direct tax codes act

8/14/2019 Direct Tax Codes Act

1/15

Direct Tax Code AnalysisThe government has released a comprehensive discussion paper and draft ofthe new Direct Tax Code that seeks to revamp and simplify the Direct TaxLaw and its administration in the country through several radical changes.

The code, which the government plans to enact and implement FY2012

onwards with suitable changes if required, envisages meaningful reduction inthe tax rates while simultaneously being revenue neutral for the government.It aims to achieve this by increasing the tax base and rationalising the myriadtax incentives prevalent under the current law. In our view, the overallchanges proposed will be quite beneficial for a number of sectors andcompanies, albeit definitively withdrawing tax holidays being currentlyenjoyed by different sectors, something that has been contemplated andproposed often in the past and therefore should not come as a majornegative surprise.

Reduction in effective tax rates for Individuals a positive

The Tax code proposes a significant increase in the tax slabs for personalincome tax which, if implemented, will result in a meaningful increase indisposable income, especially benefiting FMCG and other domesticconsumption stories. At the same time, the code proposes to do away withthe distinction between long and short-term capital gains and abolish theSecurities Transaction Tax (STT), effectively taxing all capital gains at theapplicable marginal tax rate for the tax-payers total income. At present, thelong-term capital gains tax is Nil on equity transactions on which STT is paidand 20% on all other assets, while the short-term capital gains tax rate is10% on equity transactions on which STT is paid and 30% on other assets. Inour view, the proposed increase in tax slabs is quite substantial in view of thecountrys per capita income distribution, and should reduce the impact of the

proposed increase in capital gains tax rates.

Tax incentives on SavingsThe code also proposes to increase the tax deduction limit available onsavings from Rs1lakh at present to Rs3lakh. However, the tax incentives on


2/15

Interest paid on home loans is proposed to be withdrawn. On a furthernegative note, the code also proposes to tax the savings in variousinstruments including PPF, Insurance, etc. at the time of withdrawal, i.e.investments in tax savings instruments will only lead to a postponement oftax liability rather than an outright exemption as applicable at present.Moreover, retirement benefits such as gratuity will be tax-free only if

deposited in specified retirement benefit schemes.

Effect on Corporate.

The Direct Tax Code proposes a substantial reduction in the rates of tax oncorporate income, near-removal of the difference in the tax treatment ofdomestic and foreign companies and a shift in the base of minimum alternatetax (MAT) from book profits to value of gross assets. It also envisages doingaway with a large number of exemptions and deductions though in a fewcases, these profit-linked incentives are replaced with a new set of incentiveslinked to capital investment.

The net impact of these measures on India Inc would be substantial andmostly positive but might vary from company to company, say tax experts.

There could be cases where the removal of incentives coupled with the newmethods computation would expand the tax base by up to 40%, netting outthe benefit of the low tax rate.

Once the code is implemented, both domestic and foreign companies wouldbe paying tax at a low rate of 25% as against 33.99% and 42.23%,respectively, at present (inclusive of surcharge and education cess). Whiledomestic companies would pay a 15% tax on the dividends that they actuallydistribute, foreign companies would be required to pay a branch profit tax atthe same rate whether or not they remit profits outside the country.

The code proposes to treat capital gains as business income. Losseswould be allowed to be carried forward indefinitely. As expected, the new taxcode does not provide for area-based exemptions, which anyway have enddates prescribed.

On double taxation avoidance, the code says neither the relevantbilateral treaty nor the code would have a preferential status and in the caseof a conflict, the one that is later in point of time would prevail.

As per the code, MAT would be 0.25% of value of gross assets in caseof banking companies and 2% of that value for other companies. The authorsof the code justify the re-definition of MAT as an assets tax saying that thiswould allow companies to expect to earn a specified average rate of returnon their assets which is an incentive for efficiency.

However, under the proposed dispensation, even loss-making companiescould end up paying MAT. Also, companies making huge investments wouldgain from the 100% write-off of capital expenditure in the first year itself, butthis gain would be partly negated as they would pay MAT on the value ofassets created. Infrastructure companies that have to wait for long yearsbefore starting to make handsome profits would have to pay MAT even in theinitial years of low/nil profitability.
http://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cms


3/15

And since MAT would be treated as a final tax, it wont be possible to carry itforward for claiming credit in the subsequent years. Basically, what thepolicymakers propose is to reward businesses that take high risk and expectlong payback, says Mukesh Bhutani of BMR Advisors.

It is believed that asset-heavy companies would generally find their taxliability has come down, thanks to the new investment-linked incentives.

