Direct Tax Code (DTC) draft analysed
The revised discussion paper on the Direct Tax Code (DTC) released by the Ministry of Finance on 15 June has received positive feedback from industry players by further simplifying existing tax provision and incorporating key proposals made by stakeholders.
The original draft first released in August 2009 was open for comments and suggestion from the public for almost a year before the revised version, which has now been released, will reach parliament as a bill.
While practitioners do not expect any more changes or revisions to the draft, some aspects will be considered during a parliamentary debate when the bill is introduced.
Economic Laws Practice (ELP) commented in a DTC update alert: "The discussion paper only outlines the tax proposals, and, does not provide how the proposals would feature in the final text of the DTC. Though the principles are outlined, true impact of the proposals would need to be evaluated based on the actual text of the DTC.
"However, the revision of some of the proposals that existed in the Draft DTC is indicative of the fact that the government has been open minded and responsive to several of the points of criticism and comment to the 2009 draft. Further, the DTC also shows a strong commitment on the part of the Government towards simplification of the existing tax laws in the country, thereby providing much-needed clarity in the tax statute."
Foreign Companies and FIIs:
- The revised draft subjects the income of foreign companies to taxation in India if its 'effective place of management' is situated in India, which compared to the previous draft is a welcome change but varied interpretation of this term could increase litigation.
- GAAR (General Anti Avoidance Rules) have not been revised, although CBDT (Central Board of Direct Taxes) issued guidelines will lay down circumstances for invocation of GAAR with provision for speedy disposal of disputes through DRP (Disputes Resolution Panel) in such cases.
- Overriding effect of domestic law over treaty is an issue of concern for FIIs when GAAR or CFC (controlled foreign companies) provisions are invoked or branch profits are taxed.
- The proposed categorisation of FII income as capital gains is another point of concern and the treaty protection available to them will get diluted in cases of GAAR invocation.
Impact of draft provisions on Indian Companies:
- There will be equal application of GAAR on Indian companies too.
- Calculation of MAT (Minimum Alternate Tax) upon the book profits instead of gross assets value under the revised proposal has brought major relief to the Indian corporate especially those incurring losses.
- Introduction of CFC provisions as one of the anti avoidance measure will be a huge concern for Indian companies having foreign subsidiaries.
ELP stated: "Under the CFC provisions, passive income earned by foreign companies which is controlled directly or indirectly by a resident in India, is proposed to be taxed in India. However, the extent of direct or indirect control by the Indian resident is not outlined in the proposal. Whether such control has to be in whole or in part or one would need to go back to the term effective management is yet to be clarified."
Proposed Tax Exemptions on Savings: EEE on Investments
- EEE (exempt-exempt-exempt) method of taxation would be reverted back from EET (exempt-exempt-tax) proposal of the previous draft.
- EEE proposes to provide tax relief on all redemptions on savings through instruments such as Government Provident Funds and Public Provident Funds. Pension Fund Regulatory and Development Authority administered schemes and approved pure life insurance products and annuity schemes will also be exempt.
- Rules of contribution and withdrawal will be made uniform.
- Investments made prior to DTC's commencement would continue to be subject to EEE method of taxation.
"This proposal for taxing the withdrawal of the accumulated contributions has been subject to huge debate amongst few sections of the society as it was considered to be harsh. The proposed measures were considered critical in the absence of a social security system and is also a welcome measure considering the long term nature of investments being made in such funds. However, it does not clarify whether there is any limit on account of contribution to the funds which are under EEE taxation regime," noted ELP.
House Property Income:
- The first Direct Tax Code (DTC) draft proposed to compute 'income from house property' on gross rent based on the higher of either the contractual annual rent or presumptive rent notional rent of 6 per cent.
- Revised proposal has done away such presumptive computation of rent.
"Gross rent will be the amount of rent received or receivable for the financial year in case of house property," commented ELP.
"If the house property is not let out, the gross rent will be taken as NIL and accordingly no deductions shall be allowed for taxes or interest. Computation of gross rent on the basis of presumptive rate of tax on the value or cost of construction/acquisition has been removed and shall now be computed based upon the rent received or receivable. The determination of gross rent shall now seems to be equitable.
"Further providing of deduction on account of interest on capital borrowed for one house will provide some relief. However, certain open issues remain unanswered such as taxation of unrealized rent."
Direct Tax Code (DTC) will completely replace the Income Tax Act and is scheduled to be implemented by 2011.