Over the last 50-years a 1,000 or more amendments have been made to the 1961 Income Tax Act. Amendments that have baffled not only the common man but also Chartered Accountants and lawyers. Consequently in 2005, the Finance Minister decided to simplify the Act so that the average man can easily comprehend it.
While officials at the Central Board of Direct Taxes or CBDT have already prepared draft notes, they are not in the public domain just as yet. Experts expect the direct tax code to be introduced in the Parliament by the end of this year.
When it comes to deciphering the Income Tax Act, CFOs are lost in translation.
In 2006, GMR tried to merge two power plants but failed due to tax ambiguity. According to the Income Tax Act, the company stood to lose benefits conferred by section 80IA, a section that grants a new infrastructure project tax exemptions in the first 10 years out of the 15-years of operation. But the Act did not clearly state whether the company would lose the benefit of the plants were merged and even experts could not help.
Subba Rao, CFO, Corporate Integration, GMR said, "There is no definitive answer again in this case. So we cannot even approach the Department to take an advance ruling, which way we can go and which is the definitive - whether there is any liability or otherwise. In this scenario when there is a possibility to interpret a section in two ways or multiple ways, when there is scope for litigation by the accessing officer. So these are exact reasons why the law has become so complex from accessing side."
Complexities that finally promoted the government to change the law. Now a new direct tax code has been proposed.
H.P. Ranina, Tax Advocate, Supreme Court says, "A country like Britain which has six times the number of actual tax players, it doesnt even have 10% of the litigation which India has. The reason is that our laws are too complicated, too complex, not properly drafted. So what the Finance Minister has said as an objective for a direct tax code is that I am going to simplify and put it into simple language. So for example, today you have things like previous year, assessment year - these are the words used in the income tax law. He says, I am want to simplify and put it in very simple language so that the common man can understand what is tax liabilities."
The new direct tax code is expected to bring about dramatic changes. For instance, experts say it could bring Income Tax and the Wealth Tax under one roof. This is to make a taxpayer to declare not only his income but also his assets. So assets disproportionate to taxable income can be discovered. Not just individual income, but many hope that the new code will also address ambiguity regarding corporate taxations.
Ketan Dalal, Partner, PwC says, "You have a situation of them not being clear as to the manner of computation of exemptions on say, SEZ profits, especially when they setup captive units. You have probably heard this controversy about when you have more than one unit, SEZ and non-SEZ, how do you compute profits? So those are the kinds of things that are leading to complications. You obviously have this issue of whether Mauritius is tax-exempt or not cropping up repeatedly. So the kind of certainty or uncertainty that is always there on the horizon is what is causing them the concern. Essentially, they want certainty in administration and interpretation of tax law. So there are lots of issues but these are couple of them, which at least the foreign investors are facing.
Experts also expect some substantive changes like in the case of Transfer Pricing Regulations. Transfer Pricing Regulations were introduced in 2003 and has since been a bone of contention for many.
Ranina says, "Transfer Pricing Regulation is a very simple issue of determining the arms lent price. The simple principle is that when you are dealing with an associate company, which is an international company, the transaction must be at an arms lent price so thats sufficient profits are shown in India and you dont divert the profits toward low tax country. That is the basic principle of transfer pricing. But how do you determine this price, if this depends on each transaction. Now, under the law, youre supposed to maintain records of different type of transactions which have taken place in different parts of the world. You have to maintain - how is your transaction different from some other transaction? What adjustments are to be made? So there are broad guidelines, internationally accepted guidelines. But these guidelines will remain guidelines even in the direct taxes code and therefore, government has to come up with a simple method or may be come up with some rough and ready method saying that if you are going to disclose a profit of say x-percentage say 10-12-15% which is reasonable, that should be accepted and no further issues will be considered at that stage. So thats the only way to simplify the law."
The new code may also introduce the Controlled Foreign Corporate or the CFC regime. This is to address issues such as whether passive income sitting in non-investor jurisdiction should be taxed as the income of the investor company. Take for example, if an Indian company invests in a Dutch company which is the holding company and that in turn invests in an EU operating company then according to the CFC regime, the dividend earned from the EU operating company, say Euros 100, can be taxed as income of the Indian investor company.
Dalal says, "There is no CFC regime in India and there has been talk of a CFC regime being introduced. So the possibility is that this could be introduced in the direct tax code but one only hopes that it is not so complex and it is not in a sense not unfair, so that the last thing one wants is that outbound investments getting traction, currently it has got substantial traction and one hopes that this does not become a deterrent."
But will the transition decades old income tax act into the new Direct Tax Code be easy?
Subba Rao says, "Thats the major concern - if the new tax code comes what is going to happen to the existing tax exemptions that have been granted to several industries. What kind of sunset clauses would be there? How they would be addressed and for how many years that would be given?
Dalal says, "There will be important transitional issues to be taken care of. Take an example of a penalty. Let us say a penalty preceding has started under the Income Tax Act and the relevant penalty provision is amended in the Direct Tax Code. So which provision should apply -- the new one or the old one?"
The new code is expected to bring in major policy changes related to corporate taxation, non-resident taxation and SEZ exemptions. It will hopefully bring in more certainty and will be less open to interpretation that the existing one. But experts say that although the new code may be simple and jargon free, it could also be more stringent for individuals and for corporations and thats because the government is looking at moving away from an exemption-based regime.