Critical Appraisal of the DTC Bill, 2009

The Direct Taxes Code (DTC) is the most expected Indian Legislation of the decade. For the first time, a bill has been kept open for public commentary even before its introduction in the Parliament. The DTC, as such, is the simplest any tax legislation can become. Has then the DTC, 2009 proved Albert Einstein’s saying (“The hardest thing in the world to understand is the Income Tax”) to be false? Of course not… It has become simple for people who know income tax and not the layman. Let me critically appraise some of the provisions of the Direct Taxes Code, 2009 which may have missed the common eye.

Hefty Increase in Tax Slabs:

The most welcome measure in the DTC Bill is the increase in individual tax slabs. It has increased the slabs to an extent no one expected. When the DTC Bill is enacted, income up to Rupees 10 Lakhs will be taxed only at 10%. Further income between 10 Lakhs and 25 Lakhs will be taxed at 20% and income above 25 Lakhs will be taxed at 30%. Further there will be no more surcharge, Education Cess and Higher and Secondary Education Cess. This will ensure easier tax compliance. All individual will be making whooping tax savings. Let’s compare how the Gross Total income of a General Individual will be taxed under the present regime and under the Direct Taxes Code.

S. No. Particulars As Per the Income Tax Act 1961, (For AY : 2010- 11) As per Direct Taxes Code Bill, 2009
1. Gross Total Income 15,00,000 15,00,000
2. Less : deduction for savings 1,00,000 3,00,000
3. Total Income 14,00,000 12,00,000
4. Income Tax on Above 3,24,000 1,24,000
5. Add: Education Cess on Above 6,480 Nil
6. Add: Higher and Secondary Education Cess 3,240 Nil
7. Total Tax Payable 3,33,720 1,24,000

From the above it is very much evident that the individual will be making a whooping tax savings of Rs. 2,09,720/- under the Direct Taxes Code.

Adieu Assessment Year!

The Direct Taxes Code proposes to do away with the terms Assessment Year and Previous Year. Instead, the term Financial Year is used throughout the code. Under the current Income Tax Act, 1961, Income of the Previous Year is supposed to be taxed in the Assessment Year. This caused a lot of confusion since there were two different years with the same numbers i.e. Previous Year 2008-09 and Assessment 2008-09. Now this confusion has been resolved by the uniform usage of the term Financial Year. By the time the DTC is enacted by the Indian Parliament, it will be time to wish a very Good-Bye to Assessment Year and Previous Year. At least then, the layman will be able to understand a little bit of Income Tax.

Status of a Limited Liability Partnership

The Direct Taxes Code has not clearly defined the status of a Limited Liability Partnership. Section 284 (110) of the code defines a firm as follows:

“firm” shall have the meaning assigned to it in the Indian Partnership Act, 1932 and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008;

Hence a firm includes an LLP. But Section 284(298) runs as follows,

“Unincorporated body” means –

(a)   a firm;

(b)   an association of persons; or

(c)    a body of individuals.

Therefore an LLP is also considered to be an unincorporated body. But this provision is contrary to the very concept of LLP. An LLP by concept is an alternate corporate vehicle and not an unincorporated body.

Every unincorporated body according to the code shall be taxed at 30%. Hence an LLP will also be taxed at 30%. But on the other hand a Company will be taxed only at 25%. This differential tax rate will discourage any one who contemplates about forming an LLP. Let’s hope this drafting error is resolved accordingly before introduction in the parliament later this year.

Regressive Taxation

The Code proposes taxing of partnership firms and LLPs at 30%. But on the other hand companies are taxed only at 25%. This will amount to regressive taxation. This is because only small and medium sized enterprises are constituted as partnership firms and LLPs. So their taxable income is normally lower than those of companies which are large scale enterprises. Hence companies pay lesser tax than that of Firms and LLPs even though they have capacity to pay more. This will make the Indian Income Tax more of a regressive tax, which is frowned upon by all economists.

Simpler House Property?….

For the purpose of charging income under the head house property, the income Tax act used the term Annual Value. Annual value was defined as the sum for which the property might reasonably be expected to let from year to year. But however unofficially the terms – Actual Rent, Standard Rent, Fair Rent, and Municipal Value were used in the computation of Annual Value. But the Direct Taxes Code has put an end to this process by using the terms Gross Rent, Contractual Rent and Presumptive Rent.  The comparison of the old unofficial terms and new terms used by the DTC Bill is as follows:

Annual Value = Gross Rent
Actual Rent = Contractual Rent
Standard Rent

Fair Rent

Municipal Value

Presumptive Rent

The Computation of income from house property appears to have become simple. Higher of Contractual rent and Presumptive rent shall be taken as gross rent. Gross Rent after subject to deductions will be charged to tax.

