The proposed direct taxes code (DTC) dampens entrepreneurship, the catalyst which converts resources into economic growth, in multiple ways. It removes some avenues of tax avoidance created to help business reorganisation and entrepreneurship, such as, for example, a holding period of eight years before transactions between a holding and a subsidiary company become taxable; or where assets are contributed as capital by a partner to a firm at book value; or of five years where a firm is converted to a company, and mergers and demergers.
DTC wants tax exemption conditions to continue in perpetuity; otherwise, the transaction would invite tax. The code gives draconian powers for valuation by valuers in all circumstances. It also gives very wide powers to tax officers to decide whether any series of transactions or any scheme has a genuine business purpose or is a tax avoidance or evasion even if it is fully tax compliant.
Corporate reorganisation now goes beyond mergers and demergers. Internationally , migration of registered office from one country to another is now permitted without being considered a transfer for tax purposes; the DTC maintains a golden silence. The conversion of a company into limited liability partnership (LLP), an incorporated body, and encouraged by the new LLP law of 2009 gets no tax exemption although it is on par with tax-exempt amalgamation of companies. The code also does not exempt from tax new internationally accepted forms of merger.
Shares of company B are taken over by A-Limited in exchange of shares of A-Limited whereby B-Limited becomes 100% subsidiary of company. Thus shareholders of A Ltd and B Ltd pool their economic interest. It is the commonest form of takeover worldwide and is also encouraged by the Companies Bill 2009 in India whereby minority shareholders have to compulsorily give up their shares if the dominant majority of 90% agrees to a takeover bid, as is the international practice .
In principle such a takeover is the same as merger of two companies where Company A and B become AB and shareholders of both companies become shareholders of AB, leading to a pooling of economic interests as in a takeover.
Under the group system of taxation, not recognised in India, if a business undertaking is transferred from one company to another within the same group, the transaction is not taxed until the unit goes out of the group.
Further, while Sebi wants consolidated results of holding and subsidiary to be published and internationally the profits and losses of group companies are taxed in a consolidated manner, this system of group taxation is abhorrent to our tax designers and the DTC.
Capital formation in the corporate sector has been hit by recently reduced depreciation , proposed high MAT-based on assets and tax on investors. Mr P Chidambaram in 2007 stated at a post-budget meeting, MAT was raised because the effective corporate tax rate was 22% with depreciation and exemptions.
The regular tax now proposed is 25% without exemptions . Inter-corporate dividend distribution tax remains; the investor will further pay MAT at 2% on investment at book value . Rates will reduce from 30% to 25% but impact only companies which dont make capital investment. With corporate savings being reduced due to various tax amendments, borrowings will increase thus impacting costs, inflation, and global competitiveness as also the capacity to borrow for new projects.
Venture Capital Funds (Vencap) are not being given tax pass-through . Over 75% of infrastructure equity comes from domestic Vencap and Mauritian tax haven-based private equity investments. The DTC seeks to strike out their legal tax shelter.
But is this a strong justification to overturn all tax treaties by an innocuous looking provision in the code that the latest law will prevail over the earlier tax treaties because the Indian government cannot persuade the Mauritian counterpart to change the treaty? It brings a huge risk element to new foreign investments thereby increasing costs and uncertainty.
Para 13.1 and 13.2 of the discussion paper issued by the government recognise that tax on corporate income and thereafter dividend distribution tax is double taxation of the same income.
Para 13.1: A tax on the income of companies can also be justified as a withholding tax that ... taxes the income which would otherwise flow to the shareholders . Para 13.2 states: The code provides for taxing incomes of companies. It also provides for taxing dividends distributed by resident companies . Will the CBDT be bold enough to recognise its own stated logic and stop this double tax or reduce DDT to 5%? The DTC needs serious review.