Revised Discussion Paper on the Direct Taxes Code
June 2010
TABLE OF CONTENTS
|
CHAPTER |
|
|
|
Introduction |
|
I |
Minimum Alternate Tax (MAT) - Gross assets vis-a-vis book profit. |
|
II |
Tax treatment of savings – Exempt Exempt Tax II (EET) vis-a-vis Exempt Exempt Exempt (EEE) basis |
|
III |
Taxation of
income from employment - Retirement benefits and perquisites. |
|
IV |
Taxation of
income from house property. |
|
V |
Taxation of
capital gains |
|
VI |
Taxation of
non-profit organisations |
|
VII |
Special
Economic Zone –
Taxation of existing units |
|
VIII |
Concept of
Residence in the case of a company incorporated outside |
|
IX |
Double
Taxation Avoidance Agreement (DTAA) vis-a-vis
domestic law |
|
X |
Wealth Tax |
|
XI |
General Anti
Avoidance Rule |
INTRODUCTION
1.
The draft Direct Taxes Code (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 organisations 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 issues which this Revised Discussion Paper
addresses are:
i. Minimum Alternate Tax (MAT) - Gross
assets vis-a-vis book profit.
ii. Tax treatment of savings - Exempt Exempt Tax (EET) vis-a-vis Exempt
Exempt Exempt (EEE) basis.
iii. Taxation of income from employment -
Retirement benefits and perquisites.
iv. Taxation of income from house property.
v. Taxation of capital gains
vi. Taxation of non-profit organisations
vii. Special Economic Zones – Taxation of existing units
viii. Concept of Residence in the case of a company
incorporated outside
ix. Double Taxation Avoidance Agreement (DTAA) vis-a-vis domestic law.
x. Wealth Tax.
xi. General Anti Avoidance Rule (GAAR).
Paragraph
1 in each Chapter describes the proposals in the DTC and Discussion Paper,
paragraph 2 highlights the issues and concerns raised and paragraph 3 details
the revised proposals in response to these concerns.
2.
It had been stated in the first Discussion Paper that the Government would
consider calibrating the rates of tax in the light of the response and comments
received on the scope of the tax base discussed in the
Discussion Paper.
The
proposals in this Revised Discussion Paper would lead to a reduction in the tax
base proposed in the DTC. The indicative tax slabs and tax rates and monetary
limits for exemptions and deductions proposed in the DTC will, therefore, be
calibrated accordingly while finalising the
legislation.
3.
This Revised Discussion Paper is available on the following websites:
finmin.nic.in and incometaxindia.gov.in
Responses
to the Revised Discussion Paper should be sent online through the link provided
at these websites or at the following e-mail address: directtaxescode-rev@nic.in.
Responses are solicited upto 30th June, 2010.
CHAPTER I
MINIMUM ALTERNATE TAX – GROSS ASSETS VIS-À-VIS BOOK PROFIT
1.
Chapter XIII of the Discussion Paper on the DTC deals with Minimum Alternate Tax
(MAT). As stated in the Discussion Paper, a company would ordinarily be liable
to tax in respect of its total income. However, owing to tax incentives, the
liability on total income, in many cases, has been found to be extremely low or
even zero. Internationally, a variety of economic bases and methods are used to
calculate presumptive income so as to overcome the problem of excessive tax
incentives. These presumptions could be based on net wealth, value of assets
used in business or gross receipts of the enterprise.
1.1 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.
1.2
It has been proposed in the DTC that the "value of gross assets" will
be the aggregate of the value of gross block of fixed assets of the company,
the value of capital works in progress of the company, the book value of all
other assets of the company, as on the last day of the relevant financial year,
as reduced by the accumulated depreciation on the value of the gross block of
the fixed assets and the debit balance of the profit and loss account if
included in the book value of other assets. The rate of MAT will be 0.25 per
cent of the value of gross assets in the case of banking companies and 2 per
cent of the value of gross assets in the case of all other companies. The MAT
will be a final tax. Hence, it will not be allowed to be carried forward for
claiming tax credit in subsequent years.
2.
The following major issues have been raised regarding the proposed MAT on gross
assets :
(i) 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. An asset based MAT does not have
a proximate linkage with a particular year’s income or turnover. An asset based
MAT on loss making companies would result in significant hardship since they
would not have the resources to pay the tax. While one ‘incentive for efficiency’argument could be that such companies could shut
down or restructure their businesses, such an argument would not be valid for
businesses where losses may be inherent over long periods of the business
cycle. Income tax should be on real income and any method for presuming income
should also be reasonable enough to come closer to the real income.
(ii)
The return on assets is one of the indicators for evaluating the performance of
companies. However, it is not reasonable to apply this for newly set up
infrastructure companies which have long gestation periods. Since the proposed
MAT regime does not provide any exemption for gestation period, investment
costs in new businesses will be higher on account of the MAT when compared to
old businesses which already have a depreciated asset base. Similarly, for
companies undergoing major expansion resulting in the value of assets being
much higher, the MAT may be much greater than the income tax liability.
(iii)
In the case of corporates under liquidation, a levy
of a presumptive asset tax till the time the company is dissolved is not
reasonable.
(iv) Assuming the same net income as a percentage of gross assets for
all taxpayers is not practical as this would vary depending on the industry
concerned, the degree of integration of the particular enterprise, and the type
of product or service provided.
(v)
The inclusion of
‘capital works in progress‘ which is not used in the business and
does not contribute in revenue generation would distort the asset based tax.