The vague part here is the computation of Presumptive rent. It is not based on fair value of rent but it is based on the value of house property.  Presumptive rent shall be 6% of the value fixed by the local authority for property tax purposes or cost of Acquisition or Construction Cost to the owner if no such value is fixed.

The DTC has reduced the standard deduction for repairs and maintenance of House Property from 30% to 20%, which is a heartening change. One more hurting change is the non allowance of Housing loan interest as deduction in the case of self occupied property. This will severely affect the middle class masses that are paying heavy housing loan interests.

The DTC no longer talks about Arrears of Rent and Unrealised Rent. Hence the treatment of these items in the computation of income under this head is unclear. The Ministry should suitability modify the draft bill to clarify the same.

Deferred revenue expenditure

In the Income Tax Act, there were controversial issues concerning the allowance of deferred revenue expenditure. This was because the Act did not say any thing about the deferred revenue expenditure and there were quit a few case laws also. The DTC Bill has put an end to this by providing means for allowance of deferred revenue expenditure. The Direct Taxes Code requires that the following deferred revenue expenditure be depreciated like any fixed asset in the rates prescribed under Written Down Value method:

Deferred revenue expenditure Rate
Non-compete fee 25%
Premium for obtaining any asset on lease or rent 25%
Amount paid to an employee in connection with his voluntary retirement in accordance with any scheme of voluntary retirement. 25%
Expenditure incurred by an Indian company wholly and exclusively for the purposes of business reorganisation 25%
Expenditure incurred by a person resident in India wholly and exclusively on any operations relating to prospecting for any mineral or the development of mine or other natural deposit of any mineral, to the extent prescribed 15%

This will not be practicable since under WDV method the value of the expenditure will never become Zero. Hence if the above expenditures are incurred they will be carried in the balance sheet throughout the life time of the enterprise. Hence Straight Line Amortisation may be prescribed for deferred revenue expenditure.

Amortisation in WDV Method will cause further trouble in the form of Deferred Tax since this is not the accounting treatment prescribed in the Accounting Standards. Computation of Deferred Tax will also be complicated since this aspect affects the profits of every financial year and not any standalone year.

Allowance of Capital Loss on Sale of Assets

As per the Discussion paper released by the Finance Ministry, Loss on transfer of Business Capital asset will not be an allowable deduction. The only option available is to claim depreciation on the balance of WDV even if the full block ceases to exist. Thus the code substantially differs from the Income tax Act, 1961, wherein such loss was taken as short term capital Loss and treated accordingly. Further this is contrary to the very concepts of Matching and Accrual. The loss of a year on no account should be transferred to several years. This will form another item requiring creation of Deferred Tax under Accounting Standard – 22.

Minimum Alternate Tax – Based on Assets

Under the present Income Tax Act, companies are required to pay Minimum Alternate Tax on book profits. But the Direct Taxes Code envisages Minimum Alternate Tax (MAT) payable by companies based on their book value of assets. This is something an effective and efficient tax regime will not do. The MAT rate for non Banking companies is prescribed as 2% (for banks it is 0.25%). The code proposes MAT to be a final tax. As opposed to the current MAT based on book profits, wherein MAT it is only temporary Tax arrangement. Credit is allowed which can be set off when normal Income Tax becomes payable. But under the proposed MAT no Credit shall be allowed.

As per the discussion paper released by the Finance Minister, the Ministry proposes MAT based on assets on the presumption that it will increase efficiency in operation and to nullify Tax evasion. This cannot be accepted as a valid presumption since it is arbitrary in nature. MAT based on assets will be nothing but an unethical Tax. The following factors make the proposed MAT an unethical Tax:

(a)     2% Tax on assets means that a company bare minimum has to earn Return on Assets (RoA) of 2% just to pay the Tax obligations. This is something surreal and impossible in many cases.

(b)     Further the RoA does not remain the same for all industries. Some industries are capital intensive; in such, the 2% on assets will be a huge amount. But while others may be labour intensive in such cases MAT will be a meagre amount.

(c)      This will amount to companies adopting modern and new technologies suffer more tax. This will discourage industrial development and technological upgradation.

(d)     This system of MAT will discourage efficient operation which is something contrary to the reason given in the discussion paper, favouring MAT based on assets.

(e)     MAT based on assets means that a company has to pay tax even if it really suffers loss. In the initial years of operation a company has to pay income tax even if there is no revenue inflow. This will be a kind of wealth tax rather than a Tax on Income.

(f)       Even in case of Wealth Tax (which is not applicable for companies) only Net Wealth is taxed. But in MAT all assets as they appear in balance sheet will be taxed.

(g)     It is in the nature of a presumptive tax and no scientific or technical concept is involved.

