Direct Tax Code Decoded

[R&PM: EDELMAN]

Sandip Mukherjee and Dinesh Khator

Partners, PwC

 

While pronouncing the Budget 2009 on 6^th July 2009, the present Finance Minister (FM) Pranab Mukherjee had promised to unveil the new Direct Tax Code  (DTC) within 45 days. True to his promise, the draft DTC was released for public comment, debate and deliberation on August 13, 2009.

 

The Code is the brainchild of erstwhile FM, Mr. P. Chidambaram and its stated objectives are improving the efficiency and equity of tax system by moderating tax rates and expanding the tax base, removing ambiguity and providing stability in the tax regime and reduce litigation.

 

The Code shall replace the five-decade old Income-tax Act ('the Act') from FY 2011 onwards, and true to its promise, proposes to make sweeping and radical changes to the taxation framework in India. There are many features of the Code such as rationalization/reduction of tax rates, removal of profit based exemptions to introduce investment based exemptions, EET scheme of taxation for savings instruments, introduction of general anti-avoidance measures, so on and so forth.

 

First and foremost, the Cope proposes to reduce the corporate tax rate to 25% for domestic as well as foreign companies, with unlimited carry forward of business losses. However, the foreign companies would be required to pay additional tax of 15% as branch profits tax on branch profits (i.e. total income as reduced by corporate tax). A status-quo situation has been maintained on dividend distribution tax for domestic companies @15%.

 

The Code also proposes to widen the tax residency base, by amending the definition of 'resident' to even include foreign companies partly managed in India. Further, with a view to increase the tax base, the MAT liability has been transitioned from 'book profit based taxation' to 'gross assets based taxation'. The earlier rate of 15% on book profits has been changed to 2% on the value of gross assets, with no credit for MAT in subsequent years. The change would mean that virtually all companies would now be liable to pay MAT on the basis of assets. This is going to have far reaching implications on capital intensive industries as MAT would now be payable even in the start-up years, despite book losses.

 

The export incentives or profit linked incentive schemes will cease to exist and they will be replaced by investment based incentive schemes. However, the existing provisions relating to profit linked incentive schemes would be grandfathered.

 

On the personal tax front, the income slabs have been increased substantially. The Code proposes to tax the individuals at 30% only beyond an income of INR 25 lakhs. Also, exemptions such as LTA, medical reimbursement, leave encashment, etc would no longer be available. With a view to encourage the savings, the annual limit has been increased to INR 3 lakhs from existing limit of INR 1 lakh. Further, the benefit of housing loan interest deduction is removed. The Code proposes to introduce the 'Exempt-Exempt-Taxation' (EET) method of taxation of savings invested after the commencement of the Code (i.e. the investments/savings made till 1^st April 2011 will remain unaffected by these provisions).

 

The Code is likely to significantly benefit the salaried class employees, working on a cost-to-company pay-package (which is the widely accepted practice in India). However, the government/ public sector employees could be adversely hit by these provisions, given that they are used to getting a number of tax-free perquisites/allowances.

 

The threshold exemption limit for wealth tax is proposed to be increased to INR 50 crores, with a reduced rate of 0.25%; however, the definition of assets has been widened to include even financial assets. Wealth tax on companies and firms will be discontinued.

 

The Code proposes removal of distinction between long term and short term capital gains; all capital gains would now be taxable at normal rates. The removal of lower tax rate benefit for long term capital gains, coupled with removal of Security Transaction Tax, should increase trading activity in stock-markets.

 

Foreign companies deciding to invest in India, often deride about the uncertainly in Indian tax laws and the long drawn-out procedure of tax dispute resolution. With a view to bring certainty and reduce litigation, the Code proposes to introduce the much awaited concept of Advance Pricing Mechanism ('APA'), whereby arm's length pricing of international transactions could now be upfront agreed with the tax authorities. This is a welcome step, and should definitely change the outlook of foreign investors towards India.

 

The Code is a sincere attempt towards simplifying the direct tax laws in India. The language used in the Code is much simpler than the existing Act and leaves very little scope for varied interpretations. While, it will take some time before the Code can be fully understood and analysed in-depth, it seems that the stated objectives will be met.

 

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