Revised DTC draft: Retreat from modern tax system?
June, 23rd 2010
There have been high expectations that the Direct Taxes Code (DTC) and the impending Goods and Services Tax (GST), designed to tax both goods and services under one law across the nation, will enable India to shift to a modern taxation system, enabling the country to achieve internal unification of its domestic market, while being well-integrated with the global economy.
There are, however, strong reasons to be concerned about whether the eventual design and implementation structures of these two major tax laws will be consistent with the realisation of the above vision.
The 13th Finance Commissions recommended structure of broad-based, low rate (12%) GST, with uniform base nationally, does not appear to have received the requisite political support.
Political negotiations between the Centre and the States on the design of GST are not yet completed, even though the proposed implementation date of April 2011 is less than one year away.
Media reports have suggested that a 16% rate of GST is being considered, 25% higher than what is achievable. This may be regarded as the cost borne by the aam adami as a result of the disconcerting tendency of the governments at all levels to view even nationally crucial decisions from the narrowly partisan perspective.
The DTC draft was released in August 2009 for public discussion. In subsequent months, there have reportedly been more than 1,600 submissions, primarily by those likely to benefit from the shift away from the broad-based low nominal rate tax regime.
Such a regime was correctly favoured by the August 2009 DTC version as being more efficient, equitable, minimising artificial large differences between statutory and effective rates of taxes for select taxpayers, while protecting revenue.
Such a regime is also likely to provide better incentives to new business formation, a vital need in diffusing new ideas and generating large number of productive livelihoods. India will need to generate about 15 million jobs per year for at least a decade more. It also minimises the tendency of interest groups to seek special tax treatment at the expense of broader public interest, and of the policymakers to consider them.
The revised DTC discussion paper has recently been released (www.fin min.nic.in) for comments till June 30, 2010. The government expects to present the final DTC to the Parliament during the monsoon session later this year.
There are 11 issues addressed by the revised DTC paper. These include Minimum Alternate Tax (MAT) for companies; tax treatment of savings, taxation of capital gains; taxation of non-profit organisations; taxation of existing units in Special Economic Zones (SEZs); wealth tax; and Double Taxation Avoidance Agreement (DTAA) vis-a-vis domestic law. Each one of these is a complex area. Much will depend on how general concepts of the revised DTC paper are actually worded in the Law, and how implementing regulations and procedures are set.
At this stage, therefore, only a preliminary assessment is feasible. It suggests significant departures from the broad-based low nominal rate regime in nearly all of the issues covered.
Thus, the revised paper suggests continuation of the existing method of determining MAT on book profits, and drops gross assets provision. The book profits provision appears to suit the existing large firms better than the asset based proposal. This will narrow the tax base.
It also proposes, EEE (exempt, exempt, exempt) tax treatment of approved savings, including for annuities. The revised paper suggests that the rules for contributions and for withdrawal will be harmonised for uniformity, and for long-term savings. Not only does this narrow the existing tax base, but also such narrowing will grow rapidly in the future as pension assets accumulate (they are currently about 20% of GDP), and as the number of individuals above 60 years of age increases from 110 million in 2010 to 330 million by 2050.
At the minimum, provisions for pre-retirement withdrawals from the Employees Provident Fund (EPF) need to be significantly tightened, and its investment policies modernised. The Public Provident Fund (PPF) needs to be restructured for long-term savings while ending the practice of non-market-based interest rate. The voluntary New Pension Scheme (NPS), introduced in May 2010, should be preferred over the PPF in policy reforms.
One of the positive aspects of the proposed EEE tax regime is that the tax disadvantage of the NPS no longer exists. But such tax regime is a huge tax concession benefiting the upper half of the income groups, and hence regressive. There is now even less social justification for special income tax treatment of senior citizens or of women. Any such concession benefits only the upper half of the income groups, representing yet another inconsistency between the political rhetoric of aam adami by the UPA government and its actual policy measures.
The provisions concerning taxation of capital gain, and the provision that between the DTAA and the domestic law whichever is favourable to the taxpayer will prevail, will in general favour foreign institutional investors and the tax havens such as Mauritius and Singapore with whom there are special agreements, while domestic investors may be less advantaged. The implications of such provisions for developing Mumbai (and other locations) for providing international financial services within India need to be examined further. There is a strong case for revisiting the DTAA with Mauritius and Singapore, or at least to further tighten measures to prevent possible misuse.
There is also a case for formally abandoning the global basis for income taxation, and adopt source or territorial basis. The revised paper indicates that the rate structure and the income brackets of the personal and corporate income taxes, as well as the basic exemption and deduction levels for individuals, will be adjusted once the final decisions on these and other relevant issues defining the tax base are in place. With the narrowing of the tax base, there will be higher nominal rates, and narrower income brackets for personal income tax than proposed in the 2009 DTC paper.
The prospects are that the process of instituting a modern equitable, efficient, and revenue productive tax system will only be gradual. Moreover, the proposed departures from a broad-based low nominal rate regime may have set a dynamics for even more departures in the future.
The general public has the right to expect better political leadership, including from the opposition, to ensure that departures are such that the DTC eventually enacted does not differ in essence from the outdated Income Tax Act of 1961 that it is set to replace.