Discussion Paper on Direct Taxes Code Bill, 2009

Direct Taxes Code Bill, 2009

CHAPTER - I

INTRODUCTION

1.1 The Income Tax Act was passed in 1961 and has been amended every year through the Finance Acts. The Act deals with income tax. Dividend Distribution Tax was included in the Act by inserting Chapter XIID with effect from June 1, 1997. Fringe Benefit Tax was included in the Act by inserting Chapter XIIH with effect from April 1, 2006. Wealth Tax is administered through the Wealth Tax Act, 1957.

1.2 Tax administrators, chartered accountants and tax payers have raised concerns about the complex structure of the Income Tax Act. In particular, the numerous amendments have rendered the Act incomprehensible to the average tax payer. Besides, there have been frequent policy changes due to changing economic environment, complexity in the market, increasing sophistication of commerce, development of information technology and attempts to minimize tax avoidance. The problem has been further compounded by a multitude of judgements (very often, conflicting) rendered by the courts at different levels.

1.3 Any complex tax legislation increases the cost of compliance as well as administration. Given that the cost of compliance is essentially regressive in nature, this undermines the equity of the tax system. Similarly, high cost of administration is wasteful.

1.4 Over the last twenty five years, the marginal tax rates have been steadily lowered and the rate structure rationalized to reflect the best international practices. Any further rationalization of the tax rates may not be feasible without corresponding increase in the tax base. Broadening of the base is important to enhance revenue productivity of the tax system and to improve its horizontal equity.

1.5 The strategy for broadening the base essentially comprises of three elements. The first is to minimize exemptions. For many decades, the tax base has been eroded through a steadily escalating range of exemptions. The removal of these exemptions will have three consequences: (i) it will result in a higher tax-GDP ratio; (ii) it will enhance GDP growth, since tax exemptions and deductions distort allocative efficiency; and (iii) it will improve equity (both horizontal and vertical), reduce compliance costs, lower administrative burdens, and discourage corruption. The second element of the strategy relates to the problem of ambiguity in the law which facilitates tax avoidance. Therefore, it is necessary to undertake a periodic exercise of rewriting the Tax Code in the light of new trends in interpretation by the judiciary, aggressive tax planning by taxpayers, and new opportunities for reducing compliance cost through massive induction of technology and public private partnership. The third element of the strategy relates to checking of erosion of the tax base through tax evasion.

1.6 The Direct Taxes Code (hereafter referred to as the 'Code') is designed to reflect this strategy.

The Code is not an attempt to amend the Income Tax Act, 1961; nor is it an attempt to "improve" upon the present Act. In drafting the Code, the Central Board of Direct Taxes (the Board) has, to the extent possible, started on a clean drafting slate. Some assumptions which have held the ground for many years have been discarded. Principles that have gained international acceptance have been adopted. The best practices in the world have been studied and incorporated. Tax policies that would promote growth with equity have been reflected in the new provisions. Hence, while reading the Code, it would be advisable to do so without any preconceived notions and, as far as possible, without comparing the provisions with the corresponding provisions of the Income Tax Act, 1961.

CHAPTER - II

SALIENT  FEATURES  OF THE  CODE

2.1 The Code seeks to consolidate and amend the law relating to all direct taxes, that is, income-tax, dividend distribution tax, fringe benefit tax and wealth-tax so as to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Another objective is to reduce the scope for disputes and minimize litigation.

2.2 Briefly, the salient features of the Code are as under:-

(a) Single Code for direct taxes: All the direct taxes have been brought under a single Code and compliance procedures unified. This will eventually pave the way for a single unified taxpayer reporting system.

(b) Use of simple language: With the expansion of the economy, the number of taxpayers can be expected to increase significantly.  The bulk of these taxpayers will be small paying moderate amounts of tax. Therefore, it is necessary to keep the cost of compliance low by facilitating voluntary compliance by them. This is sought to be achieved, inter alia, by using simple language in drafting so as to convey, with clarity, the intent, scope and amplitude of the provision of law. Each sub-section is a short sentence intended to convey only one point. All directions and mandates, to the extent possible, have been conveyed in active voice. Similarly, the provisos and explanations have been eliminated since they are incomprehensible to non-experts. The various conditions embedded in a provision have also been nested. More importantly, keeping in view the fact that a tax law is essentially a commercial law, extensive use of formulae and tables has been made.

(c) Reducing the scope for litigation: Wherever possible, an attempt has been made to avoid ambiguity in the provisions that invariably give rise to rival interpretations. The objective is that the tax administrator and the tax payer are ad idem on the provisions of the law and the assessment results in a finality to the tax liability of the tax payer. To further this objective, power has also been delegated to the Central Government/Board to avoid protracted litigation on procedural issues.

(d) Flexibility: The structure of the statute has been developed in a manner which is capable of accommodating the changes in the structure of a growing economy without resorting to frequent amendments. Therefore, to the extent possible, the essential and general principles have been reflected in the statute and the matters of detail are contained in the rules/Schedules.

(e) To ensure that the law can be reflected in a Form: For most taxpayers, particularly the small and marginal category, the tax law is what is reflected in the Form.  Therefore, the

(f) Consolidation of provisions: In order to enable a better understanding of tax legislation, provisions relating to definitions, incentives, procedure and rates of taxes have been consolidated. Further, the various provisions have also been rearranged to make it consistent with the general scheme of the Act.

(g) Elimination of regulatory functions: Traditionally, the taxing statute has also been used as a regulatory tool. However, with regulatory authorities being established in various sectors of the economy, the regulatory function of the taxing statute has been withdrawn. This has significantly contributed to the simplification exercise.

(h) Providing stability: At present, the rates of taxes are stipulated in the Finance Act of the relevant year. Therefore, there is a certain degree of uncertainty and instability in the prevailing rates of taxes. Under the Code, all rates of taxes are proposed to be prescribed in the First to the Fourth Schedule to the Code itself thereby obviating the need for an annual Finance Bill. The changes in the rates, if any, will be done through appropriate amendments to the Schedule brought before Parliament in the form of an Amendment Bill.

CHAPTER - III

BASE FOR TAXATION

3.1 Taxes are compulsory payments which citizens in a country are required by law to make to the government for defraying the cost of providing public goods and financing transfer payments. Therefore, they have to be financed from taxes. This immediately raises the question of the basis of allocating the costs i.e. the basis of determining the distribution of tax payments.

3.2 Since taxes are payments without a direct quid pro quo (except good governance) and are meant to cover the cost of common goods and services, it is generally accepted that individuals' or households' tax liabilities should be according to their ability to pay.  Such a basis is considered fair.  If this be granted, it would follow that those with equal abilities should make equal tax payments and those with higher abilities should be asked to make proportionately larger payments. This rule sounds simple enough but, in translating the principle into practice, a number of problems arise and several other considerations may also have to be kept in mind.

3.3 Two alternatives, income and consumption, are generally accepted as the best indicators of ability to pay.  Traditionally, income has been taken as a test of ability to pay (or index of potential welfare), and direct taxation has been mainly based on income. Consumption can also represent the ability to pay and has been used as an indicator.

