The Congress government and Modi government have been working on the simplification of the Indian Income-tax Act of 1961. The first attempt was made in 2010 by the introduction of the New Direct Tax Code (DTC) 2010 by former Finance Minister, Pranab Mukherjee. After deliberation, a revised version of the DTC was introduced in 2013, without success.
The Modi government again attempted to further revise the DTC in 2017 and a task force was formed in this regard. The task force was mandated to draft a new law to bring income tax in line with global best practice while also addressing India’s economic needs. After two years of effort, the task force submitted the new draft DTC to the present Finance Minister, Nirmala Sitharaman, in August 2019.
At the time of writing, many important proposals suggested in those draft DTCs have been introduced in the Act, for example, a general anti-abuse rule (GAAR), taxation of indirect transfer of assets, place of effective management concept, advanced pricing agreement provisions. In addition to digitalizing many tax processes, various simplification measures have also been rolled out during the last decade.
The task force, headed by a Central Board of Direct Taxes (CBDT) member and other experienced professionals, submitted its report along with draft DTC 2019 to the Finance Minister on August 19, 2019. The task force has reportedly proposed several far-reaching changes to the new DTC, which are yet to be made public. According to the report, the DTC is expected to introduce some big-ticket changes which will boost the current income tax scenario and hopefully, bring some cheer for both corporate and individual taxpayers.
Key Proposals of the Direct Tax Code
Some key highlights of the draft DTC 2019 proposals are described below.
Fundamental Ethos of the DTC
Given the present complexity in the law, which is further aggravated by conflicting judicial rulings, the ethos of the new law was simplification and removal of ambiguity. According to sources, the DTC is shorter as compared to the Act, and an attempt has been made to simplify the present law by eliminating the web of “Provisos” and “Explanations” by using simple and lucid language.
BIG Relief for Individual Taxpayers
The task force has recommended big-ticket reliefs, including increasing the threshold limit for levy of taxes; significant tax relief should be available to middle and upper class individuals earning income between 4.5–5.5 million Indian Rupees ($0.63–0.77 million).
Further, a slew of incentives is proposed for start-ups, as these are the future of economic growth and their promotion through incentives can boost the economy. A bold reform would be to scrap “angel tax” altogether as it has been causing undue hardship to taxpayers. In fact, a series of measures have already been introduced in the Finance Act 2019 and post the roll out of the Finance Act.
Common Tax Rate for Domestic and Foreign Companies
It has been recommended to reduce the base corporate tax rate to 25% for both domestic and foreign companies, which will be a major reduction, especially for foreign companies. In fact, the tax rate for domestic companies has been reduced to 25% for companies having turnover of below 4 billion Indian Rupees. This will certainly attract more foreign companies and capital to India, thereby fostering the growth of the economy, but it will not provide a level playing field for the Indian companies which are subject to larger compliance requirements.
Further similar benefits should be extended to Indian entrepreneurs carrying on business under popular models such as partnership firms, limited liability partnerships, etc. and the base tax rate for them should also be 25%.
Elimination of Dividend Distribution Tax
The DTC will eliminate dividend distribution tax (DDT), which presently stands at approximately 20% and the dividends will be taxable in the hands of the shareholders.
The dividend taxation regime has seen many changes. Initially, dividend was taxable in the hands of the shareholders, including foreign shareholders. The government later observed that this regime had not been effective, as many shareholders did not pay taxes at all by using dubious tax planning methods, and many escaped taxation as it was difficult to track whether shareholders paid tax on dividends. The government therefore introduced a DDT levy on the company paying the dividend and exempted the dividend in the hands of the shareholders.
The rate of DDT has also been revised upward twice, with a present effective rate of approximately 20%. Despite DDT, the government also introduced a super-rich tax of 10% on dividend for shareholders earning dividend above 1 million Indian Rupees in a fiscal year. This proposal will benefit domestic shareholders, but more so foreign shareholders, as many Indian tax treaties provide a lower dividend tax rate of 5% and in some treaties such dividend is taxable in the home country and not in India at all.
This proposal of eliminating DDT and taxing shareholders may not find favor given the underlying objective of the government. Further, if this proposal is introduced, the government needs to think seriously about eliminating buy-back tax and capital reduction tax, which is another form of DDT.
Branch Profits Tax
The proposal is to levy branch profits tax (BPT) for foreign companies in addition to the corporate tax of 25% (proposed). As a result, foreign companies will be required to pay BPT on the amount repatriated to their foreign headquarters, which may bring the tax rate to 40% for many foreign companies. This proposal featured in the draft DTC of 2010. The BPT concept does exist in the current tax treaty of India with the U.S.
Simplification of Tax Assessment Process
It is well-known that the tax administration has been a major litigator; a serious overhaul of the assessment process is required. With this in mind, the task force has suggested a sea change in the current process and methodology. They have suggested replacing the concept of the “assessing officer” performing the assessment, with the “assessment unit” approach, thereby giving primacy to “functional units,” which will consist of Indian Revenue Service (IRS) officers with sector/industry knowledge and expertise. Separate “technical units” of IRS officers will assist assessment/functional units in completing the assessment.
Assessments are set to become “faceless,” with scrutiny assessments being centrally and randomly allotted through the system, along with the possibility of the introduction of video conferencing in certain areas. The government has taken steps in this direction since 2018, and necessary changes in the law as well as the administrative system have been introduced to implement faceless assessment. This approach could bring standardization and make the assessments sharper and more focused.
Reduction in Tax Litigation
The task force has also recommended a separate “Litigation Management Unit.” This unit will manage the entire tax litigation process right from deciding the cases where appeals ought to be filed to formulating strategies for defending a case.