Taxation should be based on net worth and not on gross assets.
(vi) The asset based MAT does not
cover situations where there are multiple tiers of subsidiaries for handling
separate businesses or investments. There would be a cascading effect of the
asset based MAT in such cases.
(vii) The proposed MAT does not allow for any carry
forward which would result in a corporate paying more overall tax in a low
profit year without there being any relief against above average profits earned
in a subsequent year.
(viii)
The DTC proposes
‘investment linked’ incentives to specified sectors for
investment. The application of asset based MAT on companies operating in such
sectors contradicts this policy.
3.
Some of the issues raised by stakeholders (such as MAT credit) can be addressed
by making appropriate changes in the proposed scheme of the asset based MAT.
However, there may be practical difficulties and unintended consequences,
particularly in the case of loss making companies and companies having a long
gestation period. It is, therefore, proposed to compute MAT with reference to
book profit.
CHAPTER II
TAX TREATMENT OF SAVINGS – EXEMPT EXEMPT
TAX (EET) VIS-À-VIS EXEMPT EXEMPT EXEMPT
(EEE) BASIS
1.
Chapter-XII of the Discussion Paper on the Direct Taxes Code (DTC) deals with
tax incentives for savings. It proposes the ‘Exempt-Exempt-Taxation’ (EET) method
of taxation for savings. Under this method, the contributions towards certain
savings are deductible from income (this represents the first 'E' under the EET
method), the accumulation/accretions are exempt (free from any tax incidence)
till such time as they remain invested (this represents the second ‘E’ under the EET method) and all
withdrawals at any time are subject to tax at the applicable marginal rate of
tax (this represents the ‘T’ under the
EET method).
1.1
Based on the EET principle, the Code provides for deduction in respect of
aggregate contributions upto a limit of three hundred
thousand rupees (both by the employee and the employer) to any account
maintained with any permitted savings intermediary, during the financial year.
This account will have to be maintained with any permitted savings intermediary
in accordance with the scheme framed and prescribed by the Central Government.
The permitted savings intermediaries will be approved provident funds, approved
superannuation funds, life insurer and New Pension System Trust. The accretions
to the deposits will remain untaxed till such time as they are allowed to
accumulate in the account. Any withdrawal made, or amount received, under
whatever circumstances, from this account will be included in the income of the
assessee under the head 'income from residuary
sources', in the year of such withdrawal or receipt. It will accordingly be
subject to tax at the applicable personal marginal rate of tax.
1.2
Taxation on EET basis is proposed to be prospective. The DTC provides that the
withdrawal of any amount of accumulated balance as on the 31st day of March,
2011 in the account of the individual in a Government Provident Fund (GPF),
Public Provident Fund (PPF), Recognised Provident
Funds (RPFs) and the Employees Provident Fund (EPF)
will not be subject to tax. Therefore, only new contributions as well as
accretions on or after the commencement of the DTC, will be subject to the EET
method of taxation.
1.3
The permitted savings intermediaries would be approved by the Pension Fund
Regulatory and Development Authority (PFRDA). These intermediaries will, in
turn, invest the amounts deposited with them in government securities, term
deposits of banks, unit-linked insurance plans, annuity plans, bonds and
securities of public sector companies, banks and financial institutions, bonds
of other companies enjoying prescribed investment grade rating, equity linked
schemes of mutual funds, debt oriented mutual funds, equity and debt
instruments. The choice of instruments will, in some schemes, be with the
investor and in some others with the trustees of the schemes. The pattern of
investment by the latter will be as prescribed. The rollover of any amount
received, or withdrawn, from one account with the permitted savings
intermediary to any other account with the same or any other permitted savings
intermediary will not be treated as withdrawal and, accordingly, will not be
subject to tax.
2.
A large number of representations have been made with regard to the proposed
EET system. It has been stated that most countries that follow the EET method
of taxation of savings also have a social security system in place for all
their citizens. The EET savings accounts which operate for individuals in these
countries are over and above the mandatory social service payments received by
them. It has been represented that in
3.
Universal social security benefits for tax payers may not be feasible in the
near future. Also, switching over to a complete EET method of taxation for all
savings instruments would entail many administrative, logistical and
technological challenges. It would require a vast network of permitted savings
intermediaries, a central record keeping authority and a central agency to
service around more than three crore accounts and
deduct tax at the time of withdrawals. The segregation of taxable and
non-taxable amounts at the time of withdrawal and rollover from one account to
another would introduce complexities and create practical difficulties.
3.1
Therefore, as of now, it is proposed to provide the EEE method of taxation for
Government Provident Fund (GPF), Public Provident Fund (PPF) and Recognised Provident Funds (RPFs)
and the pension scheme administered by Pension Fund Regulatory and Development
Authority. Approved pure life insurance products and annuity schemes will also
be subject to EEE method of tax treatment. In order to achieve the objective of
long term savings, the rules for contribution as well as withdrawal will be harmonised and made uniform so that such savings are
actually made and utilised by the taxpayer for the
long term. Investments made, before the date of commencement of the DTC, in
instruments which enjoy EEE method of taxation under the current law, would
continue to be eligible for EEE method of tax treatment for the full duration
of the financial instrument.
CHAPTER III
TAXATION OF INCOME FROM EMPLOYMENT – RETIREMENT BENEFITS
AND PERQUISITES
1.
