The following proposals contained in the Direct Taxes Code Bill, 2010, merit attention:
RESIDENCY AND SCOPE OF TAXATION:
The definition of residential status has been amended to cover only two categories, ‘Resident’ and ‘Non Resident’. There is not much change in tax slab for individuals. There is no additional exemption limit for female taxpayers.
TAXATION OF EMPLOYMENT INCOME AND DEDUCTIONS:
There is an increase in exemption limit for medical reimbursement from Rs 15,000 to Rs 50,000. On making contributions to any approved fund for himself/spouse/child, an individual is allowed a deduction of up to Rs 100,000 from his taxable income. A further deduction of up to Rs 50,000 in aggregate is allowed for contributions to specified life insurance/health insurance plans or incurring tuition fees for children.
The code has more or less restored the EEE regime for taxability of savings. This is a welcome amendment which was very much required, given the dearth of adequate social security system in India. However, the scope of taxation has been widened for the policyholders. The amount received from life insurance policy would be subject to tax as ‘Income from Residuary Sources’ unless distribution tax of 5 per cent has been paid by the insurance company or it is received on death of an insured person or it is received on maturity, subject to satisfaction of certain conditions like premium paid for any of the years was not exceeding 5 per cent of the capital sum assured.
INCOME FROM HOUSE PROPERTY:
Income from house property is to be considered only if the property is let out. Thus, there will be no element of notional rental income any more as in the present regime.
These limit reinvestment in residential property on transfer of any investment asset, except agricultural land. The capital gains exemption available on reinvestment shall stand withdrawn if, besides other conditions, the residential house so purchased is transferred within a period of one year.
RESIDENCY RULE FOR FOREIGN COMPANIES:
‘Place of effective management’ (at any time during the year) for the purpose of determining residential status of companies is defined to mean place where the board of directors or executive directors make their decisions, or, in cases where they routinely approve commercial and strategic decisions made by executive directors or officers, the place where such executive directors or officers perform their functions.
While the stated intention was to adopt an internationally recognised concept of ‘place of effective management’, the scope of aforesaid provision is much wider. This may result in many overseas companies becoming resident in India, thereby exposing their global income to India taxation.
BRANCH PROFIT TAX:
Branch Profit Tax (BPT) at the rate of 15 per cent is introduced on branch profits of foreign companies in addition to the income tax on income attributable to a Permanent Establishment (PE) or an immovable property in India, as reduced by the income tax payable on such attributable income.
Thus, the effective tax rate for foreign companies having PE in India would be 40.50 per cent (reduction from the current rate of 42.23 per cent).
The term ‘permanent establishment’ has been exhaustively defined to include fixed place, service, equipment PE, etc. Also, it is not clear whether BPT is creditable against home country taxation.
GENERAL ANTI-AVOIDANCE RULE (GAAR), CONTROLLED FOREIGN COMPANY (CFC) AND TAX TREATY OVERRIDE:
GAAR may be invoked when there is suspected tax avoidance motive in a transaction or part of it. Considering the overarching scope of GAAR and lack of grandfathering for arrangements already in existence, its application could be subjective, resulting in litigation. Under CFC rules, profits of certain non-resident companies controlled by residents may become taxable in India.
As between the domestic law and the relevant Double Taxation Avoidance Agreement (DTAA), the provisions beneficial to a taxpayer shall prevail. However, the DTC will have preferential status where GAAR or CFC provisions are invoked or BPT is levied.
Income from transfer outside India of any share or interest in a foreign company would be taxable in India where at any time during 12 months preceding such a transfer the fair market value of the assets in India, owned directly or indirectly, by the company is 50 per cent or more of the fair market value of its total assets.
In such a case, the income arising on the transfer would be taxable in the proportion of the fair market values of assets in India to that of total assets owned by the company. This may possibly also require the non-resident to withhold tax when paying consideration to the vendor, which is onerous.
The definition of royalty has been expanded to include use or right to use transmission by satellite, cable, optic fibre or similar technology and consideration for “live feed”.
Royalty to non-residents is subject to tax at 20 per cent under DTC, an enhancement of 10 per cent over the present rate.
TAX RATE: Vis-à-vis current law the corporate tax rates
|Particulars||Income Tax Act, 1961||Revised DTC|
30.90 / 33.2175%
|Minimum Alternative Tax (‘MAT’)||
19.93% on Book Profits
20% on Book Profits
|Dividend Distribution Tax (‘DDT’)||
Time period for Minimum Alternate Tax (MAT) credit is extended to 15 years from 10 years at present. MAT exemption for SEZ developers and units is discontinued.
