Possible shocks and pleasant surprises from new direct taxes law panel

The committee, headed by Arbind Modi, a member of CBDT and the author of the earlier direct taxes code, is likely to soon submit its report to Finance Minister Arun Jaitley

Taxpayers are awaiting the recommendations of the committee on direct taxes law with anxiety and expectations. The committee, headed by Arbind Modi, a member of the Central Board of Direct Taxes (CBDT) and the author of the earlier direct taxes code (DTC), is likely to soon submit its report to Finance Minister Arun Jaitley.

Whenever has the issue of DTC come up in the past, it has left behind unpleasant memories, such as the proposals to tax long-term savings at the time of withdrawal and the general anti-avoidance rule (GAAR), among others. However, it has also started a debate over a rate overhaul, even as earlier proposals were too ambitious.

Let us look at some of the proposals that could turn contentious and some others that might go well with stakeholders.

i) The EET method

The first draft of DTC had proposed putting long-term saving schemes under the exempt, exempt, tax mode (EET), as opposed to the exempt, exempt and exempt (EEE) mode practised until then. EET means that withdrawal from funds would be taxed at the rate of the individual's slab, while contribution and accretion are not. On the other hand, EEE means even withdrawals do not attract tax.

Chapter XII of the first draft of DTC dealt with tax incentives on these savings. Based on the EET principle, the Code provided for deduction in respect of aggregate contributions up to a limit of Rs 300,000 (both by the employee and the employer) to any account maintained with any permitted savings intermediary. The permitted savings intermediaries included approved provident funds, approved superannuation funds, life insurer and New Pension System Trust.

However, the EET proposal drew flak from various quarters. It was argued that most countries that followed the EET method of taxation of savings also had a social security system in place for all their citizens. The EET savings accounts operated for individuals in these countries are over and above the mandatory social service payments received by them. As such, the revised draft did away with the EET method and again proposed the EEE mode for the government provident fund (GPF), public provident fund (PPF), recognised provident funds (RPFs) and the pension scheme administered by the Pension Fund Regulatory and Development Authority. It also approved pure life insurance products and annuity schemes as subject to the EEE method of tax treatment.

The government later also tried to introduce the EET method for provident funds. In the Budget for 2016-17, Finance Minister Arun Jaitley proposed taxing 60 per cent of the amount withdrawn from provident funds, including EPF. However, that proposal was withdrawn after it drew much criticism. If the new draft of the direct taxes law again comes out with the EET method for long-term savings, it might not go down well with people.

Naveen Wadhwa, an indirect tax expert at Taxmann, says that any such move would impact salaried taxpayers’ long-term investment planning. PF and retirement funds are the popular and effective modes of saving for the middle-class taxpayers, he says.

ii) Changing the basis of calculating MAT 

Minimum alternate tax (MAT) is imposed on companies that escape tax due to various exemptions even as they earn profits. The first DTC draft proposed to change the basis of calculation of MAT from book profit to value of assets. The economic rationale given was that investors could expect ex-ante to earn a specified average rate of return on their assets, hence it provided an incentive for efficiency.

The rate of MAT was proposed to be 0.25 per cent of the value of gross assets in the case of banking companies and two per cent of the value of gross assets for all other companies. MAT is currently imposed at 18 per cent of book profit, which after cess and surcharge comes to around 20 per cent.

In draft DTC 1, MAT was proposed to be a final tax and was not to be allowed to be carried forward for claiming tax credit in subsequent years. However, the issue arose that the changed methodology would require all companies to pay tax even if they were making losses or operating in a cyclical downturn. Also, an asset-based MAT does not have a proximate linkage with a particular year’s income or turnover. The proposal was, therefore, junked in the revised draft. Companies would be jittery if MAT on the basis of asset value would come back.

iii) Taxes on non-profit companies 

DTC had proposed some radical changes to taxation of not-for-profit organisations. As Neeru Ahuja, partner, Deloitte, explains, the most significant one was that of taxing such organisations at a 15 per cent rate after allowing Rs 100,000 of basic exemption against zero tax at present or at that time. Also, there was to be a one-time tax of 30 per cent on net worth on conversion of not-for-profit organisation into a for-profit organisation.

Currently, these organisations are allowed to spend 85 per cent of their receipts on their charitable activities and if they do not do so in a year, they are allowed to do so in subsequent years. This provision was also proposed to be taken away by DTC. These are yet to be incorporated in the Income Tax Act as of date. There will be too much opposition from these organisations if these proposals were to be proposed again.

iv) Stiffer conditions for Vodafone-like transactions

The second revised DTC code, put in public domain in March 2014, had proposed to tighten a provision that allows overseas companies to avoid paying taxes in India on the transactions where underlying assets are located in the country. The immediate provocation were incidents related to the transactions between Vodafone Group Plc and the Hutchison Whampoa group (both foreign companies) over the acquisition of what is now Vodafone India.

