India’s New Direct Tax Code

(1april 2011)

• India’s New Direct Tax Code• Jun. 25 – The Indian government has proposed significant changes to its tax code, which is

to be amended by the revised discussion paper due to be submitted, following extensive consultations, to Parliament soon. In this article we discuss the background to the tax code, the proposed changes and what they mean for the India-based business.

• BackgroundThe existing Income Tax Act of India was enacted in 1961. It replaced the first Income Tax Act of 1922. Thus, historically, the first Income Tax Act was operational for almost 40 years and the existing one has been in place for almost 48 years. Little change has been made during this time – up until the current proposals.

• Over the years, India’s tax laws have become more complicated and difficult to administer or even understand. Litigation is at an all time high in the country with tribunals and courts swamped with tax disputes being challenged by the taxpayers and the tax department. The present Income Tax Act contains more than 400 sections and even more sub‐sections, provisos and explanations. For the general tax payer, it is virtually impossible to decipher the act.

• The Indian government is seeking to initiate radical tax reforms by proposing to enact a new Direct Tax Code which will replace the existing Income Tax Act and come into effect on April 1, 2011 (for the fiscal year 2011‐12). The Direct Taxes Code Bill was placed by the Finance Minister for public debate and discussion on August 12, 2009. The code seeks to combine the law relating to all direct taxes (income tax and wealth tax) under one roof. The proposed DTC has been designed with the objective of simplification of the provisions of tax laws by having a fresh look at the provisions of the act. After taking into consideration the representations received on the proposed provisions of the DTC, the government has now proposed to modify the DTC and issued a revised discussion paper to this effect on June 15.

• The Direct Tax Code seeks to take a fresh look at the taxation of all heads and sources of income. In the existing Income Tax Act, the entire mechanism of taxation revolves around various heads of income under which there would be different sources of income. This is graphically depicted below:

• Step 1

•

Step 2

• Step 2

Step 3

• In the new DTC, the methodology for computing income has been revised. Firstly, the sources of income are divided into two categories: ordinary sources and special sources. Under each source, there are different heads of income, while under each head of income, there can now be different sources of income. This is graphically depicted below

• Step 4

• the aforementioned Steps 1 to 3 would also be applicable for Income from Special Sources. At the end of the Step 3, one would have the gross total income from special sources. The aggregate of this gross total income for all the special sources would constitute the total income from special source

• Thereafter, the following step needs to be followed:

• • These changes pertaining to the computation of

income, however, comprise only a fraction of the many changes proposed in the new Direct Tax Code.

• We will keep India Briefing readers updated with other aspects of the proposed overhaul in the Indian taxation system

The new provisions under the Direct Tax Code are as follows:

 Tax for income between Rs. 2 lakh – Rs. 5 lakh: 10%

 Tax for income between Rs. 5 lakh – Rs. 10 lakh: 20%

Tax for income over Rs. 10 lakh: 30%

• Corporate tax has been kept at 30%.

• The limit for exemptions for salaried people is Rs. 2 lakh, while that for senior citizens isRs. 2.5 lakh.

• Salary

• A)     The following amounts shall not be included in ‘Salary’ subject to specified limits.

• a)                An employer’s contribution to an approved provident fund, Super Annuation Fund and New Pension Scheme.

• b)                Retirement Benefits• c)                Gratuity• d)                VRS• e)                Commutation of Pension linked to gratuity and• f)                  Encashment of leave on superannuation.

• B) Medical facilities / reimbursement provided by an employer to employees be valued as per existing law.

• C)     Perquisite value of rent free accommodation shall not be on market value.•

• iv) Income From House Property• a)                SA Property shall be valued at Rs. NIL. However, interest upto Rs. 1.5

lakh on borrowed capital will be allowed.• b)                In case of let out property, gross rent will be the amount of rent received

or receivable.• c)                Gross rent will not be computed at a presumptive rate of 6% of rateable

value or cost of construction/ acquisition.

• 2) Capital Gains

• a)Income under the head ‘Capital Gains’ will be considered as Income from ordinary sources in case of all tax payers including non-residents. It will be taxed at the rate applicable to that tax payers.

• b)Capital Asset held for a period of more than one year from the end of the financial year in which asset is acquired.

• A)  Listed equity shares or units of an equity oriented fund, capital gains shall be computed after allowing a deduction at a specified percentage of capital gains without any indexation. Similarly, loss arising on transfer of such asset will be scaled down in a similar manner.

• B)   Other assets:-

• i) Base date is shifted to April 01, 2000 instead of April 01, 1981.

• ii) The capital gains on such assets shall be computed after allowing indexation (is a technique to adjust income payments by means of a price index )on this raised base.

• c) Income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head ‘capital gains’. No TDS on such income, however, they will have to pay advance tax.

• Income tax exemption limit proposed at Rs. 2 lakh per annum, up from Rs. 1.6 lakh

• 10 per cent tax on annual income between Rs. 2-5 lakh, 20 per cent on between Rs. 5-10 lakh, 30 per cent for above Rs. 10 lakh

• Tax burden at highest level will come down by Rs. 41,040 annually

• Proposal to raise tax exemption for senior citizens to Rs. 2.5 lakh from Rs. 2.4 lakh currently

• No mention about tax exemption to women in proposed bill

• Corporate tax to remain at 30 per cent but without surcharge and cess

• MAT to be 20 per cent of book profit, up from 18 per cent

• Proposal to levy (To impose or collect  ) dividend distribution tax at 15 per cent

• Exemption for investment in approved funds and insurance schemes proposed at Rs. 1.5 lakh annually, against Rs. 1.2 lakh currently

• Proposed bill has 319 sections and 22 schedules against 298 sections and 14 schedules in existing IT Act

• Once enacted, DTC will replace archaic Income Tax Act.1961

• DTC removes most of the categories of exempted income. Equity Mutual Funds (ELSS), Term deposits, NSC (National Savings certificates), Unit Linked Insurance Plans (ULIPs), Long term infrastructures bonds, house loan principal repayment, stamp duty and registration fees on purchase of house property will loose tax benefits.

• Only half of Short-term capital gains will be taxed

• Surcharge and education cess are abolished.

• For incomes arising of House Property: Deductions for Rent and Maintenance would be reduced from 30% to 20% of the Gross Rent. Also all interest paid on house loan for a rented house is deductible from rent.

• Tax exemption on Education loan to continue.

• Tax exemption on LTA (leave travel allowance) is abolished.

• Taxation of Capital gains from property sale : For sale within one year, gain is to be added to taxable salary.

• Tax on dividends: Dividends will attract 5% tax.

• Medical reimbursement : Max limit for medical reimbursements has been increased to 50,000 per year from current 15,000 limit.