New Direct Tax Code - The true picture

The Income Tax Act has been used in India to levy taxes on individuals and firms since
1961. Since then numerous amendments have been made to the act. This has changed the
structure of the original tax code defined, leading to several criticisms against the act. Recently
the Government of India has brought out a draft statute called the "Direct Taxes Code" intended
to replace the Income Tax Act and the Wealth Tax. When archaic rules have to be replaced with
new ones, the changes must be dramatic and path breaking. This is what Union Finance Minister
Pranab Mukherjee conveyed to all taxpayers when he introduced the draft of Direct Tax Code.
In the case of individuals, DTC’s implications are mixed. To begin with, the proposal to
implement DTC from fiscal 2013 will give individuals time to make the transition to the new
structure. The Bill has widened income slabs for individual taxpayers. The lowest tax rate of
10% is applicable to salary income of Rs2-5 lakh, 20% on income of Rs5-10 lakh and 30% on
income above Rs10 lakh. Post DTC, the distinction between man and woman is over to promote
gender equality while senior citizens will enjoy a higher tax slab starting from Rs 2.5 lakh. The
Bill proposes a deduction up to Rs1 lakh for contributions to various approved funds under
section 80C. An additional deduction of Rs. 50,000 has been proposed under the Bill for
payments for life insurance, health insurance and children’s education. The grey area in DTC
remains proposals related to tax exemptions, where it is unclear if the returns from popular unit
linked insurance plans will continue to enjoy the current tax exemption. The insurance industry
is likely to be adversely affected by the provisions of DTC.
On public demand, the finance ministry has agreed to abandon its previous proposal to
tax retirement benefits under Provident Fund. The new proposal provides for an Exempt-
Exempt-Exempt (EEE) method of taxation for the government provident fund, PPF and
recognized provident funds. Though the EEE method may act as a booster for public savings and
income, it will decrease the tax revenue of the government. Also, the long-term capital gains
exemption on listed equities stays along with STT. This will ensure that long-term capital
investments are not discouraged.
For companies, DTC has proposed a reduction in effective tax rates. Companies, both
Indian and foreign, will be taxed at a flat corporate tax rate of 30%. The big gainers here are
foreign companies as their current effective tax rate is 42.23%. The current effective rate of
taxation for Indian companies is 33.22%. The Minimum Alternate Tax (MAT) has been
increased slightly from 19.33% to 20% but the companies are allowed to carry forward MAT
credit to 15 years from the current 10 years. The MAT was introduced to make sure companies
would contribute a portion of their book profits to the government coffers which was otherwise
largely avoided by claiming a plethora of exemptions on account of being in capital intensive
industries. The MAT will continue to be calculated on book profits and not gross assets, as
proposed in the August 2009 DTC draft. The modified directive on the MAT would come as a
big relief to capital-intensive sectors such as infrastructure and capital goods among others.
With relatively more amounts of cash in the hands of individuals and corporates, inflation
might take off. It is estimated that the revised DTC may reduce revenue collections by
approximately 50,000 crores which means the purchasing power would be increased by that
much extent. The foreign companies will find it attractive to do business in India following a
significant fall in the corporate tax rate. But will this will sum up into potential losses in terms of
government revenues from taxes when already the budget deficit is at such steep levels. Such a
policy will thus not advance the objective of increasing the overall tax base. The current DTC
appears to be an amendment of the existing IT and WT laws, following the policy of pleasing as
many persons as possible, sidetracking issues of principles.