Direct Tax Code

Taxation of income in India, till now, is governed by the fifty years old Income Tax Act (IT Act) which came into legislation in 1961. But this Act has been criticized for being economically inefficient, incompatible with the current requirements and inequitable to all tax payers. It was neither cost effective nor was able to encourage voluntary compliance. So, in August 2009, the Ministry of Finance came out with the draft of Direct Tax Code (DTC) bill with the purpose of replacing the existing IT Act and also invited the public for discussions and feedback on the draft proposal. It will be a key tax reform by the government aiming at widening and deepening the tax net; and increasing tax revenue. But the draft bill had received lot of criticisms on certain amendments or changes in relation to the removal of existing tax subsidies, and modifications in the tax rate structure that it sought to introduce. So, in June 2010, the ministry again issued a new revised direct tax code bill, incorporating all the criticisms, and presented the draft to the Union Cabinet. As per the news reports, on 31st August 2010, the draft bill has been approved by the Cabinet as well as the Parliament and the new DTC will come into force from 1st April 2012. The rationale for introducing DTC is to increase the efficiency and equity of the tax system by eliminating the plethora of tax exemptions or subsidies that create distortions. Its major policies include replacement of profit-linked exemptions with investment linked incentives, particularly for export units, and reduction in the tax rates to bring more people and companies under the tax net.

Features
Salaried Class
The new revised DTC have raised and widened the income tax slabs compared to those existing under the IT Act, nevertheless the tax rates are same, the highest marginal income tax rate being 30% for all. Under the new regime gender distinction, in terms of additional exemption limit available to

women taxpayers as per the existing norms, has been removed.

For males and females

Income slab existing Up to Rs 160,000 Rs 160,001 to Rs 300,000 Rs 300,001 to Rs 500,000 Above Rs 500,001 Rate of income tax NIL 10% 20% 30% Income slab proposed by new revised DTC Up to Rs 200,000 Rs 200,001 to Rs 500,000 Rs 500,001 to Rs 1,000,000 Above Rs 1,000,001

The basic tax exemption limit for an individual male and female has been raised and brought at par from Rs 160,000 and Rs 190,000 to Rs 200,000 per annum. Senior citizens, however, will now enjoy a tax exemption on income up to Rs 250,000 per annum instead of Rs 240,000 allowed now. On the proposals of taxation of savings, in the form of provident funds whether public provident fund, government provident fund, or employees provident fund, the new DTC has reverted back to the existing Exempt-ExemptExempt (EEE) method from the earlier proposed Exempt-Exempt-Tax (EET) scheme. 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 childs tuition fees, life insurance and health insurance premiums. As far as investment in housing is concerned, the new DTC has continued with the deduction owing to interest payable on a housing loan for up to Rs 150,000 per annum but it will be allowed only on the interest component of the installment and not the principal amount. The new revised DTC has decided not to introduce any concept of presumptive tax. In the case of retirement benefits, the existing rule is EET method under which any withdrawal from the Retirement Benefit Account (RBA) is taxable. But the New Pension Scheme proposed under DTC suggests a completely new

EEE scheme that exempts even withdrawal. The limit for employees contribution to his pension fund that will be deducted from his taxable income has been increased to Rs 300,000 from the existing limit of Rs 100,000 per annum. Taxation of capital gains has gone through a change under the new DTC. Though it has retained the policy of zero tax on long term capital gains as it exists in the IT Act. Short term capital gains are now taxed at the rate of 15% for all (17% including surcharge and cess), but from 1-04-2012 onwards around 50% of the gain will be exempt and the rest will taxed at the income tax rates applicable to the investors. In other words, 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.

Corporate
The new DTC has proposed a corporate tax rate of 30% (with or without surcharge and cess) for a domestic company which is less than the existing rate of 33.22% including both surcharge and cess. As per the news reports, the tax rate for foreign companies will now be same as domestic companies instead of 40% as per IT Act. About Minimum Alternative Tax (MAT) rate, the new revised DTC has recommended to impose MAT on the adjusted book profits of the company, as it is designed now. However, the latest reports suggest that the rate of MAT may be higher at 20% per annum, from the existing rate of 18% (or 19.93% including surcharge and cess). For Special Economic Zones (SEZs), the new revised bill has further extended the duration tax sops that allow a 100% tax exemption on the profits, for two years further, after it will come to legislation i.e. till 1st April 2014. There was, however, a discussion earlier about discontinuing with most of the export linked exemptions, which are considered as distortionary. Though the actual rates will be applicable only after the parliament approves the new revised direct tax code bill, but discussion paper on DTC and the information received from the latest news reports suggests that even after the tax reform through introduction of DTC in the place of Income Tax Act, the taxation policy of India is still almost same by continuing with the existing exemptions.

