Is Direct Tax Code coming? Will it be a game changer?

The Benchmark Sensex, which crossed the 40,000 mark recently, has gained 11.11% since September 20, when the finance minister announced a sharp cut in the corporate tax rates. This works out to an annualized return of 100%! The Sensex, which rallied 3,000 points in two trading sessions, has kept up momentum since then in the wake of rumours that the government may review, revise and abolish other taxes like Securities Transaction Tax (STT), Dividend Distribution Tax (DDT) and Capital Gains. The cut in corporate taxes from 30% to 22% came on the heels of the report submitted by the eight-member government panel, headed by Central Board of Direct Taxes (CBDT) member Akhilesh Ranjan, on the new Direct Tax Code (DTC) in August 2019.

The high-level task force on direct taxes, which was appointed to review the existing Income Tax Act, is said to have proposed several changes that could reduce the tax burden for many companies and individual taxpayers. Prime Minister Narendra Modi, during the annual conference of tax officers in September 2017, had observed that the Income Tax Act, 1961, drafted 58 years back, had outlived its utility and needed to be overhauled. The task force was asked to study direct tax laws in other countries and incorporate international best practices in the new DTC, reflecting the economic needs of the country. While not all details about the report have been made public, the committee seems to have highlighted the need to review existing tax brackets. The committee’s suggestions are aimed at making the existing Income Tax Act simpler and reduce the burden for middle-income group taxpayers.

For domestic companies

After the finance minister announced the tax cuts, the tax rate for all corporates is reduced from 30% earlier to 22%. The effective tax rate, including the surcharge and education cess, for all domestic companies, would now be 25.17% – nearly 10% less than the existing 34.94%, bringing cheer to domestic companies since it would add significantly to their bottom line in the future. However, this is subject to the condition that the companies will not avail of any exemption or incentives. Among other things, the report will also focus on promoting ease of doing business by suggesting a common tax rate for domestic and foreign companies.

B K Goenka, president of Assocham, said in an interview that this steep cut in tax rate would be hugely beneficial for new manufacturing companies as they could now compete with rivals in Vietnam, Indonesia and Bangladesh and acknowledged that this would be a great catalyst to the ‘Make in India’ programme to attract foreign investment.

The panel has also recommended abolition of Dividend Distribution Tax (DDT) and sought to remove the cascading effect of taxation. DDT is the tax levied by the government on dividends distributed and paid by domestic companies to shareholders, which currently is 15% under Section 115O. The effective rate is 20.36%, including a 12% surcharge and a 4% education cess.

In a meeting with Finance Minister Nirmala Sitharaman, market players had highlighted that dividends are taxed thrice in the form of corporate tax, dividend distribution tax and finally at the investor level, making Indian capital market unattractive at the global level. If abolished, it could be a real bonanza for domestic companies.

From the government’s point of view, this could mean revenue loss of another Rs 10,000 crore, on top of the Rs 1.45 lakh crore revenue loss on account of corporate tax rate cut. That, in turn, means that government would have to raise revenue from other sources or cut down expenditure on welfare schemes, neither of which looks doable.

For individual taxpayers

The panel has suggested a cut in personal income tax rates to 5, 10 and 20% on taxable incomes at different slabs from the existing 5, 20 and 30%. The challenge for the government is that lowering personal tax rates could upset its fiscal math, though it could provide a huge relief to middle-income taxpayers. The effective tax rate for the super-rich (those with taxable income above Rs 1 crore) on incomes over Rs 1 crore is 37% while for those earning above Rs 2 crore, it is 39%.

If such proposals come into effect, individual taxpayers may see their overall tax burden go down.

For capital markets

The STT is a direct tax payable on the value of transactions done through a stock exchange. It is levied at 0.1% of turnover for delivery-based equity transactions, while for intra-day transactions, the STT for purchase is nil and for sale is 0.025% of the turnover. It is 0.001% on redemption of units held in equity mutual funds.

The RBI has recently cut the GDP forecast for FY 2020 from 6.9% to 6.1%, taking cognizance of the slowdown in the economy. There are concerns over revenue collection this fiscal, with GST collections falling below the Rs 1 lakh crore mark for the third straight month.

In view of the worsening economic situation, it is unlikely that the government will abolish STT and DDT, and the coming weeks will be crucial for Indian stock markets.

(The writer is a CFA and a former banker and currently teaches at Manipal Academy of Banking, Bengaluru)