New tax code: More money, fewer exemptions!

You get more money in your hands, but interest payment on home loans could become fully taxable, and perks to be included in salary income and taxed.

The draft Direct Taxes Code released by the government on Wednesday proposes sweeping changes in terms of increase in tax slabs and wealth tax, but it has also done away with some exemptions.

For Individuals

• Tax breaks on savings raised to Rs 300,000 from Rs 100,000 (at present under Section 80C).
• Interest component on home loan for self-occupied property to be ineligible for deduction for calculating income from house property.
• Perks to be included in salary income and taxed.
• All withdrawals from Provident Fund accounts opened from April 2011 to be taxable; life insurance also proposed to be covered by EET method.
• Wealth tax limit raised to Rs 50 crore. Tax of 0.25 per cent above this limit.
• Retirement benefits be exempted from tax only if saved in retirement benefits account.
• Scope of higher education for tax deduction purposes to be expanded.

For instance, the slabs of all categories have been changed significantly. At present, an individual pays nothing on taxable income up to Rs 1.6 lakh (Rs 160,000); 10 per cent from Rs 160,001 to Rs 3 lakh (Rs 300,000); 20 per cent for above Rs 3 lakh to Rs 5 lakh (Rs 500,000) and 30 per cent for above Rs 5 lakh.

The new numbers would look like this. No tax up to Rs 1.6 lakh (Rs 160,000); 10 per cent for income between Rs 160,001 and Rs 10 lakh (Rs 1 million); for income over Rs 10 lakh and Rs 25 lakh (Rs 2.5 million), Rs 84,000 plus 20 per cent for amount exceeding Rs 25 lakh, and for incomes above Rs 25 lakh, Rs 384,000 plus 30 per cent on income exceeding Rs 25 lakh.

In other words, on a taxable income of Rs 10 lakh, an individual now pays Rs 2.12 lakh (Rs 212,000) as annual income tax. Under the new rate, the amount would be almost one-third, at Rs 84,000 (See table). 
 

Read on further to check out what the new tax code has in store for you, the markets, and the industry. . .

Also, the wealth tax limit has been hiked to Rs 50 crore (Rs 500 million). Over that limit, the tax is a mere 0.25 per cent. And the Section 80C limit could also go up to Rs 3 lakh.

Then, there are proposals to remove the clutter. For one, the distinction between short- and long-term investment asset could go. However, if the asset is transferred after one year, there would be deduction based on cost inflation index.

This would basically mean that the long-term capital gains tax, which is applicable for debt funds after one year and housing after three years, will now be standardised at one year. So, if one sells a house after a year, he will get the benefit of cost inflation index available to him -- something available to him only after three years.

And if the individual sells the asset, whether property or shares, the capital gains will be included as a part of their income and taxed accordingly.

To make life simpler for the taxpayer, the terms 'previous year' and 'assessment year' will be replaced by a unified concept of 'financial year'.

However, while the tax slabs have been hiked substantially, there are some cuts on deductions as well.

For one, interest payment on home loans could become fully taxable. At present, home borrowers get tax deduction up to a limit of Rs 1.5 lakh (Rs 1.5 million) on interest payments. This could become zero for the self-occupied because the gross rent is assumed to be nil.

On the other hand, if the person rents out his place or owns a second home, he will get the tax benefit. The calculation will be based on the highest of the actual rent, or 6 per cent of the ratable value (decided by the Municipal authorities), or 6 per cent of the acquisition cost minus deductions, including unlimited interest payouts.

In case of equities, which used to get long-term capital gains benefits (zero taxes) after one year, the capital gains would now be included as a part of the total income.

Besides, the code also proposes the EET (Exempt-Exempt-Tax) principle for withdrawals of accumulated balance in government provident fund, public provident fund and employees' provident fund. But it will be applicable to only new contributions after the commencement of the new code.

For the Markets

• STT to be scrapped and replaced with capital gains tax.
• To do away with distinction between long, short-term capital gains.
• Base year for calculation of capital gains tax moved to April 2000; all capital gains between April 1981 and March 2000, not liable to tax.
• No tax deduction on interest payable on any government security.
• Profits of non-life insurance business to be disclosed annually.
• No tax deduction on interest payable to banking companies, insurers.

STT abolition to bring back high volumes

The Securities Transaction Tax (STT), a bugbear for the market ever since its introduction in 2005, will be abolished, according to the draft Direct Taxes Code, and market players felt this would bring back high volumes in the market.

However, investors will have to pay capital gains tax on profits earned by them on investments regardless of the length of time for which they are held.

In other words, there is no distinction between short-term and long-term, though the gains realised after one year will be eligible for indexation benefits.

"The rate of capital gains tax will be fixed as per the income slab of an individual investor. At the top end, it could be as high as 30 per cent," said Sanjay Kapadia (taxation practice), PricewaterhouseCoopers. However, the indexation benefits should soften the blow somewhat. The code notes: "In the case of a capital asset which is transferred anytime, after one year from the end of the financial year in which is acquired, the cost of acquisition and the cost of improvement will be adjusted on the basis of cost inflation index to reduce inflationary gains."

Currently, only short-term investments of less than a year attract capital gains tax at the rate of 31 per cent. Currently, indexation benefits are available for debt funds. The long-term capital gains on equity funds is zero. Also, dividends paid out on equity funds are fully tax-exempt and there is no dividend distribution tax, or DDT.

