Overview of the Direct Taxes Code
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The Income Tax Act was passed in 1961 and has been amended every year through the Finance Acts. A lot of things have changed since then. No doubt, many things have been implemented by modifying the IT Act from time to time. Thus, the IT Act today is very difficult to interpret, and has resulted in many disputes and court cases. Of late, Income Tax department of India has put the new proposal for direct tax in front of Government of India and Government has unveiled the draft of a brand new direct tax law, which will replace the five-decade old Income Tax Act. This is known as Direct Tax Code (DTC). The aim of New Direct Tax Code (DTC) is to make the current tax structure in India straightforward. An important part of the budget every year has been the detailing of the tax rates. However, with the introduction of the new direct tax code, the tax rates will not be part of the budget presented to Parliament every year. The new code will completely overhaul the existing tax proposals for not only Assessee (a person by whom income tax or any other sum of money is payable under the Act), but also corporate houses and foreign residents. It has been drawn with inspiration from the prevailing tax legislation in US, Canada and UK.
It is a topic of interest and a matter of concern for every taxpayer in India. India wants to modernize its direct tax laws, mainly its income tax act which is now nearly 50 years old. The government needs a modern tax code in step with the needs of an economy which is now the third largest in Asia. The new tax code is expected to widen the tax base, end unnecessary exemptions, moderate tax rates and add to the government’s coffers. The direct tax code seeks to consolidate and amend the law relating to all direct taxes so as to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Another objective is to reduce the scope for disputes, minimize litigation and formulate the strategy relates to checking of erosion of the tax base through tax evasion. It is designed to provide stability in the tax regime as it is based on well accepted principles of taxation and best international practices. It will eventually pave the way for a single unified taxpayer reporting system. The Philosophy behind such replacement is to make the Direct Taxes Code very easy and simple so that tax payers themselves can, without help of experts compute and file Income Tax Returns.
In planning and framing an ideal Income Tax Structure of a welfare state like ours the objectives are to give relief to the maximum possible extent to the lower and middle income group taxpayers and check creation of black money at one hand and to enable the Government to increase collection of tax revenue for development works on the other. The Direct Taxes Code (hereafter referred to as the ‘Code’) is not an attempt to amend the Income Tax Act, 1961; nor is it an attempt to “improve” upon the present Act. In drafting the Code, the Central Board of Direct Taxes (the Board) has, to the extent possible, started on a clean drafting slate. Some assumptions which have held the ground for many years have been discarded. Principles that have gained international acceptance have been adopted. Hence, while reading the Code, it would be advisable to do so without any preconceived notions and, as far as possible, without comparing the provisions with the corresponding provisions of the Income Tax Act, 1961. REASON FOR THE NEW TAX CODE
Income tax in India is governed by the Income Tax Act, 1961. This act has become very old. It has been modified many times since 1961. This has made the old act complicated and difficult to interpret, leading to many disputes and court cases. The government, wished to have a modern tax code in step with the needs of an economy. The new tax code is expected to widen the tax base, end unnecessary exemptions, moderate tax rates and add to the government’s coffers. Government feels that the new code will help improve the tax to GDP ratio significantly from around the current 11 percent. It also aims at simplifying the laws, smoothening the entire process of tax collection and better overall compliance.
As and when the DTC comes into effect, the government would not like to tinker with tax rates every year, so as to provide a greater degree of tax certainty to corporates, investors and individuals. With the introduction of the new DTC, the tax rates will not be part of the annual budget. It proposed some significant changes, like removal of most tax exemptions, putting most of retirement products like PF, PPF and New Pension System (NPS) in Exempt-Exempt-Tax category and a substantial widening of the income tax slabs applicable to individuals. This is going to bring several changes in the investment people make across various asset classes. There is a need for every individual to be well informed about these changes so that all their future investments are DTC complaint. Individuals need to readjust their investment portfolio in a manner that is both tax efficient and allow them to successfully achieve their life time financial goals.
