Decoding the direct tax code

DH News Service

The proposed Direct Tax Code is a combination of major tax relief and removal of most tax-
exempted benefits. It is expected to usher in a new tax regime of transparency and greater
compliance writes Dilip Maitra.

When archaic rules have to be replaced with new ones, the changes must be
dramatic and path breaking. This is what Union Finance Minister Pranab Mukherjee
conveyed to all taxpayers when he introduced the draft Direct Tax Code (Tax Code)
last week. The Tax Code, now open to public debate, will be introduced as a Bill in
Parliament's winter session. Ìf passed, it will become the new Ìncome Tax Act,
replacing the existing four decade old ÌT Act of 1961. The new ÌT Act will come into
force from April 1, 2011.

Ìn the foreward to the Tax Code Mukherjee explains that the aim is to eliminate
distortions in the tax structure, introduce moderate levels of taxation, expand the tax
base, improve tax compliance, simplify the language and lower tax litigations. Ìnitial
analysis shows that most of these objectives are achievable by tweaking of some provisions.

Talking to Deccan Herald, KPMG Executive Director Personal Taxation, ÌT & ESOP Vikas Vasal said
"The new proposals are in the right direction. They will simplify regulations and reduce unnecessary
litigations significantly.¨

Agreed Bangalore Chamber of Ìndustry & Commerce (BCÌC) President K R Girish. "The Code is a
completely new law and not an amendment of the existing Ìncome Tax Act. This is a commendable
change as one has always experienced tinkering of existing laws, ¨ observes Girish.

Major gains for individuaIs

What do the major changes proposed in the Tax Code look like? Personal income tax, almost all salaried
persons will agree, in our country is one of the highest in the world. More open and honest an employer is
in terms of disclosing remunerations, worse it is for the employees because taxable income goes up. The
present system thus rewards dishonesty and non-disclosure of income by way of lower tax. The Tax
Code will try to address these issues by significantly lowering income tax and by disallowing all tax-free
perks. Ìt proposed exemption of income tax on specified savings up to Rs 3 lakh a year as against the
present deduction limit of Rs 1 lakh for all types of savings under 80C of the ÌT Act. The catch, however,
is that a few long term investments like public provident fund, employer's provident fund, insurance
premium in pension (annuity) schemes, Post Office National Savings Scheme etc will be eligible for tax
exemption.

But contributions to fixed deposits, interest and principal payment on housing loans, educational
expenses of dependents, and a host of other forms of savings will not qualify as eligible for tax savings.
The thrust, clearly, is to induce long term savings for future needs.

The Tax Code also raised income tax slabs significantly, lowering the tax burden on individuals. The draft
proposed exempting the general tax payer from paying tax for income up to Rs 1.60 lakh a year.

According to the proposal, a tax payer will pay at the rate of 10 per cent for income above Rs 1.60 lakh
and up to Rs 10 lakh, at 20 per cent on income between Rs 10 lakh and Rs 25 lakh and at 30 per cent for
income beyond Rs 25 lakh.

At present, while the basic exemption limit remains at Rs 1.60 lakh a year, the limit for tax slabs are much
lower ÷ one pays 10 per cent tax on income ranging between Rs 1.60 lakh and Rs 3 lakh, 20 per cent
between Rs 3 lakh and Rs 5 lakh and 30 per cent beyond Rs 5 lakh.

Thus, for an individual with taxable income of Rs 10 lakh a year tax payment will drop from Rs 1.68 lakh
to Rs 51,000, a net annual saving of Rs 1.17 lakh. The exemption limit for women and senior citizens will
continue to be Rs 1.90 lakh and Rs 2.40 lakh, respectively.

ot without pains

Ìf the finance minister is for giving major relief to tax payers, he will also make sure that there aren't many
avenues to avoid taxes. So, as a rider, the Tax Code proposes to add all perquisites enjoyed by a tax
payer to income for the purpose of tax calculations. Ìn other words, allowances like leave travel,
furnishings, entertainment expenses, conveyance, medical etc, will be added to income.