Chapter VII of the Discussion Paper on the Direct Taxes Code (DTC) deals with
computation of income taxable under the head ‘Income from employment’. It provides
that “Income from employment” will be gross salary as reduced by the aggregate
amount of permissible deductions.
1.1 The term
‘salary’ is defined to include the value of perquisites, profits in lieu
of salary, amount received on voluntary retirement or termination, leave
salary, gratuity and any annuity, pension or any commutation thereof. Contributions
made by the employer to an approved superannuation fund, provident fund, life
insurer and New Pension System Trust is considered as salary.
1.2 Deductions from gross salary are allowed for
compensation received under voluntary retirement scheme, amount of gratuity
received on retirement or death and amount received on commutation of pension
to the extent such amounts are deposited in a Retirement Benefits Account. The
employee will have to maintain a Retirement Benefit Account with any permitted savings
intermediary in accordance with the scheme framed and prescribed by the Central
Government. The permitted savings intermediaries will be approved provident
funds, approved superannuation funds, life insurer and New Pension System
Trust. The accretions to the deposits will remain untaxed till such time as
they are allowed to accumulate in the account. Any withdrawal made, or amount
received, under whatever circumstances, from this account will be included in
the income of the assessee for the year in which the
withdrawal is made or the amount is received. Thus, retirement benefits will be
exempt only if deposited in Retirement Benefits Account and will be subject to
tax on withdrawal from such account.
1.3 Under the DTC, salary will
include, inter-alia, the following:-
(a)
the value of rent free or concessional,
accommodation provided by the employer irrespective of whether the employer is
a Government or any other person;
(b) the value of any leave travel concession;
(c)
the amount received on encashment of unavailed earned leave on retirement or otherwise;
(d) medical reimbursement; and
(e)
the value of free or concessional
medical treatment paid for, or provided by, the employer.
The
Discussion Paper states that the value of rent-free accommodation will be
determined for all employees including Government employees in the same manner
as is presently determined in the case of employees in the private sector.
2.
Representations have been received from stakeholders that in the absence of
adequate social security benefits, the social and economic norm is to use
retirement benefit amounts for savings as well as for social expenditure.
Hence, taxation of withdrawals from a Retirement Benefit Account would be
harsh.
2.1 Though valuation on the basis of
market value has not been prescribed in the DTC or the Discussion Paper,
apprehensions have also been expressed that if the value of accommodation in
the case of government employees will be taken at market rent, it would create
a high tax burden. Concerns have also been expressed regarding non-availability
of exemption for perquisites in the nature of medical benefits which are
available in the current law.
3.
Maintaining individual Retirement Benefits Account by permitted savings
intermediaries on behalf of all employees would require a centralised
nationwide authority to regulate and manage crores of
retirement benefits accounts of employees and to deduct tax on withdrawal which
entails creation of a separate institutional mechanism, complex logistics and
substantial costs. The complexity of maintaining permitted savings accounts has
been discussed in the context of the EET method of taxation. For the same
reasons, it is proposed not to introduce the Retirement Benefits Account
scheme.
3.1 An employer’s contribution to
an approved provident fund, superannuation fund and New Pension Scheme within
the limits prescribed shall not be considered as salary in the hands of the
employee. Also, retirement benefits received by an employee will be exempt
subject to specified monetary limits. Thus, the amount of gratuity received,
the amount received under a voluntary retirement scheme, the amount received on
commutation of pension linked to gratuity received and the amount received on
account of encashment of leave at the time of superannuation are proposed to be
exempt, subject to specified limits, for all employees.
3.2 The method of valuation of
perquisites will be appropriately provided in the rules. It is proposed that
perquisites in relation to medical facilities/reimbursement provided by an
employer to its employees shall be valued as per the existing law with
appropriate enhancement of monetary limits. It is clarified that the DTC does
not propose to compute perquisite value of rent free accommodation based on
market value.
CHAPTER IV
TAXATION OF INCOME FROM HOUSE PROPERTY
1.
Chapter VIII of the Discussion Paper on the draft Direct Taxes Code (DTC) deals
with the computation of income from house property. “Income from house property” is one of the five heads
under which accruals or receipts relating to ordinary sources of income are to
be classified. The Discussion Paper states that income from house property,
which is not occupied for the purpose of any business or profession by its
owner, is to be taxed under this head. The Discussion Paper proposes a new
scheme for computation of income from house property in the draft DTC, the
salient features of which are:
(a)
Income from house property shall be the gross rent less specified deductions.
(b)
Gross rent will be higher of (i) the amount of
contractual rent for the financial year; and (ii) the presumptive rent
calculated at six per cent per annum of the ratable value fixed by the local
authority. However, in a case where no ratable value has been fixed, six per cent
shall be calculated with reference to the cost of construction or acquisition
of the property. If the property is acquired during the financial year, the
presumptive rent shall be calculated for the proportionate period of that
financial year.
(c)
The advance rent will be taxed only in the financial year to which it relates.
(d)
The gross rent of one self-occupied property will be deemed to be nil, as at
present. In addition, the gross rent of any one palace in the occupation of a
ruler will also be deemed to be nil, as at present.
(e) The
following deductions will be admissible against the gross rent:-
(i) Amount of taxes levied by a local authority and tax on
services, if actually paid.
(ii) Twenty per
cent of the gross rent towards repairs and maintenance as against thirty per
cent at present.
(iii)
Amount of any interest payable on capital borrowed for the purposes of
acquiring, constructing, repairing, renewing or re- constructing the property.
