Like most other pieces of legislation, we inherited our Income-tax (I-T) Act from the British. Originally introduced in 1922, the Act was revamped in 1961. Direct tax laws, encompassing both the I-T Act and the rules as they stand today, are truly baffling with a plethora of interwoven sections, subsections, clauses, subclauses, cross references, explanations and provisos. Of the five-decade-old I-T Act, a patchwork of amendments carried out from time to time, largely through annual fiscal budgets and occasionally through various amendment Acts, have added to the complexity.
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Statistics never lie, and these statistics point to an urgent need for simplification of the I-T Act. The I-T Act originally contained only 298 sections and it is interesting to know that out of 298 original sections, only 62 sections have been deleted. Over the last 48 years, 208 sections have been amended and only 28 sections remain in original form without any amendment. As many as 390 new sections (some of which stand deleted) have been inserted over the years. Today we have about 625 sections. This figure of 625 is mind-boggling, to say the least, but hang on—it does not cover the rules, circulars and notifications which are also part of tax laws.
In his budget speech of 2005, then finance minister P. Chidambaram announced the intent to introduce a brand new and simplified I-T Act. Since then, we have often heard announcements that a new draft Bill revamping the entire I-T Act is around the corner, but in the public domain, little is known of its status or the key areas that have been taken up for simplification. Hopefully, the draft Bill will soon see the light of day for public discussion.
Some of the key issues/provisions which should stand in front of the queue, when it comes to simplification and rationalization are detailed below:
Often, tax provisions are subject to varied interpretation, recourse even has to be taken to the “introduction memorandum” of each section to understand the intent of that particular provision. The problem lies in the complexity of language used. Amendments to the sections further complicate the matter.
A classic example is section 10(23C) which exempts income received by certain entities such as hospitals, educational institutions, etc. This section was originally a simple provision; today it runs into at least five pages and contains as many as 15 provisos. (Provisos can be termed as additional provisions which require meeting of certain criteria, in the absence of which the main section will not apply.)
Or take another instance of the use of a single running lengthy sentence, worse still if it contains the terms “inclusions” and “exclusions”, adding to complexity.
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For example, explanation 2 of section 271(1)(c) (this section deals with penalty for concealment of income) is narrated by a single running sentence containing more than 290 words. A web of cross references is another area where drafters have very often stumbled while making amendments to sections as they often miss making suitable changes across all relevant sections.
When it comes to usage of language, another dichotomy exists in the tax incentive sections which originally were introduced in three categories: (i) Exemption provisions for income (ii) Deduction from gross total income (iii) Deduction from the respective head of income (tax laws tax income under various heads, such as salary, house property, income from profits and gains of business or profession, etc).
The classification of tax incentive provisions has a key impact on the taxpayer and the quantum of tax benefit that can be availed. While the incentive falling under category (ii) can only benefit the taxpayer if the gross total income (GTI) is positive and the benefit will be restricted to GTI, this is not the case for incentives falling under category (iii), where deduction is available from the income of the respective head and in situations of low profitability, the deduction can be claimed over the years by way of carrying forward such unabsorbed benefit. However, over the years, new beneficial provisions have been added depending upon the need to give a spurt to a particular activity/ business/investment in a haphazard manner without giving due emphasis to the right classification.
To illustrate: section 80JJAA provides for weighted deduction of 130% of the wages paid by labour-intensive manufacturing units to promote employment. This incentive falls under category (ii) and cannot be availed if GTI of the company is not positive. On the other hand, section 35(2AB), which provides for a weighted deduction of 150% of the expense on in-house scientific research is an incentive falling under category (iii). This incentive can be claimed fully even if there is insufficient business income and can also be carried forward and set off in subsequent years. There appears to be no rationale behind the different tax treatment provided for these two sections enumerated above. Various other ambiguities surround these tax incentive provisions and historically, these provisions have been disputed by tax authorities on frivolous grounds in contradiction to the intent with which these were introduced. Clubbing of provisions of tax holidays and putting them up for deduction under the head “business profits” will help mitigate litigations.
Other areas of litigation are those relating to taxation of non-residents, which must be compatible with international norms and tax treaty provisions. Transfer pricing is another area that needs rationalization. In addition to the above, legislators may consider withdrawing some of the tax regimes such as the minimum alternate tax (MAT) and fringe benefit tax (FBT). The MAT regime has already lost significance because of availability of tax credit in subsequent years and also narrowing of the gap between book and tax profits, and FBT merely contributes approximately 2% of direct tax collections to the government treasury.
There is clearly a strong case to rewrite the I-T Act in toto on a new slate with farsightedness so that the provisions do not need frequent amendments for a reasonable time. Removal of ambiguity, less usage of legal jargon or mathematical formulas/expressions, removal of redundant provisions, grouping of similar provisions, avoidance of frequent cross references and well-thought-out procedural law may add significant brand value to the new law.
Ganesh Raj is tax partner, policy advisory group, Ernst and Young. This is the first of a four-part series on key issues which need to be addressed by the proposed overhaul of the direct tax code. Respond to this column at email@example.com