3.4 If equitable taxation should be in accordance with the capacity to pay of the taxpaying unit, and if income is to be taken as a measure of the capacity to pay, it must be so defined for tax purposes as to reflect adequately the potential economic welfare of the individual concerned i.e., the capacity he has to spend during a year without affecting his net worth as at the beginning of the year.  This means that the definition must be comprehensive enough to include all accruals to spending power. The conventional definition of income does not do so. Ideally, we need a comprehensive definition of "income" for tax purposes. Such a definition of income would include, apart from gifts received,

(a) all earnings including labour, investment and business income net of  cost of earning and depreciation;

(b) net accrued capital gains i.e. net increases in the value of capital assets owned;

(c) value of services or utility of non-business assets owned net of cost of maintenance and depreciation;

(d) imputed value of the services rendered by the members of the family;

(e) windfall gains; and

(f) casual receipts, e.g., lottery prizes.

3.5 The conceptual basis of the definition is clear: the definition equates income to consumption plus change in net worth. However, in practice it is not possible to measure satisfactorily all the elements included. First, imputation of proper values to items of income in kind flowing from non-business assets and services rendered by the members of the family unto themselves is almost impossible to measure and, therefore, they have to be left out of the definition. This is not, however, considered a serious problem except for house property.  Second, in regard to changes in the present value of all assets owned by an individual, problems arise when they are not normally marketed. Two examples may be mentioned: (i) the change in the current value of pension rights; and (ii) the change in the value of the assets of closely owned businesses. Third, even when market values are known, taxing an increase in capital value on accrual, instead of on realization basis, will create hardship. Fourth, under a comprehensive income tax, strictly speaking, the pro-rata share of each shareholder in the undistributed profits of companies should be allocated to him and included in his taxable income. This cannot be done for reasons which are well recognised. Fifth, even in the absence of inflation, it is difficult to accurately measure economic depreciation. Since depreciation allowance has to be granted on the basis of rough estimation, the measurement of business income is at best an estimate and the true magnitude cannot be known.

3.6 If the pro-rata share of undistributed profits of companies cannot be taxed directly in the hands of the shareholders, the introduction of a personal income tax will lead to the formation of incorporated entities and avoidance of the tax by not distributing the profit. The intention would be to take profits out in course of time in the form of capital gains. To prevent such means of avoidance, a tax has to be imposed on the profits of corporations. This leads to the phenomenon of the so-called double taxation of dividends, which apart from the extra burden placed on equity holders, creates a bias towards debt finance.

3.7 The real income flowing from non-business assets such as consumer durables may have to be ignored for administrative reasons. But it would not be proper to leave out the real income or utility flowing from owner-occupied houses, because rental income from house property has to be included in taxable income. There would be taxpayers who would be renting their houses and living in rented houses in other places for reasons of business or for some other reason. As against this, those taxpayers who live in their own houses do not have to pay rent. The two groups would be treated equally only if the imputed income from owner-occupied houses is included in taxable income. But imputation of income is not easy when a house has not been rented for a long time or at all. Also, if in course of time rents rise substantially, the imputed income might become a large part, or exceed, the other income of the owner-occupier.  Hence a neat solution is not possible, and often the income from owner occupied houses is not subjected to tax. Thus the comprehensiveness of the definition of income is further eroded.

3.8 In line with the principles and the problems discussed above, the Code seeks to adopt, to the extent possible, a comprehensive definition of income. Therefore, income for the purposes of this Code will, in general, include all accruals and receipts of revenue and capital nature unless otherwise specified. Exemptions, if any, have been made on the consideration of positive externalities, encouraging human development and reducing risk, equity, and reducing compliance and administrative burden.  Further, on account of the assignment of the taxing powers under the Constitution to the States, agricultural income has been excluded from the scope of this Code. Some exceptions, which are essentially in the nature of deferrals, have also been provided in the Code with a view to mitigating the problem of liquidity.

CHAPTER - IV

SCOPE OF TOTAL INCOME

Residence based taxation versus source based taxation

4.1 The public goods and services provided by the Government are enjoyed, in general, by all persons (both natural and non-natural) living within that country.  Therefore, it is logical for all such persons to contribute towards such public goods and services. This forms the underlying basis of the principle of residence-based taxation of income.

4.2 The principle of residence-based taxation asserts that natural persons or individuals are taxable in the country or tax jurisdiction in which they establish their residence or domicile, regardless of the source of income. In the case of non-natural persons such as companies or firms, the place of incorporation or the place where control or management is exercised is deemed to be the place of residence. In the context of income tax, the ability to pay of the residents of that country is fully measured by their global income. Therefore, the principle of residence-based taxation of income envisages the taxation of global income. Key reasons for taxing the foreign source income of residents are to achieve horizontal and vertical equity goals and to improve the tax neutrality of investment decisions (efficiency).

4.3 However, there are individuals/entities whose "residence" is in one country but their business is actually carried on in another country and their income is earned in the latter country. In such cases, the principle of residence-based taxation would be inappropriate. This would be especially so in developing countries which attract substantial foreign investments. Therefore, there is a view that the country which provides the opportunity and facilities to generate income or profits should also have the right to tax the same. This forms the underlying basis of the principle of source-based taxation of income. This principle is invariably applied to non-residents in a country and envisages the taxation of only such income which is sourced in that country.

4.4 The term 'source' is generally not defined in the tax legislation. The common law has developed a number of principles which operate in the absence of statutory provisions. Whether or not the income will be seen to be sourced in a country under the common law principles is a question of fact in the circumstances of a particular case. International practice varies as to the nature and extent of the source rules. Generally, countries use geographical boundaries, types of income or a mixture of both to determine the extent to which they will seek to tax income sourced in their jurisdiction.

4.5 Conceptually, a country may adopt either pure residence based taxation or pure source based taxation. The pure residence based taxation is supported on the consideration that it promotes economic efficiency since the decision on the location of the investment remains unaffected by the tax rate.  It is neutral to capital export. Further, it is relatively easier to pin down the income unlike in the case of source based taxation. However, the pure residence based taxation is not adopted for three reasons. First, pure residence based taxation reduces revenues in poor developing countries, who rely heavily on source based taxation, and leans in favour of the rich developed countries where investors reside. Secondly, residence based taxation is much easier to evade or avoid, by channeling international investments through tax havens. Thirdly, political and economic considerations do not allow a country to give up the right to collect tax from foreigners doing business within its territory.

4.6 Pure source based taxation is an option that has been favoured by some experts. However, the major problem with this option is that it enables foreign investors to play one country against another or others in order to obtain the lowest source based tax rate. This leads to aggressive tax competition (race to the bottom) resulting in erosion of revenue base. In addition, the problems of determining the source of income and of unraveling aggressive transfer pricing that leads to suppression of income would become much more acute in a world of pure source based taxation.

