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A big step towards tax equity
August, 18th 2009

The eagerly awaited Direct Taxes Code has been announced earlier than the 45 days promised by the Finance Minister during his Budget Speech on July 6. The main reason given for replacing the existing Income-Tax Act, 1961 was that it has become too complex and is unable to keep pace with the dynamic way in which business transactions are being carried on.

The new Code, in its draft form, shows that the Government has taken a huge step to achieve equity in the Indian tax system and it also provides an insight into the Governments long-term vision on tax matters.

Peak rate retained

The Code has done away with the confusing maze of provisions, sub-provisions, clauses, sub-clauses and explanations. Though the peak tax rate for individuals has been retained at 30 per cent, income-tax slabs have been rationalised, bringing significant relief to individual taxpayers, though it might result in greater inequity in income distribution between the poor and the rich.

The Code aims at taxing withdrawals from PF, PPF and other such saving schemes, which is bound to fuel a lot of debate. The Code would hit the already beleaguered real estate sector, as interest deduction on self-occupied house properties is proposed to be abolished.

The corporate sector has reason to cheer as the tax rate is reduced to 25 per cent, making it comparable to those in Singapore and Hong Kong and lower than in most developed countries such as the US and the UK.

The Code also shifts the current profit-based incentives to investment-based incentives, marking an end to tax holidays that are dependent on the profits irrespective of investments.

MAT applicability

There is also a big shift in the applicability of Minimum Alternate Tax (MAT), which would now be based on percentage of the gross value of assets and is likely to raise concerns from the capital-intensive sectors such as infrastructure, real estate, oil and gas, and so on, without any eligibility to carry forward the tax credit.

Foreign companies have a lot to cheer about as the Code removes the discrimination in the tax rate applicable to foreign companies vis--vis Indian companies. However, the parity in tax rates would also mean that hereafter, branches of foreign companies also need to pay Branch Profit Tax equivalent to Dividend Distribution Tax. The taxation of foreign companies would undergo lots of changes, especially with the introduction of a narrow definition of resident. With this definition, a foreign company having part of its management in India could end up being treated as a resident company liable to tax on its worldwide income.

The draft provides that wherever there is any dispute between the provisions in the Code and the those in the tax treaties signed by India with over 70 foreign jurisdictions, the former would prevail. This would be a huge jolt to the foreign companies which have established their presence in India or have entered into business transactions based on certain beneficial provisions in the tax treaties.

It is unclear as to whether the Code could override the tax treaties just because it is introduced after the signing of tax treaties and in such cases what would happen to the sanctity of the various tax treaties. This requires extensive debate before the same is enacted.

Transfer pricing

On international tax and transfer pricing, the long-standing demand of introducing an Advance Pricing Mechanism (APM), which would function as a forum to bring certainty to transfer pricing issues has been accepted. The steep penal consequences for non-maintenance of transfer pricing documentation have been reduced, but prosecution followed by imprisonment has been introduced for non-compliance.

The Code has amended the concept relating to income deeming to accrue in India to state that the provisions contained therein would apply irrespective of whether the payment is made outside India or whether the services are rendered outside India to negate the the apex court decision in the Ishikawajima (288 ITR 408) case.

The case held that for a service to be brought within the ambit of taxation in the hands of a non-resident in India, the services should be rendered in India.

In addition, the term royalty has been amended to include consideration for the use of or right to use transmission by satellite, optic fibre or similar technology. This is intended to mainly target payments made by telecom operators to overseas satellite companies so as to bring such payments within the ambit of royalty.

The tax administration has reason to cheer, as the Code introduces stringent anti-avoidance measures in line with globally accepted practices. The Code is poised to be a transformational law keeping pace with the changing world economy and business dynamics. However, the intention of the Government in having a taxpayer-friendly measures should be supported by efficient tax administration so that the Code is implemented in its right spirit rather than becoming another Act resulting in protracted litigations. More than the mindset of people who have penned the Code, the mindset of tax collectors and taxpayers also need to undergo significant change to make this a success.

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