Direct Tax Code 2009 Review and Analysis

India: Direct Tax Code 2009 review and analysis

The government has released a comprehensive discussion paper and draft of the new Direct Tax Code that seeks to revamp and simplify the Direct Tax Law 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 in the tax rates while simultaneously being revenue neutral for the government. It aims to achieve this by increasing the tax base and rationalising the myriad tax incentives prevalent under the current law. In our view, the overall changes proposed will be quite beneficial for a number of sectors and companies, albeit definitively withdrawing tax holidays being currently enjoyed by different sectors, something that has been contemplated and proposed often in the past and therefore should not come as a major negative surprise.

Reduction in effective tax rates for Individuals a positive

The Tax code proposes a significant increase in the tax slabs for personal income tax which, if implemented, will result in a meaningful increase in disposable income, especially benefiting FMCG and other domestic consumption stories. At the same time, the code proposes to do away with the distinction between long and short-term capital gains and abolish the Securities Transaction Tax (STT), effectively taxing all capital gains at the applicable marginal tax rate for the tax-payers’ total income. At present, the long-term capital gains tax is Nil on equity transactions on which STT is paid and 20% on all other assets, while the short-term capital gains tax rate is 10% on equity transactions on which STT is paid and 30% on other assets. In our view, the proposed increase in tax slabs is quite substantial in view of the country’s per capita income distribution, and should reduce the impact of the proposed increase in capital gains tax rates.

Tax incentives on Savings

The code also proposes to increase the tax deduction limit available on savings from Rs1lakh at present to Rs3lakh. However, the tax incentives on Interest paid on home loans is proposed to be withdrawn. On a further negative note, the code also proposes to tax the savings in various instruments including PPF, Insurance, etc. at the time of withdrawal, i.e. investments in tax savings instruments will only lead to a postponement of tax 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