4.7 In practice, countries have tended not to stay with the pure application of either principle. They have applied a mix of residence and source based direct taxation, the former for nationals (including non-natural persons) residing in the country and the latter for income earned within the country by non-residents. The precise nature of mixes has depended on each taxing jurisdiction's perception of the relative importance of a number of factors, notably the volume of foreign investment that is attracted, the revenue implications, the domestic administrative capabilities, and the degree of cooperation that can be expected from competing jurisdictions. Under the Code, residence based taxation is applied for residents and source based taxation for non-residents. A resident in India will be liable to tax in India on his world-wide income However, a non-resident in India will be liable to tax in India only in respect of accruals and receipts in India (including deemed accruals and receipts). The total income of a person will also include the income arising to spouse, minor child and other entities in specified circumstances. However, the Second Schedule enumerates incomes that are exempt from taxation and these incomes will not form part of the total income.

Test for residency

4.8 Residency rules have an important role to play in tax treaties as they clarify the right to tax and assist in the avoidance of double taxation. All countries have residence tests for both natural persons (individuals) and legal persons (companies). The residency test for individuals is usually based on either physical presence in the country (legal form, such as citizenship) or facts and circumstances that prove residence in a country (economic substance, such as the country where the person has a fiscal presence) or a combination of the two. In many cases, this may be satisfied simply by being present in a country for a prescribed period of time. The tax residence of companies (that is, where companies are

4.9 Under the Code, the residential status of an individual in a financial year will continue to be determined on the basis of his stay in India during the financial year and the earlier years. He would be a resident in India if,-

(a) he is in India for 182 days or more during the financial year; or

(b) he is in India for 365 days or more during the four years immediately preceding the financial year and for 60 days or more in the financial year.

4.10 The residency of an individual will be determined only on the basis of the test specified in sub para (a) of para 4.9 in the case of,-

(a) an Indian citizen who leaves India during the financial year for the purpose of employment outside India with an employer;

(b) an Indian citizen who leaves India as a member of a crew of an Indian ship; and

(c) an Indian citizen or a person of Indian origin, who comes to India on a visit during the financial year.

4.11 An individual will be treated as a person of Indian origin if either he or either of his parents or any of his grand-parents was born in undivided India.

4.12 An Indian company will always be treated as resident in India. However, a foreign company can either be resident or non-resident in India. It will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated wholly or partly in India (it need not be wholly situated in India, as at present).

4.13 A Hindu Undivided Family (HUF), partnership firm, an association of persons or any other person will be resident in India if the control and management of their affairs are wholly or partly situated within India at any time in the relevant financial year.

4.14 A person will be a non-resident in India if he is not a resident in India.

4.15 Under the Code, the concept of "resident but not ordinarily resident" for an individual and a Hindu undivided family will be replaced by providing exemption to the income of an individual sourced outside India and not derived from a business controlled or a profession set up in India. This exemption will be available to the individual in the financial year in which such individual becomes a resident and in the immediately succeeding financial year, if such individual was a non-resident for nine years immediately preceeding the financial year in which he becomes a resident.

4.16 Under the 1961 Act, the income earned in a year is taxed in the next year. The year in which income is earned is termed as 'previous year' and the following year in which it is charged to tax is termed as 'assessment year'. For example if a person earns any income during the year beginning on 1 April 2006 and ending on 31 March 2007, then 2006-2007 will be the previous year and the income shall be assessed to tax in assessment year 2007-2008. The use of the two expressions has caused confusion in both compliance and administration. In order to simplify the provisions, the separate concepts of 'previous year' and 'assessment year' will be replaced by a unified concept of 'financial year'. The existing concept of assessment year will be done away with. Under the Code, all rights and obligations of the taxpayer and the tax administration will be with reference to the 'financial year'. This change will not change the existing system of deduction of tax at source and payment of advance tax in the year of earning of income and payment of self-assessment tax in the following year before filing of tax return. This proposal will simplify the existing provisions.

Meaning of 'person', 'assessee', etc.

4.17 The 1961 Act provides for an inclusive definition of the word "person".  It includes an individual, HUF, company, firm, association of persons, body of individuals, local authority and artificial juridical person. Taxable entities like co-operative society, any other society, non-profit organisation and private discretionary trust are assessed as association of persons. Similarly, the institution of Government, though otherwise exempt from tax in respect of its own income, is required to fulfill certain obligations in terms of withholding of tax and filing of information. In the Code, Government, trust, co-operative society, any other society and any non-profit organization will be included in the definition of 'person'. The persons specified in the Third Schedule will not be liable to income tax either wholly or partly, as specified therein.

4.18 Under the 1961 Act, assessee is a person by whom any tax or any other sum of money is payable or a person in respect of whom any proceeding under the 1961 Act has been taken (including representative assessee) or any person who is deemed to be an assessee or deemed to be an assessee in default. The definition is important since an assessee has certain rights and obligations under the 1961 Act.  In the Code it is proposed to include the following "other persons" within the definition of 'assessee':-

(a) any person to whom any amount of refund is payable under the Code; and

(b) any person who voluntarily files a return of tax bases irrespective of the fact that he is otherwise not under an obligation to do so.

This change will enable taxpayers to obtain refund of tax deducted at source. It will also help tax payers currently below the threshold level to report their income and maintain a track record of filing returns in anticipation of earning higher - and hence taxable - incomes in the future.

CHAPTER - V

COMPUTATION  OF TOTAL INCOME AND RATES  OF TAX

5.1 All accruals and receipts in the nature of income, other than those enumerated in the Second Schedule, will be classified into independent sources from which the income is derived. Each of these sources would be a 'special source' or an 'ordinary source'.

5.2 The special sources are sources of income specified in the Fourth Schedule.  The income from these sources will be liable to tax at a scheduler rate on gross basis. No deduction is allowed for any expenditure and the gross amount is subject to tax, generally at a lower rate. This is the application of presumptive taxation.

5.3 All other sources of income will be ordinary sources.

Ordinary sources

5.4 The accruals or receipts relating to 'ordinary sources' will be further classified under five different heads:

A. Income from employment

B. Income from house property

C. Income from business

D. Capital gains

E. Income from residuary sources.

5.5 A person may have many sources under each head. The first step will be to compute the income in respect of each of these sources. This could either be income or loss (negative income). For example, if a person carries on several businesses, the income from each and every such business will have to be separately computed. The second step will be to aggregate the income from all the sources falling within a head to arrive at the figure of income assessable under that particular head. The result of such computation may be a profit or a loss under that head. The aforesaid two steps will be followed to compute the income under each head. The third step will be to aggregate the income under all the heads to arrive at the 'current income from ordinary sources'. The fourth step will be to aggregate the current income with the unabsorbed loss at the end of the immediate preceding financial year, if any, to arrive at the 'gross total income from ordinary sources'. If the result of aggregation is a loss, the 'gross total income from ordinary sources' shall be 'nil' and the loss will be treated as the 'unabsorbed current loss from ordinary sources' at the end of the financial year. The various outcomes of this aggregation are presented in the Table below:

Table

(Amount in rupees)

5.6 The 'gross total income from ordinary sources', so arrived, will be further reduced by incentives in accordance with sub-chapter I of Chapter III. The resultant amount will be 'total income from ordinary sources'.

