Simplification and codification of tax laws

D D M Waidyasekera

One of the main objectives of the current Presidential Taxation Commission according to its Terms of Reference is the simplification and rationalization of the tax system.

Simplification of the tax system however is linked to and is dependent also on the simplification of the tax laws which have become complicated.

This is not a phenomenon peculiar to Sri Lanka alone. It is a worldwide phenomenon. Changes in fiscal policies and administrative problems usually do not permit income tax laws to remain unchanged for any length of time. It tends to become very complicated.

For instance, a well-known standard textbook on Income Tax Law in India has described the Indian Tax code as "a national disgrace."

The Indian Income Tax Act of 1961 is now to be rationalized and revised by a new Direct Tax Code (DTC) to be implemented after discussion by April 2011. In the United States the original Tax Code had 11,400 words, today it has over seven million. Not to be outdone, the US Internal Revenue Service (IRS) has 480 different tax forms plus 280 more to explain how to fill out the first 480. Randolph Paul in his "Taxation in the US" quotes President Harding.

"I can't make a damn thing out of this problem. I listen to one side and they seem right - and God! I talk to the other side and they seem just as right and I am where I started.

I know somewhere there is a book that will give me the truth. But Hell! I couldn't read the book."

President Barack Obama on March 25, 2009 established a Special Task Force to review the shortcomings of the US tax system. This is part of Obama's Economic Recovery Advisory Board known as the Volcker Task Force because it is chaired by Paul Volcker.

One of its major goals apart from fostering a fairer, simpler and more economically efficient tax system is simplifying the tax code.

In Sri Lanka income tax was first introduced in 1932 by the Income Tax Ordinance No. 2 of 1932 effective from April 1, 1932. This Ordinance was amended 17 times between 1932 and 1949 when a new Act No. 1 of 1949 replaced it.

This was also amended six times before a new Act based on the recommendations of the 1955 Taxation Commission came into being in the form of Act No. 3 of 1956.

The next piece of legislation codifying the tax laws was the Income Tax Act No. 4 of 1963 which after some amendments was replaced by Act No. 28 of 1979 which appeared to be based on a more firmer foundation.

Still, this Act was subject to no less than 18 amendments when the new revision took place in the form of Act No. 38 of 2000.

This was again amended six times between 2002 to 2005 when it was replaced by the current Inland Revenue Act No. 10 of 2006. Up to now this also has been subject to three amendments in 2007, 2008 and 2009. When the report of the current Taxation Commission is issued there will probably be a new Inland Revenue Act in 2011. Most of these amendments dealt not merely with purely legal or administrative matters but were often substantive in character involving sometimes far reaching policy changes in taxation.

Such changes included tax incentive policies, the unit of taxation, tax rate structure, corporate taxation, integration of personal and company taxation through imputation, imposition of withholding taxes, capital allowances, PAYE system and self -assessment as well as strengthening of the enforcement laws and penalties.

In the process it was inevitable that tax law, inherently complicated as it is by its very nature, became more complex and complicated with several Acts overlapping one another.

In a further development, with the onset of an open economy and an export oriented strategy based on private investment particularly foreign direct investment (FDI), tax incentives began to be granted by different institutions and under different Acts such as for instance the Board of Investment (BOI), leading consequently to the emergence of parallel tax regimes.

While codification of tax laws may not sound too difficult, simplification is something that somehow seems to elude all those who advocate its cause. It can never be made simple but we can at least try to avoid making it needlessly complex. To quote the Taxation Commission Report of 1990 "An unduly complicated and complex tax system not only leads to inequity and various anomalies, but also undermines compliance and increases administrative costs.

Simplification enables taxpayers not only to easily understand and compute their tax liabilities thus facilitating self-assessment, but also to secure the full benefits of legitimate tax deductions and allowances.

By facilitating self-assessment, the burden of assessment on revenue officials too would be reduced, enabling them to concentrate on the more revenue productive areas of auditing and enforcement."

While there are many detailed reasons why specific provisions are complicated, there are four broad types of complexity which characterises the general body of tax law - conceptual complexity, structural complexity, linguistic complexity and complexity that comes with volume.

A radical agenda to tackle all these aspects of the problem would involve institutional reform, tax reform and procedural reform.

However, rationalising the multiplicity of sources and codifying them into a single entity would probably be a good start.

One cannot however estimate the benefit of merely re-writing the legislation that already exists. Questions arise as to whether the gains justify the short-term costs and disruption of codification and the possible loss of precedent; and whether codification would be worthwhile in the long run without institutional or tax reform.

One could also consider greater use of purposive legislation that is, legislation drafted in term of general principles rather than much more comprehensive legislation designed to deal with every likely possibility.

(The writer is a former Commissioner of Inland Revenue.)