Direct Tax Code: A Roller-Coaster Ride
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The Direct Tax Code (DTC) Bill which was proposed to replace the current Income Tax Act, 1961 (the Act) with effect from April 1, 2011 was approved by the Union Cabinet on August 26, 2010 and was tabled before the parliament on August 30, 2010. The Direct Tax Code, 2010 (DTC Bill) shall now come into effect from April 1, 2012 (as against the original proposed date of April 1, 2011). The DTC Bill approved by the Union Cabinet has taken a divergent turn vis-a-vis the lofty promises made by the draft DTC initially proposed by the finance minister (FM) in August last year. This article attempts to provide a step-wise analysis of the DTC’s life-cycle from the ‘discus-sion paper’ stage to the ‘DTC Bill tabled before the parlia-ment’ stage.
Personal Taxation
When the draft DTC was first unveiled in August 2009, the FM had brought a broad smile on the faces of the ‘masses’ as well as the ‘classes’ by widening the tax slabs ambitiously. The slabs were significantly higher as compared to those in existence. Thus, while the income tax exemption limit was kept intact at Rs 1,60,000, the income subject to 10 per cent of tax was substantially increased to Rs 10,00,000, that sub-ject to 20 per cent of tax was increased to Rs 25,00,000, and income above Rs 25,00,000 was to be taxed at 30 per cent. The proposed change in the slab rates by the DTC offered tax savings of Rs 2,89,620 (when compared to the rates pre-vailing for FY 2009-10) for an individual having a taxable income of Rs 25,00,000.
However, the original DTC also proposed to do away with various exemptions such as LTA, HRA, interest on loan borrowed for acquisition of house property (self-occupied), to name a few. Further, as compared to the existing provi-sions, contributions made by the employer to the likes of provident fund were also brought within the tax net. These proposals to a certain extent would have offset the savings offered by the increased income slabs. The first cut of the draft DTC had also raised certain eyebrows as the Exempt-Exempt-Tax (EET) regime was proposed to be introduced for taxing the retirement benefits, as opposed to the cur-rent regime of Exempt-Exempt-Exempt (EEE) method. Under this proposed EET method, the retirement benefits were to be brought into the tax net at the time of their withdrawal. Current tax regulations exempt such withdrawals.
So what are the proposals under the Revised DTC Discussion Paper (RDP)? Given that India does not have a robust social security system, the RDP of DTC, which was released in June 2010, decided to do away with the proposed EET basis of taxation. Thus, withdrawals from tax savings and retirement schemes such as the government provident fund, public provident fund, recognised provident fund, approved pure life insurance products, and annuity schemes would now not be taxed in the case of individuals. The RDP also proposed to continue exemption for the contribu-tion made by the employers to employee’s provident fund, superannuation fund, and pension schemes. Also, the cur-rent exemptions on receipts such as gratuity, leave encash-ment, and amounts received under the voluntary retirement scheme (VRS) upon retirement were also proposed to be continued.
The RDP also proposed to restore the deduction with respect to interest on housing loan of Rs 1,50,000. However, the same was proposed to be part of the increased annual deduction of Rs 3,00,000 with respect to the savings plan, thereby negating much of the tax savings proposed to be offered by the increased limit. The largesse extended by the FM in the RDP raised apprehensions amongst all about the fact that the initial liberal tax slabs proposed in the original draft of the DTC could become a pipe-dream. Instead there may be a burden by way of incremental taxes so as to trade-off the government’s potential revenue loss.[PAGE BREAK]
As for the proposals under the DTC Bill placed before the parliament, it is said that ‘speak of the devil and in he walks’. The apprehensions raised came true when the FM proposed to withdraw the substantial tax benefits that were extended by him in the original DTC. In the DTC Bill, the slab rates have been revised substantially. While the basic exemption limit is now proposed to be increased to Rs 2,00,000 from Rs 1,60,000, the 10 per cent rate shall apply only up to Rs 5,00,000 as against the originally proposed limit of Rs 10,00,000. The income between Rs 5,00,000 to Rs 10,00,000 shall now attract a tax rate of 20 per cent as against the proposed limit of Rs 10,00,000 to Rs 25,00,000. So also the maximum marginal rate shall be triggered on income above Rs 10,00,000 as against that originally pro-posed on income above Rs 25,00,000.
