With 319 sections and 22 schedules, the Direct Taxes Code Bill, 2010 will change the tax structure of the country. What changes and tax reforms it talks about and where it is going to fail in curtailing tax litigations, this article explores this and much more.
The 35-page revised discussion paper on the draft Direct Taxes Code (DTC), seeks to replace the 50-year-old Income Tax Act. The current Income-tax Act, enacted in 1961, had replaced the pre-independence Income Tax Act of 1922. The government had announced its intention to introduce a revised and simplified Income-tax Bill while presenting the Union Budget for 2005-06. In a surprise move and to the disappointment of taxpayers, the government has fixed the implementation of the DTC to April 1, 2012. Let us compare the provisions of the DTC under different heads with the Income Tax Act 1961.
Under the Act, a resident’s world-wide income is taxed. A non-resident is exempt from tax on his foreign sourced income. In case of individuals and HUFs, a thirdcategory of residential status “not ordinarily resident” is there who enjoy exemption in respect of foreign-sourced income (except when such income is derived from a business controlled from India or profession set up in India). The Code proposes to abolish the status of “Not Ordinarily Resident”. However, clause 29 of the Sixth Schedule to the Code exempts from tax any income accruing to an individual outside India.
The most disciplined class of tax payers i.e. salaried employees are proposed to be given the hardest hit by the DTC. Part A of chapter III in DTC relates to income from employment. It has 4 clauses –clauses 20 to 23. There is no definition of ‘salary’ in this clause. For this, a reference to clause 314 is has to be made. The present position is that the amount received in respect of voluntary retirement under the VRS scheme, gratuities received, amounts received on commutation of pension are totally exempt from tax under section 10 of the IT act, 1961. This position greatly varies under the Code. Clause 22 of the DTC stipulated that such amounts would be termed as income initially and would be exempted only if the same were deposited in a retirement benefit account maintained with any permitted savings fund in accordance with the scheme framed and prescribed by the central government. Such a proposal raised issues whether savings were allowed only on pain of payment of tax if not kept in Government monitored savings schemes. Another proposal under the DTC that created uproar was the definition of ‘salary’ which included value of any leave travel concession, medical reimbursement, value of free or concessional medical treatment paid for or provided for by the employer and value of unveiled earned leave. In case of House Rent allowance distinction between employees living in own houses and rented houses has been removed
The significant change as compared to the Act is that tax-free limit for the medical re-imbursement is proposed to be raised from Rs. 15,000 to Rs. 50,000. The definition of perquisite under the Act in section 17(2) is an inclusive definition with exclusions of medical facilities and medical reimbursements. The proposed definition in clause 314(191) of the Code is an exhaustive definition with the present exclusions in respect of specified medical facilities and medical reimbursements retained with changes in monetary limits. To be a perquisite under the Code, what is received from the employer should satisfy the test of being “amenity, facility, privilege or service”.
Contribution to approved superannuation fund exceeding Rs. 1,00,000 in respect of any employee is not taxable in employee’s hands under the Code. The same will be disallowed in employer’s hands. Thus, the Code proposes to reintroduce Fringe Benefit Tax through the disallowance route on such contributions.
The present system of presumptive taxation of both let out and not let outproperties (except one self-occupied property/deemed to be self-occupied property) is proposed to be done away with. Only gross rent derived from actual letting out of property shall be taxed after allowing deductions of: municipal taxes paid, 20% of gross rent towards repairs and maintenance, interest on loan taken for the purposes of acquisition, construction, repair or renovation of the property; and interest on loan taken to repay the loan taken for above purpose.
Will Direct Tax Code not lead to the unsettling settled law on the Income Tax that has been achieved through hard fought litigations? If yes, kindly list out the probable implications of the Act
The most talked about provisions relating to General Anti Avoidance Rules (‘GAAR’) in the Direct Taxes Code Bill, 2010 (‘DTC’ or ‘Code’) have seemingly overshadowed some of the welcome changes, which promote certainty and simplicity in India’s income tax law. To illustrate, the concept of the financial year, which has replaced the use of complex expressions previous year and assessment year under the current law. Seamless computation provisions and process of assessment under the code also merit appreciation. Having said the same, indeed policymakers still have to afford clarity in several areas. Also, the Code in a significant policy change plans to shift all profit linked incentives to investment linked investments. The impact of the same is something that one needs to watch out.
What is the rationale or what necessitates the legislation of the proposed Direct Tax Code?
