Decoding Direct Tax Code

The government has finally come out with the Direct Tax Code, which will replace the archaic Income Tax Act and Wealth Tax Act. The DTC is considerably diluted as compared to the original draft proposed, but still has considerable implications.

Akrita Reyar

With the government unveiling the new Direct Tax Code, we look at how the new tax provisions will affect your wallet. Major Provisions of DTC: Income and Wealth Tax Rates Increase in tax exemption on income from Rs 1.6 lakh to Rs 2 lakh, with no separate benefit for women. Income from Rs 2-5 lakh to be taxed at 10 percent; Rs 5-10 lakh at 20 percent and 30 percent thereafter. Currently, income from Rs 1.6-5 lakh attracts 10 percent tax; from Rs 5-8 lakh, 20 percent and beyond Rs 8 lakh, 30 percent. Tax exemption limit for senior citizens above 65 years to be marginally raised to 2.5 lakh per annum from Rs 2.4 lakh at present. The changes will save up to Rs 41,040 for those earning more than Rs 10 lakh a year. Corporate tax to be a flat 30 %. MAT has been increased from 18 percent to 20 percent of book profit of a company. Dividend Distribution Tax will be at 15 percent. Exemption limit for imposing Wealth Tax raised to Rs 1 crore from current Rs 15 lakh. Wealth tax to be imposed at the rate of 1 percent, except on non-profit organisations which are exempt. Tax Audit Limits Tax Audit Limits raised from existing Rs 15 lakh for professionals to Rs 25 lakh, and from Rs 60 lakh for income from business to Rs 1 crore. Exemptions Exemption of interest up to Rs 1.5 lakh on housing loan retained. Deduction to be considered only on the interest component and not the principal amount. EEE (exempt-exempt-exempt) mode of taxation for insurance and pension funds also maintained. Exemption on pension, Provident Fund and Gratuity Funds to be at Rs 1 lakh, while Rs 50,000 exemption provided on pure insurance, including health cover, and tuition fee payment. LTA Tax incentives on leave travel allowance to be scrapped. For Investors Existing provision of zero tax on long term capital gains to continue. Short-term capital gains tax for annual income up to Rs 10 lakh rationalized to benefit investors in the lower income bracket. Small investors with incomes between Rs 2 lakh and and 5 lakh to pay only 5 percent capital gains tax, less than one-third of the current 17 percent (15 percent + cess). Investors in income bracket of Rs 5 lakh and 10 lakh will pay 10 percent capital gains tax. Big investors having income over Rs 10 lakh to pay short-term capital gains tax at 15 percent. Investment in equity-linked Mutual Fund schemes and ULIPs to attract 5 percent tax on the dividend paid by these entities. At present, there is no DDT applicable to equity fund schemes or insurers on income distribution to unit or policy holders. Implication of DTC While senior citizens benefit marginally, women would no longer be given a special status by the government for a higher exemption. Middle Class will continue to find purchasing a house a lucrative option, as exemptions on interests on home loans will continue. It will also give realtors some relief who are just emerging from a depressed patch. As for the outcome of personal exemptions, there will be a marginal rise in savings as exemptions have been increased for investment in approved funds and insurance schemes to Rs 1.5 lakh in a year from Rs 1.2 lakh currently. Raising the limit for imposition for Wealth Tax to Rs 1 crore is likely to improve compliance, which is currently very low. But the Rs 1 crore limit is markedly low compared to the proposed limit of Rs 50 crore, which was originally proposed. The adverse impact of the new provision comes from the fact that Wealth Tax would now include companies in its ambit. So far, they were out of the net. Small and medium investors will gain substantially by way of saving on taxes on short term gains. DTC is also expected to boost investment flow into capital markets, as the government proposes to retain a zero long-term capital gain tax. While corporates will get slight reprieve via reduction in Corporate Tax from current 33.22 percent (for incomes more than Rs 1 crore), increased MAT will counter the gain for industry. Moreover, Special Economic Zones (SEZs), which are notified on or before March 31, 2012, will get income tax benefits, as per the proposed Direct Taxes Code (DTC) bill. The Bill also proposes profit-linked deductions under the I-Tax Act to SEZ units commencing operations by March 31, 2014. This may have an adverse impact as there is no sunset clause at the moment, but improve commitment levels of players already in the fray. Asked about overall implications of the DTC, tax expert and analyst R N Lakhotia told Zeebiz.com that one should not over worry about tax implications as the government has evened out losses and gains. That is, a hike in one place would be offset at another, as no government would want to be unpopular with the electorate. So the process is a mere rationalization. Lakhotia advised that diversification of portfolio using personal discretion could be a good strategy. For example, insurance policies should be treated separately from ULIPs, whose dividend will not invite tax. A policy should be bought more with an idea of an insurance cover than anything else. A Unit, on the other hand, should be picked depending on the returns it is likely to fetch. Besides Lakhotia asked tax payers to take a broader view of things, “The word ‘income’ comes before ‘tax’. The idea should be income and wealth creation. Tax is a secondary thing.” We must try and maximize our incomes first using sensible investment policies. When there will be more and more money in your pocket, a person wouldn’t mind shelling out some of it as tax, he said. As for the government, DTC will result in an estimated revenue loss of Rs 53,172 crore in 2012-13 as gross tax collection from direct taxes will come down from an estimated Rs 5.80 lakh crore to Rs 5.27 lakh crore. Because there will be firmness and transparency in the tax structure, all in all, we will no longer wait for Union Budget with such baited breath as the personal income tax announcements will no longer be a part of the Finance Bill and thus the FM’s speech. The tax rates have been reduced to some extent with the hope of widening the base, but the changes seem fairly cosmetic when considered in comparison with the proposals which were considered in the original draft of the DTC. The powers of the tax authorities under the General Anti-Avoidance Rules (GAAR) also remain the same. Why DTC As part of its financial reforms process, the government wanted to modernise and upgrade its direct tax laws i.e. the Income Tax Act and the Wealth Tax and bring them more in line with current times. DTC is expected to widen tax base, give moderate relief to tax payers, reduce unnecessary exemptions, and improve compliance thus improving collections. It also seeks to address new realities like operations of foreign companies in Indian markets, foreign institutional investors and cross-border M&As. For example, capital gains tax would be imposed on acquisitions made overseas if the acquired company holds over 50 percent assets in Indian company. This would affect companies like Vodafone Group for its acquisition of a 67 percent stake in Hutchison Essar from Hong Kong`s Hutchison Telecommunications International Ltd. The government has also clarified that foreign companies, which were regarded as ‘resident of India’ if their control and management were wholly situated in India, will now be considered ‘resident’ if the “place of effective management” is in India. DTC replaces the archaic Income Tax Act, 1961 and Wealth Tax Act, 1957. It will come into effect from April 01, 2012. First return of income under its norms will be filed after March 31, 2013.