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Corporate tax rationalised
August, 22nd 2009

With the unveiling of the draft Direct Taxes Code, Finance Minister Pranab Mukherjee has conceived the blueprint of the Indian direct tax regime for future. Particularly, the corporate tax regime is set for a sea change.

The industry and area-specific tax incentives (in form of exemptions or deductions) are sought to be done away with and the effective corporate tax rate rationalised to 34.78 per cent (down a whopping 880 basis points) post-dividend distribution. Some of key provisions pertaining to corporate taxes are discussed below.

Corporate tax rate
The corporate tax rate is proposed at the rate of 25 per cent. The said rate applies to both, Indian companies as well as the foreign ones.

Dividend distribution tax (DDT)
Status quo is being maintained on DDT at the rate of 15 per cent, for dividend distributed by Indian companies, except dividend paid to certain specified shareholders like mutual funds, venture capital funds, LIC and approved retirement benefit funds.

The existing single-tier DDT exemption in case of the holding-subsidiary structure is sought to be continued. However, the Code does not provide for DDT exemption to SEZ (special economic zone) developers as is available under the current regime.

Branch profit tax
A new branch profit tax at the rate of 15 per cent is sought to be levied on the branch profits of foreign companies. The Code does not adequately clarify on what constitutes a branch for this purpose of levying the branch profit tax.

Also, the language is of wide amplitude and may possibly apply to all foreign companies whether or not they have a branch in India.

Basis of business income computation
The Code proposes to shift the basis of computation of business income from the current business profits with specified adjustments to an income expense model. Under the new scheme, business income would be computed as: gross earnings less business expenditure.

Interestingly, all receipts from business, including capital receipts, shall be taxable as business income. Thus, profit on sale of business capital assets or from slump sale would now be taxable as business income (as against capital gains under the current regime). Also, remission of loan is now sought to be taxed as business income, which was generally not a taxable receipt.

Business expenditure is classified under three categories operating expenditure, permitted financial charges, and capital allowance (akin to depreciation and R&D allowance, under the current regime).

Minimum alternate tax (MAT)
A material change in being sought on the MAT front, by changing the computation base from book profits to gross assets. The proposed MAT levy is 0.25 per cent of the value of gross assets for banking companies and 2 per cent for all other companies.

Interestingly, assets have been defined to include investment assets as well and thus, MAT would, effectively, be payable in respect of all the assets of the company. No deduction is proposed for debts or liabilities in relation to assets. Separately, in a multi-tier holding structure, there are no provisions to obviate multiple MAT levy at each level, in substance, on the same asset.

MAT would be a final tax, with no tax credit in subsequent years, unlike the current regime where MAT credit is provided for a period of 10 years. The existing MAT exemption for SEZ developers and units is sought to be discontinued.

Business losses
Business losses are sought to be allowed to be carried forward for an unlimited period. While the discussion paper provides that loss from speculative business would be ring-fenced, there is no specific distinction under the Code between normal and speculative business loss. Also, the Code allows for set-off of salary income against business losses.

General Anti-Avoidance Rules (GAAR)
The current regime does not contain elaborate provisions for tax anti-avoidance. The Code seeks to introduce broad, sweeping and elaborate GAAR. Under the GAAR, wide powers have been granted to tax authorities to, among other things, disregard or re-characterise whole or part of transactions and reallocate incomes, if the same has been entered into with the objective of tax avoidance, if they lack commercial substance, and so on.

Certain industry-specific provisions
The existing profit-based tax incentives for specific industries such as infrastructure sector (roads, ports, airports, etc), power sector and SEZ developers are sought to be discontinued and a new expenditure-based incentive scheme is provided in relation to some of these sectors.

This is akin to the Investment-based allowance, essentially allowing deduction of capital expenditure on day one instead of depreciation yearly.

The sweeping changes proposed will surely invite lot of discussion and representation from industry and other forums, especially on the MAT front. One will have to wait and watch the final outcome of this journey which is well begun by the finance minister.

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