Special Sources

5.7 A person may have many special sources. The first step will be to compute the income in respect of each of these special sources in accordance with the provisions of the Fourth Schedule. The income so computed with respect to each of such special sources shall be called 'current income from the special source'. The second step will be to aggregate the 'current income from the special source' with the unabsorbed loss from that special source at the end of the immediate preceding financial year, if any.   The result of such aggregation shall be the 'gross total income from the special source'. If the result of aggregation is a loss, the 'gross total income from the special source' shall be 'nil' and the loss will be treated as the 'unabsorbed current loss from the special source', at the end of the financial year.  The 'gross total income from the special source' shall be computed with respect to each of the special sources. The third step will be to aggregate the gross total income from all such special sources and the result of this addition shall be the 'total income from special sources'.

5.8 The 'total income from ordinary sources' will be aggregated with the 'total income from special sources' to arrive at the 'total income' of the taxpayer.

5.9 The loss under the head 'Capital gains' shall be ring-fenced and such loss shall not be allowed to be set off against income under other heads. Similarly the loss from speculative business will also be ring-fenced.

5.10 The losses will be allowed to be indefinitely carried forward for set off against profits in the subsequent financial years.

CHAPTER - VI

GENERAL RULES RELATING TO  COMPUTATION

Provisions for avoiding double taxation or double deduction

6.1 In line with international best practices and the principles laid down by the Courts, the following rules for avoiding double taxation or double deduction will be adopted:-

(a) An income which is included in the total income of any financial year shall not be included in the total income of any succeeding financial year.

(b) An income which is included in the total income of any person shall not be included in the total income of any other person, unless otherwise provided.

(c) Any amount which has been allowed as a deduction under any provision of the Code shall not be allowed as a deduction under any other provision of the Code.

(d) any amount which has been allowed as a deduction in any preceding financial year shall not be allowed as a deduction under any provision of this Code in the financial year.

Certain expenditure not to be allowed

6.2 Under the Code, the following expenditure will not be allowed as a deduction in the computation of total income :-

(a) any expenditure attributable to income which does not form part of the total income under this Code and determined in accordance with the method as may be prescribed;

(b) any expenditure incurred for any purpose which is an offence or which is prohibited by law;

(c) any provision made by a person for any liability if the liability remains unascertained by the end of the financial year; and

(d) any expenditure where the source of funds for such expenditure is unexplained;

(e) any expendutire incurred by a non-resident in respect of,-

(i) royalty;

(ii) fees for technical services; or

(iii) any income which is liable to tax at the special rate of income-tax specified in Part II of the First Schedule.

Disallowance of payments in respect of which tax has not been deducted at source

6.3 Under the Code, no deduction shall be allowed for any payment in respect of which the assessee has failed to deduct tax at source in accordance with the provisions of the Code or having deducted such taxes has failed to pay the same to the Government within the specified time. However, as a general rule, an assessee will be allowed deduction in the year in which the payment is made to the Government. This general rule is subject to the following exceptions:

(i) if the tax has been deducted during the last quarter of the financial year and paid before the due date of filing of tax return for that financial year, the deduction will be allowed in the financial year; and

(ii) if the payment is made more than two years after the end of the financial year in which the tax was deductible at source, no deduction shall be allowed to the assessee.

CHAPTER - VII

COMPUTATION  OF INCOME FROM EMPLOYMENT

7.1 "Income from employment" will be the gross salary as reduced by the aggregate amount of permissible deductions.

7.2 Gross salary will form part of the tax base on due or receipt basis, whichever is earlier. It will include the value of perquisites and profits in lieu of salary.

7.3 The permissible deductions will be the following:-

(a) amount of professional tax paid;

(b) transport allowance to the extent prescribed;

(c) prescribed special allowance or benefit to meet expenses wholly and exclusively incurred in the performance of duties, to the extent actually incurred;

(d) compensation under voluntary retirement scheme;

(e) amount of gratuity received on retirement or death;

(f) amount received on commutation of pension; and

(g) pension received by gallantry awardees.

7.4 The deductions in respect of the amounts referred to in items (d), (e) and (f) would be available to the extent the amounts are paid to, or deposited in a Retirement Benefits Account. The amounts received from an approved superannuation fund, hitherto exempt from income tax, will henceforth also be treated in the same manner.

7.5 This account will be required to be maintained with any permitted savings intermediary in accordance with the scheme framed and prescribed by the Central Government in this behalf. The permitted savings intermediaries will be approved provident funds, approved superannuation funds, life insurer and New Pension System Trust. The accretions to the deposits will remain untaxed till such time as they are allowed to accumulate in the account.

7.6 Any withdrawal made, or amount received, under whatever circumstances, from this account will be included in the income of the assessee for the year in which the withdrawal is made or the amount is received. Accordingly, it will be subject to tax at the appropriate personal marginal rate.

7.7 Under the Code, the salary will now include, inter-alia, the following:-

(a) the value of rent free, or concessional, accommodation provided by the employer irrespective of whether the employer is a Government or any other person;

(b) the value of any leave travel concession;

(c) the amount received on encashment of unavailed earned leave on retirement or otherwise;

(d) medical reiumbursement; and

(e) the value of free or concessional medical treatment paid for,  or provided by, the employer.

The value of rent-free accommodation will be determined for all employees in the same manner as is presently determined in the case of employees in the private sector.  The new regime of comprehensive taxation of perquisites across employees in all sectors of the economy will improve both the horizontal and vertical equity of the tax system.

CHAPTER - VIII

COMPUTATION  OF INCOME FROM HOUSE PROPERTY

8.1 Income from a house property, which is not occupied for the purpose of any business or profession by its owner, will be taxed under the head "Income from house property".

8.2 With a view to simplifying the determination of the taxable income and eliminating any scope for litigation, the Code will have a new scheme for computation of income from house property.  The salient features of the new scheme will be as follows:-

(a) Income from house property shall be the gross rent less specified deductions.

(b) Gross rent will be the higher of (i) the amount of contractual rent for the financial year; and (ii) the presumptive rent calculated at six per cent per annum of the ratable value fixed by the local authority.  However, in a case where no ratable value has been fixed, six per cent shall be calculated with reference to the cost of construction or acquisition of the property. If the property is acquired during the financial year, the presumptive rent shall be calculated for the proportionate period of that financial year.

(c) The advance rent will be taxed only in the financial year to which it relates.

(d) The gross rent of one self-occupied property will be deemed to be nil, as at present. In addition, the gross rent of any one palace in the occupation of a ruler will also be deemed to be nil, as at present.

(e) The following deductions will be admissible against the gross rent:-

(i) Amount of taxes levied by a local authority and tax on services, if actually paid.

(ii) Twenty per cent of the gross rent towards repairs and maintenance.

(iii) Amount of any interest payable on capital borrowed for the purposes of acquiring, constructing, repairing, renewing or re-constructing the property.

(f) In the case of a self-occupied property where the gross rent is deemed to be nil, no deduction for taxes or interest will be allowed.

(g) The income from property shall include income from the letting of any buildings along with any machinery, plant, furniture or any other facility if the letting of such building is inseparable from the letting of the machinery, plant, furniture or facility.

CHAPTER - IX

COMPUTATION  OF INCOME FROM BUSINESS

9.1 The computation of income from business is the most important head of income having profound implications for the Revenue. Therefore, the Code has rationalized the provisions relating to computation of income from business.