(f)
In the case of a self-occupied property where the gross rent is deemed to be
nil, no deduction for taxes or interest will be allowed.
(g)
The income from property shall include income from the letting of any buildings
along with any machinery, plant, furniture or any other facility if the letting
of such building is inseparable from the letting of the machinery, plant,
furniture or facility.
2.
The most frequent feedback on computation of income
from house property has been the determination of notional rent on presumptive
basis (at the rate of 6%) with reference to the cost of construction/
acquisition. The input is that this is inequitable as it discriminates against
recent owners as such cost is a function of inflation. The other major issue
which has been raised is that, in order to incentivize
investment in housing, the deduction for interest on capital borrowed for
acquisition or construction of a self occupied house property, up to a ceiling
of Rs. 1.5 lakhs, as
available in the existing provisions of the Income-tax Act, 1961 should be
retained.
3.
The determination of notional rent for computing income from house property has
been a cause for much litigation. Internationally also, in most jurisdictions,
income from house property is taxed on the basis of rent from letting out of
property.
3.1 Taking the above factors into
account, the following modifications are proposed:
(a)
In case of let out house property, gross rent will be the amount of rent
received or receivable for the financial year.
(b)
Gross rent will not be computed at a presumptive rate of six per cent of the rateable value or cost of construction/acquisition.
(c) In case of
house property which is not let out, the gross rent will be nil.
As the gross
rent will be taken as nil, no deduction for taxes or interest etc., will be allowed. However, in case of any one house
property, which has not been let out, an individual or HUF will be eligible for
deduction on account of interest on capital borrowed for acquisition or
construction of such house property (subject to a ceiling of Rs. 1.5 lakh) from the gross
total income. The overall limit of deduction for savings will be calibrated
accordingly.
CHAPTER V
TAXATION OF CAPITAL GAINS
1.1 Chapter X of the Discussion Paper on
the Direct Taxes Code (DTC) provides that income from transactions in all
investment assets will be computed under the head “Capital gains”. The DTC
provides that gains (losses) arising from the transfer of investment assets
will be treated as capital gains (losses). These gains (losses) will be
included in the total income of the financial year in which the investment
asset is transferred. The capital gains will be subjected to tax at the rate of
30% in the case of non-residents and in the case of residents at the applicable
marginal rate.
1.2
Under the Code, the current distinction between short-term investment asset and
long-term investment asset on the basis of the length of holding of the asset
will be eliminated.
1.3 In general, the capital gains
will be equal to the full consideration from the transfer of the investment
asset minus the cost of acquisition of the asset, cost of improvement thereof
and transfer-related incidental expenses. However, in the case of a capital
asset which is transferred anytime after one year from the end of the financial
year in which it is acquired, the cost of acquisition and cost of improvement
will be indexed to reduce the inflationary gains.
1.4 The capital gains from all
investment assets will be aggregated to arrive at the total amount of current
income from capital gains. This will, then, be aggregated with unabsorbed
capital loss at the end of the immediate preceding financial year (unabsorbed
preceding year capital loss) to arrive at the total amount of income under the
head ‘Capital gains’. If the result of the aggregation is a loss, the total
amount of capital gains will be treated as 'nil' and the loss will be treated
as unabsorbed current capital loss at the end of the financial year.
1.5 The DTC proposes to abolish
Securities Transaction Tax. Therefore, all capital gains (loss) arising from
the transfer of equity shares in a company or units of an equity oriented fund
will form part of the computation process described above.
1.6 The cost of acquisition is
generally with reference to the value of the asset on the base date or, if the
asset is acquired after such date, the cost at which the asset is acquired. The
base date will now be shifted from 1.4.1981 to 1.4.2000. As a result, all
unrealized capital gains due to appreciation during the period from
1.4.1981
to 31.3.2000 will not be liable to tax as the assessee
will have an option to take the cost of acquisition for these assets at the
price prevailing as on 1.4.2000.
1.7 The DTC also proposes that a
new Capital Gains Savings Scheme will be framed by the Central Government. Capital
Gains deposited under this scheme will not be subject to tax till the
withdrawal from such scheme.
2.
The following major issues and concerns have been raised regarding the taxation
of capital gains:
(i) Currently, short-term capital gains arising on transfer
of listed equity shares or units of equity oriented funds are being taxed at
15% and long term capital gain arising on transfer of such assets is exempt
from tax. The withdrawal of this regime will raise the tax liability and may
cause fluctuations in the capital market.
(ii)
The rate of 30 % for taxation of capital gains in the hands of non- residents
is very high as in the case of listed equity shares they are currently being
taxed at nil rate if held for more than one year.
(iii)
Foreign Institutional Investors (FIIs) play a
significant role in the Indian capital market. Various countries, including
emerging markets, offer non-residents a special tax regime to attract
investments and promote depth of capital markets.
(iv) FII should not be liable to TDS on capital
gains as this may cause undue hardship to them. The current provisions relating
to payment of the liability as advance tax should be continued.
3. After considering the inputs received
the following regime is proposed.
3.1 Income under the head ‘Capital Gains’ will be considered as income from ordinary
sources in case of all taxpayers including non-residents. It will be taxed at
the rate applicable to that taxpayer.
3.2 Capital Asset held for a period of
more than one year from the end of financial year in which asset is acquired.
