Direct Taxes Code, a Paradigm Shift

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Direct taxes code, a paradigm shift 13 Aug 2009, 1515 hrs IST, Mukesh Butani

My first overall impressions - unprecedented changes, path breaking and reformative. I think, the new code will result in change in the manner in which businesses conduct their operations in India. The scope of 'income' is widened to tax real income and is comprehensive to unravel protection that tax payers were resorting to either under the umbrella of judicial interpretation or incentive provisions. The test for residency of foreign companies is clearly aimed to protect India's tax base by retaining right to tax income based on a narrow ‘control and management’ test. Though maximum marginal tax rates for individual has remained unchanged at 30%, the slab rate at which it would apply has been raised multifold to Rs 2.5 million. This step alone should encourage voluntary declaration and reap long-term benefits to increase tax to GDP ratio. The most important change impacting individuals is introduction of EET (exempt exempt taxed) scheme under which investments made in saving instruments such as provident fund, life insurance etc shall be taxable on withdrawal. This shall apply only to new contributions after the commencement of the code. Hence, existing instruments seem to have been grandfathered. Corporates would immensely benefit from reduced tax rate of 25%, which is very competitive by global standards. However to gain, one has to lose somewhere - all profit linked incentives have been done away with. Instead, tax incentives are applicable to businesses that entail high risk and long payback. The businesses that fall in this category generally include the current set of activities that enjoy tax holidays. The catch however, is that instead of offering profit linked incentives, only the revenue and capital expenditure amortisation shall be allowed and thereafter, profits would be taxed. Further, all area based tax incentives are proposed to be eliminated. However, the above changes shall not impact existing eligible businesses. The rationale seems to be to link tax incentives to capital investment. Though the step to book profits tax on asset base aligns with practice followed in western countries, the rate of 2% is way higher than global standards of .5 to .75%. A revamped tax administration in line with international best practices is a significant change. The most heartening aspect is legislative backing for addressing tax payer grievances via ombudsman. Further, the otherwise powerful tax administration body, CBDT seems to have acquired more powers in terms of overall supervision and regulation of the functions of income tax department other than an oversight function. For the errant tax payer, the procedural and enforcement part of the law has been made stricter. Path breaking changes in the area of selection of cases for scrutiny by adopting risk management strategy, coupled with computer aided selection process shall go a long way in enhancing the overall effectiveness of tax administration. Similarly, the penal provisions and prosecution for violation have been given greater legislative teeth and adequate deterrent for tax evaders. General anti-avoidance rule has been introduced to combat tax evasion and avoidance via most forms of arrangement that either lack commercial substance or are considered impermissible avoidance arrangements by the tax administration. Wide powers have been given to the tax commissioner for invoking such anti avoidance rules. This is in line with practices followed in other mature jurisdictions. However, administering them could be a nightmare. Further, the general rule that a tax treaty shall override the domestic law shall not hold good any longer. In a situation where the domestic law is amended, subsequent to signing a treaty, such subsequent amendment shall prevail upon the treaty. In conclusion, the new tax code is path breaking and a shift from the current law. No wonder, why the legislative process is delayed up to 2011. It would require intensive debate and discussion prior to legislating it such that the over arching objective of simplicity, flexibility, stability and reduction in the overall cost of compliance and litigation is reduced. (The author is partner and leader of the direct tax practise at BMR Advisors. Views are personal.) Source - Economic Times