The draft released by the government has taken into considerations the detailed recommendations made by the Parliamentary Standing Committee on Finance in its report submitted in March 2012. The draft DTC also takes into account the several amendments that have been made in the Income-tax Act, 1961, and the Wealth Tax Act, 1957, by the Finance Acts of 2011, 2012 and 2013. The result is a comprehensive draft that contains many significant and far-reaching changes.
There will obviously be a more intense and focused debate on many of the finer aspects and nuances of the draft DTC in the coming days. However, if one were to take a somewhat wider perspective, a few broad themes are manifest in this draft DTC, which in particular may warrant a more detailed and serious policy debate over the coming days and months.
Foreign companies and investments
First, some of the changes proposed in the DTC could result in significant tax costs on foreign companies. For instance, on the controversial question of indirect transfers (i.e. the taxation in India of transfer of shares of foreign companies with underlying Indian assets), the DTC makes a significant departure from both the recommendations of the expert committee under the chairmanship of Parthasarathi Shome as well as the Direct Taxes Code Bill, 2010. The Expert Committee as well as the earlier Bill had provided that India should tax gains from transfer of shares in foreign companies only if the shares derived more than 50% of their value from assets in India. This threshold percentage is now sought to be substantially reduced to 20%.
A brief explanation for this departure is set out in another document released by the government highlighting some of the significant changes in the DTC. This states that a 50% threshold is too high and that there could be situations where a company has 33.33% assets in three countries but it will not get taxed anywhere. The fact that tax would ordinarily be levied in the country of residence of the non-resident seller and possibly even in the country where the foreign company (whose shares are transferred) is a resident has not been considered.
Mindful of the challenges faced by the Indian economy today, there is an admitted need for expanding foreign investments into India. Tax is obviously one of the key parameters that drive investment decisions today, and several of the recent changes to Indian tax laws have been met with concern in the global investing community. Provisions which significantly expand the reach of Indias taxing power over foreign companies investing in India could have an impact on the overall investment climate and, consequently, their utility will need to be debated in light of Indias overall economic needs.
Tax rates and reliefs
The second broad theme that emerges from the DTC relates to the quantum of taxes. Revenue considerations remain a high priority for the government. In a welfare state like ours, this is only natural. But the policy decisions reflected in the DTC seem to reflect a view that further moderation in tax rates may not be possible in the short to medium term given the size of our deficits and the need to fund a range of government initiatives. Some taxpayers may see their tax outflows go up through increased rates and widening tax bases as set out below.
On the tax relief front, the Standing Committees recommendations relating to revision of slabs and linking of exemption limits to consumer price index have not been accepted. The non-acceptance of the latter recommendation is important. In many ways, it was one of the most far-reaching recommendations made on the tax front in recent times, and the inflationary trends witnessed over the last few years have made it more relevant. While the practical challenges cited by the government are no doubt a concern, this issue could have perhaps warranted a more detailed examination.
Similarly, the recommendation to abolish the Securities Transaction Tax has also been rejected. However, in what will be a positive development for senior citizens, the recommendation of the Standing Committee to lower the age for senior citizens has been lowered to 60 years from 65 years.
At the same time, a new higher tax slab of 35% has been proposed for individuals and Hindu undivided families (HUFs) with income in excess of R10 crore. This is stated to be done with a view to maintaining overall progressivity in the levy of income tax. Similarly, the DTC also proposes to levy an additional tax of 10% on resident recipients of dividends in excess of R1 crore. This is stated as being proposed to address concerns that high net worth taxpayers pay only a fraction of their earnings as tax on their investments in the capital market.
In addition to the rate increases, changes have been proposed on the wealth tax front too. The base for wealth tax is proposed to be widened by eliminating the distinction between physical and financial assets by bringing financial assets within the ambit of the wealth tax net. The impact of this could be staggering.
When it comes to increasing taxes on the rich, India is not alone. Proposals to impose higher tax on the super-rich (whether in the form of higher rates or wealth taxes) are gaining traction in several western countries as well. While such levies may be justifiable purely from a fiscal theory standpoint, such taxes could have several adverse effects in developing countries. Particularly, the potential adverse effects of such proposals on domestic savings and investments in India must be considered, especially mindful of slower GDP and industrial growth in recent times.
It has long been argued that tax policy is an integral part of economic policy, and as such should serve the overall economic policy objectives of a country. At a conceptual level, the purpose of tax is to raise revenues for the government, but a focus on enhancing revenues without adequate regard to other economic priorities could pose serious challenges. As discussed above, there is a need for wider public debate on provisions relating to indirect transfers as well as tax rates and slabs in the context of the larger economic policy of the country. As the FM stated in his Budget speech, a public discussion without partisanship or acrimony is the need of the hour. This will help build consensus on this important area and contribute to the development of a modern, sophisticated and taxpayer-friendly tax regime in India.
The author is deputy CEO, KPMG in India