The government has proposed a dramatic makeover of the country’s 48-year tax law, bringing it on a par with the new economy and also with what prevails in the rest of the world.
The draft of a new direct tax code introduced by the finance ministry on Wednesday has suggested significant cuts in tax rates for individuals and companies, pruned exemptions, choked loopholes for foreign companies and radically changed definitions, all of which are likely to have a mixed impact on companies and individuals. Together with greater surveillance, it would ensure greater compliance and thereby reduce the risk of any loss in tax revenues due to a cut in rates.
“The underlying philosophy of the code is the philosophy of the government. (It is) wedded to a well-regulated free market system,” P. Chidambaram, current home minister who was involved in preparing the draft code earlier, said at a press conference called by finance minister Pranab Mukherjee to release the draft code. Mukherjee said he would strive to introduce the draft legislation in the winter session of Parliament.
The overall approach of the finance ministry has been to find ways to increase the tax base, avoid ambiguity as far as possible to eliminate scope for litigation and promise to keep rates and the Act’s provisions stable.
This is likely to cheer companies, Ganesh Raj, partner at Ernst and Young, said. “Consistency, and certainty are things industry most wants.”
The draft code has also been prepared in a way that allows the income-tax department to sidestep regulatory functions and there is no need to use tax law to regulate any sector, Mukherjee said.
The code suggested a flat tax of 25% on profits of all firms and has enhanced tax slabs for individuals to an extent where a person with an income of Rs10 lakh would be liable to pay less than half of the current tax. For higher incomes, the reduction in incidence of tax for individuals is higher, according to the code.
Simultaneously, the draft code has pruned exemptions, including tax benefits on home loans currently available to individuals. In the case of companies, definitions have been altered in a way that is likely to have a mixed impact.
Also See Proposed Changes
“Very significant and fundamental changes have been made and the impact will depend on the company,” Ketan Dalal, executive director at PricewaterhouseCoopers, said, on the implication of the change in definitions.
A critical change in definition is one pertaining to companies resident in India. The definition draws in their overseas subsidiaries, which may be under at least partial management control. The enhanced scope of the definition would target companies set up overseas with Indian money, which subsequently carry out operations in India, a tax consultant, who did not want to be named said.
Another area of critical change is the manner in which minimum alternate tax (MAT) is calculated. The draft code has suggested calculating MAT on gross assets instead of book profits. Further, companies would be required to pay the higher amount of MAT, or 25% tax on profits.
The implication is that a company that records a loss might still have to pay tax based on MAT. The mode of calculation of tax might also impact companies with a large asset base.
“Linking MAT to asset base is distortionary,” said Aseem Chawla, leader of tax practice at Amarchand and Mangaldas and Suresh A Shroff. Asset base today does not have direct correlation to earning capacity, he added.
The draft code has proposed business losses can be carried forward indefinitely.
The impact of the draft code on foreign companies is likely to be mixed. The effective tax rates will be higher as compared with Indian firms as foreign companies have to pay 15% tax on branch profits over and above the 25% tax rate.
Given the extent of internationalization of business in India, there have been high-profile tax disputes between overseas companies and revenue in the recent past.
The draft code has introduced provisions dubbed general anti-avoidance rule (GAAR), which appear to be designed to eliminate grey areas used by overseas companies with operations in India.
On the face of it, GAAR would seem to apply to recent tax disputes such as the one between Vodafone Group Plc. and the revenue department. Vodafone acquired a controlling stake in its Indian telecom assets from a holding company based overseas. The transaction was concluded overseas, and Vodafone approached the judiciary as it felt the transaction was outside the jurisdiction of Indian tax authorities.
Mint couldn’t immediately seek Vodafone’s comments on the relevance of the draft code to its earlier dispute with the revenue authorities.
The draft code simultaneously has tried to introduce a more stable regime for overseas companies through an advanced pricing authority, which freeze upfront some essential elements in calculating tax incidence.
The tax incidence for individuals is expected to be mixed. While the enhancement of tax slabs would reduce the tax incidence at one level, the draft code has also proposed to eliminate tax benefits on home loans.
Tax benefits on both interest and principal paid on monthly instalments of home loans of self-occupied houses have been a contributing factor to the residential real estate boom in the recent years.
The code has also proposed eliminating a crucial benefit in all kinds of social sector saving schemes such as employees’ provident fund and in savings put into life insurance policies. Currently, these savings schemes are exempt from tax at all three critical milestones. Initially, contribution into these schemes are exempt from tax, accretions to the scheme are also exempt, and finally withdrawals are also exempt from tax. The code plans to bring the third stage into the tax net. The final accumulations would be taxed at the marginal rate, which would be a significant change from the current practice.
Teena Jain contributed to this story.