(A) Listed equity shares or units of an
equity oriented fund:
Capital
gains arising from transfer of an investment asset, being equity shares of a
company listed on a recognized stock exchange or units of an equity oriented
fund, which are held for more than one year, shall be computed after allowing a
deduction at a specified percentage of capital gains without any indexation.
This adjusted capital gain will be included in the total income of the taxpayer
and will be taxed at the applicable rate. The loss arising on transfer of such
asset held for more than one year will be scaled down in a similar manner.
Therefore if the
“capital gains” before the deduction at the
specified rate comes to Rs.100, it would stand reduced to Rs.50 (if the
specified deduction rate is 50 percent). This capital
gains would then be included in the taxpayer’s total income and taxed at the
applicable rate. In this example, for a taxpayer in the tax bracket of 10%,
such gain will bear an effective tax at the rate of 5% and for taxpayers in tax
bracket of 20% or 30%, the effective tax rate would be 10% or 15% respectively.
The
Table below gives examples of the effective rate of taxation for different
taxpayers at different specified rates of deduction:
|
Examples of specified percentage deduction for computing adjusted Capital Gain |
Effective tax rate for taxpayer whose applicable marginal tax rate is 10 percent |
Effective tax rate for taxpayer whose applicable marginal tax rate is 20 percent |
Effective tax rate for taxpayer whose applicable marginal tax rate is 30 percent |
|
50 |
5% |
10% |
15% |
|
60 |
4% |
8% |
12% |
|
70 |
3% |
6% |
9% |
The proposed scheme is therefore specially beneficial to low and middle income category of taxpayers as they are to be taxed at their applicable marginal rate of 10 percent or 20 percent after the specified deduction for computing adjusted capital gains. The specific rate of deduction for computing adjusted capital gain will be finalized in the context of overall tax rates.
As there will be a shift from nil rate of tax on listed equity shares and units equity oriented funds held for more than one year, an appropriate transition regime will be provided, if required.
(B) Capital gains on other assets held for more than one year
For taxation of capital gains arising from transfer of investment assets held for more than one year (other than listed equity shares or units of equity oriented funds), the base date for determining the cost of acquisition will now be shifted from
1.4.1981 to 1.4.2000. As a result, all unrealized capital gains on such assets between 1.4.1981 and 31.3.2000 will not be liable to tax. The capital gains will be computed after allowing indexation on this raised base. The capital gains on such assets will be included in the total income of the taxpayer and will be taxed at the applicable rate.
3.3 The complexity of maintaining a permitted savings account and retirement benefits account scheme has been discussed in detail in context of EET method of taxation and taxation of Income from Employment. For the same reasons it is proposed not to introduce the Capital Gains Savings Scheme.
3.4 Capital gains on assets held for less than one year from the end of
Financial Year in which asset is acquired.
The capital gain arising from transfer of any investment asset held for less than one year from the end of the financial year in which it is acquired will be computed without any specified deduction or indexation. It will be included in the total income and will be charged to tax at the rate applicable to taxpayer.
3.5 Characterization of income of Foreign Institutional Investors (FII)s
A major area of dispute is whether the income
from transactions in the capital market should be characterized as business
income or as capital gains. This has ramification for taxation in the case of FIIs. A foreign company is not allowed to invest in
securities in
3.6 The capital gains arising to FIIs shall not be subjected to TDS and they will be
required to pay tax by way of advance tax on such gains as is the existing
practice.
3.7 Securities Transaction Tax
The
Securities Transaction Tax (STT) is a tax on specified transactions and not on
income. Accordingly, STT is proposed to be calibrated based on the Revised taxation regime for capital gains and flow of funds
to the capital market.
CHAPTER VI
TAXATION OF NON-PROFIT ORGANISATIONS
1.
Chapter XV
of the Discussion Paper on the Direct Taxes Code (DTC) deals with taxation of
non-profit organizations. The Code uses the phrase ‘permitted welfare activities’ instead
of the phrase "charitable purpose" used in the current legislation to
define the activities to be pursued by these organisations.
Permitted welfare activities has been defined to mean any activity involving
relief of the poor, advancement of education, provision of medical relief,
preservation of environment, preservation of monuments or places or objects of
artistic or historic interest and the advancement of any other object of
general public utility. Advancement of any other object of general public
utility will not include any activity in the nature of trade, commerce or
business, or any activity of rendering any service in relation to any trade,
commerce or business, for a fee or for any other consideration, irrespective of
the nature of use, application or retention of the income from such activity.
1.1 The Discussion Paper mentions that while trusts and
institutions established for charitable purposes have generally enjoyed tax
exemptions, the following shortcomings have been observed in the exemption
regime:-
(a)
The exemption regime is complex, overlapping and dissimilar since it varies
across institutions based on their activities.
(b)
The provisions fail to meet the test of efficiency as they provide different
conditions for institutions carrying on similar activities.
(c)
The provisions also do not meet the test of equity as the compliance cost for
an institution varies depending upon the provision of law under which the
exemption is granted.
(d)
The concept of income of such an institution has been the subject matter of
litigation. Should gross receipts of the institution or the net income of the
institution be reckoned as the income? This question has been the subject
matter of extensive debate.
(e)
A vexed issue is whether the institution should be allowed to accumulate income
not applied or utilized for charitable purposes and how the accumulation should
be treated.
(f)
There is unending dispute whether a business is incidental to attainment of the
objectives of the institution or not, since the income from incidental business
is exempt from tax.