The other significant change suggested is that the tax officer who passes the assessment order shall no longer be filing the appeals. The government has taken reasonably good measures in the past year to reduce the amount of litigation, and administrative orders have be issued not to file an appeal up to a certain tax threshold,and also existing appeals with tax effect below the prescribed threshold are withdrawn.
This initiative has helped to a certain extent. However, more rigor and discipline needs to be introduced among tax officers to achieve this objective.
Settlement Through Mediation
One of the suggestions of the task force is the introduction of the concept of “mediation.” This is a unique concept which will be introduced for the first time in Indian law if accepted and is said to be revolutionary: a taxpayer will be able to opt for a negotiated settlement before a Collegium of Commissioners once they receive the draft order. The negotiations will be assisted by mediators on both sides. This proposal is recommended in the hope that there will be a substantial reduction in tax litigation. With the introduction of this mechanism, the Settlement Commission process will likely be given a quiet exit from the DTC.
Option of Public Ruling for Taxpayers
Taxpayers will have the option of approaching the CBDT to obtain clarification on any important point of law not case- or fact-specific. This suggestion is in line with the international practice followed in many countries. India already has the regime of Authority for Advance Rulings (AAR); however, it has not proved to be as effective as it ought to have been. It remains to be seen how this process of public ruling and the AAR will be aligned and whether both will co-exist.
De-linking of Transfer Pricing Assessments
Another dynamic proposal is to separate transfer pricing and regular assessments by de-linking them. The transfer pricing assessments are to be carried out by a separate functional unit and shall be done for a block period of four years. This would lead to fewer but intense risk profile based transfer pricing audits of multinational enterprises. Again, the intent is to focus on significant issues and make the adjustments/assessments more robust as well as defendable at a later stage in the litigation process.
The other notable proposals are:
- redrafting of many definitions under the existing Act to minimize litigation;
- a new regime which may bring ease in compliance requirements for taxpayers;
- a slew of incentives proposed for start-ups as well as small and medium-sized businesses.
Fortunately, the task force has not suggested introducing the much-feared inheritance tax in the DTC.
A high corporate tax rate is often cited to be a major barrier to private investment and growth. Reduction in the corporate tax rate also for foreign companies will promote both local and foreign direct investment, thereby further strengthening the Indian economy, and will also help in achieving the government vision of a $5 trillion economy.
The introduction of faceless assessments, settlement though a mediation mechanism, public rulings, de-linking of transfer pricing assessment from corporate tax assessment, and many more simplification related proposals should bring about the desired transparency, consistency and rationalization in the way the tax assessments/litigation are administered. This, in turn, will boost the confidence of business and foreign investors, thereby making India a business-friendly destination.
Lower tax rates will curb evasive tax planning by corporates, thereby minimizing tax litigation, and help corporates to achieve their objective of minimizing overall tax costs and maximizing enterprise value. Foreign companies and foreign investors will also be incentivized to inject more funds into the Indian economy, given the effective, transparent, and fair tax environment in the country coupled with business enabling policies of the government.
Effectively, DTC could act as a stimulus in lifting the Indian economy and bringing it back on track—considering that it is currently impacted by an economic slowdown coupled with global socio-economic challenges.
Issues to Consider
It is not clear whether the task force has suggested transition provisions in the DTC, as having these provisions in place is critical to a smooth transition from the current tax regime to the new regime, and also to minimize the chances of significant litigation arising. Further, appropriate measures need to be built in for resolution of pending litigation cases, which runs into billions of dollars.
The other important aspect is that the DTC should not introduce retrospective changes as this will kill the fundamental objective of the government.
Another issue which requires consideration is unilateral amendments in the DTC. As per tax treaty provisions, a nonresident taxpayer can choose to be governed by the provisions of the Act or the tax treaty, whichever is more beneficial to them. Until now, the government has made certain unilateral amendments to the Act, which has taken away this benefit of the nonresident taxpayer, e.g. DDT, buy-back tax, GAAR, etc. It needs to be ensured that the DDT should eliminate these unilateral amendments restricting the tax treaty benefits and respect the negotiated bilateral tax treaties.
Further, considering the global dynamic changes in fiscal policies adopted by various countries, the Base Erosion and Profit Shifting (BEPS) Action Plans implemented by India, and the multilateral Instrument (MLI) document ratified by the Indian government as late as July 2019, the DTC should be crafted so as to include provisions which are aligned with these changes and legislation.
This is an opportunity for the Indian government to rewrite the present Income-tax Law through the DTC so as to simplify the law, the administration of the tax system, to minimize the cost of doing business, attract foreign resources and capital, and much more. This is an opportunity to rewrite the Act in line with the economic needs of the country and to keep pace with evolving global best practices.
What is needed is a more holistic tax reform in the shape of direct tax legislation that attracts foreign investment, boosts business confidence, motivates honest taxpayers, reduces the compliance and administrative burden, and provides a transparent, stable and less litigious environment.
One key consideration is to ensure that the economy becomes more tax compliant to facilitate expansion of the tax base. While its stated objectives are worth appreciating, the challenges to be addressed through the DTC are more critical.
Finally, introduction of the DTC will consume the time and energy of all stakeholders—taxpayers, tax authorities, tax advisers, the judiciary—in implementing the new code in its true spirit. This will entail the need to unlearn the existing law and to learn the new code from scratch.
This is a very good initiative and should be pursued by the government in an unbiased manner after engaging with all the relevant stakeholders.
Jayesh Kariya and Nikita Verma are Chartered Accountants.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.