India Issues New Direct Tax Code Proposals

by Mary Swire, Tax-News.com, Hong Kong

17 August 2009

A proposed new direct tax code in India features generous tax cuts, however, according to the government, the ultimate purpose of streamlining the tax system is to increase the tax take as a percentage of GDP through 'better compliance and collection'.

As promised in the Budget, the Indian government has released details of a proposed new direct tax code, which will be introduced in a bill to parliament to replace the Income Tax Act of 1961. After reasonable consultations, it is hoped that the bill will be passed in 2009 and take effect by 2011. All direct taxes are affected – personal and corporate income tax (including minimum alternate tax), dividend distribution tax, fringe benefit tax, and wealth tax. If the bill is passed, the following changes will be implemented:

• Personal income tax rates will be progressive, with marginal income tax rates of 10% on income up to INR1m (USD20,752), 20% on income from INR1m to INR2.5m, and 30% on income above INR2.5m. Retirement income will be taxed at point of withdrawal, and the deduction limit for savings will be increased from INR100,000 to INR300,000. Benefits in kind will be taxed as normal income. Gambling and lottery winnings will be taxed at 30%.
• A wealth tax will be reintroduced at a reduced rate of 0.25%, but only on net wealth exceeding INR500m, eliminating all but a small number of wealthy individuals.
• Corporate income tax will be reduced to a standard rate of 25% on both domestic and foreign-owned companies – domestic companies pay 15% on dividends, whereas foreign companies pay a "branch profit" tax irrespective of whether or not profits are repatriated. Capital gains will count as business income, and it will be possible to carry forward loss allowances indefinitely. Although shareholders can treat dividend payments as tax-free income, the current exemption on capital gains on listed securities will disappear.
• Minimum alternate tax will be assessed on the basis of gross assets (as opposed to the present system based on book profits) at a rate of 0.25% for banks and 2% for other companies. Since this alternative to corporate income tax is final, there are no carryforward provisions and tax may be payable even on loss-making companies.
• The removal of profit-based tax incentives might be compensated by an allowance for immediate deduction of the capital and revenue expenditure, but there are also suggestions that existing tax holidays could be phased out more gradually. The infrastructure sector, including oil and gas, power, and roads, has enjoyed tax holidays over several years. The elimination of tax holidays will be offset in the long run by the reduction in the corporate tax rate.
• Mergers and acquisitions treatment is to be reformed to encourage business reorganization in a tax-neutral fashion.
• The securities transaction tax will be abolished.

The new code includes a range of anti-tax avoidance measures, much of which will be debated during the upcoming period of consultation. Such measures include the already flagged advanced pricing agreements that multinational companies will be able to negotiate with the tax authorities in respect of their transfer pricing. There will be an increasing onus on taxpayers to show that they are acting in good faith rather than just following the letter of the law. Tax authorities will have more discretion to prioritize pursuit of delinquent situations according to the size of the potential loss of tax revenue.

The initial reaction from the Indian media has been positive; the new rates of taxation are thought to be appropriately competitive for an emerging nation. One commentator described the measures as "well-meaning, comprehensive and refreshing."

India's tax take to GDP at about 11.5% is low by international standards, but has grown from 2% over the past few decades while tax rates have come down and the tax base has expanded. It is anticipated that a modern, uncomplicated tax system will reduce tax avoidance and evasion, and further improve tax collection as befits a modern state.

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