1.2 The DTC proposes a new tax
regime for all trusts and institutions carrying on charitable activities. The
salient features of the new regime are as under:-
(a) An organization shall be treated as a
non-profit organization if,-
(i) it is established for the
benefit of the general public;
(ii) it is established for carrying on permitted welfare
activities;
(iii) it is not established for the benefit of any particular
caste;
(iv) it is not established for the benefit of any of its members;
(v)
it actually carries on the permitted welfare
activities during the financial year and the beneficiaries of the activities
are the general public;
(vi) it does not intend
to apply its surplus or other income or use its assets or incur expenditure,
directly or indirectly, for the benefit of any interested person;
(vii) any expenditure by
the organisation does not enure,
directly or indirectly, for the benefit of any interested person;
(viii)
the funds or assets of the organisation are not used
or applied, or deemed to have been used or applied, directly or indirectly, for
the benefit of any interested person;
(ix) the surplus, if any,
accruing from its permitted activities does not enure,
directly or indirectly, for the benefit of any interested person;
(x)
the funds or the assets of the non-profit organisation are not invested or held in any associate
concern or in any prescribed form or mode;
(xi) it maintains such
books of account and in such manner, as may be prescribed;
(xii)
it obtains a report of audit in the prescribed form from an accountant before
the due date of filing of the return in respect of the accounts of the
business, if any, carried on by it; and the accounts relating to the permitted
welfare activities and
(xiii) it is registered with the Income-tax Department under the
Code.
(b) The tax
liability of a non-profit organisation shall be 15
per cent. of the aggregate of the following:-
(I)
the amount of surplus generated from the permitted welfare activities;
and
(II)
the amount of capital gains arising on transfer of an
investment asset, being a financial asset;
Surplus generated from permitted
welfare activities;
The amount of
surplus generated from the permitted welfare activities shall be the gross
receipts as reduced by the outgoings.
The gross
receipts shall be the aggregate of the following:-
(i) The amount of voluntary contributions received during
the financial year;
(ii)
Any rent received in respect of a property consisting of any buildings or lands
appurtenant thereto;
(iii)
The amount of any income derived from a business which is incidental to any of
the permitted welfare activities;
(iv) Full value of the consideration received from the transfer of
any investment asset, not being a financial asset;
(v)
Full value of the consideration received from the transfer of any business
capital asset of a business incidental to its permitted welfare activities;
(vi) The amount of any income
received from any investment of its funds or assets; and
(vii) All other incomings, realizations, proceeds,
donations or subscriptions received from any source.
The amount of outgoings
shall be the aggregate of-
(i) voluntary contributions
received during the financial year by the non- profit organisation
made with a specific direction that they shall form part of the corpus of the
non-profit organisation;
(ii)
the amount actually paid during the financial year for
any expenditure, excluding capital expenditure, incurred wholly and exclusively
for earning or obtaining any "gross receipts";
(iii)
the amount actually paid during the financial year for
any expenditure, excluding capital expenditure, on the permitted welfare
activities;
(iv) the amount of
capital expenditure actually paid during the financial year in relation to-
(A) any business capital asset of a business incidental to any
of the permitted welfare activities; or
(B) any investment asset, not being a financial asset.
(v)
any amount actually paid during the financial year to
any other non- profit organisation engaged in a
similar permitted welfare activity;
(vi) any amount applied
outside
(c)
The surplus generated from permitted welfare activities will be determined on
the basis of cash system of accounting.
(d)
Capital gains arising on the transfer of an investment asset, being a financial
asset, will be computed in accordance with the provisions under the head
"Capital gains".
(e)
A non-profit organisation will be prohibited from
investing any of its funds or holding any of its asset
in any associate concern or in any prescribed form or mode.
(f)
It will be mandatory for every non-profit organisation
to register with the Income-tax Department by making an application to the
Chief Commissioner or Commissioner concerned. The registration, once granted,
shall be valid from the financial year in which the application is made till it
is withdrawn.
(g)
The donations made to a non-profit organisation will
be eligible for deduction in the hands of the donor at the appropriate rates.
(h)
The income of any trust or institution recognised/registered
under the religious endowment Acts of the Central Government or the State
Governments shall be fully exempt from income-tax. However, donations to such
trusts or institutions will not enjoy any deduction in the hands of the donor.
2. A number of
inputs have been received regarding the proposed regime –
(i) The Code provides for fresh registration of NPOs after introduction of DTC. This will lead to increase
in the compliance cost for NPOs and also
substantially increase the workload of the income-tax department.
(ii)
The status of public religious institutions in the DTC is not clear as the DTC
exempts the income of only such religious trusts which are registered under a
religious endowments legislation of the Central or a State Government. However,
there are many states where such legislation does not exist or even if it
exists, it does not cover all religious institutions.
(iii)
The status of partly religious and partly charitable institutions is not clear
under the Code.
(iv) Instances have been cited where NPOs receive grants at the end of the financial year or are
unable to spend due to reasons beyond their control. In the absence of any
window for carry forward of surplus for use in the subsequent years, taxation
of the surplus of income over expenditure will be harsh.
(v)
The phrase ‘charitable
purpose’ should be used instead of
‘permitted welfare activity’ in order to emphasize the charitable intent
of the activities rather than permitting of certain specified welfare
activities. This will ensure greater clarity and will minimize litigation as
the phrase has been in use for long.
(vi) Only cash system of accounting
is stipulated for NPOs, whereas under the existing
provisions of the Income-tax Act, 1961 NPOs can
follow either cash or mercantile system of accounting. The option of choosing
one of the systems should be allowed.
