People's Democracy

DIRECT TAXES CODE

Generous For The Rich

Regressive For Low Income Group

W R Varada Rajan

THE Ministry of Finance has placed a draft Direct Taxes Code (Code) for debate in the public domain, as a part of the tax reform, which the Finance minister during his budget speech on July 6, 2009 stated as �a process and not an event�. The Code, it is claimed by the government, �seeks to consolidate and amend the law relating to all direct taxes, that is, income-tax, dividend distribution tax, fringe benefit tax and wealth tax so as to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio�.

It is an undisputed fact that the entire expenditure of the government is based on the tax revenues mobilised by it. This revenue is earned through direct and indirect taxes. An equitable and progressive tax system is one under which the tax liabilities of individuals or households are determined according to their ability to pay. The Code asserts: �those with equal abilities should make equal tax payments and those with higher abilities should be asked to make proportionately larger payments�.

Direct taxes are levied on the incomes earned or wealth possessed by individuals or entities like companies. Indirect taxes are levied in respect of goods and services produced, imported or exported. The entire burden or impact of the indirect taxes falls on the lay public who are the consumers of the goods and services, irrespective of their �ability to pay�. Only the direct taxes relate to the income or wealth of the tax-payers according to their �ability to pay�. A fair tax system should normally be one in which the proportion of indirect taxes to the total revenue of the government should be lesser than that of the direct taxes. In India this is, admittedly not the case. Hence, one would have expected the new Code to attempt to set right this anomalous situation by raising the share of direct taxes in the total revenue of the government. But, for the �reforms� savvy UPA government, the priorities are different and the Code is in line with that.

Though this Code had been released in the first quarter of the UPA � II regime taking over, the preparatory work had begun much earlier during the earlier period itself when P Chidambaram was heading the Finance ministry. That is borne out by his presence when Pranab Mukherjee released the Code.

The Code proposes to revise the income-tax base comprehensively and substantially liberalise the new tax rate for individuals as under:

Income up to Rs 1,60,000 in the case of any individual will be exempt from taxation.  (This was Rs 1,50,000 before the budget for current year).This limit is enhanced to Rs 1,90,000 and Rs 2,40,000 in the case of women below the age of 65 and senior citizens respectively. Beyond these threshold limits the existing tax rates are proposed to be revised as follows:

The existing rate of 10 per cent for income exceeding the exemption limit up to Rs 3 lakh is proposed to be applied to income exceeding the exemption limit up to Rs 10 lakh. The existing rate of 20 per cent levied for income beyond Rs 3 lakh upto Rs 5 lakh is proposed to be applied for income exceeding Rs 10 lakh  up to Rs 25 lakh. The existing rate of 30 per cent levied for income beyond Rs 5 lakh is proposed to be applied for income exceeding beyond Rs 25 lakh.

THE DEVIL IS  IN THE DETAIL

On the face of it, this will appear to be a very generous tax reduction package for the individuals earning between Rs 3 and Rs 25 lakh. But the devil is in the detail.  In the name of comprehensive revision of the income-tax base, the Code proposes that gross salary will include the value of perquisites and profits in lieu of salary. Para 7.7 of the Code states that the salary will now include, inter-alia, the following:

(a) The value of rent free, or concessional, accommodation provided by the employer irrespective of whether the employer is a government or any other person;

(b) The value of any leave travel concession;

[c] The amount received on encashment of unavailed casual leave on retirement or otherwise;

(d) Medical reimbursement; and

(e) The value of free or concessional medical treatment paid for, or provided by, the employer.

Furthermore, the Code is regressive on the fixed income earners or the salaried class. Superannuation benefits hitherto have remained exempt from taxation. The Code now lays down that deductions (from gross salary) in respect of i) compensation under voluntary retirement scheme, ii) amount of gratuity on retirement or death and iii) amount received on commutation of pension would be to the extent the amounts are paid to or deposited in a Retirement Benefits Account. The amount received from an approved superannuation fund, hitherto exempt from income tax, will henceforth also be treated in the same manner. The game plan behind this Retirement Benefits Account is laid bare when the Code stipulates that only the accretions to the deposits in this account will remain untaxed till such time as they are allowed to accumulate in the account but any withdrawal made, or amount received, under whichever circumstances, from this account will be included in the income of the assessee for the year in which the withdrawal is made or amount is received.

