Taxation made simpler & more effective

The Congress-led UPA government has set the ball rolling for injecting much-needed reforms in the direct tax system by finally introducing the long-awaited Direct Tax Code (DTC) Bill in the Parliament the previous month. But the overwhelming dilution of original tax proposals has raised a question mark on the government’s seriousness on bringing about radical tax reforms.

A close scrutiny of proposals contained in the DTC Bill in regard to various kinds of direct taxes, including the Income Tax and Corporate Tax, gives rise to an impression that the government has adopted a cautious and conservative approach to the very sensitive issue of injecting necessary reforms in the taxation system to bring it at par with global standards.

A dispassionate scrutiny of the DTC Bill against the first draft unveiled in August 2009 subtly reflects how the overwhelming concern over probable revenue losses has forced the government to adopt a cautious approach to push forward radical reforms in the existing taxation system through measures like significant lowering of existing tax rates and removal of plethora of exemptions. 

In the first draft of the DTC Bill, which seeks to replace the archaic Income Tax Act 1961, the government had essentially proposed to drastically reduce tax rates especially in the personal income tax, and moderately restructured the tax slabs with an objective of widening the tax base and moderate the rates of tax. Keeping reforms in mind, the draft even had made a bold proposal of reducing the Corporate Tax from the current 30 per cent to 25 per cent.   The first draft, for example, proposed abolition of plethora of exemptions including removal of tax exemptions on popular long term savings like the Public Provident Funds and Employees Provident Fund. But the final DTC Bill, which will now be scrutinised by the Parliamentary Standing Committee of Finance, is a much diluted version of the first draft as far as tax rates are concerned.

Lowering revenue loss

It is being overwhelmingly felt that the primary factor behind such a cautious approach by the government in diluting the tax proposals of the first draft is the fear of revenue loss. As the Revenue Secretary Sunil Mitra has indicated that even by way of further moderating the tax rates as well as tax slabs as proposed in the DTC Bill, the government will lose Rs 53,172 crore in the very first year of implementation.  Given the high level of fiscal deficit—the net difference between the income and expenditure—and growing pressure on the kitty to fund popular socio-economic development projects, no government can afford to push forward tax reforms by incurring revenue losses of high order. Thus the hard reality on fiscal front appears to have dampened the spirit of government to go full hog for infusing radical changes in tax rates.

Sensitive to salaried class

However, notwithstanding fiscal constraints, the DTC Bill has brought cheers to middle-income salaried class by proposing moderation in the existing personal Income Tax rates as well as tax slabs. Of course, the proposed tax rates and slabs will pale before tax bonanza promised in the original draft. Still the government’s intention to give some relief to the lower middle income group should be appreciated given the fast erosion in purchasing value of rupee in view of high inflation.  As per an estimate under the new tax structure as proposed in the DTC Bill those earning between Rs 2 lakh and Rs 5 lakh per annum will get tax benefit of Rs 7,660 per annum while tax burden will be reduced by Rs 21,540 for those earning between Rs 5 lakh and Rs 10 lakh. Those earning more than Rs 10 lakh a year may get tax benefit of Rs 41,040 under the new tax system.  The proposal in DTC Bill to do away with preferential treatment for women is a welcome move.

It is a well known fact that in our country the concept of single mother households is still not significant and most women taxpayers belong to double income families. What is significant is that while pursuing even the toned down agenda of  tax reforms the DTC Bill playing to gallery has retained and in some cases enhanced existing tax incentives for the salaried class.

 But experts say continuation of tax exemptions on investment made in various saving instrument like Provident Fund, Pension Fund and pure life insurance polices and specific expenditure on medical treatment, children’s education and payment of housing loans reflects the sensitivity of the government to protection of legitimate concerns of average salaried class.    

Significantly, among the DTC proposals that have received maximum accolades from working class is the dropping of the earlier proposals of taxing long term savings like GPF, PPF and EPF at the time of withdrawal under the EET (Exempt-Exempt-Tax) mode. The Bill now finally proposes no tax on these long term statutory savings during all the three stages—when investment is made, interest earned and when the money is withdrawn.

Not so damaging

As far as Corporate sector is concerned, the DTC Bill has offered a mixed bag. In contrast to the proposal made in the first draft to levy a moderate Corporate Tax at 25 per cent, the DTC Bill proposes to retain it at the current level of 30 per cent. The only relief is there will be no surcharge or cess which push up the effective tax rate to 33.30 per cent. But the India Inc felt let down as the industry was expecting a lower rate. Tax experts say levying of a lower Corporate Tax would have sent a distinct inclination of the government to push through bold reforms in taxation system. In the face of rapid globalization a lower Corporate Tax would have made Indian trade and industry more competitive.  Many believe that the fear of revenue loss might have played a major role in government not lowering the Corporate Tax rate. Extending some relief to industry the Bill proposes to continue with the existing system of Minimum Alternate Tax (MAT) on book profits and not on gross asset value—though with a marginally high rate of 20 per cent as against the current 18 per cent.

MAT is a tax levied on profit earning companies, which otherwise do not fall under the tax net because of various exemptions. From a realistic point of view most of the corporate sector was never expecting full withdrawal of MAT. The proposal to continue with the current system of MAT on book profits, undoubtedly has provided solace to the corporate sector.

But several Information Technology (IT) firms, who have been attracting MAT, are apprehensive that if the MAT is extended to profits earned by IT units in Special Economic Zones, it would have a dampening impact on the IT sector. Though the overall tone of tax proposals in DTC Bill relating to the corporate sector appears to be conservative, there are still some measures that can be considered as reform-oriented.  

For instance, the DTC Bill proposes wholesale shifting from the existing profit-linked deductions to investment-linked deductions for the Corporate sector to avail tax incentives. Though in initial years there could be revenue loss, in the long run it would force the trade and industry to focus more on investment and its efficient utilization. This in turn will make the economy more efficient and productive. The government in the original draft DTC had proclaimed to establish an economically efficient, effective and equitable direct tax system through a broader tax base and progressive secular tax rate.
But with the dilution of original provisions as reflected in the DTC Bill the government’s cherished objective of putting in place necessary tax reforms to widen the tax base and expedite the process of transition to a lower tax regime may not be realized to the fullest extent.