9.2 Every business will constitute a separate source and, therefore, income will be computed separately for each business. With a view to reducing the scope for litigation, a business will be treated as distinct and separate from another business if there is no interlacing or interdependence or unity embracing the two businesses.

9.3 There are two models for computation of income under this head. The first is the model where the taxable income is equal to business profits with specified adjustments. However, this model does not provide for items of receipts which form part of business profit and deductions to be made therefrom. As a result, there are frequent disputes about taxability of receipts and deductions for expenses. The second model is the income-expenses model which is now followed in countries like U.S.A., Canada, Australia and most Asian countries. The computation of income from business under the Code will be based on the income-expenses model where the taxable income under this head will be equal to gross income minus allowable deductions. To the extent possible, the items of receipts and deductions for expenses are enumerated to reduce the scope for litigation.

9.4 The new framework for computation will be as follows:-

(i) All assets will be classified into business assets and investment assets. The business assets will be further classified into business trading assets and business capital assets.

(ii) The income from transactions in all business assets will be computed under the head 'income from business'. The income from transactions in all investment assets will be computed under the head 'capital gains'.

(iii) The profits from business will be equal to gross earnings from the business minus the amount of business expenditure incurred.

(iv) Income from business will be equal to the profits from business.

(v) Ordinarily, all accruals and receipts derived from, or connected with, business will form part of the 'gross earnings' irrespective of whether they are derived from business trading assets or business capital assets. These will, inter-alia, include the following:-

(a) Profit on sale of business capital assets. (This will no longer be treated as capital gains).

(b) Profit on sale of an undertaking under a slump sale. (This will no longer be treated as capital gains).

(c) The reduction or remission of any liability by way of loan, deposit or advance (other than those which are received by an individual from his relative, as defined).

(d) Consideration accrued or received in respect of transfer of any business asset self generated in the course of the business.

(e) Amount accruing to, or received by, the assessee on account of the cessation, termination or forfeiture of any agreement entered into in the course of business.

(f) Amount accruing to, or received by, the assessee, whether as advance or security deposit or otherwise, from the long term leasing or transfer of the whole or part of, or any interest in, any business asset.

(g) Amount accruing to, or received by, the assessee as reimbursement of any expenditure incurred by him.

(vi) The new items which are to be excluded from 'gross earnings from business' are:-

(a) income by way of interest other than the interest accruing to permitted financial institutions. (This will be treated as income from residuary sources).

(b) income from letting of any property consisting of any building or lands appurtenant thereto, of which the assessee is the owner, other than income from letting of any property in the course of running a hotel, convention centre or cold storage. (This will be treated as income from house property).

(vii) Business expenditure is classified into three mutually exclusive expenditure categories: (i) operating expenditure; (ii) permitted financial charges and (iii) capital allowances.

(viii)Operating expenditure is defined to include all expenditure laid out or expended wholly and exclusively for the purposes of business. This category covers all expenses which do not fall under 'permitted financial charges' or 'capital allowances'. The provision also contains a positive list of items of business expenditure which shall be treated as operating expenditure and a negative list of items of business expenditure which shall not be treated as operating expenditure.

(ix) Permitted financial charges are defined as expenses on account of interest payable on borrowed capital. These include interest payable to any creditor, discount on bonds/ debenture etc. and also other incidental charges payable for obtaining any loan. The deduction in respect of interest payable to banks/ financial institutions shall continue to be allowed on 'actually paid basis'.

(x) Capital allowance relates to deduction in respect of capital cost. It includes depreciation and initial depreciation on business assets and allowance for scientific research and development.

(xi) Depreciation on business capital assets will be allowed with reference to the adjusted written down value of the block of assets. The rates of depreciation presently prescribed in the Income-tax Rules will be specified in the Schedule to the Code. Further, the depreciation regime will also be extended to expenses hitherto amortised.

(xii) Scientific research and development allowance will be allowed with reference to expenditure on scientific research and development since such expenditure generates positive externalities. The salient features of the allowance are:

(a) 100 per cent deduction for any revenue expenditure laid out or expended on scientific research related to the business.

(b) 100 per cent deduction for any capital expenditure, other than expenditure on land.

(c) 150 per cent deduction for any expenditure (both revenue and capital) incurred on in-house research and development by a company, excluding expenditure on land.

(d) The scope of the weighted deduction of 150 per cent will be extended to all industries.

(e) The term 'scientific research' will be comprehensively defined.

(xiii)Loss on sale of business capital assets, which is treated as capital loss under the 1961 Act, will be treated as intangible asset and depreciation will be allowed at the same rates applicable to the relevant block of assets. Effectively, therefore, a taxpayer will be allowed to set off only a fraction of the loss every year.  This will, accordingly, serve as a disincentive for asset stripping and loss manipulation.

(xiv)The determination of profit of certain businesses on presumptive basis will continue. These include :-

(a) Business of civil construction.

(b) Business of supplying labour for civil construction

(c) Business of plying, hiring or leasing of heavy goods vehicle.

(d) Business of plying, hiring or leasing of light goods vehicle.

(e) Business of retail trading.

(f) Business of civil construction in connection with a turnkey power project approved by the Central Government in this behalf.

(g) Business of erection of plant or machinery or testing or commissioning thereof, in connection with a turnkey power project approved by the Central Government in this behalf.

(h) Business of providing services or facilities in connection with the prospecting for, or extraction or production of, mineral oil.

(i) Business of supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils.

(j) Business of operation of ships (including an arrangement such as slot charter, space charter or joint charter)

(k) Business of operation of aircraft (including an arrangement such as slot charter, space charter or joint charter)

(xv) Separate income determination regimes are provided for the following:-

(a) Business of insurance.

(b) Business of operating a qualifying ship.

(c) Business of mineral oil or natural gas.

(d) Business of generation, transmission or distribution of power.

(e) Business of developing a special economic zone.

(f) Business of operating and maintaining a hospital.

(g) Business of processing, preserving and packaging of fruits or vegetables.

(h) Business of developing, or operating and maintaining, or developing, operating and maintaining, any infrastructure facility.

CHAPTER - X

COMPUTATION  OF  CAPITAL GAINS

10.1 Income from transactions in all investment assets will be computed under the head "Capital gains".

10.2 Investment asset has been defined to mean any capital asset other than business capital asset.

10.3 Capital gain is the term used for the amount by which the sale price of a capital asset, net of any expense incurred in connection with the sale of the asset, exceeds the acquisition price of the capital asset. Capital gain is a return on investment or a form of compensation for foregoing current consumption opportunities. Since capital gain increases the ability to pay of the person receiving such gain, it should form part of taxable income.

10.4 Special treatment of capital gains under an income tax regime is merited for two reasons. Firstly, taxing gains each year, as they accrue, would strain the finances of an individual who has yet to receive these gains in hand. Secondly, the capital gain realized when a capital asset is sold is usually the accumulated appreciation in the value of the asset over a number of years. The 'bunching' of such appreciation in the year in which the asset is sold pushes the seller into a higher marginal tax bracket if the value of the asset is sufficiently high. If no special treatment is accorded to capital gains, a progressive income tax would discriminate against those whose income from capital assets is in the form of capital gains as compared to those whose income is derived from interest or dividends.