HIGHLIGHTS OF DTC
Earlier Income Tax Act and Wealth tax Act are abolished and single code of Tax, DTC in place. Some of the major highlights of New DTC are – 1. Concept of Assessment year and previous year is abolished. Only the “Financial Year” terminology exists. 2. Only status of “Non Resident” and “Resident of India” exits. The other status of “resident but not ordinarily resident” goes away. 3. Earlier the terminology of ‘Assessee’ was meant for the person who is paying tax and/or, who is liable for proceeding under the Act. Now it has been added with 2 more definitions namely a person, whom the amount is refundable, and/or, who voluntarily files tax return irrespective of tax liability. 4. Income to be now classified under two broad categories:
* Income from special sources; and
* Income from ordinary sources.
5. Income from Special Sources includes income taxable at special rates like income of non-residents, winning from lotteries and horse races etc. Income from Ordinary Sources includes: * Income from employment;
* Income from house property;
* Income from business;
* Income from capital gains; and
* Income from residuary sources.
6. Housing Loan Interest for Self Occupied house disallowed. 7. Returns to be processed within one year, otherwise no demand notice can be raised. 8. VRS Gratuity and commuted pensions, taxable if not invested in approved savings, will be taxable on withdrawals. 9. Government and Non-Government Taxation Difference removed. 10. Savings limit eligible for deduction increased to Rs. 3 lakhs from the current Rs. 1 lakh. 11. Deductions like 80D, 80DD, 80DDE, 80U, 80E, 80 GG retained. 12. No changes in the system of Advance Tax, Self-Assessment Tax and also TDS. 13. Government assessee is covered in Direct Tax Code. Even though they are not liable for Income Tax / Wealth Tax. IMPACT OF THE DTC
The important provisions of the bill that are going to affect the individual investment choices are as under: Impact on Investments Enjoying Tax Exemptions (Under Section 80C): In our country most of the individual investments are guided by their tax status. Most of the savings and investments by individuals are done just before the close of the financial year, based on the criterion of taking full advantage of income tax incentives. The information on income tax exemptions and categories of investments that qualify for exemption is critical input to investment decisions of most individuals.
The first draft of DTC had proposed the EET method of taxation for savings, where the contributions made by an individual, along with accumulations/accretions thereto, would be exempt only till one remained invested. However, withdrawals at any time would be subject to taxation at the marginal rate. This would result in the amount withdrawn or amount received under whatever circumstances being brought into the computation of total income of the assessee, and then being taxed at the marginal rate, according to the applicable tax slab. Further based on the EET principle, the original code had provided for a deduction in respect of aggregate contributions upto a limit of Rs 3,00,000 (both by the employee and the employer) to any account, maintained with any permitted savings intermediary during the financial year. The list of the permitted savings intermediaries included: * Approved provident funds
* Approved superannuation funds
* Life insurer
* New Pension System Trust
But under the revised DTC bill, all the above permitted savings have been put back under the Exempt-Exempt-Exempt (EEE) regime of taxation. In the revised DTC, income tax exemptions for the above savings would be available only upto Rs.1,50,000. This is up from the current Rs. 1,00,000 for investments under section 80C plus Rs.20,000 for investment in infrastructure bonds u/s 80CCF. However, the new limit of Rs. 1,50,000 under revised DTC would have 2 sub-limits: * Rs.1,00,000 for approved long term savings, which are geared towards retirement like the new pension scheme (NPS), provident fund (PF) and PPF. * Rs. 50,000 for some other investments, like pure life insurance, health insurance premiums, and children’s tuition fees. Under the revised DTC bill, most of current tax saving investment will not be eligible for tax deduction. There will be loss of tax immunity on the popular Equity Linked Savings Scheme (ELSS), National Savings Certificate, 5-year tax saving bank fixed deposits and investment in ULIPs.
