Opinion - Direct Tax Code

The New Direct Tax Code Bill (DTC) was presented in the parliament on August 30, 2010. DTC was initially drafted and released in August 2009 with the aim of widening and deepening the tax net and bringing about a tax reform in the country. The intention of DTC is to bring about efficiency in tax system by eliminating the vices of tax exemptions and subsidies that create economic distortions.

This switchover to DTC with higher exemption limits and lower corporate tax, Revenue Secretary Sunil Mitra says, will cost the government a revenue loss of Rs 53,172 crore on reduced rates and a loss of Rs 38,829 crore in the first year from corporate tax rate. “India's direct tax collection for 2011-12 is expected to be at Rs 5.27 lakh crore in the first year, if current rates hold,” he adds. The bill proposes to cut tax rates, replace profit-linked exemptions for companies with investment-linked incentives and simplify rules on corporate mergers, aimed at creating a tax code that can support growth in Asia's third-largest economy.

 

Tax exemption limits have been enhanced for individuals to 2,00,000 INR and for senior citizens it has been increased to 2,50,000 INR. Parity for the women and men tax payers has been brought about. The applicable tax layer is given as:

Income	Tax Rate
Less than 2,00,000 INR	0%
2,00,000 – 5,00,000 INR	10%
5,00,000 – 10,00,000 INR	20%
Above 10,00,000 INR	30%

The new tax rate would be resulting into a direct saving of 4,000 INR for the tax payers. It would effectively save up to 41,040 INR for people earning more than 10,00,000 (10 lakh) INR per annum.

Indian governments have been increasing the limits for the taxable slabs, but it is not working towards reducing the tax rates applicable. As the taxable slabs are increasing the majority of the beneficiaries are the upper middle-class tax payers. This is based on the fact that still more than 95% of the tax payers are in the first bracket (2 lakh to 5 lakh), but they contribute nearly only 30% of the total tax revenue. The majority of tax revenue is collected from the rest 5% which falls under the higher slabs.

Corporate tax rate has been fixed at 30%. The cess and surcharge has not been implemented. It has been reduced from 33.2% presently to the 30% mark and would result into a loss of 38,829 crores INR in revenue. This is useful for the foreign companies operating in India as they were presently paying 40% tax rate. The above parity has been offset by the introduction of branch profit tax on foreign companies. 

Worldwide the corporate tax rate is found to vary from 9% to 55%, though majority of them fall in the range of 25%-30%. This would move the corporate rate regime to the equivalent of more mature economies like that of USA.

The dividend distribution tax (DDT) for holding companies has been removed up to any level and the securities transaction tax (STT) rate has been kept same at 0.25%. The effective rate for a domestic company after considering the dividend distribution tax comes to around 39.13% and for foreign firms after branch profit comes to nearly 40.5%.

Capital gain has been included when the asset has been held for a period of more than a year. Also as the base index year has been changed to 1.4.2000, the capital gains realised between 1.4.1981 and 1.4.2000 would not be taxed. Tax has been made applicable on sale of long term securities, which presently was nil. No Tax on Long term capital gain on securities & equity linked Mutual Funds. For short term capital gain tax rate is 50 % of normal slab rate applicable to the assesse. Under new DTC the effective rate of tax for short term capital gains will be 5%, 10% and 15% according to income slab in which an individual investor will fall. This reduction in applicable tax would incentivise investors to deploy a part of their savings in equities.

In case of short term assets, there is no relaxation to the tax payer and tax will be required to pay as in case of any other ordinary income. It is learnt that short-term capital gains will be taxed at income tax rates while short-term capital gains for companies is flat at 30%. Besides, the new DTC Bill will have dividend distribution tax of 5% for both equity mutual funds (MFs) and unit linked insurance policies (ULIPs).

For the buyback or open offer the concessional rate of 20% is done away with and the taxes would now have to be paid as per applicable tax rate. This would increase the cost of cash distribution for the companies.

The Government has also proposed to restore back the taxation of retirement savings, in the nature of provident fund contributions and pure life insurance and annuity products, to the Exempt-Exempt-Exempt (EEE) scheme from the earlier proposition of Exempt-Exempt-Tax (EET) scheme under the revised discussion paper in the DTC.

In the new DTC savings limit allowed for deduction from the taxable income has been increased from the existing limit of Rs 120,000 (including Rs 20,000 for investment in infrastructure bonds) to Rs 150,000 which is decomposed as Rs 100000 for investment in provident funds, pension funds and other approved securities; and Rs 50,000 for child’s tuition fees, life insurance and health insurance premiums.

ULIP's and ELSS will lose its sheen as it will be taxed marginally at the time of withdrawal. ULIP's where Annual Premium is more than 5% of sum assured will be taxed at marginal rate of 5%.

The MAT (Minimum Alternative Tax) is proposed to be at 20% whereas presently it is held at 18% plus cess and surcharge, which amounted to nearly 19.93%. Moreover, it is to be done on book profits and not on gross assets relieving the capital intensive companies.

Tax benefit on the principal component of housing loans to discontinue, however benefit continues for the interest repayment. Interest on house loan benefit continues, HRA benefit also have a place in DTC. Housing loan comprises 50% of the total deduction of up to 3 lakh INR on savings which means if you have not taken housing loan, you can claim maximum of 1.5 lakh INR and the 3 lakh tax benefit will not apply to you.

No clarity of LTA or LTC in the exemptions and its possible that the tax benefits on these components may be withdrawn.

DTC has proposed to retain the current tax system of exemptions till 2014 for the SEZs, but in return has imposed a 20% MAT on all units. Instead of profit based exemptions the government looks forward to an investment based tax exemptions. The government is hopeful of saving 80,000 crores INR from tax exemptions.

General Anti-Avoidance Rules (GAAR) provisions enable a commissioner of income-tax (CIT) to declare an arrangement as impermissible if it has been entered with the objective of obtaining tax benefit and lacks commercial substance. CIT may invoke GAAR provisions where the Offshore Funds are set up primarily to obtain tax benefit under the Double Taxation Avoidance Agreement.

Controlled Foreign Company (CFC) Rules shall apply when a foreign company is controlled by resident taxpayers, the tax payable in the foreign company is less than 50% of the corresponding tax payable under the DTC, and similar other conditions are satisfied. If CFC Rules apply, pro rata net profit of the CFC will be attributed to the resident taxpayer.

As a result, offshore investments of resident funds and individuals may have an impact on account of CFC Rules. Further, where a foreign company is treated as a ‘resident’ in India and is taxable on net income basis; it appears its Indian parent may also be subject to CFC rules and the same income could be subject to double taxation.

The exemption limit for imposing wealth tax to 1 crore INR from 15 lakh INR is a move that will help a lot of taxpayers avoid the levy – especially the wealth tax payers.

*References taken from various newspapers including Economic Times, and DNA India.

*Views mentioned here are strictly of the author