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Budget 10: a step towards direct tax code
March, 02nd 2010

The finance minister was walking a tightrope while delivering his Budget speech this year. He had to keep up the growth momentum while keeping the fiscal deficit and inflation situation under control at the same time.

In the calibrated and gradual approach to roll back the stimulus package that the finance minister took lies a fine balancing act.

On the tax front, though, he continued to show clear signals of the governments commitment to push for a simplified and easy tax system. The commitment to roll out the two most important fiscal legislationsthe direct tax code and the goods and services tax (GST) regimewas clearly manifested in the Budget speech.

Corporate surcharge

The Budget proposes a reduction in corporate surcharge from 10% to 7.5%. This lowers the effective corporate tax rate from 33.99% to 33.22% and the dividend distribution tax rate from 16.99% to 16.61%. The minimum alternate tax (MAT) rate is also reduced on this count.

The impact may seem small, but clearly, this is a step in the right direction to bring in a simplified and single tax rate regimeone of the basic contours laid out in the tax code. However, one would have wished for a full removal of surcharge.

Individual tax slabs

The tax code proposes very liberal tax slabs for individuals. Income up to Rs10 lakh (over and above the basic exemption limit) attracts 10% tax, while the highest tax slab (30% rate) kicks in only once the taxable income crosses Rs25 lakh.

Again, whats important is not how close we are to the tax code benchmark, but that a step in that direction has been taken.

TDS/tax audit threshold

One of the key structural issues with the Indian tax system has been that it is very complex and heavily compliance-oriented. While this may be feasible for large companies and high net-worth individuals, for the large part of the population, particularly small businesses, this adds up to the costs, eventually resulting in non-compliance. This is evident in terms of the low taxpayers base and the tax-gross domestic product ratio.

While the mere fact that the law is complex and entails compliance costs is no reason to avoid taxes, the government certainly has a role in easing this structural flaw. And this has been the key focus of the direct tax code.

Budget 2010 has sought to lay emphasis on easy and voluntary compliance by taxpayers. For instance, the tax audit limit for businessmen and professionals has been enhanced to Rs60 lakh and Rs15 lakh from the current limits of Rs40 lakh and Rs10 lakh, respectively.

Also, the trigger limits for deduction of tax at source on a whole host of payments has been enhanced by 50-100%. This should facilitate cash flow management for the income recipient as also reduce compliance cost for the payer. In other similar moves aimed to ease up compliance, the threshold limit for qualifying under the presumptive taxation scheme (deemed 8% income) for small and medium enterprises has been enhanced from Rs40 lakh to Rs60 lakh. One genuinely hopes this would promote voluntary compliance across the cross-section of the Indian economy and reduce costs.

Change incentives

A mature and simplified tax regime calls for lower rates but wider coverage. This calls for removal of incentives and exemptions. One argues (and rightly so) that the Indian economy has not yet reached that level of maturity to do away will all tax incentives. The tax code, while observing the need to do so in the long run, has retained certain investment-linked incentives for the priority sector.

While it is debatable whether the shift in the incentive regime is appropriate given the current stage of the Indian economy, it is one more hint at the integration of the current tax regime with the tax code framework.

Minimum alternate tax

The tax code had proposed an asset-based tax, which was widely criticized by all sections of the industry. Although there is no specific reference to asset-based tax, the Budget enhances the MAT rate from 15% (plus surcharge) to 18% (plus surcharge), signalling, to some extent, a continuity bias for the profit-based MAT. While the reason cited is equality in payment of corporate taxes, one hopes the finance minister is paving the way for giving in to the demands of the industry to scrap the asset-based MAT and continue with the current profit-based MAT regime, albeit with a higher rate.

Excise and service tax

By rolling back the excise stimulus partially (rate enhanced from 8% to 10%) but retaining the service tax rate at 10% with more services under the tax net, the finance minister has, by far, sent out the strongest signal for a single rate of tax for goods and services, rationalization of duties and broadening of the tax base by introducing new services.

In conclusion, Budget 2010 signals a directional approach in dovetailing the current tax regime into the direct tax code and GST framework, and this is good news. However, one really hopes that greater clarity emerges on other aspects of the tax code such as the treaty override, capital gains taxation and exempt-exempt-tax regime for savings, and of GST, such as rate level and procedural framework, among various others.

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