Raise tax exemption limit for small businesses

Small industries will be hit hard by demonetization. They are already reeling under the slowdown of manufacturing in the country. The credit given by the banking sector to micro and small industries was growing at the rate of 2.4 percent in January 2016. It declined by (-) 3.8 percent in June 2016. According to data released by the Labour Bureau, India created only 135,000 jobs in 2015, compared with 419,000 in 2013 and 900,000 in 2011. The contraction of credit to small industries and contraction of employment generation are going hand in hand as expected. This is as may be expected because small industries generate most of the employment in the country.

The cost of production of small industries is more because they use smaller machines, antiquated technologies, and less-skilled labour; have to buy raw materials in small quantities from retailers, and bear high cost of regulatory compliance. They have nevertheless survived because of tax concessions. They do not have to pay excise duty if the total value of production is less than Rs 1.5 crore. Similar concessions in sales tax are available in all states.
They employ small numbers of workers. They mostly do not pay the minimum wages. They do not also pay the employer’s provident fund contribution. They pay fewer taxes because they buy raw materials in No 2 and sell finished goods in No 2, thus avoid paying excise and sales taxes. Since most business is done in cash, the income tax official is not able to prove that they have earned money. Thus, they avoid paying income tax as well.

Against these disadvantages, small industries generate most of the employment in the manufacturing sector. They are also incubators of entrepreneurs. Dhirubhai Ambani was once a small businessman. He was able to become ‘big’ because the government provided tax concessions to small businessmen. These concessions enable small industries to compete with large industries. Dhirubhai survived as a small businessman on the back of these concessions. He would not have become a small businessman, and not grown into a big businessman, if these concessions were not given to small industries.

The Government is seized of this situation and the need to revive small industries and jump-start employment generation. Kalraj Mishra, the Union minister for Micro, Small and Medium Enterprises, said that four of its ongoing initiatives will help revive the small industries: the public procurement policy, the micro and small enterprises cluster development programme, the Prime Minister’s Employment Generation Programme, and skill development. These initiatives are in the right direction and welcome. But the efficacy of these is brought into question by the contraction of credit to the small industries reported above. The reason is that these measures are like firefighting. The basic disadvantage faced by the small industries due to the high cost of production is not overcome by these fringe measures.

Other arms of the Government are making things worse for them. A manufacturer of air pollution control equipment said that the Ministry of Environment has issued a notification that manufacturers of air pollution control equipment installed in India will have to provide a certificate from the United States Environment Protection Agency that the equipment conforms to the standards laid out by them.

Now, it is prohibitively expensive for small Indian equipment manufacturers to obtain this approval from US authorities. As a result, this small scale industry in India is on the verge of becoming extinct. The Ministry of Corporate Affairs has made it mandatory for small Private Limited Companies to file large numbers of certificates such an energy audit, and also that they file the returns online. This requires them to employ a skilled computer person whom they cannot afford.

The Ministry of Finance has unleashed a raid rage against black money. This means that small industries that were surviving by undertaking business in No 2 and evading tax will have to shut down. The GST will bring all goods and services under the tax net. This will make it difficult for small industries to evade taxes and kill them. The enabling measures being implemented by the Minister of Small Enterprises are being nullified by a host of such measures taken by other ministries.

On top of these problems has come demonetization. Small industries undertake most transactions in cash. For example a jaggery manufacturing unit buys sugarcane in cash, pays wages to its workers in cash, and sells the jaggery in cash. The Government now wants him to make all these transactions through bank. In consequence, these transactions will appear in his bank account.

The authorities would ask him to pay Mandi tax on the purchase and sale. The labour inspector would ask him to pay minimum wages to his workers and also to pay employer’s provident fund contribution. The income tax official will know of his profits and seek a slice of the income. As a result, the cost of production of small businessmen will increase.

The small jaggery manufacturer will not be able to compete with the large sugar factory and fold up his business. Reports from all over the country indicate that this has already started to happen. A small part of this is due to the immediate shortage of cash that is preventing people from buying goods from the market. This problem affects the small and big industries alike. The bigger problem is that small industries will be saddled with a higher tax burden that will price them out of the market.

Thus we see that small industries are under greater stress today than big industries. The real gainers from demonetization are government servants. They get their salaries through bank accounts. Tax is deducted at source from their salaries. Thus demonetization has not impacted their official incomes. It has, however, opened up a huge new window of taking bribes. Large numbers of bank employees have made huge monies in surreptitiously converting black money into white. Income tax officials are gloating over the stream of income from the scrutiny of the bank transactions.

The measures taken by the Government to clean up the black economy are welcome. But these should be accompanied with an increase in tax exemption limit for small industries from present 1.5 crore to at least Rs 10 crore, raising income tax limit to Rs 10 lakh, and raising the minimum levels for coverage under sales tax, factory act and other regulations. There is also a need to root out corruption among lower level tax and bank officials. Otherwise, we shall see a widespread extinction of small industries, increase in unemployment, and overall increase in unrest in the country. It will be a cashless death though.(The author was formerly Professor of Economics at IIM Bengaluru)

By Dr Bharat Jhunjhunwala