DIRECT TAX CODE

Pankaj K. Jain

INTRODUCTION• The much-awaited revised discussion paper on the Direct Tax Code

(DTC) is set in the public domain by the Manmohan Singh government. The earlier discussion paper on the Direct Tax Code Bill was released in August 2009 to receive public feedback and inputs on the proposals. The revised paper is said to have addressed some of these issues after attracting sharp criticisms from several quarters on various grounds.

• The new simplified tax code, which is likely to be introduced in Parliament in the forthcoming monsoon session, is expected to raise tax slabs and lift the ceiling for tax-free savings. The new DTC will replace the decades old Income Tax Act.

• At least, for now, there is some sort of relief from the amended proposal as compared to the previous one that intended to tax the savings at the last stage of withdrawal of the investments as per the Exempt-Exempt-Tax (EET) methodology of taxation.

Capital Gains

• Under the proposal on the capital gains, the government intends to do away with the distinction between the short-term and long-term capital gains in a bid to bring simplicity in the taxation of capital gains.

• The discussion paper recommends that the capital gains of the tax payer will be added to their total income. Thus, the tax liability of the assessee, on account of income from the sale of capital assets, would be in line with their income slabs. The capital gains will be considered as income from ordinary sources.

• Now, this move will definitely hinder the long term savings. Currently, investments in stock market assets and equity-oriented mutual funds which are held for more than 1 year are considered as long-term capital assets and are not taxable. Whereas income from short-term investments that are held for less than 12 months from the date of acquiring such assets are taxable at rate of 15%.

• The phasing-out of distinction between short-term and long-term capital assets may not provide incentive to an investor to hold their equity assets for a longer duration, if their actual investments are yielding capital gains over a shorter period of time frame. They may be tempted to book gains more frequently as and when available and take home the profits that are accruing, irrespective of the time period.

House Property

• The earlier version of DTC code had proposed that the gross rent from house property that has been rented out be computed at a presumptive rate of 6% with reference to the cost of construction or acquisition.

• The second draft of DTC has done away with this presumptive rate of calculation for the gross rent. It recommends that the gross rent for taxation will be the actual rent received in case of houses that are let out.

• Deduction on interest payment for the loan taken by individual borrowers for acquiring (or constructing) a house property would continue to enjoy the tax benefit subject to a ceiling of Rs.1.5 lakh (only for one house that is used for residing purpose).

Minimum Alternate Tax

• A minimum alternate tax (MAT) is the one which is had to be paid by the companies that are enjoying various tax exemptions under different schemes. In the previous draft code, the Centre had proposed levying MAT on the asset base of the company – at the rate of 2% on the value of gross assets for all the non-banking companies.

• However, due to practical difficulties in calculating the MAT for the loss-making companies as per the older version of the proposal, the revised draft code set out by the government says that the MAT should be calculated on the book profits. Thus, the new proposal would ensure that the loss-making companies do not get away from their legitimate taxation liabilities.

• The modified directive on the MAT would come as a big relief to capital-intensive sectors such as infrastructure and capital goods among others. The older proposal of calculating MAT on asset base could have translated into effective higher tax rate based on huge asset base for the companies operating in such industries.

Savings• On public demand, the finance ministry has agreed to

abandon its previous proposal on tax retirement benefits under Provident Fund. In the absence of a social security scheme, the new proposal provides for an Exempt-Exempt-Exempt (EEE) method of taxation for the government provident fund, PPF and recognized provident funds. Even pure life insurance products and annuity schemes are approved under tax exempted categories.

• Thus, the government has proposed not to levy tax on the earnings from investments, made by the people, with intention of saving taxes in long-term saving instruments. However, withdrawals of savings above Rs.3 lakh will be taxed.

• The modified draft also includes pensions administered by interim Pension Fund and Regulatory and Development Authority (PFRDA), including pensions of government employees who are recruited since January 2004, under the EEE treatment.

• Though, this measure may act a booster for public savings and income, it may sum up into potential losses in terms of prospective government revenues from taxes that could have been earned during the maturity (or withdrawals) of such savings as per the EET methodology of taxation, proposed during the earlier version of the DTC.