Impact on Insurance:
Many individuals in our country prefer to buy life insurance policies merely to save tax. Therefore it is important for them to know about tax breaks pertaining to life and health insurance policies under DTC. The reason, they need to understand DTC provisions on insurance are because it will have retrospective effect. This means policies that you may buy this year and even those that you bought in the past, might see different tax treatment in future. The revised second DTC bill will have significant impact on insurance. Under the revised DTC bill, to be eligible for tax deduction, a policy should provide a life cover of at least 20 times the amount of annual premium. That is, if your policy offers a cover of Rs.10 lakh, then your annual premium cannot be more than Rs 50,000. If this condition is not met, an individual will not get any tax deduction on the amount of annual premium paid on life policy. Not only this, even the income from the policy will be taxable. At present, any income received from life insurance policies is tax free. In times to come, if you are looking for tax deduction on any life insurance plan, make sure you buy a policy in which the life cover is 20 times or more than the amount of annual premium. This is possible only if you take a pure term plan of long duration.
Under the current laws, an individual can claim deduction on premium of up to Rs. 1 lakh per annum paid for life insurance. Life insurance is among the many tax -saving avenues under section 80C of the Income-Tax Act. The section also offers tax breaks on investments in provident fund, pension fund, and equity-linked saving schemes, besides home loan principal repayment and children’s tuition fees. If revised DTC bill becomes effective, the total savings-related deduction will be Rs 1.5 lakh. However, out of this, an aggregate deduction on life as well as health insurance premium and children tuition fees will be restricted to Rs 50,000. What’s more, you will not be entitled to deduction on life insurance premium if it exceeds 5% of the policy’s sum assured. This apart, the maturity proceeds will be exempt from tax only if they are received upon the death of the insured or completion of the original period of contract of the insurance. Another change is that both forms of insurance – life and health – are clubbed together for calculating deductions unlike now, where health insurance-related concessions for premiums up to Rs 35,000 fall under section 80D.
The intention of these changes in DTC appears to be, to give encouragement to pure term insurance products of long tenure and to discourage combination products like ULIPS and endowment policies. Most combination products neither provide sufficient life cover nor provide good returns over the term of insurance. Most such products provide a cover of less than 20 times the amount of annual premium. Therefore they will lose the tax advantage and favour of the investing community. The objective of this change in DTC appears to encourage individuals to look upon life insurance as a product that only provides a financial cover to the family in case of loss of life of the insured. This should also motivate individuals to take a long term view on this investment. Most current Ulips will lose their tax advantage when the Direct Tax Code comes into effect. This is because most existing Ulips have a life cover of less than 20 times the amount of annual premium. This makes ULIPs far less attractive once DTC comes into effect. Impact on Equity Investment:
The first draft of DTC had suggested that the Securities Transaction Tax (STT) that is currently levied on transactions in equities would be abolished. Instead of the STT, the long term capital gain (LTCG) tax wouldbe reinstated. The revised DTC bill placed before the Parliament on August 30, 2010, had the following provisions related to equity investment: Securities Transaction Tax (STT) that is currently levied on transactions in equities is to be continued. The long term capital gains from sale of shares and units of equity mutual funds would remain completely tax free. This means there would be no tax on gains from sale of shares/equity oriented mutual fund units held for more than a year. This is positive news as the earlier proposal in the first draft to tax the LTCG, would have badly hurt the capital market. In case of gain on sale of equity shares and units of equity mutual funds held for less than 12 months, deduction of 50% of gains will be allowed and the balance will be added to the income of individual and taxed as per his income tax slab. Effectively, for short term capital gains, the tax-rate would come to be 5%, 10% or 15% depending on the tax bracket of investor.
