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Shrey Raj Saxena

IVth B.S.L.L.L.B., ILS Law College, Pune

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Direct Tax Code vis-à-vis Income Tax Act,1961

Direct Tax:

Direct tax is the tax which is charged directly on the tax payer.  In other words direct tax is that tax that is deducted from one’s salary.

In the general sense, a direct tax is one paid directly to the government by the persons on whom it is imposed which is  accompanied by a tax return filed by the taxpayer). Examples include some income taxes, some corporate taxes, and transfer taxes such as estate (inheritance) tax and gift tax. Some commentators have argued that “a direct tax is one that cannot be shifted by the taxpayer to someone else, whereas an indirect tax can be.
Direct Taxation in India:

Direct taxation in India is governed by Income Tax Act, 1961 and  taken care by the Central Board of Direct Taxes (“CBDT”); it is a division of Department of revenue under Ministry of Finance. CBDT is governed by the Revenue Act, 1963. CBDT is given the authority to create and control direct taxes in India. The most important function of CBDT is to manage direct tax law followed by Income Tax department.
Under Income tax Act, 1961(“Act, 1961”), taxes are charged on the basis of residential status and not on the basis of citizenship. The assesses are charged based upon the following factors

  • Resident
  • Resident but not ordinary resident.
  • Non-resident.

Capital gains tax, personal income tax, tax on corporate income and tax incentives all come under the purview of direct tax.

An income tax is a tax levied on the income of individuals or businesses (corporations or other legal entities. When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or profit tax.

Direct Tax Code:

TheDirect Tax Code (“DTC”) is said to replace the existing Act in India. It is expected to be enforced from 2012. During the budget 2010 presentation, the finance minister Mr. Pranab Mukherjee reiterated his commitment to bringing into fore the new DTC into force from 1st of April, 2011, but same could not be fulfilled and now it will be applicable from 1st April, 2012.[1]

The draft DTC along with a Discussion Paper was released in August, 2009 for public comments. Since then, a number of valuable inputs on the proposals outlined in these documents have been received from a large number of organizations and individuals. These inputs have been examined and the major issues on which various stakeholders have given their views have been identified. This Revised Discussion Paper addresses these major issues. There are a number of other issues which have been raised in the public feedback, which, though not part of this Discussion Paper, will be considered while finalising the Bill for introduction in Parliament.

“The key objective underlying the proposed enactment of the DTC is to mitigate the uncertainty and complexity created by the existing patchwork of direct tax legislations and annual finance acts,”. “At the same time, the DTC has not lost sight of the need for flexibility and ensures that amendments – of tax rates, for instance – can be accommodated within the schedules to the DTC. While the DTC has proposed to lower corporate tax rates simultaneously it incorporates new provisions which will result in broadening the tax base,”.

One aim of the new tax code is to provide a system which takes into account the increase in cross-border mergers and acquisitions undertaken by Indian companies over the last few years. In addition, while lowering corporate tax rates, the DTC aims to remove the administrative burden on foreign companies and investors for whom the country is now a leading target for investment. By implementing the new code, the Government of India also intends to streamline and simplify legislation, as well as iron out many ambiguities in the current system[2].

The issues which this Revised Discussion Paper addresses are:

        i.            Residential status of foreign companies;

      ii.            Taxation of Companies;

    iii.            Minimum Alternate Tax;

    iv.            General anti avoidance Rules;

      v.            Double Taxation Avoidance Agreement;

    vi.            Branch Profit Tax;

  vii.            Royalties and Fees for Technical services;

  1. Controlled Foreign Companies;

    ix.            Wealth Tax.

Comparative Analysis of provisions :

1.     Residential status of foreign companies:

DTC discusses the test of residence of a person for tax purposes. The tax residence of companies (that is, where companies are established or carry on business) is usually based on either place of incorporation (legal seat), location of management (real seat) or a combination of the two. The DTC provides that a company incorporated in India will always be treated as resident in India. However, a company incorporated abroad (foreign company) can either be resident or non-resident in India. It has been proposed in the DTC that a foreign company will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated „wholly or partly‟ in India (it need not be wholly situated in India, as at present).

Generally, the test of residence for foreign companies is the “place of effective management”or “place of central control and management”. At the same time, it is noted that the existing definition of residence of a company in the Act based on the control and management of its affairs being situated wholly in India is too high a threshold.  Place of effective management‟ is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction.[3]

  • Act, 1961:

A company is said to be Resident in India only if, the company is controlled and managed wholly partly in India at any time during the said financial year[4].

