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(Pic: Tribhuwan Sharma)

On 12 August 2009 — four years after former finance minister P. Chidambaram talked about the need for a new tax law — Finance Minister Pranab Mukherjee unveiled the draft Direct Tax Code, which will replace the existing Income Tax (IT) Act of 1961 and other direct tax laws.

Mukherjee said the new code will “improve efficiency and equity of our tax system” and at the same time “eliminate distortions in the tax structure” and “increase the tax base”. The code offers sweeping reduction in corporate and personal tax rates. On the personal tax front, there would be no tax for salaries up to Rs 1.6 lakh; there would be tax at 10 per cent for salaries between Rs 1.6 lakh and Rs 10 lakh; for salaries between Rs 10 lakh and Rs 25 lakh, the tax would be a gross amount of Rs 84,000 plus 20 per cent on the amount exceeding Rs 10 lakh. Similarly, for annual incomes above Rs 25 lakh, the tax would be Rs 3.84 lakh plus 30 per cent on the amount above Rs 25 lakh.

Currently, annual income above Rs 5 lakh attracts a tax rate of 30 per cent.

 
While substantially hiking the personal tax slabs, the code also encourages long-term savings by increasing the annual deduction on savings from Rs 1 lakh to Rs 3 lakh, and following the exempt taxation method on all savings.



WHAT THE DIRECT TAX CODE MEANS


Business losses to be carried forward
indefinitely


Distinction between long- and shortterm
capital gains eliminated


Mutual funds, venture capital funds, life
insurance companies to be treated as pass through entities


Exempt-exempt taxation method for
taxation on all savings


Securities transaction tax abolished


Shifts base year for capital gains from
1981 to 2000

On the corporate front, while the draft code reduces the tax rate from 30 per cent to 25 per cent, in an equally significant move, it also allows business losses to be carried forward indefinitely. According to tax experts, the code breaks away from an exemption-driven tax regime and move towards an investment-based incentive regime.

But there are grey areas, too. Pointing to a clause in the code on the treatment of Indian firms registered aboard, Ketan Dalal, executive director of PricewaterhouseCoopers, says, “A foreign company can either be resident or non-resident in India. It will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated wholly or partly in India.” This can affect the bottom line of companies such as Infosys, which have businesses in Europe and the US.

The code also retains the concept of minimum alternate tax and has based this on gross value of assets as against the current practice of basing it on profits. According to Anurag Jain, partner of BMR Advisors, this is likely to adversely impact capital-intensive sectors as the benefit of enhanced depreciation would be lost.

Terming the code as well thought out, Dalal says the key would be in implementation, especially on aspects such as the anti-avoidance rule to combat tax evasion. A similar sentiment is also echoed by Uday Ved, head of taxation at KPMG, who says while the intent is good, it needs to be seen how it will be implemented.

The government is hopeful of making the draft code a law by 2011. But this timeframe seems ambitious as the fineprint of the code is still being interpreted by stakeholders. After being tabled in Parliament, it could be referred to a Standing Committee. After this, it will be referred back to the government and then back to Parliament. The bottom line: any radical change will take time to happen.

(Businessworld Issue Dated 18-24 Aug 2009)