This is a positive measure and should boost the stock market. In case of short term capital losses (STCL), under the revised DTC bill, it is possible to set off 50% of STCL against STCG. Currently it could be completely set- off. * S.T.T. currently levied on transactions Equity is to be continued. * Long term capital gains from sale of shares & units of equity mutual funds would remain completely tax free it hold more than a year. * If sale within 12 months deductions of 50% gain allowed and bal.will be added to income of individual & taxed as per his income tax slab depend on the tax bracket of investor. This is a positive measure and should boost the stock market. * Also ELSS & ULIPS will pay 5% tax on the dividend declared. * EEE tax of direct tax code will continue for all ELSS investments made in the past. Impact on Investment in House Property:
The original draft of DTC had suggested that tax benefit for payment of interest on a home loan should be withdrawn. But the revised second DTC bill has retained the current tax benefit on interest payment on home loans. The limit for it remains at Rs. 1,50,000. However, no income tax benefit would be available for the principal component of the home loan. In the revised DTC bill, there is removal of tax on notional rent. Right now people who own more than one house have to pay tax on notional rental income even if second house is lying vacant. The DTC will remove this anomaly and make investment in second home more tax efficient. Another landlord friendly move is that advanced tax received from a tenant will be taxed in the year, to which it relates, not when it was received.
The bill proposes to reduce the standard deduction on account of repairs and maintenance from the existing 30% to 20%. DTC, by retaining the tax benefit on the interest paid on home loan should encourage investment in residential house property. The tax benefits reduce the effective cost of home loan thus making it affordable for borrowers. The home buyers will still have incentive to take home loan even though the extent of deduction for interest paid on home loans not been increased. It is positive news, not only in respect of existing home loans but also for a large number of potential buyers of homes from burgeoning middle class of the country. DIRECT TAXES CODE-A PIPE DREAM
The DTC seeks to make far-reaching changes on certain basic concepts such as the meaning of income, persons liable to tax, and the scope and basis of taxation. Apart from unsettling prevailing tax positions, the changes create new uncertainties that will likely increase the tax burden. A significant rise in the Effective Tax Rate is not only a disincentive to grow and earn but also adversely affects competitiveness and, in turn, earnings. Likewise, it affects new investments, capital formation as also the ability to raise capital and attract talent. Some provisions in the DTC may be in direct conflict with economic objectives. Relevance of MAT:
To illustrate, imposition of MAT (Minimum Alternate Tax) and elimination of MAT credit would reduce competitiveness by increasing the ETR due to double taxation. There is perhaps no need for MAT anymore as most incentives, except those for the infrastructure sector, have been withdrawn, thereby ending the regime of liberal tax incentives that created a mismatch between tax and book profit. Also, provisions such as the General Anti-Avoidance Rules (GAAR), Controlled Foreign Company (CFC), and the modified scheme of capital gain taxation could deter private capital formation, reduce savings and divert investments from capital markets. A comprehensive study of such provisions is needed to determine their economic impact. Wooing Foreign Investment
Fiscal incentives and a liberal regulatory regime are, in many respects, important policy tools of a government when competing with other countries to attract potential investors. International studies have shown that incentives along with general economic and framework conditions are important in determining the size and quality of investment flows. Tax incentives can compensate for deficiencies prevalent in a developing economy such as ours, and are often seen as effective policy tools for achieving economic and social objectives. Hence, deterrents in the tax code must not be so excessive, in form or administration, as to render businesses uncompetitive. Moreover, investors value transparency, simplicity, stability and certainty in the application of tax law and tax administration as equally as, if not more than special tax incentives. Assessing the Impact:
The objective of a tax code should not only be the efficient collection of tax revenue but also formulating the Government’s tax policy. The evaluation process should be two-fold: Impact on taxpayer and revenue; and economic impact, that is, competitiveness, savings, investments and private capital formation. This is an effective cost/benefit analysis of the change. Also, the ‘change’ should only achieve what it is meant to and no more. In the current economic scenario where private capital — domestic and foreign — is expected to fuel high growth, the quest for higher tax collections must not create an adverse economic impact. Heavy taxation of productive income is detrimental to private capital formation. Excessive taxation is not a sustainable solution to budget problems. Also, other jurisdictions should be kept in mind when setting the tax law, as taxes raised to an uncompetitive level can render businesses uncompetitive too. When taking a fresh look at DTC, a broad-based committee, similar to the recently appointed expert group for GAAR, could bring the needed objectivity to the development of a fiscal legislation that is crucial to the Government’s reform process.