How tax rates influence fiscalpolicyFiscal PolicyFiscal policyinvolves the use ofgovernment spending, taxation andborrowing to influence both the pattern of economic activity and also the level

and growth of aggregate demand, output and employment. It is important torealise that changes in fiscal policy affect both aggregatedemand(AD) andaggregate supply(AS).

Discretionary fiscal changes are deliberate changes in direct andindirect taxation and govt spending for example a decision by thegovernment to increase total capital spending on the road building budget orincrease the allocation of resources going direct into the NHS.

1. Taxation and work incentives

Can changes in income taxes affect the incentive to work? This remains a controversialsubject in the economic literature!

Consider the impact of an increase in the basic rate of income tax or an increase in therate of national insurance contributions. The rise in direct tax has the effect of reducing

the post-tax income of those in work because for each hour of work taken the total net

income is now lower. This might encourage the individual to work more hours tomaintain his/her target income. Conversely, the effect might be to encourage less work

since the higher tax might act as a disincentive to work. Of course many workers have

little flexibility in the hours that they work. They will be contracted to work a certainnumber of hours, and changes in direct tax rates will not alter that.

The government has introduced a lower starting rate of income tax for lower income

earners. This is designed to provide an incentive for people to work extra hours and keepmore of what they earn.Changes to the tax and benefit system also seek to reduce the risk of the poverty trap

where households on low incomes see little net financial benefit from supplying extra

hours of their labour. If tax and benefit reforms can improve incentives and lead to anincrease in the labour supply, this will help to reduce the equilibrium rate of

unemployment (the NAIRU) and thereby increase the economys non-inflationary growth

rate.
http://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cmshttp://economictimes.indiatimes.com/Personal-Finance/Tax-Savers/Tax-News/New-Direct-Tax-Code-mostly-profitable-for-India-Inc/articleshow/4887924.cms


4/15

2.

Taxation and the Pattern of Demand

Changes to indirect taxes in particular can have an effect on the pattern of demand forgoods and services. For example, the rising value of duty on cigarettes and alcohol is

designed to cause a substitution effect among consumers and thereby reduce the demand

for what are perceived as de-merit goods. In contrast, a government financial subsidyto producers has the effect of reducing their costs of production, lowering the market

price and encouraging an expansion of demand.

The use of indirect taxation and subsidies is often justified on the grounds of instances ofmarket failure. But there might also be a justification based on achieving a more

equitable allocation of resources e.g. providing basic state health care free at the point

of use.

3. Taxation and labour productivity

Some economists argue that taxes can have a significant effect on the intensity withwhich people work and their overall efficiency and productivity. But there is little

substantive empirical evidence to support this view. Many factors contribute to

improving productivity tax changes can play a role - but isolating the impact of tax cutson productivity is extremely difficult.

4. Taxation and business investment decisions

Lower rates of corporation tax and other business taxes can stimulate an increase in

business fixed capital investment spending. If planned investment increases, the nationscapital stock can rise and the capital stock per worker employed can rise.

The government might also use tax allowances to stimulate increases in research and

development and encourage more business start-ups. A favourable tax regime could also

be attractive to inflows of foreign direct investment a stimulus to the economy thatmight benefit both aggregate demand and supply. The Irish economy is often touted as an

example of how substantial cuts in the rate of corporation tax can act as a magnet for

large amounts of inward investment. The very low rates of company tax have beeninfluential although it is not the only factor that has underpinned the sensational rates of

economic growth enjoyed by the Irish economy over the last fifteen years.Capital investment should not be seen solely in terms of the purchase of new machines.Changes to the tax system and specific areas of government spending might also be used

to stimulate investment in technology, innovation, the skills of the labour force and social

infrastructure. A good example of this might be a substantial increase in real spending onthe transport infrastructure. Improvements in our transport system would add directly to

aggregate demand, but would also provide a boost to productivity and competitiveness.


5/15

Similarly increases in capital spending in education would have feedback effects in the

long term on the supply-side of the economy.

Automatic stabilisers include those changes in tax revenues andgovernment spending that come about automatically as the economy movesthrough different stages of the business cycle

Tax revenues: When the economy is expanding rapidly the amount oftax revenue increases which takes money out of the circular flow ofincome and spending

Welfare spending: A growing economy means that the governmentdoes not have to spend as much on means-tested welfare benefitssuch as income support and unemployment benefits

Budget balance and the circular flow: A fast-growing economytends to lead to a net outflow of money from the circular flow.Conversely during a slowdown or a recession, the government

normally ends up running a larger budget deficit.