As regards the basic exemption limit, while it has been revised for senior citizens to Rs 2,50,000, there is no specific mention of a higher exemption limit for resident women. The revised proposals would offer a marginal saving of Rs 24,000 as against the savings of over Rs 2,80,000 proposed by the original DTC. The FM, however, did some dam-age control by keeping the promise offered by the RDP by restoring the EEE method of taxation for the specified securities, re-introducing the deduction with respect to HRA, and increasing the exemption with respect to medical reimbursement from Rs 15,000 to Rs 50,000. As far as income from house property is considered, the concept of ‘deemed let out’ has been done away with. Accordingly, income from house property would be taxable only if the property is actu-ally let out during the relevant financial year.
Corporate Taxation
To simplify the direct tax, the FM had proposed to do away with the various exemptions offered by the current provisions of the Act and in return had offered a reduced corporate tax rate of 25 per cent. However, he had also given the corporate world sleepless nights by proposing a Minimum Alternative Tax (MAT) of 2 per cent on the gross value of the assets against the existing provision of 15 per cent for FY2009-10 and 18 per cent for FY2010-11 on the book profits of a company. Accordingly, the original DTC brought within the tax net even those companies that had booked losses.
As for the proposals under the Revised DTC Discussion Paper (RDP), while the RDP was silent on the corporate tax rates, the FM seems to have succumbed to sustained corporate pressure and retained the concept of MAT on book profit in the DTC in line with the existing provisions of the Act. Under the ambit of the proposals under the DTC Bill placed before the parliament, as for individuals, likewise for corporate, the DTC has taken an about-turn and restored the current corporate tax rate of 30 per cent against the earlier proposed tax rate of 25 per cent, with the only saving grace being the removal of education cess and surcharge. However, as far as MAT is concerned, the impact of surcharge and education cess seems to have been incorporated by making an upward revision of 20 per cent from the current rate of 18 per cent.
Further, MAT credit has been reinstated by the FM and allowed to be carried forward up to 15 years. As for special economic zone (SEZ) developers and units, there is some good news as well as some bad news in store. The SEZ developers would on one hand be eligible for a tax holiday if the SEZ is notified before March 31, 2012. However, all the SEZ developers would now be subject to MAT and Dividend Distribution Tax (DDT), which were erstwhile not applicable to them. Similarly, those SEZ units starting operations before March 31, 2014 will enjoy a tax holiday under the DTC. However, all the SEZ units would now be subjected to MAT. The DTC has given some relief to small business organisations by increasing the threshold limit for tax audit to Rs 10 million from the current limit of Rs 6 mil-lion.[PAGE BREAK]
Capital Gains Tax
The original proposals had removed the distinction between short-term and long-term capital asset. It had also proposed to tax capital gain at the applicable marginal rates for residents and at a flat rate of 30 per cent in case of non -residents. The current exemption enjoyed by the assessee in case of long-term capital gain on the sale of specified equity shares, subject to security transaction tax (STT), was also done away with. Toeing the line with the various repre-sentations made by the tax-payers, the distinction between short-term and long-term capital asset was re-introduced by the Revised DTC Discussion Paper, with the shift of base year indexation from April 1981 to April 2000.
While the exemption for long-term capital gain on the sale of specified equity shares was not total-ly restored, percentage deduction was introduced from these gains, thereby reducing the effective capital gain tax rate. The FM had, applying the principal of parity, also removed the higher capital gain tax rate for non-residents. Accordingly, both residents as well as non-residents were to be subjected to capital gain tax at the applicable mar-ginal rates in the proposed DTC. Now, under the DTC Bill placed before the parliament, the FM has re-introduced some of the benefits offered by the current Act in the DTC Bill.
While restoring the exemption for specified long term equity shares or units of equity-oriented fund, it is now pro-posed that the short-term capital gains tax on their transfer would be reduced to 50 per cent if the STT is paid on such a transfer. Also, the fair market value of the asset as on April 1, 2000 would be substituted for the purchase price of the asset at the option of the tax-payer. Further, the cost of acquisition of an asset would be treated as nil if it cannot be determined or ascertained. In summary, it may suffice to comment that the manner in which the DTC has evolved over the last one year while being under public scrutiny, there has been many a slip between the cup and the lip. We only hope that the final Bill, after deliberations by our ‘wise’ parliamentarians, shall have something more to cheer about.