WEALTH TAX BENEFITS
The proposed Tax Code has sought to make major changes in wealth tax calculations and rates. The threshold limit for wealth tax will be raised to Rs 50 crore from the present Rs 30 lakh and the tax rate was reduced from 1 per cent to 0.25 per cent. But, in a smart move, to expand the scope of taxation the Tax Code included financial assets like shares, corporate bonds, fixed deposits, etc in wealth tax. The valuation of these assets will be done at cost or at market price, whichever is lower. In case of capital gains tax too, the Tax Code proposed some sweeping changes. It has done away with the present system of short-term and long-term capital gain tax, and replaced it with a uniform structure and gains will be taxed at the marginal tax rate as applicable to the tax payer. The implications of these changes are clear: The period of holding has no bearing on the tax payable and bigger investors will be taxed at higher rates than the smaller ones. A MIXED BAG
For the corporate world, the proposed reduction in the tax rate to 25 per cent from the existing 30 per cent is certainly good news and will help lowering the tax burden of India Inc in a big way. But at the same time the Tax Code proposes to do away with many exemptions that help lowering the tax. In a significant policy change, the Tax Code plans to discontinue all profit linked incentives for area-based investments like setting up plants in a backward area or in the north-east with investment-linked incentives in specific sectors like infrastructure, power, exploration and oil production etc. Moreover, under the new proposal, tax holiday will not be for a specific period, as is the case now, but will be equal to all capital and revenue expenditure barring land, goodwill and debts. Once a firm recovers the permitted investments and profits will be taxed. This change is aimed at incentivising capital formation in critical areas and remove incentives to shift profits from the taxable unit to the exempted unit.
THE SALIENT FEATURES OF THE CODE IN BRIEF * Single Code for direct taxes: all the direct taxes have been brought under a single Code and compliance procedures unified. This will eventually pave the way for a single unified taxpayer reporting system. * Use of simple language: with the expansion of the economy, the number of taxpayers can be expected to increase significantly. The bulk of these taxpayers will be small, paying moderate amounts of tax. Therefore, it is necessary to keep the cost of compliance low by facilitating voluntary compliance by them. This is sought to be achieved, inter alia, by using simple language in drafting so as to convey, with clarity, the intent, scope and amplitude of the provision of law. Each sub-section is a short sentence intended to convey only one point. All directions and mandates, to the extent possible, have been conveyed in active voice. Similarly, the provisos and explanations have been eliminated since they are incomprehensible to non-experts. The various conditions embedded in a provision have also been nested. More importantly, keeping in view the fact that a tax law is essentially a commercial law, extensive use of formulae and tables has been made.
* Reducing the scope for litigation: wherever possible, an attempt has been made to avoid ambiguity in the provisions that invariably give rise to rival interpretations. The objective is that the tax administrator and the tax payer are ad idem on the provisions of the law and the assessment results in a finality to the tax liability of the tax payer. To further this objective, power has also been delegated to the Central Government/Board to avoid protracted litigation on procedural issues. * Flexibility: the structure of the statute has been developed in a manner which is capable of accommodating the changes in the structure of a growing economy without resorting to frequent amendments. Therefore, to the extent possible, the essential and general principles have been reflected in the statute and the matters of detail are contained in the rules/schedules. * Ensure that the law can be reflected in a Form: for most taxpayers, particularly the small and marginal category, the tax law is what is reflected in the Form.
