Decoding the Direct Taxes Code proposals

The new Direct Taxes Code (DTC) was supposed to have given the 49-year old Income Tax Act (ITA) an extensive facelift.

The rationale behind replacing the ITA with the DTC, as per the authorities, was that the existing Act passed way back in 1961 had undergone numerous amendments over the years.

This in turn rendered the legislation extremely complex and incomprehensible to the average taxpayer.

Besides, there had been frequent policy changes due to changing economic environment, complexity in the market, increasing sophistication of commerce, development of information technology and attempts to minimise tax avoidance.

The problem was further compounded by a multitude of judgments (very often conflicting) rendered by the courts at different levels.

The DTC was a solution expected to result in a higher tax-GDP ratio, reduce compliance costs, lower administrative burdens, discourage corruption and most importantly improve equity (both horizontal and vertical).

However, the Bill (after several revisions of the original) that was finally presented in the Lok Sabha has turned out to be nothing but old wine in a new bottle. There have been significant departures and dilutions from the radical changes that were originally proposed. Even now it is not final.

The next step will be to place it before a parliamentary select committee that will recommend changes based on the views and feedback received from various stakeholders. 

Therefore, as things stand, the DTC will only come into force from April 1, 2012, and the first return of income under its provisions will only be filed for income pertaining to FY12-13.

Basic exemption limit chopped
The original DTC bill had proposed to impose extremely liberal tax slabs. For income between Rs1.6 lakh and as much as Rs10 lakh, the tax rate was just 10%. The 20% rate was applicable for the Rs10 lakh to Rs25 lakh slab and only those earning above Rs25 lakh were to pay 30%.

This had indeed come as a pleasant surprise and exceeded, I am sure, every taxpayer’s expectation. But sadly, when something seems too good to be true, in all probability it is.

The revised discussion paper on the DTC released in June cryptically stated that the indicative tax slabs and rates (as well as monetary limits for exemptions and deductions) proposed in the DTC will be decided while finalising the legislation.

Translated, this meant that the liberal limits proposed originally were going to be significantly toned down. And toned down they were. The proposed new tax slabs are as per the table below.

What’s more—the new slabs promote gender equality by discontinuing the higher exemption hitherto available to ladies. Now both women and men have to pay tax beyond an income of Rs2 lakh. For senior citizens, the basic exemption limit is higher at Rs2.5 lakh, just Rs10,000 more than the current Rs2.4 lakh!!

Good news on capital gains
One of the key features of the current direct tax regime and a high point (if one can call it that) for the entire taxpayer community, both domestic as well as international, is the fact that long-term capital gains on equity and equity MFs are fully tax-free.

The DTC bill (in its various avatars) had, in one way or another, tried to discontinue this blanket exemption. The original proposal was to do away with the system of considering capital gain income separately and instead include it in the normal income to be taxed at slab rates applicable.

The revised discussion paper though also intending to tax capital gains, however, proposed to retain the difference between normal income and capital gains. But it was fuzzy regarding how exactly this end had to be achieved. There was a mention of some ad-hoc percentage deduction to be finalised later on. Well, looks like they decided on 100%!! In other words, in a move that will bring cheer to everyone concerned, long-term capital gains will continue to be tax-free even under the DTC.

Even on the short-term capital gains front, there has been an attempt to bring about equality. Currently, short-term capital gain on equity is taxed at the flat rate of 15%. This is unfair to those who are in the 10% bracket, and advantageous to taxpayers in the 20% and 30% brackets.  Therefore, the bill proposes to levy short-term tax at half the rate of income tax payable by the investor as per his or her tax bracket. The Security Transaction Tax (STT) will continue to apply.

Impact on the salaried class
It is too early to ascertain the exact effect of the DTC on salary earners. The reason is that the Bill is just the bare Act containing the broad structure and contours of what is to be taxed and what isn’t. But the exact extent and nature of taxation has yet to be ‘prescribed’ — presumably with the aid of circulars and notifications.

For example, the Bill states that retirement benefits like leave salary, gratuity, VRS etc, will be exempted but within ‘prescribed’ limits. Similarly, the Bill is silent on the treatment of perquisites such as use of company car, employer-provided accommodation, etc. So we will have to wait for detailed guidelines to be released.

Tax deductions
On the deductions front, the DTC is a mixed bag.

While the currently available interest deduction of Rs1.50 lakh on home loan on self-occupied property has been retained, the deduction on principal repayment, covered under Sec 80C has been dropped.In place of the existing Sec 80C, the bill proposes a two-tiered deduction.

The first tier is a Rs1 lakh deduction for savings in respect of contributions to the employee provident fund, PPF, pension fund etc.

The second tier is a deduction with a ceiling of Rs50,000 reserved for deduction in respect of life insurance and health insurance premium as well as for tuition fees.

More clarity is required in this respect. For example, it is not clear how some of the existing instruments that are eligible for tax deduction like ELSS funds, post office instruments such as NSC and time deposits, senior citizen saving scheme (SCSS) and tax-saving bank deposits would be treated under the new regime. Secondly, one cannot help but feel that Rs50,000 is too little for significant payments like life and health insurance as also tuition fees.

Earlier, since all these payments were covered by Section 80C, taxpayers could suit the deductions as per their individual situations.

Those with kids could take the shelter offered by tuition fees, those who were self-employed did not have PF contributions but could if owning a house take advantage of the principal repayment. Elders could use bank deposits and SCSS and in the absence of social security and government sponsored health support and everyone could pay life and medical insurance premiums and take respective deductions separately.

However, under the proposals of the new bill, this freedom is significantly hampered. One immediate solution could be to drop the Chinese walls and offer an inclusive Rs1.50 lakh deduction and let the taxpayers decide what suits them the best.

To sum
I cannot help but get the feeling that this new DTC bill is yet again a work in progress. In due course, as taxpayers, practitioners and administrators offer their observations and comments, the Bill would indeed undergo additional nips and tucks. Watch this space for updates.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com