I-T exemption threshold up, corp tax rate down in new tax code

Written by fe Bureau | New Delhi | Updated: Aug 31 2010, 06:44am hrs
Capital gains sop for small investors; MF/Ulip tax bites

The Direct Tax Code (DTC) Bill introduced in Parliament on Monday sought to encourage investments in the equity market by allowing relatively low-income taxpayers to pay tax on short-term capital gains from listed securities at less than the current rate. Capital gains on listed securities held for less than a year will be scaled down to 50% and then taxed at the person's marginal tax rate.

This means that as opposed to a flat rate of 15% at which such value gains are being taxed at present, there would be three different rates in the DTC regime5%, 10% and 15%.

While this and the continuance of the exemption for long-term capital gains on listed securities would boost market sentiments, a new proposal to tax income distributed by equity-oriented mutual funds and approved Ulip schemes at 5% would be a dampener. The tax will be levied in the hands of the MF/Ulip operator and the income will be exempt in the hands of the unit/policy holder.

The decision to tax the income of equity-oriented MFs is at odds with market regulator Sebi's open appeal to the finance ministry against the proposal that figured in earlier DTC drafts.

The code also proposes that long-term capital gains tax on all classes of assets other than listed securities would now be levied at the marginal rate of the taxpayer concerned after indexation, instead of a flat rate of 20% at present. This would be of benefit to investors. These changes, according to Sudhir Kapadia, tax head, E&Y, would encourage risk capital. In the case of short-term value gains from assets other than listed securities, the marginal tax rates would apply without indexation.

The Securities Transactions Tax (STT)being levied at a moderate rate on the value of the transaction, rather than the gainwould also remain.

In the DTC regime which kicks in from April 1 next year, however, FIIs would lose some of their freedom to claim business income from value gains they make by holding assets. If there is no permanent establishment for the FII in India, their business income is not taxed. In the DTC regime, such gains could come under capital gains and taxed accordingly. However, in cases where the tax treaties override Indian income tax law, there could still be flexibility for FIIs, said Ajay Kumar, executive director at PwC.

The Bill proposes to retain the minimum alternate tax (MAT) on book profits and tax it at 20% sans surcharge. This is akin to retaining the current rate as the 18% rate becomes closer to 20% with the surcharge.

Although MAT remains the same, the differential between it and the corporate tax rate would be narrowed as the latter would now be levied at 30% sans surcharge and cess, instead of 33.22% (inclusive of surcharge and cess). A large number of profit-linked deductions would go, while a few investment-linked incentives to specific infrastructure industries would exist till their specified tenures end.

The progressive alignment of MAT rate with the corporate tax rate is to promote inter se equity among taxpayers, a government official told FE. The idea is to bring the MAT rate closer to the effective corporation tax rate, so that there is no serious gap between the two rates.

Tax incentive for savings up to Rs 1.5 L, boost for insurance

In a significant departure from its original plan of making major structural changes in the direct tax regime, the government on Monday tabled a new direct tax code in Parliament, which seeks to retain many of the existing exemptions and propose moderate cuts in tax rates for individuals and corporate houses. Retaining the exemptions significantly undermined the government's ability to lower tax rates as steeply as it had originally planned.

Still, there are gains for all types of taxpayers and investors. Revenue secretary Sunil Mitra said the implementation of the code would result in a revenue loss of Rs 53,172 crore. The first return according to the DTC will be filed only for the year ending March 31, 2013, Mitra added.

The government intends to implement the new code 19 months from now, replacing the five decade-old Income-Tax Act.

As per the direct tax code (DTC) bill, individual incomes up to Rs 2 lakh a year will not be taxed and senior citizens will not be taxed for income upto Rs 2.5 lakh. Now the limit is Rs 1.6 lakh for individuals and Rs 2.4 lakh for senior citizens. The bill proposes 10% tax on Income from Rs 2-5 lakh, 20% on income from Rs 5-10 lakh and 30% thereafter. Now, income from Rs 1.6-5 lakh attracts 10% tax; from Rs 5-8 lakh, 20% and beyond Rs 8 lakh, 30%.

In addition to the Rs 1 lakh deduction for approved long-term savings products like provident fund, superannuation fund, gratuity fund and pension fund, the government has introduced a deduction of Rs 50,000 for expenditure on tuition fees of children, pure life insurance premia and health insurance premium. This adds up to a total of Rs 1.5 lakh deduction, up from the current Rs 1 lakh on various expenditures and an additional Rs 20,000 for investment in infrastructure bonds.

The move is expected to give a major fillip to the insurance industry. Also, the Rs 1,50,000 deduction allowed on acquiring a house, has been made applicable only on interest payments.

The first draft of the DTC proposed many radical and structural changes with the intention of weeding out deductions and making the Income Tax law simple and with lower tax rates. The bill introduced in Parliament on Monday indicates that the structural reform theme has been diluted, said Vikas Vasal, executive director, KPMG. Many of the exemptions intended to be scrapped have been retained in some form or the other, Vasal said.

Domestic companies will have to pay 30% tax on their profits but need not pay the surcharge and cess that now raise their liability to 33.22%.

Foreign companies, that now pay over 40% tax, got a significant relief as their liability has been made at par with domestic companies. The government also narrowed the difference between corporate tax rate and the minimum alternate tax (MAT) rate. MAT has been raised from 18% plus surcharge now to a flat 20% of book profits. MAT credit will now be allowed to be carried forward for 15 years.

The government has retained many of the benefits in line with the existing provisions, with enhanced limit. Obviously, when tax payers are given a lot of exemptions, the government is left with little room for making steep cuts in the rates of taxation, said Kuldip Kumar, executive director, PricewaterhouseCoopers. The original plan was to levy a 10% income tax on individuals for income up to Rs 25 lakh, and a 25% tax on corporate houses. Both plans have been diluted.

The Bill also seeks to tax income from house property excluding 20% spending meant for repair and maintenance, the taxes paid to local authority and the interest on loan taken for buying or repairing the house. It would be taxed on actual and not on notional basis, government officials explained.

The changes, when they take effect, will help save up to Rs 41,040 for those earning more than Rs 10 lakh a year. The exemption on savings and as also payment of interest up to Rs 1.5 lakh on housing loan has been retained in the proposed DTC Bill. The Bill tabled in the Lok Sabha has been referred to select committee of Parliament for scrutiny.

Corporate houses said they would have been happier with the 25% tax rate proposed in the original draft, but the government had no choice but to keep the rate of taxation at 30% because it had to go back on several fronts including on levying MAT on gross assets. FICCI Taxation Advisor S B Gupta said, The tax burden of corporates would come down. It would have been better if it was 25%.