REVISED DTC Old Wine in a New Bottle

The revised discussion paper on the Direct Tax Code (DTC) was released on June 15, 2010, by the Ministry of Finance (MOF). It seems that this new draft has abandoned the intent and spirit of the originally proposes draft.

Before we get into a more detailed discussion let us illustrate this with a quick example. Earlier, the original DTC paper had proposed the following income tax rates for individuals:

But, now it appears that even this could be tweaked. A senior CBDT (Central Board of Direct Taxes) said, this could be tweaked and the prerogative to fix the rate will be with the legislature”. The trade-off could be to scale down the liberal tax slabs for individuals proposed in the original code. And that is bad news for the tax payers.

The revised discussion paper proposes the under-mentioned recommendations for individuals and investors on the different topics:

1.  Tax treatment of savings Exempt Exempt Tax (EET) vis-à-vis Exempt Exempt Exempt (EEE)

The original DTC draft had proposed the EET method of taxation for savings, where the contributions made by an individual, along with accumulations/accretions thereto, would be exempt only till one remained invested. However, withdrawals at any time would be subject to taxation at the marginal rate. This would result in the amount withdrawn or amount received under whatever circumstances being brought into the computation of total income of the assessee, and then being taxed at the marginal rate (according to the applicable tax slab).

Further based on the EET principle, the original code had provided for a deduction in respect of aggregate contributions upto a limit of Rs 3,00,000 (both by the employee and the employer) to any account, maintained with any permitted savings intermediary during the financial year. The list of the permitted savings intermediaries included:

• Approved provident funds
• Approved superannuation funds
• Life insurer
• New Pension System Trust

The original DTC had proposed taxation on EET basis, to be prospective. Thus the withdrawal of any amount of accumulated balance as on the 31st day of March, 2011 in the account of the individual in a Government Provident Fund (GPF), Public Provident Fund (PPF), Recognised Provident Funds (RPFs) and the Employees Provident Fund (EPF) would not be subject to tax. This would have led to only new contributions and accretions, commencing on or after the initiation of DTC, being taxed as per the EET principle of taxation.

Now interestingly, the revised discussion paper on the DTC is reflecting some realisation that EET method of taxation can be adopted only in those countries which have a strong social security system in place for all their citizens. They seem to have understood that in the absence of a universal social security system, the proposed EET method of taxation of permitted savings would be harsh. Realisation has also dawned upon them that tax payers require some flexibility, during withdrawals in lump sum without being subjected to tax. They have realised that people may need lump sum funds on retirement to meet various family obligations. Moreover, being more prudent and practical on the logistic side, they have also realised that completely switching to the EET method of taxation for all saving instruments would entail many administrative, logistical and technological challenges. Hence, in light of the same, the revised discussion paper on DTC has proposed to provide EEE method of taxation on the following investment instruments:

• Government Provident Fund (GPF)
• Public Provident Fund (PPF)
• Recognised Provident Funds (RPFs)
• Pension scheme (administered by Pension Fund Regulatory and Development Authority)
• Approved pure life insurance products
• Annuity schemes

While playing it politically correct by giving EEE status for fewer (public sector/ Government) investment instruments, the revised discussion paper on the DTC aims to achieve the objective of long-term savings. It also states that the rule for contribution as well as withdrawal will be harmonised and made uniform so that such savings are actually made and utilised by the taxpayer for the long-term.

2. Taxation of income from employment

The original DTC had proposed the calculation of income from employment as under:

Gross Salary                                                                   Rs xx

Less: Aggregate amount of permissible deductions           Rs xx

Taxable salary                                                                Rs xx

However, the deductions from gross salary were allowed for compensation received under voluntary retirement scheme, amount of gratuity received on retirement or death and amount received on commutation of pension to the extent such amounts are deposited in a Retirement Benefits Account (RBA). It also pronounced that the employees will have to maintain a RBA, with any permitted savings intermediary in accordance with the scheme framed and prescribed by the Central Government. The permitted saving intermediaries included:

• Approved provident funds
• Approved superannuation funds
• Life insurer
• New Pension System Trust

It had also been proposed earlier that, the accretions to the deposits will remain untaxed till such time as they are allowed to accumulate in the account. Any withdrawal made, or amount received, under whatever circumstances, from this account would be included in the income of the assessee for the year in which the withdrawal is made or the amount is received. Thus providing the exemption only if it was deposited in the RBA, but later taxing an amount on withdrawal.

But interestingly realisation has dawned, and now the revised discussion paper on the DTC clearly mentions that taxing withdrawal from the RBA would be a harsh step. Moreover, recognising the need for a centralised nationwide regulator to regulate and manage so many RBAs. The revised discussion paper has proposed not to introduce RBAs. The revised discussion paper has also taken a good initiative in the larger interest of the employed individuals by not considering the following items as salary in the hands of the employee:

• Approved provident fund
• Superannuation fund
• New Pension Scheme

Moreover, the revised discussion paper has also proposed to exempt the retirement benefits received by an employee, subject to the specified monetary limits. Thus the following amounts received are proposed to be exempt for all employees but subject to their respective limits in:

• Gratuity
• Voluntary retirement
• Commuted pension linked to gratuity received
• Leave encashment salary at the time of superannuation

3. Taxation of Capital Gains

The original DTC proposed that under capital gains, the present distinction between long Term Capital Gain / (loss) and Short Term Capital Gain / (Loss), should be eliminated. It also proposed that for non-resident individuals capital gains be taxed at the rate of 30% (flat) and resident individuals at the applicable marginal rate. It also proposed to abolish Securities Transaction Tax (STT), thus leading to all capital gain (loss) on transfer of equity shares in a company or units of an equity oriented fund, to form a part of the computation process.

