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Major direct tax reform in offing
July, 25th 2008

The UPA government is set to propose major reforms in direct tax policies that could ease the tax burden for companies and individuals in the coming years. Policy changes for various segments of taxpayers, including companies, individuals, domestic and foreign institutional investors (FIIs) and charitable institutions, are set to feature in the new direct tax code. It will replace the existing income tax law that is perceived to be cumbersome.

Taxpayer-friendly measures will be proposed in the code and a discussion paper will be released with the draft bill soon, said an official involved in the drafting exercise. But tax policy changes will come into force only after the bill is ratified by Parliament. Currently, companies are charged a 33.99% tax, though they pay a lot less than the prescribed rate due to various exemptions. For individuals, tax at the highest bracket of 30% kicks in for incomes above Rs 5 lakh a year. Including the cess, the rate is comparable with companies.

Finance minister P Chidambaram pushed restructuring of income tax slabs in this years Budget to benefit individual taxpayers . Greater compliance provided the leeway to offer this bonanza. But he did not tinker with the tax rate for companies and also left most exemptions untouched. On the contrary, the government extended the tax holiday for software companies on their export profits by one more year.

In-house working groups, set up earlier to suggest policy changes in the new code, proposed phasing out of major exemptions to boost revenues. An option before the government now is to provide a time-table for ending exemptions. But the pros and cons of such a move are still being debated as general elections are just a winter away. Any proposal to end income tax deductions enjoyed by individuals will have political ramifications.

For instance, the government has virtually dropped the idea of levying a tax on public provident fund and other savings instruments at the time of withdrawal. Chances of such proposals featuring in the new code appear to be remote. Besides, the government has a cushion as tax revenues are buoyant.

On non-resident taxation, the government may propose the introduction of antiabuse and anti-avoidance provisions in the new code. The idea is to curb treaty-shopping , a practice where residents of a third country take advantage of a tax treaty between two countries.

A telling example is the rampant misuse of the Indo-Mauritius tax treaty. Since Mauritius has not re-worked its tax-treaty with India, anti-abuse provisions could feature in the code. The code may also look at ending the uncertainty on the taxtreatment of income earned by FIIs from the sale of Indian shares, said a source. If the draft bill is not ratified by Parliament before the elections, it could well be showcased as a reform-agenda that the UPA government will pursue if voted back to power.

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