Similarly, the tax treatment for post-retirement benefits may prove to be a major dampener. Money saved
in specified instruments like PPF and PF for getting tax exemption will become taxable when they are
withdrawn later.

These investments, when accrued, were earlier exempted from tax. The Tax Code says that under the
Exempt Exempt Tax (EET) system all withdrawals will attract tax because the amount withdrawn will be
treated as part of the income for that year.

But in the Tax Code it is unclear if the employee's contribution to PF and PPF will be taxed at the time of
withdrawal. KPMG's Vasal says that this is an anomaly that needs to be corrected. He believes that only
the employer's contribution and interest accrued to the account will be taxed.

Though taxing financial gains available after retirement will pinch the retired people, Vasal is of the view
that the proposal is equitable as income is liable to be taxed at least once.

However, as a relief to senior citizens, tax exemption limits for them should be raised to Rs 5 lakh per
annum instead of Rs 2.40 lakh at present. The Tax Code, however, specified that the tax exempt status
currently available to withdrawals would continue to apply to amounts accumulated in post-retirement
savings schemes like PPF, EPF, etc, up to March 31, 2011. Money that accrues from April 1, 2011 will be
taxed on withdrawal.

WeaIth tax benefits

The proposed Tax Code has sought to make major changes in wealth tax calculations and rates.

The threshold limit for wealth tax will be raised to Rs 50 crore from the present Rs 30 lakh and the tax rate
was reduced from 1 per cent to 0.25 per cent.

But, in a smart move, to expand the scope of taxation the Tax Code included financial assets like shares,
corporate bonds, fixed deposits, etc in wealth tax. The valuation of these assets will be done at cost or at
market price, whichever is lower. Ìn case of capital gains tax too, the Tax Code proposed some sweeping
changes. Ìt has done away with the present system of short-term and long-term capital gain tax, and
replaced it with a uniform structure and gains will be taxed at the marginal tax rate as applicable to the
tax payer. The implications of these changes are clear: The period of holding has no bearing on the tax
payable and bigger investors will be taxed at higher rates than the smaller ones.

A mixed bag

For the corporate world, the proposed reduction in the tax rate to 25 per cent from the existing 30 per cent
is certainly good news and will help lowering the tax burden of Ìndia Ìnc in a big way. But at the same
time the Tax Code proposes to do away with many exemptions that help lowering the tax. Ìn a significant
policy change, the Tax Code plans to discontinue all profit linked incentives for area-based investments
like setting up plants in a backward area or in the north-east with investment-linked incentives in specific
sectors like infrastructure, power, exploration and oil production etc.

Moreover, under the new proposal, tax holiday will not be for a specific period, as is the case now, but
will be equal to all capital and revenue expenditure barring land, goodwill and debts.

Once a firm recovers the permitted investments and profits will be taxed. This change is aimed at
incentivising capital formation in critical areas and remove incentives to shift profits from the taxable unit
to the exempted unit.

On the mat

The Tax Code has also proposed changes in the calculation of minimum alternate tax (MAT) payable by
corporates. MAT will now be levied at 2 per cent of the value of gross assets of a firm in case of all
companies except for banks which will pay tax at 0.25 per cent. This shift in MAT from book profits to
gross assets is aimed at encouraging optimal utilisation and increased efficiency of assets.

But Ernst & Young Partner- Tax & Regulatory Services, Sudhir Kapadia feels that this proposal seems to
run counter to the objective of encouraging of capital investments for productive growth. Vasal of KPMG
also of the view that changes in MAT rule will cause hardship to loss making companies as they will have
to pay tax on assets.

Carrot and stick

Ìf the Tax Code is generous in giving relief to tax payers, be sure, it will also make life miserable for those
who evade tax through fraudulent means. As the Tax Code prescribes stiff penalties and prosecution for
non-compliance with the tax laws, it proposes that every tax offense under the Code will be punishable by
both imprisonment and fine.

Apart from defaulters, the Tax Code proposes to punish tax consultants who help in tax evasion. Ìt gives
sweeping powers and blanket protection to Ìncome Tax officials for initiating court proceedings on matters
relating to tax offences.

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