The revised discussion paper on the other hand, recognises the atrocities of eliminating the distinction between long term capital gain /(loss) and short term capital gain /(loss), as they think that withdrawal of this limit will increase the tax liability and bring in wild fluctuations in the capital market. It also believes that the tax rate of 30% (flat) is too high in the case of non-residents. Listed equity shares, are currently being taxed at nil rate, if held for more than one year. Hence the revised discussion paper on the DTC has proposed that income from capital gains should be considered as income from ordinary sources, in case of all tax players including non-residents and should be taxed at the marginal rate as applicable to the tax payer.

• Capital gain on assets held for a period more than one year:
  
  In case of listed equity shares or units of an equity oriented fund held for a period of more than one year, the revised discussion paper on DTC has proposed computation of capital gains after allowing for deduction at a specified percentage, (not yet specified) of capital gains without indexation benefit to tax payer. The resultant amount obtained there from, known as the “adjusted capital gain, should be included in the total income of the tax payer and will be taxed at the applicable rate. The loss arising on transfer of such asset held for more than one year should also be scaled down in a similar manner.
  
  In the case of other assets (other than listed equity shares and unit of equity oriented funds), held by the assessee for a period more than one year, the base date for determining the cost of acquisition, has been shifted from 1.4.1981 to 1.4.2000, thus resulting in no tax liability on capital assets held between 1.4.1981 and 1.4.2000. The revised discussion paper on the DTC also calls for allowing indexation at the raised base. The capital gain on such assets will be included in the total income of the assessee and will be taxed at the applicable rate.



 
• Capital gain on assets held for a period less than one year:
  
  Here, for an investment in any asset for a period less than one year, the revised discussion paper on DTC has not provided any specified deduction or indexation benefit. The capital gain will be included in the total income of the assessee and will be charged to tax at marginal rate applicable to the assessee.
   
• On STT, the revised discussion paper on DTC has proposed to calibrate the charge based on the revised taxation regime for capital gains and flow of funds to the capital market. Effectively, STT is being reinstated, albeit in a yet unclear watered down form.

 

4. Taxation of income from house property

The original DTC had proposed that income from house property should be calculated as:

Gross Rent                                                       Rs xx

Less: Specified deductions                                Rs xx

Taxable Income from House Property               Rs xx

Where the gross rent, will be higher of the following:

1. (i) The amount of contractual rent for the financial year; and
   
   (ii) The presumptive rent calculated at 6% per annum of the ratable value fixed by the local authority

However, it had also proposed that in case where no rateable value has been fixed, then 6% should be calculated with reference to the cost of construction or acquisition of the property. And if the property is acquired during the financial year, the presumptive rent shall be calculated for the proportionate period of that financial year. For specified deductions, the following would be admissible:

1. (i) Amount of taxes levied by a local authority and tax on services, if actually paid.
   
   (ii) 20% of the gross rent as a flat deduction towards repairs and maintenance as against 30% at present
   
   (iii) Amount of any interest payable on capital borrowed for the purposes of acquiring, constructing, repairing, renewing or re-constructing the property.

But interestingly, the revised discussion paper on DTC has a little different view. They have proposed that in case of Let-Out Property (LOP) the gross rent will be the rent received or receivable by the assessee during the financial year and not the presumptive rent as proposed in the original DTC, and the deductions as mentioned in the original DTC will continue.

In case the house property is not let-out by the assessee, the revised discussion paper has proposed to take the gross rent as nil, thus not allowing for deduction for municipal taxes and interest paid on capital borrowed for acquisition or construction of the property. Similarly, if has an assessee has two or more house properties which have not been let out, he will be eligible for deduction on account of interest on capital borrowed for acquisition or construction of such house property (subject to a ceiling of Rs 1.5 lakh) from the gross total income.

Wealth Tax:

The original DTC had proposed that Wealth Tax should be levied on the net wealth on the valuation date (i.e. last day of the financial year). But, the revised discussion paper on DTC has suggested that, the Wealth Tax should be levied broadly on the same lines as provided in the Wealth Tax Act, 1957.

OUR VIEW ON THE NEW DTC AND THE CHANGES FROM THE EARLIER VERSION:

We strongly feel that the revised discussion paper on the DTC, strongly pulls the original DTC back towards the present Income Tax Act, 1961 & the Wealth Tax Act, 1957. In fact the recommendations mentioned in the revised discussion paper are almost in tandem to the present provisions of the Income Tax Act, 1961 and Wealth Tax Act, 1957. So, in our opinion it’s old wine in a new bottle.

Has the Government succumbed to ‘pressures? This was a golden opportunity to make some real progressive tax reforms. What they have done is “tinker around” and more so, go back to some old provisions as currently prevalent. It’s taken 50 years to bring in a new Tax Code surely we could have done a better job and made real progress.Yet, its not too late the next new Act maybe another 50 years away, and in the long run we are all dead!

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zsofi_a@freemail.hu Jan 19, 2012 I can't believe you're not playing with me--that was so helpful.

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