10.5 The gains (losses) arising from the transfer of investment assets will be treated as capital gains (losses). These gains (losses) will be included in the total income of the financial year in which the investment asset is transferred irrespective of the year in which the consideration is actually received. However, in case of compulsory acquisition of an asset, capital gains will be taxed in the year in which the compensation is actually received.

10.6 The present distinction between short-term investment asset and long-term investment asset on the basis of the length of holding of the asset will be eliminated.

10.7 The capital gains arising from the transfer of personal effects and agricultural land beyond specified urban limits will be exempt from income-tax.

10.8 In general, the capital gains will be equal to the full consideration from the transfer of the investment asset minus the cost of acquisition, cost of improvement thereof and transfer-related incidental expenses.  However, in the case of a capital asset which is transferred anytime after one year from the end of the financial year in which it is acquired, the cost of acquisition and cost of improvement will be adjusted on the basis of cost inflation index to reduce the inflationary gains.

10.9 The capital gains from all investment assets will be aggregated to arrive at the total amount of current income from capital gains. This will, then, be aggregated with unabsorbed capital loss at the end of the immediate preceding financial year (unabsorbed preceding year capital loss) to arrive at the total amount of income under the head 'Capital gains'. If the result of the aggregation is a loss, the total amount of capital gains will be treated as 'nil' and the loss will be treated as unabsorbed current capital loss at the end of the financial year.

10.11 The Securities Transaction Tax will be abolished.  Therefore, all capital gains (loss) arising from the transfer of equity shares in a company or units of an equity oriented fund will form part of the computation process described in para 10.8 above.

10.12 For the purposes of capital gains, certain transactions are not treated as transfer, in order to allow deferral of tax liability.  For example, the transfer of a capital asset under a gift or will is not treated as a transfer for the purpose of capital gains.

10.13 The cost of acquisition is generally with reference to the value of the asset on the base date or, if the asset is acquired after such date, the cost at which the asset is acquired. The base date will now be shifted from 1.4.1981 to 1.4.2000. As a result, all capital gains between 1.4.1981 and 31.3.2000 will not be liable to tax.

10.14 Courts have ruled that where the cost of acquisition of a capital asset is indeterminable, the machinery provisions for computing capital gains fail. Therefore, the gain from such asset cannot be subject to income tax. A general provision has therefore been made to the effect that the cost of acquisition of an investment asset shall be deemed to be nil if it cannot be determined or ascertained for any reason, and capital gains will be computed accordingly. A similar provision has been provided in respect of cost of improvement.

10.15 The benefit of 'rollover' will be available only to the following:-

(a) From agricultural land to one or more pieces of agricultural land.

(b) From any investment asset transferred anytime after one year from the end of the financial year in which the asset is acquired by the assessee, to a residential house, if the assessee does not own any residential house, other than the new asset, on the date of transfer of the original asset.

(c) From any investment asset transferred anytime after one year from the end of the financial year in which the asset is acquired by the assessee to deposit in an account maintained under the Capital Gains Savings Scheme.

10.16 All withdrawals, under whatever circumstances, from the account maintained under the Capital Gains Savings Scheme will be included in the income under the head 'income from residuary sources' and accordingly subject to tax.

CHAPTER XI

INCOME FROM RESIDUARY SOURCES

11.1 The income under this head will be equal to the gross residuary income minus the specified deductions.

11.2 The gross residuary income will comprise of any income which does not form part of any other head of income.

11.3 Further, the scope of gross residuary income has been broadened to include, inter alia, some forms of income without regard to the fact that they may otherwise relate to, or have any incidental nexus with, some other head of income. These include, inter alia, the following:-

(a) Interest other than interest accruing to or received by permitted financial institutions.

(b) Amount received or retained on account of settlement or breach of any contract, if not included under the head "income from business".

(c) The redemption or withdrawal of the principal amount from any investment that is eligible for deduction in computing the total income. However, withdrawals/ redemptions from provident funds and pure life insurance policies will not be included under this head.

(d) Any amount accruing to, or received by, the assessee, whether as advance or security deposit or otherwise, from the long term leasing or transfer of the whole or part of, or any interest in, any investment asset.

11.4 Any amount exceeding Rs.20,000 taken or accepted or repaid as loan or deposit otherwise than by account payee cheque or draft shall be deemed to be income, and included under this head and taxed accordingly.

11.5 Any sum received under Life Insurance Policy, including any bonus, shall be exempt from income tax, provided it is a pure life insurance policy. In order to achieve this objective, the Code provides that deduction will be allowed in respect of any sum received under a Life Insurance Policy, including any bonus, only if the premium payable for any of the years during the term of the policy does not exceed 5 percent of the capital sum assured. Consequently, in all other cases, the sum received under the policy, including any bonus, will be included under this head and taxed accordingly.

CHAPTER - XII

TAX  INCENTIVES

12.1 Tax incentives take the form of exemptions or deductions. Tax incentives are usually classified into business tax expenditure or social tax expenditure.

12.2 Ordinarily, tax incentives are inefficient, distorting, inequitous, impose greater compliance burden on the tax payer and on the administration, result in loss of revenue, create special interest groups, add to the complexity of the tax laws, and encourage tax avoidance and rent seeking behaviour. The Parliamentary Standing Committee on Finance has recommended a comprehensive review of the tax incentives so that they are limited and confined to exceptional cases. Accordingly, all exemptions under the Income Tax Act, 1961 have been reviewed. Based on a comprehensive review, it has been decided that all business tax expenditures, other than for activities which create externalities, will be withdrawn. The social tax expenditures will, however, continue to be allowed with such modifications as are necessary to improve their efficacy.

Exemptions under section 10 of the 1961 Act

12.3 Tax exemptions either exempt persons (liable to tax) or exempt income (from a specified source). Under the Code, tax exemptions have been rationalized in the following manner:-

(a) The source specific exemptions have been separately provided under section 9 read with the Sixth Schedule;

(b) The entity related exemptions have been separately provided under section 10 read with the Seventh Schedule;

(c) Exemptions which relate to specific heads of income have been provided for as deductions under the relevant heads of income;

(d) Non-profit organisations like scientific research associations, news agencies, professional association, welfare fund, education and medical institutions, religious trusts, trade unions, etc. will be allowed concessional tax treatment.

Social tax expenditures

(A) Incentive for savings

12.4 Tax incentives for savings have been rationalized so as to encourage net savings. Accordingly, in line with the best international practice in this regard, the Code proposes to introduce the 'Exempt-Exempt-Taxation' (EET) method of taxation of savings. Under this method, the contributions are exempt from tax (this represents the first 'E' under the EET method), the accumulation/accretions are exempt (free from any tax incidence) till such time as they remain invested (this represents the second 'E' under the EET method) and all

12.5 Based on the aforesaid EET principle, the Code provides for deduction in respect of contributions (both by the employee and the employer) to any account maintained with any permitted savings intermediary, during the financial year.  This account will be required to be maintained with any permitted savings intermediary in accordance with the scheme framed and prescribed by the Central Government in this behalf. The permitted savings intermediaries will be approved provident funds, approved superannuation funds, life insurer and New Pension System Trust. The accretions to the deposits will remain untaxed till such time as they are allowed to accumulate in the account.

