The Direct Taxes Code (DTC) Bill has been tabled in Parliament and straightaway referred to a parliamentary standing committee on finance for review. The deadline for replacing the archaic Income-tax Act has been shifted from 1 April 2011 to 1 April 2012, which seems imperative because the select committee will need time to look into the finer aspects of smooth transition to the new regime. The deadline shift is a relief for investors because it would allow more time for evaluating the tax cost of doing business in the DTC regime.
The Bill proposed a northward revision of tax rates vis-à-vis the original proposals in the DTC. The change had been much anticipated on account of restoration of the Minimum Alternate Tax on companies from their asset base to book profits and on account of dropping the contentious proposal for taxing long-term savings such as provident funds at the time of withdrawal.
Tax partner and national leader, policy advisory group, Ernst & Young
The original code had proposed the levy of a gross asset tax (GAT) on firms at the rate of 2% of gross assets. The proposal had attracted maximum resistance as it was not linked to profits and could have resulted in taxation of loss-making companies. Thanks to the aggressive representations against the GAT proposal, the MAT regime has been linked to profits in the DTC Bill and has been kept at 20%, against an effective tax rate of 19.93% under the current Act. At the same time, the corporate tax rates are proposed at 30% for all taxpayers, including Indian and foreign firms and partnerships, against the original proposal of 25%.
A new concept of branch profits tax (BPT), which was introduced in the original DTC, whereby “every foreign company” shall be liable to pay a BPT of 15%, has been retained in the Bill. BPT on total income is comparable to the dividend distribution tax (DDT) payable by Indian domestic firms at the rate of 15% on the amount of dividends distributed. While DDT is payable at the time of distribution of dividends, BPT is not linked to remittance of profits to the head office. Thus, effectively, the corporate tax liability imposed on a foreign company would be 40.50%.
The capital gains tax regime seems to be a sandwiched version of the current provisions and the first draft of the DTC. While there is no concept of long-term or short-term gains, a graded taxation for listed securities has been introduced depending upon the period of holding, and, at the same time, the securities transaction tax (STT) shall continue. If the period of holding of listed securities is more than a year and STT is paid, there will be no capital gains tax. For holdings of less than a year, 50% of the effective tax rate would be applicable on capital gains. For example, individuals shall be subject to effective slabs of 5%, 10% or 15% on such gains. All other kind of capital gains shall be taxable as any other income.
While the DDT scheme is largely unchanged, except for a marginal reduction from 16.61% to 15%, the DTC Bill proposes to levy tax at the rate of 5% on income distributed by a mutual fund to the unitholders of equity-oriented funds or a life insurer to policyholders of an approved equity-oriented insurance scheme, which under the current tax laws is exempt from distribution tax. This additional levy is likely to increase the tax costs and equity-oriented mutual funds may be less lucrative now.
The proposed DTC has introduced the concept of controlled foreign corporations (CFCs), which inter alia provides that the total income of a resident assessee for a fiscal year shall include an income attributable to a CFC. The mechanism specified in the DTC purports to capture the income earned by the CFC during the fiscal apportioned to the Indian stakeholder to the extent of its share in the profits of a CFC less any amount received during the fiscal year as a dividend from such an entity.
Lastly, the much debated general anti-avoidance rules (GAAR) have been retained, which seek to give wide powers to authorities to declare any transaction as impermissible or reclassify a transaction which is deemed to have been entered for tax avoidance. A detailed guideline on GAAR provisions would be prescribed for implementation of the provisions in the right spirit.
While the Indian tax system for tomorrow would look at a tax-GDP (gross domestic product) ratio in the range of around 25% with a higher share of direct taxes to ensure a more progressive tax structure, this can only be achieved through a broader base and improved administration and compliance. The direction of the government’s tax reforms and the stated objective in the original discussion paper—to establish an economically efficient, effective and equitable direct tax system—is only partially achieved for the time being. The dilution of provisions has led the potential tax base to shrink and affected the transition to a lower tax regime. However, as the new system settles, the industry can look forward to a stable and efficient tax regime that also provides it a competitive edge in the international arena.
These are the author’s personal views.
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