  • DTC:

A company is said to be Resident in India if the place of effective management of company is in India. ‘Place of effective management of company’ means-

  • the place where the board of directors of the company or its executive directors, make their decisions; or
  • In a case where the board of directors perform their functions.”
  • Impact:

Such proposed change may create difficulties in implementation as their could be difference of opinion in regard to where is placed effective management

  1. Taxation of companies:

Under present legislation, the Domestic companies and Foreign companies are taxed at different rates, where there income exceeds 1 crore but DTC has proposed to make a uniformity in taxation of Domestic and Foreign companies at a same rate.

  • Act, 1961:

Under present law, Domestic companies are taxable @ 33.90% where income exceeds ` 1 crore and Foreign companies are taxable @ 42.33% where income exceeds ` 1 crore.

  • DTC

Under DTC, the proposal is to tax all companies including the foreign companies @ 30% and thus, to make a uniformity in taxation of companies.

  • Impact

Marginal relief for domestic companies.Welcome proposition for foreign companies- relief of about 13% on tax rates. However, profits of Indian branches of foreign companies will be subject to additional ‘Branch Profits Tax’ leviable @ 15%.

  1. Minimum Alternate tax:

The DTC has proposed a Minimum Alternate Tax (“MAT”) on companies calculated with reference to the “value of gross assets”. The economic rationale for the assets tax is that investors can expect ex-ante to earn a specified average rate of return on their assets, hence it provides an incentive for efficiency.Computation of MAT with reference to gross value of assets will require all companies to pay tax even if they are loss making companies or operating in a cyclical downturn[5]

  • Act, 1961:

Under present law, MAT rate is @ 19.93% (inclusive of surcharge and education cess) where income exceeds ` 1 crore. Tax credit for MAT paid is available for 10 years.

  • DTC:

Under DTC, MAT is proposed to be taxed @ 20% without any surcharge and education cess.Credit for MAT is proposed for 15 years.[6]

  • Impact:

After such proposed change MAT rate of tax increases slightly but Credit for MAT gets extended from 10 years to 15 years.

  1. General Anti Avoidance Rules (“GAAR”):

DTC deals with the provisions of the General Anti Avoidance Rule (GAAR). The harmful effects of tax avoidance on the tax base, on tax equity and on the compliance regime have been discussed at length. The need for general anti avoidance provisions instead of legislative amendments to deal with specific instance of tax avoidance has also been discussed. The GAAR provisions apply where a taxpayer has entered into an arrangement, the main purpose of which is to obtain a tax benefit and such arrangement is entered or carried on in a manner not normally employed for bona-fide business purposes or are not at arm‟s length or abuses the provisions of the DTC or lacks economic substance.

  • Act, 1961

There is no provision with respect to GAAR in the present law.

  • DTC

The following safeguards are also proposed for invoking GAAR provisions:-

  • The Central Board of Direct Taxes will issue guidelines to provide for the circumstances under which GAAR may be invoked.
  • GAAR provisions will be invoked only in respect of an arrangement where tax avoidance is beyond a specified threshold limit.
  • The forum of Dispute Resolution Panel (“DRP”) would be available where GAAR provisions are invoked.
  • Impact

Such proposed change can lead to harassment and hardship for taxpayers.

  1. 5.      DOUBLE TAXATION AVOIDANCE AGREEMENT (“DTAA”):

Under the current provisions of Act, 1961, the Domestic law and DTAA, the one which is more beneficial to taxpayer will apply But DTC provides that, DTAA will not have preferential status over the domestic law in the specified circumstances.

  • Act, 1961:

The current provisions of the Income-tax Act provide that between the domestic law and relevant DTAA, the one which is more beneficial to the taxpayer will apply. However, this is subject to specific exceptions e.g., the taxation of a foreign company at a rate higher than that of a domestic company is not considered as a less favourable charge in respect of the foreign company.

  • DTC:

It is proposed to provide that between the domestic law and relevant DTAA, the one which is more beneficial to the taxpayer shall apply. However, DTAA will not have preferential status over the domestic law in the following circumstances:-

  • when the General Anti Avoidance Rule is invoked, or
  • when Controlled Foreign Corporation provisions are invoked or
  • when Branch Profits Tax is levied. [7]
  • Impact:

This limited treaty override is in accordance with the internationally accepted principles. Since anti-avoidance rules are part of the domestic legislation and they are not addressed in tax treaties, such limited treaty override will not be in conflict with the DTAAs. Further this will not deprive any taxpayer of any intended tax benefit available under the DTAAs.

  1. Branch profit tax:

Under DTC additional levy of Branch Profit Tax (“BPT”) @ 15% is proposed. The same is to be levied on the total income for the financial year as reduced by the amount of income tax thereonForeign Companies liable to pay branch profit tax on total Income reduced by corporate tax.

  • Act, 1961

There is no provision with respect to BPT in the present law.

  • DTC

Under DTC, it is proposed to levy Additional branch profit tax @ 15% on all foreign companies having any form of PE in India.

