married persons with 2 children.
      3. Withdrawal of the married allowance for persons with income above Rs.20,000.
      4. Re-adjustment of the present tax rates and reduction of the highest rate of tax from 91.8% to 84% (for un-earned income) and 77% for earned incomes.

In the field of corporate taxation, the rate of Income-tax was raised from 26.25 % to 31.5% and the rate of super-tax on Indian companies was raised from 17.2 % to 20%.

Repeal of the 1922 Act and passing of I.T. Act, 1961

As stated before, the 1922 Act was revised by the Law Commission. The revised draft was sent to the Government as 12^th Report of the Law Commission in 1959. Based on this draft, a Bill was prepared substituting the 1922 Act with a new Act which was passed in 1961 and became the Income-tax Act, 1961. The major changes in law made through this Act was the taking over of the tax recovery work from the State Governments. This was made possible by creating the institution of T.R.Os who were to be the I.T.Os. The procedure for recovering of tax by the T.R.Os was provided in the I.T. Act itself by way of the Second Schedule. The Act also contained provision for gradually taking over the recovery work from the State Governments and this process was completed in stages and now the tax recovery work is practically handed entirely by the Department all over the country.

Income Tax Administration

The passing of every new law and the amendments in the Income-tax law posed a serious challenge to the Income-tax administration for their proper implementation. The growth of parallel economy in the wake of Second World War got a shot in the arm due to heavy expenditure in the wake of the development plans. The Department was called upon to take administrative steps for curbing tax evasion. The increase in the number of assessees and growing complexity of assessment work required the Department to tackle the problem of ever increasing arrears of assessment. To these developments, a new factor was added which created further work load for the department.

After the advent of Independence in 1947, the State started promoting actively the policies aimed at economic growth, modernisation, self-reliance and social justice. The Income-tax law was, therefore, increasingly used as an instrument of promoting economic development by encouraging savings and investment. In 1948, the Finance Act prescribed a rebate from super tax of one anna (about six paise) in the rupee on all undistributed profits of companies.

Introduction of Sec. 15C, in 1949 was another step in this direction, as detailed above.

Inter-corporate dividends were exempted from tax by way of an incentive to investment. To encourage investment in industry, initial depreciation equal to the normal depreciation was introduced through the Taxation Laws (Extension to Merged States and Amendment) Act, 1949. All buildings newly erected or new plant and machinery installed after 31^st March, 1948 qualified for this depreciation in the year in which the building was erected or the plant or machinery was installed.

For encouraging investment in the immovable properties, Finance Act 1961 provided for the exemption from the annual value of the property, a sum upto Rs.600 per year for a period of 3 years in respect of a building which was erected and completed after 1^st April, 1961.

Exemption was also granted to incomes of approved scientific institutions through the Taxation Laws (Extension to Merged States and Amendment) Act, 1949.

The Income-tax (Amendment) Act, 1953 exempted the income of foreign employees if their stay in India did not exceed 90 days. Exemption was also granted to foreign technicians if they were employed by the Government, local authority or any corporation set up under any law or in any business carried on in India if such person was not a resident within any of the four financial years immediately preceding the financial year in which he arrived in India. For promoting savings, interest on several types of Government securities and Post Office Cash Certificates/National Saving Certificate etc. were exempted.

For achieving certain other social objectives, the income of a registered trade union from interest on securities, property and from other sources was fully exempted by the Finance Act, 1958. For encouraging sports, exemption was granted by the Finance Act, 1961 to the income of an association or an institution having as its objective the control, supervision, regulation or encouragement of any of the games like cricket, hockey, football, tennis or other specified games.

Strengthening of the administrative machinery – Constitution of Indian Revenue Service Class – I

Earlier, the I.T.Os used to be of Grades I and II and formed part of Class II Services. The Class I Service started with the Assistant Commissioners of Income-tax. The initial recruitment under the new Scheme was only to Grade II of Class I and was –

1. by direct recruitment through a competitive examination conducted by the Federal Public Service Commission (later on Union Public Service Commission) and
2. by promotion from Class II, Grade III, the prescribed ratio being 80 per cent by direct recruitment and 20 per cent by promotion from Class II Service.

In case, sufficient number of candidates were not available for promotion, surplus vacancies were to be filled up by direct recruitment. In October, 1951, the recruitment quota was 66-2/3 per cent by direct recruitment and 33-1/3 per cent by promotion. The Class II officers, on promotion, got 2-3 years weightage in seniority over directly recruited officers because of their experience and rigorous selection on merit. The recruitment to Class I Grade I was wholly by promotion from Class I Grade II ; the directly recruited officers had to put in 5 years service before promotion while an officer promoted from Class II to Class I Grade II was promoted on the basis of the seniority irrespective of his length of service in Class I Grade II. This situation lasted till 1973 when the Rules regarding seniority in service were changed as a result of prolonged litigation between directly recruited Class I Officers of the Department & Union of India.