Profit-based tax incentives are sought to be systematically eliminated in the draft Direct Taxes Code. This is proposed to be achieved by migrating from a profit-based to an expenditure-based incentive scheme. For example, large infrastructure projects including development of Special Economic Zones (SEZs) have moved away from profit-based deduction to a deduction of revenue and capital expenditure from gross receipts. For individuals, the focus is to move firmly towards the “Exempt-Exempt-Taxable” (EET) model where tax exemptions are available at the time of contributions and accruals but are taxable at the time of withdrawal. Continued emphasis on deductions based on social tax expenditure such as medical premia and interest on education loans are likely to be retained.
The move towards the EET model has been on the anvil for a while. The concept of EET is to keep annual contributions and accumulations tax-free year-on-year and to allow tax withdrawals of accumulated balances. If the Code was to come into force, withdrawals out of savings in accumulated retirement funds until March 31, 2011, should also enjoy tax protection irrespective of the withdrawal date.
Social tax expenditures also include amongst others, medical treatment, deduction for handicapped and donations to various relief funds where the Code seeks to continue incentives. Together, the aggregate deduction for such savings and expenditure is proposed to be increased from Rs 1 lakh to Rs 3 lakh in a financial year.
For the corporate sector, the focus seems to be more on expenditure-based deductions rather that profit-based deductions. However, in the efforts at rationalisation, deductions such as the one available to units located in an SEZ under section 10AA of the Income Tax Act, 1961 (the Act) may see the axe. Clearly, that will prove very embarrassing to the government, given the attention paid to tax benefits in the SEZ space ever since the SEZ regulations were rolled out. However, units set up prior to March 31, 2011, should continue to get the benefits derived from section 10AA of the Act. Though grandfathering such deductions is intended in the Code, a deeper look into the details reveals that the proposed Code Bill may need insertion of specific enabling provisions.
The Code will see new taxation schemes being provided to businesses. For example, the computation of taxable profits will be undertaken after deduction not only of the usual revenue expenditure but also of capital expenditure, including expenditure on purchase, lease or rental of land or land rights or certain expenditure incurred even before the commencement of business. Even if loss is arrived at in a particular year, it is to be taken as “nil” for that year. Such loss is eventually ring-fenced since it is allowed as a deduction in future years as a deemed expenditure of that year.
Seven specific infrastructure projects have been covered in the Code. The ones recognised include generation, transmission or distribution of power, defined infrastructure facility, hospitals in specified areas, processing of fruit and vegetables, cold chain and agricultural warehouse facilities. Cross-country natural gas and crude and petroleum pipeline distribution networks are also covered.
In summary, the new Code has taken cognizance of the recommendations made by the Parliamentary Standing Committee on Finance that recommended a comprehensive rationalisation of existing tax incentives.
Vikram Bapat
Executive Director (Tax & Regulatory Services), PwC