6/15

APPENDIX TABLE 32 : DIRECT AND INDIRECT TAX REVENUES OF THE CENTRAL AND THE STATEGOVERNMENTS

(Rupees crore)

Yea r Centre (Gross) States@ Centre and States Combined

Direct Indirect Total Direct Indirect Total Direct Indirect Total

1 2 3 4 5 6 7 8 9 10

1995-96 33,563 77,661 1,11,224 8,040 55,587 63,627 41,603 1,33,248 1,74,851(a) 30.2 69.8 100.0 12.6 87.4 100.0 23.8 76.2 100.0

(b) 2.8 6.5 9.3 0.7 4.7 5.3 3.5 11.2 14.7

2002-03 83,085 1,33,181 2,16,266 18,151 1,24,526 1,42,677 1,01,236 2,57,707 3,58,943

(a) 38.4 61.6 100.0 12.7 87.3 100.0 28.2 71.8 100.0

(b) 3.4 5.4 8.8 0.7 5.1 5.8 4.1 10.5 14.6

2003-04 1,05,090 1,49,258 2,54,348 20,531 1,40,703 1,61,234 1,25,621 2,89,961 4,15,582

(a) 41.3 58.7 100.0 12.7 87.3 100.0 30.2 69.8 100.0

(b) 3.8 5.4 9.2 0.7 5.1 5.9 4.6 10.5 15.1

2004-05 1,32,771 1,72,187 3,04,958 24,043 1,65,045 1,89,088 1,56,814 3,37,232 4,94,046

(a) 43.5 56.5 100.0 12.7 87.3 100.0 31.7 68.3 100.0

(b) 4.2 5.5 9.7 0.8 5.2 6.1 5.0 10.7 15.7

2005-06 1,65,201 2,00,949 3,66,150 30,211 1,90,658 2,20,869 1,95,412 3,91,607 5,87,019(a) 45.1 54.9 100.0 13.7 86.3 100.0 33.3 66.7 100.0

(b) 4.6 5.6 10.2 0.8 5.3 6.2 5.4 10.9 16.4

2006-07 2,30,181 2,43,331 4,73,512 37,579 2,14,029 2,51,608 2,67,760 4,57,360 7,25,120

(a) 48.6 51.4 100.0 14.9 85.1 100.0 36.9 63.1 100.0

(b) 5.6 5.9 11.5 0.9 5.2 6.1 6.5 11.1 17.6

2007-08 3,12,198 2,80,949 5,93,157 1,24,383 3,09,849 4,34,232 4,36,581 5,90,798 10,27,379

(a) 52.6 47.4 100.0 28.6 71.4 100.0 42.5 57.5 100.0

(b) 6.6 5.9 12.6 2.6 6.6 9.2 9.2 12.5 21.8

2008-09 3,65,000 3,22,715 6,87,715 1,39,189 3,66,117 5,05,306 5,04,189 6,88,832 11,93,021

BE (a) 53.1 46.9 100.0 27.5 72.5 100.0 42.3 57.7 100.0

(b) 6.9 6.1 12.9 2.6 6.9 9.5 9.5 12.9 22.4

2008-09 3,45,000 2,82,949 6,27,949 1,38,157 3,60,975 4,99,132 4,83,157 6,43,924 11,27,081RE (a) 54.9 45.1 100.0 27.7 72.3 100.0 42.9 57.1 100.0

(b) 6.5 5.3 11.8 2.6 6.8 9.4 9.1 12.1 21.2

2009-10 3,70,000 2,71,079 6,41,079 1,52,545 3,94,822 5,47,367 5,22,545 6,65,901 11,88,446

BE (a) 57.7 42.3 100.0 27.9 72.1 100.0 44.0 56.0 100.0

(b) 6.3 4.6 10.9 2.6 6.7 9.3 8.9 11.4 20.3

Memo Items:

(Average)

1998-99 (a) 40.9 59.1 100.0 14.0 86.0 100.0 30.6 69.4 100.0

to 2007-08 (b) 4.0 5.6 9.6 0.9 5.2 6.1 4.9 10.8 15.7

RE : Revised Estimates. BE : Budget Estimates.

@ : Excluding States share in Central Taxes as reported in Central Government budget documents.

(a) : Represents percentages to total tax revenue.(b) : Represents percentages to GDP.

Source : Budget Documents of the Central and the State Governments.


7/15

Contribution of direct and indirect tax inrevenue collection of India

Taxation

We now turn to the revenue that flows into the governments accounts fromtaxation. There are so many different kinds of taxation and the tax systemitself often appears to be horrendously complex! But one importantdistinction to make is between direct and indirect taxes.

Direct taxation is levied on income, wealth and profit. Directtaxes include income tax, national insurance contributions, capitalgains tax, and corporation tax.

