A completely new and revised Direct Tax Code

Taxation of income in India, till now, is governed by the fifty years old Income Tax Act (IT Act) which came into legislation in 1961. But this Act has been criticized for being economically inefficient, incompatible with the current requirements and inequitable to all tax payers. It was neither cost effective nor was able to encourage voluntary compliance. So, in August 2009, the Ministry of Finance came out with the draft of Direct Tax Code (DTC) bill with the purpose of replacing the existing IT Act and also invited the public for discussions and feedback on the draft proposal. It will be a key tax reform by the government aiming at widening and deepening the tax net; and increasing tax revenue. But the draft bill had received lot of criticisms on certain amendments or changes in relation to the removal of existing tax subsidies, and modifications in the tax rate structure that it sought to introduce. So, in June 2010, the ministry again issued a new revised direct tax code bill, incorporating all the criticisms, and presented the draft to the Union Cabinet. As per the news reports, on 31st August 2010, the draft bill has been approved by the Cabinet as well as the Parliament and the new DTC will come into force from 1st April 2012. The rationale for introducing DTC is to increase the efficiency and equity of the tax system by eliminating the plethora of tax exemptions or subsidies that create distortions. Its major policies include replacement of profit-linked exemptions with investment linked incentives, particularly for export units, and reduction in the tax rates to bring more people and companies under the tax net. The salient features of the New Revised Direct Tax Code bill that would mostly have an impact on the financial status of the salaried class and corporates - are as follows: Salaried Class The new revised DTC have raised and widened the income tax slabs compared to those existing under the IT Act, nevertheless the tax rates are same, the highest marginal income tax rate being 30% for all. Under the new regime gender distinction, in terms of additional exemption limit available to women taxpayers as per the existing norms, has been removed. For males and females Income slab existing Rate of income tax Up to Rs 160,000 NIL Rs 160,001 to Rs 300,000 10% Rs 300,001 to Rs 500,000 20% Above Rs 500,001 30% Income slab proposed by new revised DTC Up to Rs 200,000 Rs 200,001 to Rs 500,000 Rs 500,001 to Rs 1,000,000 Above Rs 1,000,001

The basic tax exemption limit for an individual male and female has been raised and brought at par from Rs 160,000 and Rs 190,000 to Rs 200,000 per annum. Senior citizens, however, will now enjoy a tax exemption on income up to Rs 250,000 per annum instead of Rs 240,000 allowed now.

 On the proposals of taxation of savings, in the form of provident funds whether public provident fund, government provident fund, or employees provident fund, the new DTC has reverted back to the existing Exempt-Exempt-Exempt (EEE) method from the earlier proposed Exempt-Exempt-Tax (EET) scheme. In the new DTC savings limit allowed for deduction from the taxable income has been increased from the existing limit of Rs 120,000 (including Rs 20,000 for investment in infrastructure bonds) to Rs 150,000 which is decomposed as Rs 100000 for investment in provident funds, pension funds and other approved securities; and Rs 50,000 for childs tuition fees, life insurance and health insurance premiums. As far as investment in housing is concerned, the new DTC has continued with the deduction owing to interest payable on a housing loan for up to Rs 150,000 per annum but it will be allowed only on the interest component of the installment and not the principal amount. The new revised DTC has decided not to introduce any concept of presumptive tax. In the case of retirement benefits, the existing rule is EET method under which any withdrawal from the Retirement Benefit Account (RBA) is taxable. But the New Pension Scheme proposed under DTC suggests a completely new EEE scheme that exempts even withdrawal. The limit for employees contribution to his pension fund that will be deducted from his taxable income has been increased to Rs 300,000 from the existing limit of Rs 100,000 per annum. Taxation of capital gains has gone through a change under the new DTC. Though it has retained the policy of zero tax on long term capital gains as it exists in the IT Act. Short term capital gains are now taxed at the rate of 15% for all (17% including surcharge and cess), but from 1-04-2012 onwards around 50% of the gain will be exempt and the rest will taxed at the income tax rates applicable to the investors. In other words, under new DTC the effective rate of tax for short term capital gains will be 5%, 10% and 15% according to income slab in which an individual investor will fall. Corporate The new DTC has proposed a corporate tax rate of 30% (with or without surcharge and cess) for a domestic company which is less than the existing rate of 33.22% including both surcharge and cess. As per the news reports, the tax rate for foreign companies will now be same as domestic companies instead of 40% as per IT Act. About Minimum Alternative Tax (MAT) rate, the new revised DTC has recommended to impose MAT on the adjusted book profits of the company, as it is designed now. However, the latest reports suggest that the rate of MAT may be higher at 20% per annum, from the existing rate of 18% (or 19.93% including surcharge and cess). For Special Economic Zones (SEZs), the new revised bill has further extended the duration tax sops that allow a 100% tax exemption on the profits, for two years further, after it will come to legislation i.e. till 1st April 2014. There was, however, a discussion earlier about discontinuing with most of the export linked exemptions, which are considered as distortionary. Though the actual rates will be applicable only after the parliament approves the new revised direct tax code bill, but discussion paper on DTC and the information received from the latest

news reports suggests that even after the tax reform through introduction of DTC in the place of Income Tax Act, the taxation policy of India is still almost same by continuing with the existing exemptions. There is definitely some relief for women and senior citizens, and in a way the tax payers are saved from dealing with a complex piece of legislation. Ideally, it should help convert paying taxes in India less complex and improve the tax revenue collection system. However, the challenge will be to ensure that the government and IT department raises up to expectations, where voluntary compliance becomes more acceptable.