Revised direct tax code proposal to lead to lower tax regime  

June 16, 2010

 The revised draft has proposed significant changes in 11 areas; the most important includes doing away with all tax exemptions and EEE treatment to long-term investment products and taxing of capital gains on shares

Almost after one year since the government came out with the first draft of the Direct Tax Code (DTC), it has proposed several significant changes in the revised draft with respect to minimum alternative tax (MAT), capital gains taxes—among others—heralding a lower tax regime. However, unlike the first draft, the revised draft does not specify any tax rate.

The most important changes include doing away with all tax exemptions, characterisation of foreign institutional investors’ (FII) income as capital gains, abolition of securities transaction taxes (STT), exempt-exempt-exempt (EEE) treatment to all kind of long-term saving investment products such as provident funds, annuity and life insurance products.

The DTC also suggests taxing long-term capital gains on shares and equity mutual funds and classifies short-term capital gains on such products as normal income to be taxed fully. If these three provisions are implemented, equity prices will come down by 20%-30%.

The revised draft also puts pension administered by the interim regulator Pension Fund Regulatory and Development Authority (PFRDA), including pension of government employees who were recruited since January 2004, under EEE treatment. The first DTC draft had proposed to tax all savings schemes including provident funds at the time of withdrawal, bringing them under the exempt-exempt-tax (EET) mode.

Under EEE mode, contributions in certain savings schemes become tax-exempt as they are deductible from income, the accumulations are also exempt from tax till they remain invested and withdrawals are also not taxed. However, in EET, the first two steps remain tax-exempt, but withdrawals are taxed.

MAT will continue to be calculated with reference to the book profits as against previously proposed gross assets, elimination of distinction between short-term and long-term assets on the basis of the length of holding and dilution of general anti-avoidance rules (GAAR).

FIIs would also be no longer subject to withholding taxes like TDS, rather, their income would be taxed as capital gains irrespective of the fact whether they have a permanent establishment in India or not, unless they are covered by any double-tax avoidance treaty.

There also is a proposal to restrict interest deduction u/s 24 on income from housing properties to just one self pre-occupied house.

The revised draft has proposed changes in around 11 areas. However, there is no mention of any tax slabs. The first draft had proposed three slabs for income-tax, a tax rate of 10% on income up to Rs10 lakh, 20% for income up to Rs25 lakh and 30% thereafter.

According to the revised draft, the proposals in this revised discussion paper would lead to a reduction in the tax base proposed in the DTC. The indicative tax slabs and tax rates and monetary limits for exemptions and deductions proposed in the DTC will, therefore, be calibrated accordingly while finalising the legislation.

The revised discussion paper on DTC, which would help replace the decades old Income-Tax Act, has retained the tax exemption for up to Rs1.5 lakh paid as interest on housing loans. However, both the first and revised drafts are silent on the exemption given on principal amount paid on housing loans. At present, borrowers can enjoy exemption on payment of principal amount. However, it is part of exemption to savings capped at Rs1 lakh per annum. Interestingly, the first draft had proposed to revise this limit to Rs3 lakh a year.

Under the revised DTC, taxation of non-profit organisations would be rationalised to include basic exemption and allow carry-forward of surplus up to specified limits. The revised draft proposes to levy wealth-tax on all taxpayers, except non-profit organisations (NPOs). However, in case the NPO ceases, taxation at 30% of its net worth—proposed in the first draft of the DTC—will continue. At present, wealth-tax is levied only on unproductive assets. The second draft proposes to calibrate threshold limit for levy of wealth-tax and rate of wealth-tax in the context of overall tax rates.

 — Moneylife Digital Team