Perks will no longer be free

Come 2011, your worries on the tax front

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may be eased a little. Not only does the new direct tax code, announced on Wednesday and to be implemented from that year, seeks to lighten your burden, it also makes it much simpler to calculate the tax you will need to pay, as it proposes to remove all exemptions, including those on provident fund and insurance.

The code has been thrown open to discussion. It is only after the consultation process that finance minister Pranab Mukherjee will table it in Parliament. It will replace the Income-Tax Act.

The code advocates modest tax rates for individuals. Up to an annual income of Rs 1.6 lakh there will be no tax. And incomes beyond that amount will be taxed at lower rates.

The new rates proposed are: 10 per cent for annual incomes above Rs 1.6 lakh but below Rs 10 lakh, 20 per cent for incomes of Rs 10 lakh to Rs 25 lakh; and 30 per cent for incomes beyond that.

You currently pay: 10 per cent for incomes of Rs 1.6 lakh to Rs 2.5 lakh; 20 per cent for incomes of Rs 2.5 lakh and Rs 5 lakh; and 30 per cent for all incomes beyond Rs 5 lakh.

You may also be able to save on wealth tax. “The code raises the threshold limit for wealth tax to Rs 50 crore from Rs 30 lakh now. The enhancement, if implemented, will benefit many individuals,” said K R Girish, partner, KPMG.

Moreover, the code proposes a new deduction limit of Rs 3 lakh, against the existing Rs 1 lakh per annum.

“On the face of it, individuals will benefit. But a closer look suggests that individuals may end up benefiting only a little, as many perquisites such as reimbursement of medical expenses and leave travel allowance will now be included in salary income,” said Subhash Lakhotia, an independent tax expert.

Ketan Dalal, executive director, PwC, agreed: “Some will gain, some will not. Though, tax rates will become moderate, benefits on housing loan will stand abolished. Some other benefits too will vanish. Thus, the gain or loss would vary from person to person. ”

Apart from perquisites, one may have to pay tax on any withdrawal from the employee provident fund, public provident fund, and some categories of insurance policies, among others.

Currently, such withdrawals are tax-exempt. Through the new code, the government hopes to move towards an exempt- exempt- taxation (EET) method of taxation for all savings.

D Swarup, chairman of the Pension Fund Regulatory and Development Authority, said, “We have been asking for a level-playing field with other savings products. This meant either bringing other products to the EET regime or shift the new pension system (NPS) to EEE. If the intention of the tax code is to bring all other savings products under EET it will help NPS.”

NPS is now under EET, and thus at a disadvantage compared to PPF and EPF.

“Giving the EET status to all savings products will bring uniformity in tax treatment. The idea is to rationalise deductions that the government has been talking about for some time,” said G V Nageswara Rao, managing director and chief executive officer of IDBI Fortis Life Insurance.

“Most insurance products are tax free on withdrawal. However, pension plans returns are taxable,” Rao added.

Corporate tax to be cut to 25%

India Inc’s financial spin doctors will have a big task in recalculating its tax liability if the direct tax code, announced on Wednesday, is implemented in full. The code proposes to reduce the corporate tax rate to 25 per cent from 30 per cent but takes away various exemptions.

Foreign companies operating in India will also be charged the same rate of tax. However, if a foreign company has only a branch in India, the tax liability will be 15 per cent of its profits.

The code also seeks to treat companies softly in bad times. It suggests that business losses be indefinitely carried forward for setoff against eventual profits. (Tax laws now allow a carry-forward only for eight years.)

Finance minister Pranab Mukherjee wants the code implemented from 2011, replacing the Income-Tax Act. For this, he will pilot a bill in the winter session of Parliament.

The code is expected to benefit highly capital-intensive sectors like power.

Ketan Dalal, executive director, PriceWaterhouseCoopers, “A business can be benefited if there are relatively lower profits for several years and high capital expenditure,” he said.

Ficci president Harsh Pati Singhania explained: “At present only depreciation losses can be carried forward indefinitely. (The new proposal) may be an attempt to club losses with depreciation.”