Indirect taxes are taxes on spending such as excise duties on fuel,

cigarettes and alcohol and Value Added Tax (VAT) on many differentgoods and services


8/15

Progressive, proportional and regressive taxes


9/15

With a progressive tax, the marginal rate of tax rises as incomerises. I.e. as people earn more income, the rate of tax on each extrapound earned goes up. This causes a rise in the average rate of tax(the percentage of income paid in tax). The UK income tax system isprogressive. Everyone is entitled to a tax-free income. Thereafter, asincome grows, people pay the starting rate of tax (10%) before moving

onto the basic tax rate (22%). Higher income earners pay the top rateof tax (40%) on each additional pound of income over the top rate taxlimit. This is the highest rate of income tax applied.

With a proportional tax, the marginal rate of tax is constant. Forexample, we might have an income tax system that applied a standardrate of tax of 25% across all income levels. If the marginal rate of tax isconstant, the average rate of tax will also be constant. Nationalinsurance contributions are the closest example in the UK of aproportional tax, although low-income earners do not pay NICs belowan income threshold, and NICs also do not rise for income earnedabove a top threshold.

With a regressive tax, the rate of tax falls as incomes rise I.e. theaverage rate of tax is lower for people of higher incomes. In the UK,most examples of regressive taxes come from excise duties of items ofspending such as cigarettes and alcohol. There is well-documentedevidence that the heavy excise duty applied on tobacco has quite aregressive impact on the distribution of income in the UK.

DIRECT & INDIRECT TAX

PROJECTBY-HARSH SACHDEV

ROLL-39SYBBI MMK


10/15

CountryBangladesh

China

Indonesia

Philippines

Exp 10.74

1.91

0.59

0.55

Exp 22.0712.87

2.134.47

Tax0.16

1.03

0.61

0.27Note: Medium-term is defined as the period from 2008-10.

Table 4.4. Effectiveness of Automatic Stabilizers: ExpenditureAdjustment

Shock toConsumption

Investment

ExportsBangladesh 0.01 -0.01 -0.04 -0.02 -0.04 -0.02China0.07-0.060.08

-0.060.08-0.06Indonesia -0.05 0.24 -0.12 0.25 -0.05

Medium-term fiscal multipliers: the impact on GDP of apermanent increase (decrease) in government expenditure(tax) by 1% of GDP


11/15

0.23Philippines 0.04 0.09 0.05 0.05

-0.03 0.03

Notes:(a) The upper figures correspond to smoothing as defined in Eq. (1) in Section 2. The

italicized lower figures correspond to smoothing as defined in Eq. (2).(b) The smoothing power is measured for the period of the shock and the year

immediately after (2006-7).

Table 4.5. Effectiveness of Automatic Stabilizers: Tax AdjustmentShock toConsumption

Investment

Exports

Bangladesh

0.00 0.00 0.01 0.00 0.01 0.00China-0.01

0.01-0.01

0.01-0.020.01

Indonesia 0.04 0.15 -0.02 0.16 0.04 0.14Philippines -0.04 0.01 -0.03 0.02 -0.08 0.03

Notes:(a) The upper figures correspond to smoothing as defined in Eq. (1) in Section 2. The

italicized lower figures correspond to smoothing as defined in Eq. (2).

(b) The smoothing power is measured for the period of the shock and the yearimmediately after (2006-7).


12/15

CountryBangladesh

China

Indonesia

Philippines

1990-1999

Table 3.1. GDP Growth Rate: Bangladesh, China, Indonesia, and thePhilippines; 1990-2005 (in percent)


13/15

(Average)

20005.9

8.4

4.9

4.4

20015.38.3

3.8

1.820024.4

9.1

4.4

4.4

20035.3

10.0

4.94.520046.3

10.1

5.1

6.0

20055.4

9.9

5.6

5.1

4.8

10.0

4.3

2.8

Table 4.1. Short-term fiscal multipliers: the impact on GDP of anincrease (decrease) in government expenditure (tax) by1% of GDP for one year

CountryBangladesh

China

Indonesia

Philippines

Exp 1

0.400.29

0.22

0.27

Exp 20.791.57

0.76

0.74


14/15

Tax0.13

0.44

0.16

0.03Note: Short-term is defined as year contemporaneous with the shock and the year after,

i.e. (2006-7).Table 4.2. Medium-term fiscal multipliers: the impact on GDP of anincrease (decrease) in government expenditure (tax) by1% of GDP for one year

CountryBangladesh

China

Indonesia

PhilippinesExp 1-0.05

0.59

0.02

0.00Exp 2-0.02

3.83

0.19

1.36Tax

-0.05

0.06

-0.03

0.09Note: Medium-term is defined as the period from 2008-10


15/15