(h)     When a company reports loss, it is not always necessary that it is avoiding or evading Tax or that the company is inefficient. It may be due to genuine industrial conditions. Imposing higher tax on a company for a reason which it is not responsible is ethically incorrect.

(i)       MAT based on Assets violates the Canon of Equity since in most cases the taxpayer is obliged to pay more than his capacity permits.

Cash Loans are now Income!

The Income Tax Act provided that if  any loan is accepted or repaid in cash exceeding Rupees Twenty Thousand otherwise than by an Account Payee Bank Draft or Cheque, the Joint Commissioner shall have powers to levy a penalty of equal amount. This was a discretionary provision because since if there was any reasonable cause, such penalty was not imposable. But the DTC Bill proposes that such cash loans will be treated as income from Residuary Sources. Hence it is no longer discretionary but mandatory.

Further Sections 269SS and 269T of the Income Tax Act provided the following exception for acceptance and repayment to the below persons:

  1. Government ;
  2. any banking company, post office savings bank or co-operative bank ;
  3. any corporation established by a Central, State or Provincial Act ;
  4. any Government company as defined in section 617 of the Companies Act, 1956 ;
  5. such other institution, association or body or class of institutions, associations or bodies which the Central Government may, for reasons to be recorded in writing, notify in this behalf in the Official Gazette.

But the Ministry of Finance while drafting the DTC Bill has failed to consider the above exceptions. This constitutes a serious drafting error since even cash loans accepted and repaid to Banks will be taxed as Income.

Are You Ready for Early Tax Audits?

The DTC has advanced the last date for filing Income Tax Returns of Assessess whose accounts are subject to Tax Audit form 30th September to 31st August. So are we ready for this? Definitely this requires thinking. But such measures will surely instill more efficiency and effectiveness. If the big corporate like Infosys with operations all over the globe are able to declare and approve their audited financial statements one month form the end of the financial year why can’t the small and medium sized entities do the same. But this should be with a word of caution; this should not in any way decrease the quality of service of a Chartered Accountant. In case the threshold limit for Tax Audit is increased, Chartered Accountants will continue to render quality service even with advancement of the Tax Audit deadline.

Definition of an Accountant

The definition of an Accountant who can audit the books of an assessee under section 84 of the code retains the same old definition as follows:

Accountant” –means

(a)     a chartered accountant within the meaning of the Chartered Accountants Act,1949, and

(b)     any person who is entitled to act as an auditor of companies under sub-section (2) of section 226 of the Companies Act, 1956;

It is worth noting that the provisions of clause (b) above are obsolete and unnecessary. This is because at present no person other than a Chartered Accountant can act as an auditor of a company within the qualifications prescribed under section 226 of the Companies Act. This obsolete provision should be removed for the purpose of better clarity as envisaged by the Direct Tax code.

This definition given in section 284(2) should be favourably changed as follows:

Accountant” – means a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949, holding a valid Full Time Certificate of Practice issued by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act, 1949.

Alternatively, the word Chartered Accountant itself may be used rather than referring an Accountant and then defining who is an Accountant.

Exempt-Exempt-Taxation

The Direct Taxes Code seeks to introduce the principle of Exempt-Exempt-Taxation (EET) in taxing saving which are allowed as deduction. In the Income Tax Act 1961, savings are allowed as deduction under sections 80C and 80CCC subject to a maximum ceiling of Rs.1,00,000/-. It may be noted that such savings escape tax net when it is earned, saved and also when it matures. So Exempt-Exempt-Exempt (EEE) principle was involved. For e.g. if a person pays Insurance Premium such amount can be deducted from the taxable income. Also the maturity amount received from the insurance policy is exempt under Section 10. But the code seeks to introduce the principle of EET, wherein the income gets exempted while earning and saving but will be fully taxed when it matures. Hence under the proposed Direct Taxes Code, one cannot avoid tax for ever by saving in the prescribed modes, but only delay the timing of chargeability of Tax. This will be an unfavourable blow for pensioners.

Non-Repeal of Wealth Tax Act

Section 282 of the Bill provides for the repeal and savings of the Income Tax Act 1961. But it fails to repeal or save the provisions of the Wealth Tax Act. This constitutes a serious drafting error.

Conclusion

Whether or not the code gets enacted by the Parliament and comes to effect on 01/04/2011, as envisaged, it is at present nothing more than ‘A Bundle of Tax Wonders and Blunders’. It is no doubt that the DTC if enacted will revolutionize the Indian Direct Tax Regime. But without the key issues being addressed all the efforts put forth in drafting the Brand New Direct Taxes Code will go nothing but waste. Let’s hope that the drafting errors and key issues are resolved by proper public interaction before the final enactment of the Direct Taxes Code.

One thought on “Critical Appraisal of the DTC Bill, 2009

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