A sharp cut in corporate tax rate proposed in the direct taxes code is likely to be done in stages to ensure that tax collections do no
plummet, derailing the governments attempts to bring the fiscal situation under control.

The direct taxes code, or DTC, has proposed a cut in corporate tax rate to 25% from the current 30%, but will withdraw most tax exemptions available to companies. The government is likely to lower the tax rate to 27.5%, or a reduction of 2.5 percentage points, when the code comes into effect, likely from April 2011.

The general view is that the corporate tax rate be brought down to 25% in a phased manner in the DTC regime, said a government official familiar with the manner. A sharp reduction in the statutory tax rate could dent the tax revenues particularly when the code has also proposed to widen the tax slabs for individuals as well with the highest 30% rate indicatively pegged at incomes in excess of Rs 25 lakh against the current Rs 10 lakh.

Though the statutory corporate tax rate is 30%, the effective overall tax rate is about 22% because of the various exemptions available.

It would not have been possible for the government to keep the original plan of levying corporate tax at 25% because of the revenue giveaways on MAT (minimum alternate tax) and capital gains tax, said Uday Ved, head of tax at consultancy firm KPMG.

But even a tax rate of 27.5% is good news for companies and would be very competitive compared with other countries barring China, he added.

The government has laid out a roadmap to reduce fiscal deficit from the current unsustainable levels. A bonanza from the auction of 3G spectrum will help it cut deficit to the budgeted 5.5% of the GDP in the current year. But going down from thereon to 4.8% will be difficult if the government lowers the tax rates sharply. A special task force under the central board of direct taxes (CBDT), the apex direct taxes body, is working on a legislation for the new code, which is expected to be introduced in the monsoon session of Parliament.

Finance minister Pranab Mukherjee has kicked off a comprehensive reform of the countrys taxation regime a new code for the direct taxes and a comprehensive goods and services tax, or GST, to replace the plethora of indirect taxes. Both are expected to be introduced from the next fiscal.

The government has already come out with a second draft to address the specific concerns of the industry and the individual tax payers. The new discussion paper, which will be the basis for the law on direct taxes, has made several changed including addressing the biggest concern of the industry, the minimum alternate tax, or the MAT.

The MAT is now proposed to be levied on book profits, as is the case now, and not on gross assets as proposed in the first draft of the code. The rule was seen to be loaded against the asset heavy companies such as those in the infrastructure sector while favouring operating cost intensive industries like IT.

The new discussion paper has also reworked the taxation rules for retirement savings, giving relief to the individual taxpayers.