There is definitely some relief for women and senior citizens, and in a way the tax payers are saved from dealing with a complex piece of legislation. Ideally, it should help convert paying taxes in India less complex and improve the tax revenue collection system. However, the challenge will be to ensure that the government and IT department raises up to expectations, where voluntary compliance becomes more acceptable.

Residence

In the case of a company, it is proposed that the company shall be resident in India if it is an Indian company or if the place of effective management (POEM) is in India. POEM has been defined to mean the place where the board of directors or executive directors make their decisions or the place where such executive directors or officers of the company perform their functions and the board of directors routinely approves the commercial and strategic decisions taken by such executive directors or officers. In all cases, other than an individual, the persons would be a resident in India, if the place of control and management of the affairs, at any time of the year is situated wholly, or partly, in India.

Source rules:

Additional source rules for income arising to a non- resident are proposed to be introduced as income deemed to accrue in India; for e.g. insurance premium including reinsurance covering any risk in India, from the transfer of any share or interest in a foreign company, where the fair market value of the assets in India

owned by the company represent at least 50% of the fair market value of all the assets owned by the company etc.

Computation of total income

Income has been proposed to be classified as income from ordinary sources and income from special sources; Income from ordinary sources would comprise of income from employment, house property, business, capital gains and residuary sources. Income from special sources would refer to specified

income of non residents, winning from racehorses, lottery etc. However where the income of a non resident is attributable to a PE, then the same would not be considered as income from special sources.

Personal taxes

Changes in income slabs which will result in incremental savings in tax. ? o The concept of Not ordinarily resident is removed. The condition of 729 days has been retained to determine the taxability of overseas income of an individual o A person not entitled to HRA is allowed a deduction of rent paid upto 10% of GTI or INR 2000 per month & other conditions as may be prescribed o Exemption for medical expenses has been increased to INR 50,000. o Contribution to approved funds is deductible to the extent of INR 1 lacs. o Deduction for insurance premium (not exceed five percent. of the capital sum assured), Health Insurance covered & Tuition fees to the extent of INR 50,000. o Wealth tax to be levied at 1% for wealth in excess of INR 10 million

Capital gains

Income from all investment assets to be computed under the head Capital gains?. Investment asset to include any capital asset which is not a business capital asset, any security held by a Foreign Institutional Investor and any undertaking or division of a business. Distinction between short-term investment asset and long-term investment asset on the basis of the length of holding of the asset to be eliminated. No tax on gains on transfer of shares of a company or unit of equity oriented fund that are held for more than one year and such transfer is chargeable to Securities Transaction Tax (STT). STT would be chargeable on transfer of equity shares of a company or a unit of an equity oriented fund. Fifty percent of the capital gains are allowed as deduction on transfer of shares of a company or unit of equity oriented fund that are held for a period of one year or less and such transfer is chargeable to STT.

The base date for determining the cost of acquisition to be shifted from 1 April 1981 to 1 April 2000. Consequently, all unrealized capital gains on assets between 1 April 1981 and 31 March 2000 not to be liable to tax. Cost of acquisition to be Nil, if cannot be determined or ascertained for any reason. Capital loss to be allowed to set off only against capital gains. The capital loss can be carried forward for indefinite period.

MAT:
o Computation of book profits broadly similar to existing law o Credit for tax paid under DTC 2010, would be available. The credit would be allowed to be carried forward for 15 years. o MAT now applicable to SEZ developers and units in an SEZ

Tax incentives:
The DTC 2010 provides for expenditure based incentives wherein capital expenditure incurred by the specified business would be allowed as a deduction. Specified businesses, amongst others would include generation, transmission or distribution of power, developing or operating and maintaining any infrastructure facility, operating a maintaining a hospital in a specified area, SEZ developers and units established in an SEZ, exploration and production of mineral oil or natural gas, setting up and operating a cold chain facility, developing and building a housing project under a scheme of slum redevelopment etc.