The code also recommends that all profit-linked incentives be substituted with investment-linked sops, as there is no motivation for investment.

Anil Gupta, joint managing director of Havells India, said substituting profit-linked incentives with investment- linked sops would spur investment by companies. R V Kanoria, chairman of Kanoria Chemicals, agreed.

Arguing that profit-linked incentives led to significant revenue losses, the text of the code says, “Under the new scheme, a person would be allowed to recover all capital and revenue expenditure (except that on land, goodwill and financial instrument). He would be liable to income tax on profits made thereafter.”

Besides, a general anti-avoidance rule to combat tax evasion like dividend stripping has been proposed. According to Diljeet Titus, managing partner of law firm Titus & Co, the anti- avoidance rule is a provision in the tax act which allows certain deductions or exemptions, subject to certain conditions. “It is basically paperwork which is done to avoid paying tax.”

The code contains provisions on tax- neutral reorganisation of businesses, involving an amalgamation or a de-merger.

And to provide certainty in respect of a company’s tax liability arising from any future international transaction, the code seeks to empower its board to enter into advance pricing agreements for such transactions.

Rationalisation of tax on charitable trusts and institutions has been proposed, as shortcomings in the existing exemption regime, which varies across institutions based on their activities, came to light.

The code also overhauls the minimum alternate tax (MAT). This tax, at 2 per cent, is to be applied to the gross value of assets. In this year’s budget, MAT was increased to 15 per cent from 10 per cent on book profits.

In the new dispensation, MAT will have to be paid even if a company does not report profits under normal circumstances. This is a “structural change”, said Vikas Vasal, KPMG executive director, adding that, instead of book profits, asset-based valuation was proposed to arrive at a company’s MAT liability.

All capital gains to be taxed, STT to go

The draft Direct Taxes Code has significant implications for the stock market and investors. It proposes to do away with the securities transaction tax (STT), reintroduce tax on long-term capital gains from equities and shift the base year for the calculation of capital gains so as to exempt all capital gains arising before April 1, 2000 from tax.

The tax code is expected to come into effect not before 2011, but when it does, it would remove the 0.125 per cent tax on delivery-based trades and 0.017 per cent on derivative segment of stock market transactions that was introduced in the Union Budget of 2004.

Though this tax net turned out to be a cash cow for the government, it did not go down well with market participants as costs had to be passed on to investors and traders. The government had collected Rs 5,408 crore in STT in 2008-09.

“In the first place, the introduction of STT was itself a short-sighted move. Removal of the STT is the right thing to do, especially under the present market conditions,” says Deena Mehta, managing director of Asit C Mehta Investment Intermediaries.

“The securities transaction tax will be abolished. Therefore, all capital gains (loss) arising from the transfer of equity shares in a company or units of an equity-oriented fund will form part of the computation process described in para 10.8 above,” the draft Code says.

As per para 10.8, the finance minister proposes to factor in inflationary gains for taxable purpose on sale of capital assets. As of now, capital gains are arrived at by deducting the acquisition cost and cost of improvement of assets from the selling price.

“However, in the case of a capital asset which is transferred anytime after one year from the end of the financial year in which it is acquired, the cost of acquisition and cost of improvement will be adjusted on the basis of cost inflation index to reduce the inflationary gains,” it says.

The draft code also proposes to eliminate the distinction between long-term and short-term capital gains. At present, investment made in listed securities for more than a year is treated as long-term capital gains (loss), on which there is no tax. By treating the two forms of capital gains at par for tax purposes, the draft code envisages reintroduction of the tax on long-term capital gains.

But the good news is that the base year for calculation of capital gains is proposed to be shifted from April 1, 1981 to April 1, 2000. This means that all capital gains arising before April 1, 2000 will be exempt from tax.

The finance ministry on Tuesday released the draft code after markets had closed for the day. The 50-share Nifty of the National Stock Exchange ended at 4,457.50 points, down by 0.31 per cent.