Presently there are certain incentives for savings in that the amounts invested in Small savings Schemes like Post office Savings Certificates of various types are exempted from income tax up to certain limits, say Rs 3 lakh for an individual or Rs 6 lakh for a couple. The Code proposes to introduce the �Exempt-Exempt-Taxation� (EET) method of taxation of savings. Under this method, the contributions are exempt from tax (this represents the first �E� under the EET method), the accumulations/accretions are exempt (free from any tax incidence) till such time as they remain invested (this represents the second �E� under the EET method) and all withdrawals at any time are subject to tax at the applicable personal marginal rate of tax (this represents the �T� under the EET method). The same will apply to the deposits under the New Pension System (NPS), introduced for government employees recruited from 1January, 2004. The Code also provides that contributions made in the accounts of General Provident Fund (GPF), Public Provident Fund (PPF), Recognised Provident Funds (RPFs), and the Employees� Provident Fund (EPF) under the Employees� Provident Fund and Miscellaneous Provisions act, on or after commencement of this Code (i.e. from 1at April 2011) will be subject to the EET method of taxation.

CHANGES TO BENEFIT AFFLUENT AND RICH

All these are intended to take away any relief that the salaried class of employees can hope to get from the application of the 10 per cent rate of tax for income exceeding the exemption limit up to Rs 10 lakh. In fact, the Exemptions at the two stages of contribution and accumulation/accretions will only lead to �bunching� of the exempted amount for taxation at the withdrawal stage pushing the employee into higher marginal tax bracket. But this very same Code takes due care to avoid such �bunching� of appreciation in respect of a capital asset (for the purpose of taxing capital gains) in the year in which the asset is sold, pushing the seller into a higher marginal tax bracket by proposing a special treatment for the same! Even in respect of any sum received under Life Insurance Policy, the Code prescribes that exemption from income tax would be admissible only in case the premium payable for any of the years during the term of the policy does not exceed 5 per cent of the capital sum assured and in all other cases the sum received under the policy, including any bonus would be included under the head �Income from Residuary Sources� and taxed accordingly!

Thus, the changes proposed in the personal income tax rates are mainly intended to benefit the affluent and rich. It is a paradox that annual income exceeding Rs 25 Lakh will be taxed at the same rate of 30 per cent even if the income is hundreds or thousands of crore Rupees!

This much is for the personal income tax. The Code proposes that tax rate for companies (both domestic and foreign) could be substantially reduced to a uniform rate of 25 per cent. Today, the tax rate for domestic companies is at the same (maximum) rate of 30 percent as for the individuals and the tax rate for foreign companies is 40 per cent.

For the corporate world and wealthy individuals, the Code confers a huge bonanza in its proposals on treatment of capital gains and wealth for taxation purposes.

The Code has incorporated certain cosmetic changes in the present definition of �net wealth� �assets chargeable to wealth tax� etc. But as against the present exemption limit of Rs 30 lakhs for the purpose of wealth tax, the Code proposes to hike the threshold limit for wealth tax to Rs 50 crore. The rate of tax will also be reduced from the present rate of one per cent to a mere 0.25 per cent.

In respect of tax on capital gains, the Code proposes: �The present distinction between short-term investment asset and long-term investment asset on the basis of the length of holding the asset will be eliminated�. The capital gains arising from the transfer of personal effects and agricultural land beyond specified urban limits will also be exempt from income tax. At present, the cost of acquisition of (any investment asset) is generally with reference to the value of the asset on the base date or, if the asset is acquired after such date, the cost at which the asset is acquired. The Code proposes: �The base date will now be shifted from 1April 1981 to 1April 2000. As a result, all capital gains between 1April 1981 to 31 March 2000 will not be liable for tax.� Capital gains, calculated as the difference between the sale value of the asset and the value as on the base date or later in case of acquisition on or after 1April 2000, will form part of taxable income and be subjected to tax at the marginal rate applicable in the case of individuals or at 25 per cent in the case of companies (domestic and foreign).

The biggest disappointment the Code causes is in respect of its proposal for grant of relief from �Double Taxation�. India has, according to the Code, evolved its own model (treaty to avoid double taxation), and based on this model entered into Double Taxation Avoidance Agreements with about 75 countries. Under these DTAAs, an individual or a company, resident in India but opts to subject his/its income to be taxed in any other country, India is to give tax credit or exemption to that income in order to avoid double taxation. These DTAAs have created �tax havens� in Mauritius and elsewhere, which have been the subject matter of a raging debate for a very long time and even the UPA regime in its first edition had talked of reviewing such DTAAs, in order to curb glaring instances of tax evasion. But the Code sanctifies all the DTAAs stating that �power has been given to the central government to enter into an agreement with the government of any country in order to provide relief on double taxation�, which will jolly well continue as ever before.

In fine, the Draft Direct Tax Code is generous to the rich, wealthy, affluent and corporate entities (both domestic and foreign) and harsh on low income earners.  The UPA government is hell bent on converting this Draft Code into law, in the ensuing winter session of the parliament this year (2009). It is imperative that the democratic forces who value an equitable and progressive system of taxation should rally to defeat this move.