‘When archaic rules have to be replaced with new ones, the changes must be dramatic and path breaking’ is what the Hon’ble Finance Minister stated at the time of introduction of the new Code. The primary intention behind introduction of the new Code was seemingly to eliminate distortions in the tax structure, introduce moderate levels of taxation, expand the tax base, encourage voluntary tax compliance, simplify the language / process and lower tax litigations.
What according to you may be the right ingredients to be put in the Direct Tax Code to bring in a robust, efficient and simple Tax law in the country?
The effective implementation of the Code by the tax authorities will be critical to its success. The importance of policy statements, departmental circulars, notifications and guidelines in providing clarity to the taxpayers and ensuring uniformity in the tax authorities’ approach and understanding of the law cannot be overemphasized. Moreover, the new tax regime should be used as an opportunity to usher in a renewed cooperation amongst all stakeholders in the fiscal system – policymakers, the practitioner community, the tax authorities and the courts.
There is a long list of some 43 heads of deductible operating expenditure with the44th clause being a residual clause “any other operating expenditure”. This is not in any way going to reduce litigation. People will only try to book expenditures under the 43 heads and the basic objection that was raised against FBT and led to its abolition now applies to these 43 heads also.
The Code provides that “amount accrued to, or received by, the person from his employees as their contribution to any fund for their welfare” shall be part of gross earnings from business. Deduction will be allowed of contribution to any fund for the welfare of employees to the extent (a) The amount has been received from his employees as their contribution to the fund and (b) It is actually paid.
Income under the head ‘Capital Gains’ will be considered as income from ordinary sources in the case of all tax payers including non-residents. It will be taxed at the rate applicable to those tax payers. Capital asset held for a period of more than one year from the end of the financial year in which asset is acquired. Listed equity shares or units of an equity oriented fund, capital gains shall be computed after allowing a deduction at a specified percentage of capital gains without any indexation. Similarly, loss arising on transfer of such asset will be scaled down in a similar manner.
Other assets:
Income arising on purchase and sale ofsecurities by an FII shall be deemed to be income chargeable under the head ‘capital gains’. No TDS on such income, however, they will have to pay advance tax. Under the Code, the current 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.
The DTC proposes to abolish Securities Transaction Tax. Therefore, all capital gains (loss) arising from the transfer of equity shares in a company or units of an equity oriented fund will form a part of the computation process. The DTC also proposes that a new Capital Gains Savings Scheme will be framed by the Central Government. Capital Gains deposited under this scheme will not be subject to tax till the withdrawal from such scheme.
It is a well known remark that equity and taxation are strangers. Minimum Alternate Tax (MAT), first introduced in the Finance Act 1987, was inspired by similar levies in western countries, where the objective for introduction of MAT was to increase the revenue based by the government from tax collection to accomplish their planned economies. In India, MAT was introduced in the statute by virtue of section 115J in an effort to tax ‘zero tax companies’- the companies which have large profit in their books but for purposes of the Income-tax Act 1961 by virtue of various incentives / deductions which have been claimed, have little or negligible taxable income..
As regards applicability of other provisions of the code, Clause 107 here is similar to existing section 115JB (5) of the IT act, 1961.
One of the significant areas of tax reform under the direct taxes is with respect to pruning of exemptions and deductions granted while computing taxable income. During the last fifty years, number of exemptions and deductions has been increasing resulting in taxing artificial income. In the last five years, there has been increasing awareness amongst the policy-makers about the cost of such exemptions and deductions. It is being felt that the revenue foregone in the process of granting exemptions and deductions is nothing but an expenditure which is named as ‘Social Expenditure’. Each exemption and deduction has its objective. For example, in the case of deduction from gross total income granted under section 80C, the objective is to give relief to the taxpayer for savings made for future, more particularly for his retirement age. Apart from that the savings so made are also providing resources for capital formation. In order to give greater push, the model followed so far was threepronged viz., (a) to provide tax incentive in the year of investment, (b) not to levy tax on the income accruing on suchinvestment, and (c) not to charge any tax when the investment matures in future. Thus, from the perspective of taxability, the entire process remains tax-free, i.e., Exempt, Exempt and Exempt (EEE).
