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The code will increase tax compliance
April, 12th 2010

After years of waiting and indecision, the Indian direct tax system is set for a sea-change, with the proposal to replace the Income Tax Act, 1961, by the new Direct Taxes Code (DTC) from the fiscal year 2011-12. Tax reforms were long overdue in this country, and it is a promising step that the government is finally moving in the direction of streamlining the tax system.

The first thing that catches the attention is the language used in the draft code, which is far simpler than that in the existing one. The level of complications often faced by common citizens and companies alike will also reduce, as it proposes to reduce the number of exemptions and aims to widen the slabs for individuals and reduce tax rate for corporate entities. This rationalisation exercise is likely to reduce confusion and also litigation, thereby leading to a revenue-positive strategy as a whole set of exemptions can bring down the effective tax rate. For instance, one of the findings of the survey conducted by the revenue department was that the effective tax rate of companies reporting profit before tax (PBT) of Rs 500 crore or more was at 21.85%, against the statutory tax rate of close to 34%.

On the face of it, it may seem that the tax base has not been widened, as the minimum exempt limit is kept at the existing level. But the actual number of people paying the income tax will increase because, even after increasing the savings exemption limit for individuals from Rs 1 lakh to Rs 3 lakh, the code proposes to introduce the exempt-exempt-tax (EET) regime for savings. It is a best approach to take to move away from the existing exempt-exempt-exempt (EEE) regime, which means the individual will enjoy exemption only at the time of investment and accumulation but will be taxed at the time of withdrawal. This proposal can straightaway put an assessee, who was exempt or under the lowest slab, into the higher slab.

The draft also proposes to replace the securities transaction tax with the restructuring of long-term capital gains tax. India, facing severe capital constraints, needs huge amount of money to build or rebuild its infrastructure and so, there has to be an incentive for people willing to invest their savings in equities to provide long-term capital for investment-starved sectors. The EET regime can act as a dampener for savings.

In the Indian context, the direct tax system is very important, because more than 50% of the tax collections of the government come from direct taxes. Also, when the policy thrust is towards achieving inclusive growth, the logical way for the government to expand the scope of the spending on social sector infrastructure is by increasing tax revenues, rather than running huge deficits. If better tax compliance is ensured and the incentive for tax avoidance is reduced, it will plug many a loophole and increase the tax revenues. The point cannot be overemphasised: the black economy has to be contained.

The proposed tax code must be viewed along with other reforms like the goods & service tax, companies Bill and International Financial Reporting Standards. Taken together, they will change tax compliance of Indian businesses and citizens for the better. Its agreed that it will be difficult to get all aspects right and satisfy interests of each and every stakeholder. But the code is a step in the right direction, as India seeks to inject more vibrancy and dynamism to the economy in tune with its rising global ambitions.

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