3. The issues
have been examined and having considered the concerns, the tax regime for NPOs is proposed to be modified to provide that-
(a)
NPOs already registered under the Income-tax Act,
1961 and holding valid registration on the date on which DTC comes into effect,
would not be required to apply for fresh registration under the DTC. However,
they would be required to provide additional information to facilitate the
administration of the new provisions.
(b)
The income of a public religious institutions will be
exempt subject to fulfillment of all the following conditions:
(A) it shall be registered under the Code.
(B)
the trust/institution shall apply its income wholly
for public religious purposes;
(C) it shall be registered under the state law, if any;
(D) it is established for the benefit of the general public;
(E)
the trust / institution shall file the return of tax
bases before the due date;
(F)
it shall maintain books of account and obtain an audit
report from a qualified accountant in case its gross receipts exceed a
prescribed limit;
(G) the funds or the assets of the trust /
institution shall be invested or held, at any time during the financial year,
in specified permitted forms or modes; and
(H) the funds or the
assets of the trust / institution shall not be used or applied or deemed to
have been used or applied, directly or indirectly, for the benefit of
interested person.
Donations
to these institutions will not be eligible for any deduction in the hands of
the donor.
(c)
Partly religious and partly charitable institutions will also be treated as NPOs if they are registered under the Code. Their income
from public religious activity will be exempt subject to the fulfillment of the
following conditions-
(i) the trust deed / memorandum of
the institution shall contain a clause specifying the application of its gross
receipts in a pre- determined ratio between charitable and religious
activities;
(ii)
it shall maintain separate books of account and
separate financial statements in respect of religious and charitable activities;
(iii) it shall fulfil the conditions
stipulated in clause (b) above.
In
respect of income from charitable activities, the income of the trust /
institution will be liable to tax in the manner provided for NPOs if they fulfill the conditions prescribed in the Code.
Donations to such trust / institution will not be eligible for deduction in the
hands of the donor.
(d)
To address the concern that an NPO would not be able to spend the entire
receipts during the financial year itself, it is proposed that upto 15% of the surplus or 10% of gross receipts, whichever
is higher, will be allowed to be carried forward to be used within three years
from the end of the relevant financial year.
(e)
Donations by an NPO out of its accumulated surplus to another NPO will not be
considered as application for the charitable purpose.
(f)
The definition of the phrase
‘permitted welfare activity’ is on the same lines as what is
currently used for the phrase
‘charitable purpose’.
Accordingly,
to maintain continuity and minimise litigation, the
phrase ‘charitable purpose’ will be retained in place of ‘permitted welfare activity’.
(g)
A basic exemption limit will be provided and the surplus in excess of such
limit will be subject to tax.
(h)
It is proposed to retain the cash system of accounting since it is simple to
follow and easy to administer.
(i) It is also proposed that the Central Government shall be
empowered to notify any non-profit organization of public importance as an
exempt entity.
CHAPTER VII
SPECIAL ECONOMIC ZONES – TAXATION OF EXISTING UNITS
1.
Chapter XII of the Discussion Paper on Tax Incentives deals specifically with
the grandfathering of area based exemptions. It has been stated that the case
for area based exemption is based on the consideration of balanced regional
development. However, such area based exemptions create economic distortion,
i.e., allocate/ divert resources to areas where there is no comparative
advantage. Such exemptions also lead to tax evasion and avoidance. Besides,
there is a huge cost of administration. Hence, the Code does not allow
area-based exemptions. Area-based exemptions that are available under the
Income Tax Act, 1961 will be grandfathered.
2.
It has been pointed out that while the current profit linked deductions
available to developers of Special Economic Zones (SEZs)
have been protected for their unexpired period in the DTC, there is no mention
of grandfathering of these profit linked deductions in
the case of units operating in these SEZs.
3.
Profit linked deductions are distortionary in nature
as they create an incentive to inflate profit as well as to transfer profits
from a taxable entity to a non-taxable one. As a policy, it has, therefore,
been decided not to extend the scope or the period of profit linked deductions.
However, specific provisions for protecting such deduction for the unexpired
period have been provided in the DTC in the case of SEZ developers. A similar
provision to protect profit linked deductions of units already operating in SEZs for the unexpired period will also be incorporated.
CHAPTER VIII
CONCEPT OF RESIDENCE IN THE CASE OF A COMPANY INCORPORATED
OUTSIDE
1.
Chapter-IV of the Discussion Paper on the draft Direct Taxes Code (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
2.
It has been pointed out that under the new test for determining residence in
the DTC, a foreign company whose control and management is partly in
3.1 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 Income Tax Act, 1961 based
on the control and management of its affairs being situated wholly in
3.2 ‘Place of effective management’ is
an internationally recognized concept for determination of residence of a
company incorporated in a foreign jurisdiction.
Most
of our tax treaties recognize the concept of ‘place of effective management’ for
determination of residence of a company as a tie-breaker rule for avoidance of
double taxation. It is an internationally accepted principle that the place of
effective management is the place where key management and commercial decisions
that are necessary for the conduct of the entity’s business as a whole, are, in
substance, made. In case of a company incorporated outside India, the current
domestic law is too narrow compared to our tax treaties as the test of
residence of a foreign company is based on “whole of control and
management”
lying in India. However a test of residence based on control and management of
the foreign company being situated “wholly or partly” in
3.3 It is therefore proposed that
a company incorporated outside
‘place of effective management of the company’ means-
(i) the place where the board of
directors of the company or its executive directors, as the case may be, make
their decisions; or
(ii)
in a case where the board of directors routinely
approve the commercial and strategic decisions made by the executive directors
or officers of the company, the place where such executive directors or
officers of the company perform their functions.”