  • Impact

This can have dampening effect on foreign trade transactions and volumes.

  1. Royalties and Fees for Technical services:

The ambit of fees for technical services (“FTS”) widened to include development & transfer of design, drawing , plan & software or similar services. The ambit of Royalty widened to include the consideration for use/right to use of transmission by satellite, cable, optic fibre, ship or aircraft and live coverage of any event

  • Act, 1961

Currently, royalty and FTS are taxable @ 10% on gross income for foreign companies[8]

  • DTC

Under DTC, Royalty and FTS proposed to be taxed @ 20% on gross income for foreign companies

  • Impact

Rate of tax on these income is proposed to be doubled. Can adversely affect import of technology in the country.

  1. Controlled foreign companies (“CFC”):

It is proposed to introduce Controlled Foreign Corporation provisions so as to provide that passive income earned by a foreign company which is controlled directly or indirectly by a resident in India, and where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received from the foreign company[9].

  • Act, 1961:

There are no rules concerning CFCs in the current legislation.

  • DTC:

CFC provisions have been introduced to tax passive income earned by a foreign company (controlled directly or indirectly by a resident in India).

Under proposed CFC rules, even income of such foreign companies not distributed to shareholders would be deemed to be distributed and consequently taxable in India in the hands of resident shareholders as dividend received from the foreign company.

  • Impact:

The proposal can affect outbound investments. There is no provision for getting credit for taxes paid abroad. This can result in double taxation.

  1. Wealth tax:

DTC deals with the levy of wealth tax. Under the DTC, wealth-tax will be payable by an individual, HUF and private discretionary trusts. It will be levied on net wealth on the valuation date i.e. the last day of the financial year. Net wealth is defined as assets chargeable to wealth-tax as reduced by the debt owed in respect of such assets. Assets chargeable to wealth-tax shall mean all assets, including financial assets and deemed assets, as reduced by exempted assets. Exempted assets include stock in trade, a single residential house or a plot of land etc. The net wealth of an individual or HUF in excess of Rupees fifty crore shall be chargeable to wealth-tax at the rate of 0.25 per cent. [10]

  • Act, 1961:

Wealth tax Act, 1957 is applicable but there is no wealth tax is levied on companies.

  • DTC:

Wealth tax is proposed on wealth exceeding ` 1 crore. Tax generally on non-productive assets. However value of equity in preference shares held by a resident in controlled foreign company will be liable to tax.

  • Impact:

Companies hitherto non-taxable will be taxable. Favourable aspect is that limit of ` 30 lakh gets extended to 100 lakh.

CONCLUSION:

Thus, it can be said that the key objective underlying the proposed enactment of the DTC is to mitigate the uncertainty and complexity created by the existing patchwork of direct tax legislations and annual finance acts,”.
One aim of the new tax code is to provide a system which takes into account the increase in cross-border mergers and acquisitions undertaken by Indian companies over the last few years. In addition, while lowering corporate tax rates, the DTC aims to remove the administrative burden on foreign companies and investors for whom the country is now a leading target for investment. By implementing the new code, the Government of India also intends to streamline and simplify legislation, as well as iron out many ambiguities in the current system.
However, the professional community is divided over the logic and scope of some of the Code’s provisions and some experts are anxious about the impact such legislation will have on business and investment activity. The need to maintain a balance between reaping tax rewards under the new legislation and maintaining the interest of businesses and investors is of utmost importance. There is some anxiety as to whether the DTC achieves this balance, especially given the Government of India’s reputation for enforcing tax legislation. “Since there is a direct correlation between taxation and economic growth, tax policies need to be directed so they achieve objectives such as increasing growth, savings and investments, consumption, and so on,”. “Although the goals of the DTC are laudable, some of the provisions raise concerns stemming largely from an unsatisfactory experience with the manner of enforcement of tax provisions at the field level.”



[2]http://www.financierworldwide.com/article.php?id=7632

[3]Revised discussion paper on DTC June 2010,  Central Board of Direct Taxes, Department of Revenue (Ministry of Finance)

 

[4]Section 6 of Income Tax Act, 1961

[5]Revised discussion paper on DTC June 2010,  Central Board of Direct Taxes, Department of Revenue (Ministry of Finance)

 

[6]Section 115 JB of Income tax act, 1961

[7]Revised discussion paper on DTC June 2010,  Central Board of Direct Taxes, Department of Revenue (Ministry of Finance)

 

[8]Section 115 A Income Tax Act, 1961

[9]Revised discussion paper on DTC June 2010,  Central Board of Direct Taxes, Department of Revenue (Ministry of Finance)

 

[10]Revised discussion paper on DTC June 2010,  Central Board of Direct Taxes, Department of Revenue (Ministry of Finance)

 


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