TAX NEWS - 2010

India Tax: New tax system will be simpler and easier to implement

The revised tax code is sure a step forward

The revised draft of the direct taxes code (DTC) of India released on Tuesday is a compromise between the best principles of taxation and the need to promote savings in a country with no effective social security net. An ideal taxation system discourages exemptions and concessions as they create complexity, affect the uniformity of application, promotes litigation and political discretion and allows more powerful tax payers to evade taxes.

India's tax system was riddled with these problems and the original code released last year was an attempt to solve them. But the code seems to be based on a realisation that exemptions and concessions have a major role in encouraging savings. A high rate of savings is necessary for financial security in later years of life and for the growth of the economy.

Therefore, the most controversial proposals in the original tax code — taxing retirement benefits and imposing a minimum alternate tax (MAT) on companies based on their assets — have been dropped. The first will please individuals, especially in the middle class, and the second corporate entities. Provident funds, long-term savings schemes and retirement and pension plans will be exempt from taxation at the time of investment, accumulation and withdrawal.

The earlier proposal was to tax them at the withdrawal stage. The tax relief available for home loans will also continue. If these exemptions had been discontinued there would have been less incentive for individuals to save and many would have been in dire straits after their retirement. The prime minister had accepted the merit of the argument and supported it. Companies would welcome the proposal to impose MAT on profits, rather than on assets, because otherwise even loss-making firms would have been forced to pay tax. The entire corporate sector had opposed the earlier proposal. But this may lead to evasion of tax by companies which manipulate their books and suppress or divert profits. On the other hand, a tax on assets would have burdened capital intensive companies and those with a long gestation period.

Even after the changes in many areas, the tax system will be simpler and easier to implement than the existing one. The new tax rates have not been mentioned and may be finalised only after a public discussion on the revised code. It may not widen the tax base and may not do away with all the distortions in the system but is still a step forward.