12.6 Any withdrawal made, or amount received, under whatever circumstances, from this account will be included in the income of the assessee under the head 'income from residuary sources', in the year in which the withdrawal is made or the amount is received. Accordingly, it will be subject to tax at the appropriate personal marginal rate.

12.7 Further, the Code also provides that the withdrawal of any amount of accumulated balance as on the 31st day of March, 2011 in the account of the individual in the Government Provident Fund (GPF), Public Provident Fund (PPF), the recognised provident funds (RPFs) and the Employees Provident Fund (EPF) under the Employees Provident Fund and Miscellaneous Act will not be subject to tax.  In other words, only new contributions on or after the commencement of this Code will be subject to the EET method of taxation.

12.8 The permitted savings intermediaries would be required to be approved by the Pension Fund Regulatory and Development Authority (PFRDA).  These intermediaries will, in turn, invest the amounts deposited with them in government securities, term deposits of banks, unit-linked insurance plans, annuity plans, bonds and securities of public sector companies, banks and financial institutions, bonds of other companies enjoying prescribed investment grade rating, equity linked schemes of mutual funds, debt oriented mutual funds, equity and debt instruments. The choice of instruments will, in some schemes, be with the investor and in some others with the trustees of the schemes. The pattern of investment by the latter will be as prescribed.

12.9 Further, the rollover of any amount received, or withdrawn, from one account with the permitted savings intermediary to any other account with the same or any other permitted savings intermediary will not be treated as withdrawal. Hence, such rollover will not be subject to tax.

12.10 The Government will also design a system of central record keeping by an independent agency which will serve as a depository of all information relating to investment and withdrawal from the various accounts maintained by the assessee with the permitted savings intermediaries.

12.11 An individual or HUF will also be allowed deduction for amount paid towards tuition fees for children.

12.12 The aggregate amount of deduction for payment into the account maintained with any permitted savings intermediary and for the amounts referred to in para 12.11 above, shall not exceed rupees three hundred thousand.

(B) Incentives for medical treatment

12.13 The Code contains provisions that are intended to promote human development. Accordingly, deductions will be allowed:

(a) to an individual or HUF in respect of medical insurance premium for self, spouse, dependent children, or member of HUF upto a maximum of Rs.15,000 (Rs.20,000in the case of a senior citizen) and an additional sum in respect of medical insurance premium for parents upto a maximum of Rs.15,000 (Rs.20,000 if the parent is a senior citizen).

(b) to an individual or HUF for medical treatment or maintenance of disabled dependent of an amount of Rs.50,000 (Rs.75,000 in case of severe disability).

(c) to an individual or HUF for expenditure on medical treatment for prescribed diseases in case of self, spouse, dependent parents/children or a member of HUF up to a maximum of Rs.40,000 (Rs.60,000 in the case of a senior citizen).

(C) Deduction to a handicapped

12.14 Deduction of an amount of Rs.50,000 (Rs.75,000 in the case of a person with severe disability) will be allowed to an individual who is handicapped.

(D) Deduction for interest on loan taken for higher education

12.15 Deduction will be allowed to an individual for interest actually paid on a loan taken for higher education for self or spouse or children. The scope of the term 'higher education' has been enlarged. Higher education will mean full time studies in a graduate or postgraduate course.

12.16 The deduction will be allowed only if the loan is taken from a banking company or any other financial institution notified by the Central Government.

(E) Deduction for family welfare:

12.17 Deduction will be allowed to a company for both capital and revenue expenditure incurred by a company for promoting family planning as well as for preventing HIV/AIDS amongst its employees.

(F) Deduction for rent paid:

12.18 Deduction will be allowed to an individual, who is self-employed, for rent actually paid for his residence, in excess of ten per cent of his gross total income from ordinary sources. However, there will be a ceiling of rupees two thousand per month on the amount allowed as deduction.

(G) Deduction in respect of donation:

12.19 The case for providing tax concessions for donations to non-profit organizations (charitable organizations) is based on two considerations. The first argument is that such donations usually create positive externalities. Secondly, such donations increase the flow of public goods and mitigate the burden on Governments. Therefore, the Code provides incentives for donations to non-profit organizations as follows:

(a) Deduction to all donors at the rate of 125 per cent of donations made to the following institutions:-

(i) scientific research association or National Laboratory; and

(ii) university, college or other institution for research in social science, scientific research or statistical research;

(b) Deduction to all donors at the rate of 100 per cent of donations made to the following institutions:-

(i) Prime Minister's National Relief Fund;

(ii) Chief Minister's Relief Fund;

(iii) The Army Central Welfare Fund, The Indian Naval Benevolent Fund and The Air Force Central Welfare Fund; and

(iv) such other funds as are enumerated in Part B of The Sixteenth Schedule.

(c) Deduction to all donors at the rate of 50 per cent of donations made to any other non-profit organization.

Business tax expenditure

(A) Tax holiday for certain businesses

12.20 The case for tax holiday for certain businesses is based on the consideration that these businesses entail extremely high risk, lumpy investment, and a long payback period.

12.21 However, profit-linked incentives are inherently inefficient. Essentially, a profit-linked incentive is regressive in nature. Consequently, there is an inbuilt incentive for laundering and shifting of profits to the exempted activity. Since profit is the basis for exemption, there is no incentive for investment and upgradation during the period of tax holiday. Such profit-linked incentives also lead to significant loss of revenue and encourage rent-seeking behaviour. Hence, the Code substitutes profit-linked incentives by a new scheme. Under the new scheme, a person would be allowed to recover all capital and revenue expenditure (except expenditure on land, goodwill and financial instrument) and he would be liable to income tax on profits made thereafter. The period consumed in recovering all capital and revenue expenditure will be the period of tax holiday. The new scheme will apply to the following:-

(a) Business of exploration and production of mineral oil or natural gas.

(b) Business of developing a special economic zone.

(c) Business of generation, transmission or distribution of power.

(d) Business of developing, or operating and maintaining, any infrastructure facility;

(e) Business of operating and maintaining a hospital in any area, other than the excluded area;

(f) Business of processing, preservation and packaging of fruits and vegetables.

(g) Business of laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of the network;

(h) Business of setting up and operating a cold chain facility; and

(i) Business of setting up and operating a warehousing facility for storage of agricultural produce.

12.22 The provisions of the Income Tax Act, 1961 that allow profit-linked incentives and other tax incentives contrary to the new scheme contained in the Code will be grandfathered.

(B) Area based exemptions grandfathered

12.23 The case for area based exemption is based on the consideration of balanced regional development. However, such area based exemptions create economic distortion, i.e., allocate/ divert resources to areas where there is no comparative advantage. Such exemptions also lead to tax evasion and avoidance. Besides, there is a huge cost of administration. Hence, the Code does not allow area-based exemptions. Area-based exemptions that are available under the Income Tax Act, 1961 will be grandfathered.