A large number of representations have been made with regard to the proposed EET system. It has been stated that most countries that follow the EET method of taxation of savings also have a social security system in place for all their citizens. The EET savings accounts which operate for individuals in these countries are over and above the mandatory social service payments received by them. It has been represented that in India, in the absence of a universal social security system, the proposed EET method of taxation of permitted savings would be harsh. Tax payers require some flexibility in making withdrawals in lump sum without being subjected to tax. People may need lump sum funds on retirement for various family obligations. Requests have therefore been made for continuation of EEE method of tax treatment of investments. Alternatively, the applicationof EET should be restricted to new savings instruments after the date from which the DTC comes into effect, and it should not apply to existing saving instruments.
In order to encourage net savings, it is proposed to rationalise tax incentives. For the said purpose, the DTC proposes EET method of taxation. With the introduction of EET, goods and service tax as proposed with effect from 2010, open economy, free flow of funds on current account, etc., we shall be moving with the other developed countries. All these are major moves in the process of reform. Since these are structural changes, they are bound to create uncomfortable conditions for large number of persons. For the taxpayer, ‘T’ in the EET will never look like preferable to EEE. However, looking at EET as a certainty, one will have to learn to live under it. The only alternative for the taxpayer is to organize the affairs in such a way that there is no additional burden due to tax-outflow. Therefore, as of now, it is proposed to provide the EEE method of taxation for Government Provident Fund (GPF), Public Provident Fund (PPF) andRecognised Provident Funds (RPFs) and the pension scheme administered by Pension Fund Regulatory and Development Authority. Approved pure life insurance products and annuity schemes will also be subject to EEE method of tax treatment. In order to achieve the objective of long term savings, the rules for contribution as well as withdrawal will be harmonised and made uniform so that such savings are actually made and utilised by the taxpayer for the long term. Investments made, before the date of commencement of the DTC, in instruments which enjoy EEE method of taxation under the current law, would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument.
The new DTC has 319 sections and 22 schedules as against 298 sections, 14 schedules under the income tax Act, 1961 and 47 sections and three schedules under the Wealth Tax Act. The law which had been subject to review by Parliament and scrutiny of the Supreme Court, High Courts and Tribunal and led country’s growth is proposed to be crucified by a legislation
In the present case, the necessity of committees, debates, discussions, etc. was not considered necessary. The government appears to be in great hurry to get it passed. The DTC is stated to have been drafted in a common man’s language so that it is easily comprehensible by the taxpayers, which would lead to better tax compliance. Tax laws by their very nature are very complex. The complexity is not because of the language but because of the nature of the subject.
The DTC has as many Schedules, containing substantive and even computation provisions. These should have been enacted in the Code itself. Some important taxing provisions of the Income-tax Act, 1961 have been shifted to Schedules, such as income not to be included in the total income, persons exempt, computation of income from any other special source, etc.
This is perhaps done to avoid frequent amendments in the Code, which claims to be containing essential and general principles so that the changes as regards matters of details are accommodated through rule/Schedule. Exemption of income or computations of profits are matters of substantive law and not of details so as to find place in the Schedule. Neither from the foreword nor from the discussion paper(s) one can find the policy (relating to direct taxes) framed or considered in making of DTC. It only deals with the mechanics. It does not spell taxation principles to be applied, the objective of the DTC (in terms of overall economic policy), the role of taxpayers (barring onerous obligations) and the role of administration (barring wide powers) in making it effective discussion paper.
Separate threshold exemption limits for men and women done away with common threshold limit of Rs. 2,00,000. For resident senior citizens, threshold increased from Rs. 2,40,000 to Rs. 2,50,000. The slab attracting 20% tax is Rs. 5,00,000 to Rs. 8,00,000 at present. Under the Code, the slab attracting 20% tax is Rs. 5,00,000 to Rs. 10,00,000. For all those earning up to Rs. 8,00,000, tax relief is a meager amount of Rs. 4,000 (for men) and Rs. 1,000 (for women and senior citizens).
The Act of 1961 has been in force for about 48 years. Almost all issues have been settled and constitutionally determined. The Code is not drafted in a legal language. The Code may not be a good vehicle to convey the legislative intent on tax matters. The set pattern of tax laws – of first defining the chargeability, then classifying, computing, aggregating and quantifying income is not followed under the new direct tax code. Computing provisions are scattered and some of them have been pushed to schedules. Under the code all rights and obligations of the tax payer and the tax administration will be in reference to ‘financial year’. The law remains as complex as before as it is only an amalgamation of the Income tax Act 1961 and the Wealth tax Act 1957. The code does not introduce any new concepts and the litigations will continue unabated under it.
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