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All you need to know about direct tax code

  The entire income of a country depends on its direct taxes, which, in India’s case, is quite outdated. A committee has been set up to come up with an entirely new direct tax code, which will purportedly benefit the common man. In this article, we explore how this can be brought about.  

Dr Suresh Srinivasan

With the introduction of the Goods and Services tax (GST), the indirect tax code in the country was restructured and converged into a single window ‘indirect’ taxation across the country. The Government of India is now at an advanced stage of introducing a new direct tax code, and is preparing this direct tax code with an objective to replacing the Income Tax Act of 1961.
Direct tax, which generally deals with personal income tax, corporate tax and other levies such as the capital gains tax, has undergone numerous changes over the years.

India’s tax receipts
The size of India’s annual gross revenue receipts is around `23 lakh crore. Out of this, corporate tax and income tax together constitute around `12 lakh crore, translating to more than 50% of the total gross revenue receipts. Taxing companies and individuals is the main source of income for the country. Corporate tax is the tax that is levied on the profits of companies. This constitutes around 27% of India’s gross revenue receipts. Income tax, being the tax levied on the personal income of individuals, amounts to around 23% of the total gross revenue receipts.
Direct taxation, in general, and corporate taxation in specific is, therefore, a key source of national income. It is natural that the economy needs more investments to flow into the country with an objective to boost corporate revenue and profits. This will, in turn, help the economy end up with higher corporate tax receipts.

Lower tax equals higher FDI
One of the key drivers for the investments to flow into the country is the effective corporate taxation rate. The lower the corporate tax rate in comparison to other countries in the region, the more the long term foreign direct investments (FDI) are likely to flow into the country. Institutional investors look at the capital gains tax regime and the profits on their financial investments. Investors also look for ease of understanding the taxation code and systems.

The evasion issue
Another problem we face today is the taxpayer base. There are a number of assessees, both small sized corporates and individuals, who have managed to keep themselves out of the tax net; evading tax by assessees is one of the main sources of leakage in the tax revenue. This is due to the fact that the taxation rates are high, and the process of tax filing is complicated. The government also spends large sums of monies in the process of collection of taxes, which can be reduced if the taxation laws are simplified, taxation rates reduced and the filing of income tax made much simpler.

Out with the old?
Direct taxation in the country is governed by the Income Tax Act of 1961, and the amendments to the original enactment that happens on a periodic basis. Naturally, it is clear that this legislation is old, quite outdated and in need of a compelling revamp.
In 2017, one of India’s top taxmen Arbind Modi was asked to come up with a new direct taxation code that would effectively revamp the existing, outdated enactment. Other members of the task force, bestowed with the responsibility to come up with a new direct taxation code include Girish Ahuja, a chartered accountant, Rajiv Memani, chairman and regional managing partner of EY, Mukesh Patel, a practising tax advocate, Mansi Kedia, a consultant, and G.C. Srivastava, a retired IRS officer and advocate. The Chief Economic Advisor is also part of the committee. The primary objective of the committee is to enhance the taxpayer base, reduce tax rate over the longer term, and remove disparities among taxpayers.

 Committee mandate
One of the areas that the committee will look into more closely will be the exemptions included under the current tax legislation. Tax exemptions have always been a problem and have made the direct tax regime quite complicated, leading to large volumes of litigation. Exemptions under Section 10 of the Income Tax are intended to provide relief to the assessees, exempting certain streams of income from the purview of taxation.
Over a period of time, there have been a number of amendments adding many sources of incomes that are exempted under section 10 of the Income Tax Act 1961. These include income from interest earned from bank accounts (with a cap), certain allowances received from the employer part of the salary income including leave encashment and gratuity income received, proceeds from life insurance policy, agricultural income, long term capital gains, etc. These make the tax computations very complicated. There is a strong view that the government can improve the overall collections by minimising or totally eliminating exemptions, and in parallel, reducing the tax rate. This in effect will not compromise on the tax collection, but would simplify the process in terms of tax administration and improving transparency.

The global scenario
We all know that globally, countries attempt to steadily decrease the tax rate, increase the net and base of taxpayers and thereby reduce the effective tax rate. The new direct tax code will target a 5% drop in the short to medium term from the existing tax rate of 30%, with the introduction of the proposed new tax code. Already small companies are eligible for the 25% direct tax rate.
The US recently reduced its direct tax rate by almost 40% from its 35% to close to 20%. This has now encouraged many domestic companies to bring back investments and jobs into the US, including companies like Apple Inc. The proposed taxation code is expected to be in line with international and peer group nation benchmarks, and in line with tax laws prevalent in other countries, incorporating international best practices, and keeping in mind the economic needs of the country.
New business models that are emerging, including e-commerce, have become complicated in terms of transactions and have conclusively established the place accrual of effective taxation. A certain lack of clarity and transparency in this respect has opened up a floodgate of litigations between the tax authorities and the assessees. This is likely to be conclusively addressed in the new direct taxation code.

What next?
Once the recommendations of the committee and the new taxation code is tabled, the Indian Parliament needs to eventually approve the legislation, and an amendment to the Finance Bill will also be required for the draft legislation to become effective as law.
This is not the first time this exercise is being attempted. In 2009, former finance minister P. Chidambaram had proposed the original direct taxe code to replace the cumbersome IT law with a clean new law and to embody the principle of keeping taxes low and removing exemptions. The current taskforce leader Arbind Modi had earlier assisted the former finance minister in preparing the code. However, the Bill, which underwent many changes subsequently, was not passed by Parliament. The Direct Taxes Code (DTC) Bill, 2010, which was introduced in Parliament in 2010, lapsed with the dissolution of the 15th Lok Sabha.
Personal taxation is a very sensitive subject and impacts millions of the salaried class in the country. In all probability, the government may not table such a sensitive subject in Parliament, given that we are getting closer to the general elections slated to be held in 2019. Although the committee would have completed with their task of coming up with the new direct tax code, the probability of this being put up in Parliament for approval, especially in the election year, is quite low. We may have to wait for some more time for such an important regulation to see the light of day!