North Block officials presented the revised discussion paper on the Direct Taxes Code (“Code”) to rush tabling a bill in the monsoon session of the Parliament. Changes proposed in the revised draft are very much in line with expectations and the reform agenda set out by the Finance Minister.
A combination of path-breaking changes proposed in the original DTC Bill and sweeping powers proposed for tax administration to invoke anti-avoidance rules witnessed vigorous reactions from various the industry & chambers.
The revised paper dealing with priority 11 issues puts to rest several months of speculation around shape and form of the new legislation; more particularly with respect to tax avoidance provisions which were rather sweeping in nature than ‘general’ and re-alignment of Minimum Alternate Tax levy to ‘book profits’ tax regime against the ‘gross asset’ levy originally proposed.
The revised paper however is accompanied with anxiety and uncertainty on account of Government’s tentativeness in holding back on corporate tax rate; curiously, tax rate determination has been deferred to the legislature’s discretion.
Whilst most tax policy decisions are indeed an annual Finance Act exercise, it is likely that the trade & industry would view Government’s silence as possible rethinking on tax rate rationalisation at 25% as originally proposed.
In my analysis, what possibly could thwart the Government committing the policy for rationalizing tax is lack of data on tax revenues foregone as a result of grandfathering of tax incentives under the extant law and enhanced individual income slabs taxable. Or perhaps, it’s the likely dent which tax collections foregone would leave on fiscal deficit targets.
Rationalization of gross assets tax levy re-affirms North Block’s agenda for ushering in reforms as the move would clearly rub off the anxieties for infrastructure, insurance and financial services sector. I am hoping that MAT rate shall be brought to more reasonable levels from the present 20%.
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Withdrawal of tax treaty override provisions (barring in exceptional circumstances) can be hailed as well thought policy move, aligning to global benchmark and the spirit of Vienna Convention.
Drop of the guard by the Government would also dilute sweeping powers accorded to the Revenue for denying treaty benefits unless explicit anti-abuse provisions have been invoked in a taxpayer’s case. Needless to say, supplementary guidance shall be keenly awaited to provide adequate checks & balances for preventing misuse by the administration.
To push formalization of anti-abuse rules in the DTC, rigors of GAAR provisions have been considerably diluted; the revised document proposes GAAR to be made more ‘specific’ with Central Board of Direct Taxes authorized to prescribe guidelines for invoking GAAR.
Dilution of what would have been a draconian piece of legislation, would take hands off panic button for the time being; however, one would expect more objective prescription for GAAR applicability than a mere two page devoted to explain rationale of this important piece of legislation. I would expect that the CBDT has robust administrative guidelines before Revenue’s powers are indiscreetly resorted to.
As far as Financial Institutional Investors (FIIs) are concerned, there is certainly more to cheer for than in original draft DTC. The revised discussion paper brings out clarity on income characterisation for FIIs which would save expensive litigation; however, classification of FIIs’ income from securities as ‘capital gain’ could partially undo the advantage.
I was expecting a similar clarity on characterization from income derived from derivatives, though, we should anticipate this in the DTC bill. Re-thinking on withdrawal of Securities transaction tax would could worsen the overall tax cost matrix for portfolio investors, though, statements made by North Block on the week indicate that STT impact would be factored for determination of capital gains base. The proposed graded taxation for long term capital gains replacing special tax rates will to an extent compensate lost ground for long term strategic investors as well as individual traders. Once again, the holding back of tax rates declaration on such gains would cause anxiety.
My view is that we have over engineered the concept of capital gains tax given the current simple regime. Government should review the DTC provisions on capital gains to simplify them as the proposals are unwieldy and far from simple.
I am surprised with U-turn on policy decision for abolition of Securities transaction tax, given that gains on listed securities are proposed to be taxed as ordinary income. A back of the envelope calculation reveals that the Government won’t collect a whole lot by way of capital gains and the extant law on STT ensures decent collection with least administrative cost of collections. Why are we proposing such significant change is beyond my imagination!
Introduction of CFC provisions, though a anti avoidance measure is premature, considering that India businesses has embarked on global vision in past decade; even more importantly, administering such shift in tax policy would necessitate an effective administration. Prescription of ‘effective management test’ for foreign company in India would definitely bring sigh of relief to MNC’s holding Board and management meetings in India as the draft proposal for determining resident test for a foreign companies did not make sense. It is imperative that the tax administration balances CFC rigors with ‘effective management’ test as India would be dealing with its tax treaty partners on opposite sides with respect to both the regulations.
Proposal to grandfather tax holiday for existing SEZ units is the right move; it however needs to be seen whether grandfathering shall apply to all units existing until the date of commencement of the Code. My personal view is approved SEZ’s commencing operations before April 1, 2011 shall get covered under the grand fathering provisions.
Proposal to define a tax exemption threshold limit for non-profit organisations (NPOs) is a bold move. The revised draft permits NPOs to accumulate and carry forward surplus; this will certainly provide greater flexibility to NPOs.
The Government has softened the blow on tax treatment of house property by dropping the proposal to compute gross rent on 6% of the cost of construction or acquisition. Salaried taxpayers too have been spared of a high tax burden on perquisites. Roll back to EEE taxation scheme for certain savings instruments such as Govt PF, PPF, statutory PF and approved pure life insurance products and annuity schemes is encouraging From a common mans standpoint, tax administration can reflect upon the need to include long term infrastructure bonds under the EEE category.
In conclusion, Government’s commitment to introduce DTC from the next fiscal is commendable; there are however, more stopovers before we hit the last mile. It is also expected that the Government will objectively define the framework for smooth implementation of the new law, more importantly for explicit anti-abuse provisions and residence based principles for taxation of foreign earnings. I am also hoping that several glitches in the procedural part of law that crept in the first draft are adequately dealt with before the bill is presented.
(The author is a Partner with BMR, and was assisted by Sumit Singhania; views are entirely personal)