Foreign Firms and Flows

• The revised tax code has sought to clear the ambiguity regarding the treatment of income earned by foreign institutional investors (FII) from securities transactions will be classified as capital gains and not business income, a step which could increase their tax liability. This modified status of income being classified under the capital gains would also make the FIIs eligible to pay advance tax installments, just like any other corporate.

• The new code has also succeeded to address the concerns of the foreign firms on the issue of treaty override. The code clarifies that those foreign firms having a part of business operations in India for a certain period could be treated as a resident company liable to tax over here.

Salient Features• Here are some of the salient features and highlights of the DTC:• 1. The concept of “Previous Year” has been replaced with “Financial Year”,

which essentially means the year beginning from 1st of April of the respective year. Thus financial year 2009-10 would mean the year beginning on 1st of April, 2009.

• 2. Income has been broadly classified into two heads, which are:• Income from Ordinary Sources • Income from Special Sources • 3. Income from Ordinary Sources includes:• Income earned as Salary • Income from Business or Profession • Income from House Property (rental income) • Capital Gains • Residual income from miscellaneous sources • 4. Income from Special Sources includes:• Winning from Lotteries • Winning from Horse Race etc. • Specified income of Non Residents

Salient Features• 5. Any losses arising of Ordinary Sources may be eligible to be

set off or carried forward against income from Ordinary Sources ONLY without any time limit. Similarly for Income from Special Sources.

• 6. Scope of income is expanded to include value of perks, gifts, profit in lieu of salary and capital gains but excludes farm income.

• 7. DTC removes most of the categories of exempted income. In order to make up for the same, the tax rates and slabs have been modified. In effect on the first glance the tax liability looks a lot less with the new rates and slabs – however, there needs to be calculations made to get the true impact of overall tax liability. This particularly holds true for people who have been claiming the “home loan” tax benefits.

Salient Features

• 8. The tax rates and slabs have been modified. The proposed rates and slabs are as follows:

Annual Income Tax Slab

Up-to INR 160,000 Nil

Between INR 160,000 to 1,000,000 10%

Between INR 1,000,000 to 2,500,000 20%

Above INR 2,500,000 30%

9. The DTC abolishes the difference between Short Term Capital Gain and Long Term Capital Gain - and makes Long Term Capital Gain taxable. Therefore, the “Capital Gains” on shares and securities is to be taxed as income. Capital gains on investment assets (equities and units of equity oriented funds) held for more than a year to be computed after deducting a specified percentage, without indexation, and added to total income of the taxpayer.Capital gains on asset held for less than a year from the end of the financial year in which it is acquired to be computed without specified deduction or indexation.

Salient Features• 10. The securities transaction tax or STT has been abolished.• 11. The upper limit on Tax Savings based investment has been hiked from

INR 100,000 to 300,000.• 12. The long term savings schemes (e.g. PPF) would be moved from EEE

(Exempt-Exempt-Exempt) to EET (Exempt-Exempt-Taxed) method of taxation.

• The savings are exempted from Taxation (subject to the INR 300,000 limit) • The accretion of income till withdrawal is exempted • Any withdrawal made is taxable with the only exception of: Withdrawals

pertaining to approved Provident Fund accumulated balance as on 31 st of March, 2011.As per changes on 15th June, 2010, Tax exemption at all three stages—savings, accretions and withdrawals—to be allowed for provident funds, pension scheme administered by PFRDA, pure life insurance products & annuity schemes. Earlier DTC wanted to tax withdrawals.

• 13. ULIPs, Equity MF (ELSS), Term deposits, NSC (National Savings certificates) and house loan principal repayment will loose tax benefits.  Only GPF (general provident fund),  PPF (public provident fund), NPS (New pension scheme by PFRDA), annuities and pure life insurance (term insurance) schemes will be exempt from tax at all 3 stages.

Salient Features• 14. No tax deduction is allowed on interest payable to banking

firms and insurers.• 15. Dividend will continue to be tax-free in the hands of investors.• 16. For incomes arising of House Property, the Gross rent is to

be calculated as the higher amount of:• The contractual value of the rent’ • Presumptive rate of six percent of rateable value / construction

cost / acquisition cost • 17. Deductions towards interest payment of House Loan for the

self occupied property would not be allowed in the DTC. Exemption will remain same as 1.5 lakhs per year for interest on housing loan.

• 18. Deductions for Rent and Maintenance would be reduced from 30% to 20% of the Gross Rent.