Grandfathering provisions for SEZ developers and SEZ Units:

Grandfathering of profit linked incentives under the Income-tax act, 1961 to continue for SEZ developers notified on or before 31 March 2012. In case of SEZ units, the deduction would be permissible for units commencing operations on or before 31 March 2014

Anti- abuse provisions General anti-avoidance rules:

The characteristics of the originally proposed rules have been retained. Additionally it is proposed that an arrangement would be presumed for obtaining a tax benefit would include reduction in tax base including increase in losses. The provisions would be applicable as per the guidelines to be

framed by the Central Government. Further the definition of lacking commercial substance has been amended to clarify that obtaining tax benefit cannot be the only criteria for applicability of GAAR.

Controlled foreign company (CFC) rules:

As indicated in the revised discussion draft, CFC rules have been incorporated to provide for the taxation of income attributable to a CFC to be taxed in the hands of the resident. A foreign company would be considered as a CFC which

for the purposes of tax is a resident of a country or territory with a lower rate of tax the shares of the company are not traded on any stock exchange one or more persons individually or collectively exercise control over the company it is not engaged in any active trade or business the specified income exceed INR 2.5 million.

Rules pertaining to the computation of the income attributable to the CFC which would be required to be added to the income of the resident have been provided.

Tax treaty provisions:

It has been proposed to revert to the provisions under the existing law, wherein the provisions of the Code shall apply in relation to an assessee to whom the agreement applies, to the extent they are more beneficial. However, the provisions relating to GAAR, CFC and Branch profit tax would continue to apply irrespective of the beneficial provisions of the tax treaty provisions. It has also been proposed that a person shall be entitled to claim relief under the provisions of the agreement on production of a certificate in the prescribed form, from the tax authorities of the country that such person is a resident of the country. A resident in India would be entitled to claim credit of taxes paid or deducted at source in the country in accordance with the provisions of the tax treaty against the income tax payable in respect of the income for the financial year. Where tax has been paid or deducted in a country with which there exists no agreement credit can be claimed only at the lower of the rate of tax under the DTC 2010 and the tax rate levied in the other country. However, the credit cannot exceed the tax payable under the DTC 2010.

Features in Nutshell:
The following are the salient features of Direct Tax Code. 1.Use of Simple language : so as to convey with clarity the intent, scope and amplitude of the provisions of law 2.Single Code for Direct Taxes. 3.Flexibility: By reflecting the general principles in the statute and leaving the matter of details to rules, Schedules so that changes in the structure of growing economy resorting to frequent amendments. 4.Reducing the scope of litigation: By avoiding ambiguity in the provisions so that the taxpayer and tax administration are ad idem on the provisions and the assessment results in a finality. 5.Consolidation of regulatory functions provisions relating to definitions, incentives, procedure and rates of taxes have been consolidated for better understanding of the legislation by rearranging various provisions to make them consistent with general scheme of the Act. 6.Ensuring that the law can be reflected in a Form - by designing the structure of tax laws so that it is capable of being logically reproduced in a Forum. 7.Elimination of the regulatory functions - by withdrawing the regulatory function of the taxing statute; Providing stability - by prescribing the rates of taxes in the Schedule of the Code instead of being done annually in the Finance Act.

Highlight:
Common threshold income tax exemption limit for men and women proposed at Rs. 2 lakh per annum, up from Rs. 1.6 lakh 10 per cent tax on annual income between Rs. 2-5 lakh, 20 per cent on between Rs. 5-10 lakh, 30 per cent for above Rs. 10 lakh Tax burden at highest level will come down by Rs. 41,040 annually

Proposal to raise tax exemption for senior citizens to Rs. 2.5 lakh from Rs. 2.4 lakh currently Corporate tax to remain at 30 per cent but without surcharge and cess MAT to be 20 per cent of book profit, up from 18.5 per cent Proposal to levy dividend distribution tax at 15 per cent Exemption for investment in approved funds and insurance schemes proposed at Rs. 1.5 lakh annually, against Rs. 1.2 lakh currently Proposed bill has 319 sections and 22 schedules against 298 sections and 14 schedules in existing IT Act Once enacted, DTC will replace archaic Income Tax Act.

Direct Tax Code Assignment

By: Chandresh Mohan Singh 0911513 III Yr. BBA - A