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Will the new tax code be a policy vehicle?
June, 28th 2007
Nearly nine months ago, a few tax professionals were called to North Block for a hush-hush meeting. They were shown an initial draft of the new direct taxes code that will replace the Income Tax Act. Their mandate: suggest improvements to keep it simple and easy for taxpayers to understand.

The Central Board of Direct Taxes (CBDT) debated on the suggestions given by tax professionals before presenting the draft code to finance minister P Chidambaram. The FM has already spent several hours with senior tax officials discussing further refinements.

He had undertaken a similar exercise in 1996 as the finance minister of the United Front government. But the bill could not be passed by Parliament. The UPA government is now targeting the monsoon session to table the new code.

Rewriting income tax law in simple English is the main goal. But the government is set to go beyond this and usher in some major policy changes as well. Pruning corporate tax exemptions and deductions and new policy initiatives in non-resident taxation will be a part of this marathon exercise.

Several policy prescriptions were, in fact, given earlier by in-house panels set up to rewrite the existing income tax law. One group looked at tax exemptions and deductions and another at charitable institutions. A third group examined non-resident taxation.

The panel on non-resident taxation wanted the introduction of anti-abuse and anti-avoidance provisions 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. Anti-abuse provisions are bound to find their place in the new code, if Mauritius does not rework its tax-treaty with India.

Will the code lend certainty to the tax-treatment of income earned by FIIs from the sale of Indian shares? Chances are remote. Tax officers will go by the facts of each case to decide whether an FII is an investor or a trader in shares. Simply put, there may not be anything black and white in the code, at least on this issue.

Big-ticket policy are unlikely for charitable institutions. For several years, these institutions have enjoyed a tax shelter and this may continue.

Phasing out corporate tax exemptions and deductions will, perhaps, be the main focus in the new code. The government has been talking about ending exemptions for sometime. But resistance from India Inc has forced it to go slow. Even now, the effective tax rate for several companies is lower than the statutory rate of 33.99%.

Companies enjoy two kinds of open ended exemptions. One, where the exemption is perennial. Another, where the exemption is for a finite period, but companies are free to claim it at any point in time.

One of the major tax benefits is the tax holiday for infrastructure service providers. The exemption, under a section known as 80 IA, has no end date set for it. An option before the government is to set a time period for ending this exemption in the direct tax code.

The biggest income tax exemption available on date is the tax holiday for SEZ developers: it is estimated to cost the exchequer over Rs 1-lakh crore. But the policy muddle on SEZs due to problems of land acquisition will see fewer entrants. A good bet is status quo on tax breaks for SEZ developers.

Tax exemptions enjoyed by individuals on savings and investments are also set to be reviewed. The most significant one is the tax deduction up to Rs 1 lakh on investments in select savings schemes such as PPF, insurance premia, bank deposits and so on. They do not have to pay tax at any stage. The government has been looking at levying a tax, at least on some instruments, at the time of maturity.

The million dollar question is whether the direct tax code will incorporate such policy changes as well. After all general elections are just two years away.
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