(C) Deduction for royalty income of authors

12.24 Deduction will be allowed to a resident individual, being an author, in respect of royalty received for the assignment or grant of any of his interest in the copyright of any book of literary, artistic or scientific nature and in respect of any textbook certified by the prescribed authority for an amount upto a maximum of Rs.300,000.

(D) Deduction for royalty on patents

12.25 Deduction will be allowed to a resident individual, being a patent holder for income received by way of royalty in respect of a patent registered on or after the 1st day of April, 2003 under the Patents Act, 1970.  The deduction will be upto a maximum of Rs.300,000.

(F) Deduction for income of co-operative societies

12.26 Cooperative societies are formed for the promotion of thrift and self-help among agriculturists, artisans, crafts persons etc. The case for tax exemption to cooperative societies is based on the principle of mutuality i.e., no one can make a profit out of himself. In the context of cooperative societies, the surplus (profits) is essentially the return of what members have contributed to the society. Therefore, the surplus accruing to it cannot be regarded as income, profits or gains and subject to income tax.

12.27 Deduction will be allowed to cooperative societies which are essentially formed for self-help amongst agriculturists, artisans, craftsmen etc. The salient features of such deduction are as follows:-

(a) The profits derived from the business of providing banking or credit facilities to its members by the Primary Agriculture Credit Societies and Primary Cooperative Agriculture and Rural Development Banks will be entitled to 100 per cent deduction.

(b) The profits derived from agriculture or agriculture related activities by a Primary Co-operative Society will be entitled to 100 per cent deduction. For this purpose, "Agriculture-related activities" are defined to mean the following activities:-

(i) purchase of agricultural implements, seeds, livestock or other articles intended for agriculture for the purpose of supplying them to the members of the society;

(ii) the collective disposal of,-

(a) agricultural produce grown by the members; or

(b) dairy or poultry produce of the members;

(iii) fishing or allied activities, that is to say, the catching, curing, processing, preserving, storing or marketing of fish or the purchase of materials and equipment in connection therewith for the purpose of supplying them to the members of the society;

(c) In the case of any other primary cooperative society engaged in activities other than those specified in (a) and (b) above, the profits derived from such activities will be entitled to 100 per cent deduction up to a maximum amount of Rs.100,000.

Chapter - XIII

TAXATION OF COMPANIES

Case for taxing corporate profit

13.1 Companies or corporations are the most widely used and most efficient forms of doing business. They earn huge incomes. Hence, a tax on the profit of companies is considered reasonable and just. A tax on the income of companies can also be justified as a withholding tax that, in a comprehensive and timely manner, taxes the income which would otherwise flow to the shareholders.

13.2 The Code provides for taxing incomes of companies. The Code also provides for taxing dividends distributed by resident companies.

Dividend distribution tax (DDT)

13.3 In theory, all profits should be distributed as dividends to the shareholders but, in the real world, only a part of the post-tax profit is distributed to the shareholders as dividend. A tax on dividend can either take the form of a tax in the hands of the shareholder at his personal marginal rate or take the form of a tax at a flat rate upon distribution of dividend by the company.  The first method of taxation has been found to be administratively cumbersome and prone to leakage. The second method is administratively simple and with no possibility of leakage. Therefore, under the Code, dividends will be taxed under the second method in respect of dividend distributed by a resident company.

13.4 A resident company will be liable to dividend distribution tax at the rate of fifteen per cent of the amount declared by way of dividends.

13.5 Once a dividend has suffered dividend distribution tax, it will be exempt in the hands of the recipient.

Minimum Alternate Tax (MAT)

13.6 A company would ordinarily be liable to tax in respect of its total income. However, owing to tax incentives and tax evasion, the liability on total income, in many cases, has been found to be extremely low or even zero. Therefore, internationally, a variety of economic bases and methods are used to calculate presumptive income so as to overcome the problems of tax incentives and tax evasion. For example, certain presumptions are based exclusively on the taxpayers' net wealth or on the value of the assets used in his business. Other presumptions are based on the gross receipts of the enterprise; some others are based on visible signs of wealth. Standard assessment methods use several key factors and indices of profitability, which vary according to the activity, to determine the taxpayer's income.

13.7 Several countries have adopted minimum taxes based on a fixed percentage of the assets of a business. The economic rationale for the assets tax is that investors can expect ex-ante to earn a specified average rate of return on their assets. Therefore, it provides an incentive for efficiency.  Accordingly, the Code provides for Minimum Alternate Tax calculated with reference to the "value of the gross assets". The shift in the MAT base from book profits to gross assets will encourage optimal utilization of the assets and thereby increase efficiency

13.8 "Value of gross assets" will be the aggregate of the value of gross block of fixed assets of the company, the value of capital works in progress of the company, the book value of all other assets of the company, as on the last day of the relevant financial year, as reduced by the accumulated depreciation on the value of the gross block of the fixed assets and the debit balance of the profit and loss account if included in the book value of other assets.

13.9 The rate of MAT will be 0.25 per cent of the value of gross assets in the case of banking companies and 2 per cent of the value of gross assets in the case of all other companies.

13.10 Under the Code, MAT will be a final tax. Hence, it will not be allowed to be carried forward for claiming tax credit in subsequent years.

CHAPTER - XIV

ASSESSMENT OF  UNINCORPORATED BODY

Treatment of unincorporated bodies

14.1 Under the Code, partnership firms, Association of Persons and Body of Individuals will be collectively referred to as "unincorporated body" and their members as "participants".

14.2 The salient features of the scheme of taxation of unincorporated bodies are as under:-

(a) An unincorporated body will be taxed as a separate entity.

(b) Any salary, bonus, commission or remuneration (by whatever name called), paid/payable to a working participant will be allowed as a deduction.

(c) Any interest paid to any participant will be allowed as a deduction.

(d) The total income of the unincorporated body after allowing deduction for payments referred to in (b) and (c) above will be subject to tax at the maximum marginal rate applicable to individuals. There will be no threshold exemption limit. However, the share of the participant in the profits of the unincorporated body will be exempt in his hands.

(e) The amount of salary, bonus, commission, remuneration and interest paid to a participant will be taxable in his hands.

(f) The unincorporated body will be entitled to carry forward and set off losses.

(g) In the case of change in the constitution of an unincorporated body on account of death/retirement of a participant, the body will not be entitled to carry forward so much of the loss as is attributable to the deceased/retiring participant.

Treatment of financial intermediaries

14.3 Under the Code, financial intermediaries like the mutual fund, venture capital fund, pension funds, superannuation funds, provident funds and life insurance companies will be treated as pass-thru entities. As a result, they would receive to the extent possible, income without any incidence of tax. They would also not be liable to pay any tax on income received by them for, or on behalf of, their investors.  The investors will be liable to tax on any income which accrues to them from investment with any of the pass-thru entities. Further, this benefit will be available to all pass-thru entities irrespective of the sector in which they invest.

14.4 Based on the principle of pass-thru, the Code provides for rationalisation of the tax treatment of life insurance. Under the new scheme, contributions by the insured will be liable to EET method of taxation of savings.  As a result, life insurance companies will not be required to pay any tax on the actuarial surplus in the policyholders' account.

CHAPTER - XV