Market participants have welcomed the proposed abolition of the STT. Nilesh Shah, deputy managing director, ICICI Prudential AMC said: "The removal of the STT will reduce the cost of transactions and therefore, create more arbitrage opportunities. Moreover, daily transactions are good since they will increase the depth of the market."

Some others said the STT abolition would be beneficial for brokers and day-traders, for whom the cost of transactions had increased considerably. And this will bring back high volumes in the market. But there's more...

For Companies

• Tax rates to be cut from 30 to 25%.
• All capital gains arising before April 1, 2000 will be exempted.
• New framework for computation of business income .
• Profit-linked incentives to be replaced with investment-linked incentives; companies allowed sops for period in which they can recover capital and revenue expenses.
• Eligible sectors include SEZs, petroleum and natural gas and developing, power, maintaining and operating infrastructure facilities, maintenance of hospitals, certain food and warehousing units.
• Tax breaks for sectors such as IT to be withdrawn.
• Area-based exemptions to be grandfathered.
• Profit determination on a presumptive basis for sectors such as retail trading, goods vehicles business, operation of ship and aircraft business, civil construction.
• Amalgamations and demergers to be made tax-neutral.
• Business losses can be carried forward indefinitely.
• Dividend distribution tax of 15%.
• Foreign company can be treated as an Indian resident if control, management in India at any time in a financial year. At present, the company has to be wholly-situated in India.
• MAT burden to increase as tax will be be calculated on gross value of assets; carry forward to be disallowed.
• The rate of MAT will be 2% of the value of gross assets; for banking companies rate proposed at 0.25% for banking companies.
• Specified international transactions to be reported to the designated Transfer Pricing Officer.

Companies may end up paying more taxes

The draft Direct Taxes Code that proposes to reduce the rate of corporate tax to 25 per cent from about 30 per cent may have overhauled the taxation structure and rates for companies, but experts see that in real terms companies may end up paying more corporate tax.

Corporate Tax

The current effective rate of corporate tax has been worked out to be 23-24 per cent. Besides, the code proposes calculation of taxable income that excludes certain expenditures, said Aseem Chawla, partner of Amarchand Mangaldas, and head of its tax practice. "At a first glance, 25 per cent appears attractive, but the Budget section on revenue foregone itself states that the effective tax was lower," he added.

Dividend Distribution Tax

The code leaves no escaping from the dividend distribution tax for resident companies that would be required to pay 15 per cent of the amount, declared as DDT. Foreign companies would not be paying DDT but will have to pay a branch profit tax of 15 per cent, which is equivalent to 15 per cent of DDT, said Shyamal Mukherjee, executive director, PricewaterhouseCoopers (PwC).

Transfer Pricing

On transfer pricing, Samir Gandhi, partner of Deloitte, welcomed introduction of advance pricing arrangements (APA) as it provides certainty to the tax payers on the issue of transfer pricing for a specified period of time and prevent time consuming litigation and examination for taxpayer and tax authorities.

It also provides both the taxpayer and the tax authorities to consult and cooperate in no adversarial spirit and environment avoiding confrontation position, Gandhi added.

Separate tax computation regime for 8 sectors

The government has provided for separate tax computation regime for eight businesses. Spread over separate schedules, it would govern companies in business of insurance, shipping, oil and gas producers, power, special economic zones, hospital, fruit and vegetable processing, and infrastructure.

There is another set of 11 businesses, including airlines, civil construction, retail trading, construction of power plants and oil exploration service providers, for whom the determination of profit on presumptive basis will continue.

Doubt cleared over mineral oil definition

The government has removed the ambiguity over the definition of mineral oil in the draft Direct Taxes Code by stating that "the business of mineral oil or natural gas means any business consisting of the prospecting for or extraction of mineral oil or natural gas".

The clarity would help companies take an informed investment decision.

The tax code, which would be discussed before being placed before Parliament for approval, has a separate schedule on the income determination regime for the "business of mineral oil or natural gas". The definition has been spelt out in the schedule.

Others

• The government proposes to term those who do not file returns on time as wilful defaulters. Those under-reporting incomes now face higher penalties and stepped-up prosecution procedures.
• Those wilfully under-reporting tax base liable to penalty of up to twice the tax payable.
• Tax evaders may face prison terms up to seven years apart from fines to ensure compliance.
• To act as deterrent, a list of wilful defaulters proposed; it will include those who do not file returns by due date.
• The code also suggests introduction of a general anti-avoidance rule to combat tax avoidance to check instances of round-tripping, dividend-stripping and accommodating "party transactions".
• Changes in rates to be undertaken through amendment of Schedules.
• Concept of assessment year scrapped.
• Taxation of all non profit organisations rationalised.
• Tax recovery officers to deal with recovery of taxes that are due for over a year.
• Steps to be taken to amend the Right to Information Act prohibiting disclosure of information relating to any assessee to a third party except under special circumstances.
• In the case of a conflict between the provisions of a DTAA and the tax code, the one that is later in point of time will prevail.
• To deal with issues such as round-tripping, General Anti-avoidance Rule proposed; to be invoked if an arrangement is to misuse the provisions of the law, lacks commercial substance, avoid payment of taxes.