The much awaited draft direct tax code (DTC), unveiled last month, is an attempt by the government to simplify and rationalize existing tax laws, rates and exemptions and make them more equitable. The draft released by the government is accompanied by a discussion paper that outlines the intent behind the proposed structural changes and new provisions. Here are the key highlights of the draft that affect corporate taxpayers (see table 1).
Other important changes include expansion of the tax deduction at source (TDS) regime to cover all types of incomes, simplification of provisions relating to carrying forward and setting off of losses and the introduction of general anti-avoidance principles for resident as well as non-resident taxpayers.
• Similar provisions have been regrouped
• Redundant provisions removed
• Separate schedules listing comprehensive provisions such as the calculation of tax holiday for developing special economic zones, operating ships, and running minerals and natural gas businesses, and so on
• Mathematical formulas provided for calculations that may not be easily expressed in sentences
The effort has been worth it. It has reduced the number of tax sections to 285 from more than 600 sections in the existing Income-tax Act, 1961. The language used is far simpler, contains less technical and legal jargon, fewer cross references, shorter sentences and bullet points.
Also See Meeting Expectations (Graphics)
The expectation is that the new provisions will be less dispute-prone. Of course, the purpose of the new DTC will be served only if it is not frequently tweaked; the large-scale amendments introduced every year to the Income-tax Act have made the law complicated and cumbersome.
Now, let’s have a closer look at some of the key changes affecting the tax burden on corporate tax payers.
MAT as asset tax
One setback is on account of the proposed replacement of profit-linked minimum alternate tax, or MAT, with asset-linked MAT. The expectation was that the current MAT (applicable at 16.9% on accounting profits) will be totally withdrawn, particularly if tax incentives are removed. There is surely a fallacy in the argument put in the discussion paper that MAT is necessary because of the erosion of the tax base on account of incentives. Since the mantra now is to withdraw incentives, there is no case for MAT.
The DTC proposes the MAT levy based on gross assets (i.e. book value of all assets less book depreciation, effectively the capital of a company) with no carry forward/set off. What does this imply?
• It means that tax is on capital rather than revenue or profit. This impacts all capital-intensive firms such as manufacturing, automobiles, steel and power that are not able to achieve book profits in the initial years of operation. This seems unconstitutional because income tax is levied on income and not on capital.
• The basis is gross assets and not net assets (net of debt). Indirectly, it is a tax not only on shareholders capital but also on borrowed capital.
• It is a final tax and cannot be carried forward for future credit/offset.
• Even a loss-making company has to pay the tax, which can’t be offset in subsequent years.
An analysis based on some listed firms reflects that even in the case of profit-making firms, the 2% gross assets tax would, as a percentage of accounting profit, vary significantly from 4.47% (in the case of home and personal care product makers) to as high as 21.5% (in the case of engineering firms) and 56% (in case of one of the telecom firms). This shows that MAT in its new avataar will be harsher than existing MAT and even higher than normal tax on some firms.
Effective corporate tax
With the repealing of the fringe benefits tax in Budget 2009, followed by a proposed reduction in the corporate tax rate from 33.99% to 25% in DTC, corporate taxpayers may have been initially overjoyed.
However, the relief seems illusory. The effective tax rate for most large corporate taxpayers is currently in the range of 15-20% owing to tax incentives. With no or fewer tax incentives in the future, the DTC seeks to impose a tax rate of 25%. This, however, only relates to taxpayers enjoying incentives; in other case, the lowering of tax rates would definitely reduce the tax burden.
Dividend distribution tax
There is no major change in the dividend distribution tax, or DDT, to be paid by domestic firms except that, owing to removal of the surcharge, the DDT rate will be marginally reduced from 16.99% to 15%.
There is a strong case to reduce the tax rate from 15%, as DDT in any case is a surrogate tax being paid by firms on dividend income on behalf of shareholders. With the individual tax slab proposed to be enhanced, it is better to return to the old system of taxing the dividend in the hands of shareholders and to increase the threshold limit for TDS on dividend income.
Ganesh Raj is tax partner and national leader of the policy advisory group at consultancy Ernst and Young.
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Graphics by Ahmed Raza Khan / Mint