?You can have a Lord, you can have a King, but the man to fear is the tax collector?

Proverb recorded on a Sumerian Clay Tablet

Rapid, big bang changes are often more successful than a series of small gradual changes. Gunnar Myrdal had observed that such rapid changes are like a plunge in the cold water, which is less painful than slow submersion. Tax law has taken the plunge. For 50 years, we have been inflicted the pain of frequent annual or semi-annual changes in the tax law. Nani Palkhiwala had represented a one man army fighting against these inequities and frequent changes. The Income Tax Act, he said, is like a railway ticket, good only for one journey in time, sometimes not even for the whole of the journey.

All this is set to change. For the first time in India?s fiscal history, tax rates will be incorporated in the Income Tax Act itself and not in the annual Finance Act. It is more difficult to amend the main body of the Act to bring about changes in tax rates. The Direct Tax Code has announced tax rates in the Act itself. This is a big gain and will ensure certainty and stability. The Code has been liberal in laying down three rates and three slabs for personal taxation. Surcharges and cesses find no mention in the Code. So far, so good.

Adam Smith laid down four canons of taxation, namely, equity, convenience, economy, certainty and clarity. The Act of 1922 had only 67 Sections. The present Act of 1961 contains 297 Sections. Provisos, explanations, non-obstante clauses and words in parenthesis only add to the confusion in interpretation. The Code promises simplicity but it still has as many sections as the present Act. Equity requires that taxes must be equitable and fair between different classes of society. The Code taxes non-corporate entities at a maximum marginal rate of 30%. Companies are taxed at a 25%. The principle of non-discrimination with regard to the form of the business organisation is given the go-by.

Agricultural income is outside the purview of central tax purely as a result of a historical accident. When James Wilson brought in the income tax law in India in 1860, agricultural income was also taxed. Later on, it was subjected to a cess. In 1886, the Income Tax Act was re-imposed after an interregnum. Cess on agricultural income was removed. Since then, the farm lobby has been able to block levy of central tax on agricultural income. The Code could have remedied this injustice.

The Code withdraws tax concessions on interest paid on loans taken for construction of self-occupied residences. Deduction is allowed for houses let out. This discrimination flies in the face of the policy announced by the housing and urban development ministry.

A radical change is brought about with regard to taxation of foreign companies. Hereafter, even if a foreign company is partly controlled and managed from India, it will be treated as an Indian resident company and tax will be levied on par with Indian companies. This can result in Indian subsidiaries of foreign companies being taxed on world income. The foreign companies would suffer additional branch profit tax at 15% in addition to the basic corporate tax of 25%. Indian companies will pay additional dividend distribution tax at 15%. Does this ensure parity? Hopefully. For far too long, foreign companies have been exploiting the archaic residency rules peculiar to Indian tax law.

For ages, tax pundits have been urging the government to bring in an anti-avoidance provision in the law. There?s a provision in the Code bringing in a general anti-avoidance rule. This should effectively tackle situations arising out of round tripping of funds through the Mauritian route. Simultaneously, provisions for penalty and prosecutions have been tightened.

A word of caution may be necessary. No doubt, tax evasion is harmful to the economy. But as Palkhiwala commented, ?It is not permissible to enact a law which, in effect, spreads an all-inclusive net for the feet of everybody, upon the chance that, while the innocent will surely be entangled in its measures, some wrong-doers also may be caught.? Some fine tuning is required for the anti-avoidance arrangement.

The author is a former Chief Commissioner of Income Tax and ex-member Income Tax Appellate Tribunal

Are companies being put on the MAT?

Farouk Irani

We congratulate the finance ministry on its transparent approach to introducing the Direct Tax Code, planned for implementation in 2011. We cannot expect any one body in India, even if it had the benefit of 10 Peter Druckers sitting on its committees, to foresee the unintended consequences of some of the proposed regulations, which is why the government is commended for its farsightedness in offering these proposals for preview and comments.

I focus on tax provisions that would impact non banking financial institutions and, in particular, the leasing industry. Some of the proposals could prove destructive to economic growth, which is why they should be considered in depth.

The new Code proposes a radical redefinition of the tax base on which MAT is computed. The government proposes to move away from a revenue stream (such as book profits) towards an asset stream, or value of gross assets: ?Value of Gross assets will be the aggregate of the value of gross block of fixed assets of the company, the value of capital works in progress of the company, the book value of all other assets of the company, as on the last day of the relevant financial year, as reduced by the accumulated depreciation on the value of the gross block of the fixed assets and the debit balance of the profit and loss account if included in the book value of other assets.?

In the case of banks, the tax rate is reduced to 0.25% because otherwise a 2% tax on their loan assets would be astronomical. The consideration is that these assets are used by borrowers and not assets used by the bank (except as an accounting entry representing money that has been loaned out but not used for manufacture). Accordingly government recognises the need to restrict MAT to 0.25%. NBFCs? activities are akin to that of a bank in that assets are leased or hire purchased to third parties. Effectively, both banks and leasing companies extend credit facilities. NBFCs ought not to be discriminated against and may similarly be taxed only at 0.25% and not at 2% for MAT purposes.

To illustrate, a NBFC for its fiscal year ended March 31, 2008 paid a MAT liability of Rs 5 crore. If the new Code is applied, then on an identical pre-tax income, MAT tax would climb to around Rs 21 crores, an increase of 320%. This is almost certainly an unintended consequence of government taxing a company?s pre-tax post depreciation profit of Rs 46.76 crore at Rs 5.33 crore and then in the next moment taxing it at Rs 21.78 crore as per the new Code (2% of Rs 1089.14 crore, or the concerned NBFC?s asset footing as of March 31, 2008).

Moreover, under present tax regulations a corporate is taxable under the regular corporate tax procedure if it has ?taxable income?, failing which it is taxable under MAT, but the overriding requirement is that a corporate has to pay whichever tax liability is higher. The implication is that under the new Code almost every company in India will probably have to pay MAT.

Also, this could lead to a paradoxical situation in which a company may have actually made a loss, may be unable to pay dividends but has to pay MAT even if it hasn?t commenced operations. Moreover, let?s not forget that ?advance tax paid? is included in current assets until tax assessment is paid. So why place a tax on taxes paid?

Under the new MAT scheme, infrastructure projects for approximately the first five years (a period when infrastructure projects are unlikely to report profits) will pay high MAT because of their investment in equipment, transport vehicles etc, or gross value of book assets and other assets. This is surely anti-infrastructure?

Regrettably as per the Code, MAT is to be a ?final tax?, where at present it is not a ?final tax? and can be adjusted within a period of 10 years against regular corporate tax payable.

At three places in the section dealing with MAT under the new tax Code, the proposed Code uses the word ?evasion?. Surely this does not mean that tax evasion is endemic among MAT payers or that MAT facilitates tax evasion.

Finally the Code may have placed emphasis on the word ?net? assets, a basic courtesy extendable to MAT paying corporates. In the tax provisions relating to wealth tax, it is net wealth that is correctly seen as relevant?gross assets less liabilities incurred to procure those assets. Why should the same fair provision not be made available to the definition of the tax base for MAT?

The author is chairman of the Association of Leasing & Financial Services Cos