BUSINESS INCOME — INCLUSIONS AND ALLOWANCES:
Gross earnings for computing business profit would include certain new items like capital receipts (excluding subsidy for capital assets), reimbursements, advances and security deposits for long-term leases, profit on transfer of business capital assets and transfer of carbon credits. The wide scope of ‘gross earnings’ to include receipts even where there is no accrual points to a shift to cash basis rather than mercantile basis for the purpose of taxation. Finance lessees will henceforth get deduction for depreciation. Certain disallowances like all expenses where tax has not been withheld, incidental finance charges for issue of bonds are noticeable. These make the tax regime harsher. Income from certain businesses (eg infrastructure businesses) will be eligible for relief on the basis of investment rather than profits, which may not be as beneficial to them as in the present regime.
LOSS CARRY FORWARD:
Business losses will be allowed to be carried forward indefinitely (like unabsorbed depreciation), as against the current limitation period of eight years. This is a welcome move. Perhaps loss carry backward could have been introduced to incentivise businesses.
DEFERRED REVENUE EXPENDITURE:
Concept of deferred revenue expenditure for specified capital payments
|Non-compete fees||6 years|
|Premium for obtaining any asset on lease or rent||6 years|
|Voluntary retirement scheme expenditure||6 years|
|Business Reorganisation expenditure||6 years|
|Expenditure relating to prospecting of mineral or development||10 years|
|of mine/other natural deposit of any mineral|
|Loss on account of forfeiture of any agreement entered in the||6 years|
|course of business|
|Preliminary expenditure||6 years|
On an overall basis, this is a welcome change because some of the aforesaid expenditures were being disallowed in the existing regime as capital expenditure.
REMISSION/CESSATION OF LIABILITY TAXABILITY:
No transaction with creditor – ‘Remission or cessation of any liability’, interalia – specifically cover cases where there is no transaction with the creditor during the period of five years from the end of the financial year in which the last transaction took place. Taxability of outstanding liability merely on the basis of no movement in the creditor account may be anomalous and prejudicial, especially to sick companies or companies facing financial hardships.
M & A
BUSINESS REORGANISATION ONLY BETWEEN RESIDENTS:
The DTC narrows the definition of amalgamation and demerger to include only reorganisation between “residents”, thereby not facilitating tax-neutral cross-border transactions.
TAXABILITY OF INCOME FROM SALE OF INVESTMENT ASSETS:
DTC has done away with the differential rate of taxation of long-term and short-term capital gains. As such, the benefit of lower rate of taxation in certain cases stands withdrawn. Accordingly, all capital gains shall now be taxed at the normal rates like income from other heads. Indexation benefit shall be available on all investment assets transferred after one year from the end of the financial year in which they were acquired. Thus, while in respect of all other investment assets, this period of holding has been effectively reduced as regards shares of a private limited company, this limit stands enhanced as compared to the present regime.
TAXATION OF SALE OF LISTED EQUITY SHARES OR UNITS OF EQUITY-ORIENTED FUNDS:
Securities Transaction Tax (‘STT’) regime is retained. Capitals gains from transfer of listed securities (STT paid) shall be taxable as under:
- Securities held for more than one year: Nil
- Securities held for one year and less: 50 per cent of gains shall be taxable (50 per cent carry forward in case of loss)
CARRY FORWARD OF LOSSES IN CASE OF BUSINESS REORGANISATION:
Conditions for carry forward such as nature of business, continuation of business for a period of three years and holding 75 per cent fixed assets for a minimum period of three years before the date of amalgamation have now been done away with. Carry forward of losses of the demerged unit is only upon satisfaction of the business continuity test.
FOREIGN CURRENCY CONVERTIBLE BONDS (FCCB), FOREIGN CURRENCY EXCHANGEABLE BONDS (FCEB):
Transfer by way of conversion of foreign exchange convertible bond of a company into shares or debentures of that company has been exempted. Whether this refers to an FCCB or an FCEB, is unclear. However, if this were to pertain to conversion of an FCEB, the part on issuance of shares of “that” company shall have to be modified.
SURPRISES IN THE DTC
- MAT now applicable to SEZ developers and SEZ units. SEZ developers now subject to DDT similar to SEZ units. This move dampens the attractiveness of SEZs
- Deduction at 150% proposed in the DTC 2009 has been enhanced to 200% for any expenditure (both revenue and capital except land and building) incurred on in-house scientific research and development by a company in any industry (not restricted to manufacturing)
- Reach of wealth tax has been extended to include helicopter, archeological collections, drawings, paintings, sculptures, or any other work of art or watch having value in excess of ’50,000, any equity or preference shares held by resident in CFC.
- General Anti-Avoidance Rules (GAAR) and Controlled Foreign Company (CFC) rules have been introduced. The conditions which would result in invocation of GAAR are not clearly indicated. CFC rules would result in taxing income of certain overseas subsidiaries in the hands of their Indian owners, even before such income is distributed; there is no provision for claiming foreign tax credit on such income.
- Scope of reassessment and revising an order prejudicial to the interest of revenue has been significantly broadened.