The draft proposed that if 20 per cent of the total assets of a company were located in India, the income arising from such a transaction would be taxed in the country. The previous version of the Bill had proposed that such transactions would be taxed if at least 50 per cent of the total assets were located in India. After much discussions, currently these deals are being taxed if more than 50 per cent of the total assets are based in India. If the new direct tax law proposals again make it 20 per cent, these might draw flak from companies.

On the other hand, stakeholders would be pleasantly surprised if the following changes are proposed to the law laws:

a) STT is abolished

The first draft of DTC proposed to do away with the distinction of long-term and short-term capital gains tax. It proposed that capital gains should be subject to tax at the rate of 30 per cent in the case of non-residents and at the applicable marginal rate for residents. It also suggested doing away with the securities transaction tax (STT).

The revised draft changes the structure after getting feedbacks from stakeholders. In practice, distinction between long-term and short-term capital gains persisted. So far as listed securities were concerned, there was no long-term capital gains tax for many years until 2018-19. The Budget for 2018-19 proposed long-term capital gains tax at the rate of 10 per cent on any capital gains of over Rs 100,000 made after January 10, 2018. Short-term capital gains tax at 15 per cent continued.

While short-term capital gains tax applies when equity is held for one year, long-term capital gains tax is imposed when equity is sold after a year of acquisition. There also are distinctions between short-term and long-term capital gains taxes on other classes of assets. While the latter was imposed on listed securities, STT was not withdrawn. Now, the committee is looking at a single levy on capital market investments. It might consider doing away with STT to make the capital market attractive to investors.

STT is a direct tax payable on the value of taxable securities transactions done through a stock exchange. It is levied at 0.1 per cent of turnover for delivery-based equity transactions, while for intra-day transactions the STT for purchase is nil, and for sale it is 0.025 per cent of the turnover.

The STT collection stood at Rs 111.23 billion for 2017-18, an increase of 24 per cent over 2016-17. The amount is 43 per cent higher than the Revised Estimates of Rs 77.7 billion. The markets might or might not be enthused, depending on the exact nature of capital gains tax that would be proposed, but they will welcome an abolition of STT.

ii) Tax rationalization

Assessees will be delighted if the direct taxes law proposes for individuals a tax structure that is somewhat similar to the draft DTC 1. That draft had proposed an overhaul of direct tax rates. The threshold proposed by it, of Rs 160,000 a year, has long been surpassed, but the other tax structures were quite ambitious. Ten per cent tax was to kick in at Rs 160,000 for up to Rs 1 million of annual income, 20 per cent for over Rs 1 million and up to Rs 2.5 million, and 30 per cent for more than Rs 2.5 million. These have not been achieved even after nine years of first draft of DTC, as these were moderated in later drafts.

The current threshold: A five per cent rate kicks in at Rs 250,000 for up to Rs 5,00,000 of annual income, it is 20 per cent for an annual income between Rs 5,00,000 and Rs one million, and 30 per cent for over Rs 1 million. There also is a ten per cent surcharge for income above Rs 5 million, and 15 per cent for income above Rs 10 million. The surcharge kicks in at a much lower income than that proposed by the revised DTC draft of 2014. That draft had recommended a 35 per cent rate on income over Rs 100 million.

In fact, the first draft had proposed a 25 per cent tax rate for companies; that is yet to be achieved for all companies. At present, a concessional 25 per cent tax rate applies to companies with a turnover of up to Rs 2.5 billion. Then there are surcharges — at seven per cent if the income is between Rs 10 million and 100 million, and 12 per cent if it is over 100 million.

DTC ride: A timeline of prolonged wait for just proposals

August 2009: First draft DTC code is released along with a discussion paper

June 2010: A revised discussion paper comes

August 2010: DTC Bill is tabled in Parliament, is referred to Parliament's standing committee on finance

March 2012: Committee submits its report to the government

March 2014: A revised DTC draft comes

July 2014: New government says it will review DTC

February 2015: FM Arun Jaitley junks DTC, says there is no great merit in going ahead with DTC "as it exists today"

November 2017: A task force on direct tax law is appointed under the chairmanship of Arbind Modi, a CBDT member and author of the previous DTC; its report is to be submitted by May 2018

May 2018: The term of the task force is extended by three months to August 2018

August 2018: The task force is given a one-month extension