Therefore, the structure of the tax law has been designed so that it is capable of being logically reproduced in a Form. * Consolidation of provisions: in order to enable a better understanding of tax legislation, provisions relating to definitions, incentives, procedure and rates of taxes have been consolidated. Further, the various provisions have also been rearranged to make it consistent with the general scheme of the Act. * Elimination of regulatory functions: traditionally, the taxing statute has also been used as a regulatory tool. However, with regulatory authorities being established in various sectors of the economy, the regulatory function of the taxing statute has been withdrawn. This has significantly contributed to the simplification exercise. * Providing stability: at present, the rates of taxes are stipulated in the Finance Act of the relevant year.
Therefore, there is a certain degree of uncertainty and instability in the prevailing rates of taxes. Under the Code, all rates of taxes are proposed to be prescribed in the First to the Fourth Schedule to the Code itself thereby obviating the need for an annual Finance Bill. The changes in the rates, if any, will be done through appropriate amendments to the Schedule brought before Parliament in the form of an Amendment Bill. * Carrot and Stick: If the Tax Code is generous in giving relief to tax payers, be sure, it will also make life miserable for those who evade tax through fraudulent means. As the Tax Code prescribes stiff penalties and prosecution for non-compliance with the tax laws, it proposes that every tax offense under the Code will be punishable by both imprisonment and fine. Apart from defaulters, the Tax Code proposes to punish tax consultants who help in tax evasion. It gives sweeping powers and blanket protection to Income Tax officials for initiating court proceedings on matters relating to tax offences.| RECOMMENDATION
The government should introduce Direct Tax Code compulsory in order to have uniformity. Following recommendations are also drawn from the side of tax payers for New Direct Tax Code – 1. Public must be given training in computation of tax under Direct Tax Code. 2. The government should give a handbook to all assessee giving guidelines to compute tax under Direct Tax Code. 3. To abolish the problem of corruption and black money.
4. Tax benefit should be allowed on housing loan.
5. Limits of sec. 80C to 80U should be increases.
6. The government should review the income tax slabs and should make it assessee friendly. (Tax-free income limit should be increased.)
The Code shall replace the five-decade old Income-tax act. The new tax code aims to make the system more efficient and easy for tax payers, with simplified rules and regulations. DTC has integrated all Direct Taxes as a single Act. The aim of the DTC is to simplify tax legislation minimize litigation, broaden tax base and eliminate tax exemptions in part to attract foreign business and investment. But, there are always two sides of any coin. The Direct Tax code in India is very much discussed and criticized now a day. Even though, the basic aim behind DTC is simple and helpful to the people, it is very much criticized because many provisions under this proposal may harm the investors and FIIs. The Direct Tax Code changes the whole taxation system of India. It will surely help in the growth of our economy because the tax rate has been reduced for person who earns up to ten lakhs. This reduction in tax may motivate them to contribute their money in the development of the economy, like establishing business firms, building hotels etc., which play major role in the growth of economy.
[ 1 ]. Article by Dr. Vinod Kumar, Associate Professor, Commerce and Dean (H), ICoFP “Implications of proposed direct tax code on financial planning”. [ 2 ]. http://www.ijmbs.com/22/kamal.pdf. Last Accessed on 12/02/2013. [ 3 ]. http://www.jagoinvestor.com/2010/07/changes-in-new-direct-tax-code-dtc.html. Last accessed on 10/02/2013. [ 4 ]. supra note 1.
[ 5 ]. http://www.finanzindia.com/new_direct_tax.html. Last Accessed on 11/02/2013. [ 6 ]. http://www.lifeinscouncil.org/media-centre/archives/242-life-insurers-seek-changes-in-tax-code. Last Accessed on 11/02/2013. [ 7 ]. supra note 5.
[ 8 ]. Ibid.
[ 9 ]. http://www.thehindubusinessline.com/industry-and-economy/taxation-and-accounts/article3901217.ece. Last Accessed on 11/02/2013. [ 10 ]. http://www.deccanherald.com/content/19934/decoding-direct-tax-code.html. Last Accessed on 10/01/2013. [ 11 ]. Ibid.