3.4 As an anti-avoidance measure,
in line with internationally accepted practices, it is also 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
CHAPTER IX
DOUBLE TAXATION AVOIDANCE AGREEMENT (DTAA) VIS-À-VIS
DOMESTIC LAW
1.0 Chapter –XXIII of the Discussion
Paper deals with relief from double taxation. Ordinarily, countries follow both
residence-based taxation and source-based taxation. However, if two countries
tax the same income, one based on the principle of residence and the other based
on the principle of source, it could lead to double taxation of the same
income. Hence, countries have agreed on certain principles to avoid double
taxation and accordingly, entered into Double Taxation Avoidance Agreements
(DTAA).
1.1 DTAA provides for certainty on
how and when will income of a particular kind be taxed and by which contracting
State. The taxation right of each State is defined. If one State has the right
to tax a certain income, provision is made for the other State to give tax
credit or exemption to that income in order to avoid double taxation.
1.2 The DTC provides that neither a
DTAA nor the Code shall have a preferential status by reason of its being a
treaty or law. In the case of a conflict between the provisions of a treaty and
the provisions of the Code, the one that is later in point of time shall
prevail.
2.
Apprehensions have been raised that the aforesaid proposal would lead to treaty
override and the existing DTAAs could be rendered
otiose. This would result in higher rate of taxation on royalty, fees for
technical services and interest income etc , which are
taxed in the source country at a concessional rate as
per the provisions of the DTAA. The uncertainty regarding cost of doing
business in
3.
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.
3.1 Similarly 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:-
3.2 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.
WEALTH TAX
1.
Chapter XVII of the Discussion Paper on the Direct Taxes Code (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.
2.
The inputs on the Wealth Tax proposals are
(i) Productive assets should be exempted from wealth tax as
is currently the case.
(ii) The
threshold limit of Rupees 50 crore for levy of wealth
tax is too high.
(iii) On the
other hand it has also been argued that tax on financial assets will be harsh
as they are currently exempt.
3.
Wealth tax is an anti- abuse measure in the integrated tax system. It ensures
reporting of significant assets held by a tax payer. It is proposed that Wealth
Tax will be levied broadly on the same lines as provided in the Wealth Tax Act,
1957.
Accordingly,
specified “unproductive assets” will be subject to the wealth tax.
However,
it will be payable by all taxpayers except non-profit organizations. The
threshold limit and rate of tax will be suitably calibrated in the context of
overall tax rates.
GENERAL ANTI-AVOIDANCE RULE
1. Chapter XXIV
of the Discussion Paper on the Direct Taxes Code (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 is not at arm’s length or abuses the provisions of the DTC or lacks
economic substance. The Assessing Officer in accordance with the directions of
Commissioner of Income Tax may in such cases determine the tax consequences for
the assessee by disregarding the arrangement. These
provisions have been further elaborated in the Discussion Paper.
1.1
Under the Code, the power to invoke GAAR is bestowed upon the Commissioner of Income- tax.
For this purposes the Code empowers him to call for such information as may be
necessary. He is also required to follow the principles of natural justice
before declaring an arrangement as an impermissible avoidance arrangement. He
will determine the tax consequences of such impermissible avoidance arrangement
and issue necessary directions to the Assessing Officer for making appropriate
adjustments. The directions issued by him will be binding on the Assessing
Officer.
2.
Apprehensions have been expressed that the GAAR provision is sweeping in nature
and may be invoked by the Assessing Officer in a routine manner. Apprehensions
have also been raised that there is no distinction between tax mitigation and
tax avoidance as any arrangement to obtain a tax benefit may be considered as
an impermissible avoidance arrangement. It has been represented that to avoid
arbitrary application of the provisions, further legislative and administrative
safeguards be provided. Besides suitable threshold limits for invoking GAAR
should be considered.
3 GAAR legislation exists in a number of countries. Jurisdictions which do not have GAAR legislation impose significant additional information and disclosure requirements on tax practitioners regarding advance intimation and registration of tax shelters with the tax administration. These can be investigated and potentially abusive arrangements can be declared impermissible. A statutory GAAR can act as an effective deterrent and compliance tool against tax avoidance in an environment of moderate tax rates.
3.1 The proposed GAAR provisions do
not envisage that every arrangement for tax mitigation would be liable to be
classified as an impermissible avoidance arrangement. It is only in a case
where the arrangement, besides obtaining a tax benefit for the assessee, is also covered by one of the four conditions
i.e. it is not at arms length or it represents misuse or abuse of the
provisions of the Code or it lacks commercial substance or it is entered or
carried on in a manner not normally employed for bona-fide business purposes,
the GAAR provisions would come into effect.
3.2 The following safeguards are
also proposed for invoking GAAR provisions:-
i)
The Central Board of Direct Taxes will issue guidelines to provide for the
circumstances under which GAAR may be invoked.
ii)
GAAR provisions will be invoked only in respect of an arrangement where tax
avoidance is beyond a specified threshold limit.
iii) The forum of Dispute Resolution Panel (DRP) would be available where GAAR provisions are invoked