The evolving tax code

Hindu Editorial

The government is to be commended for not only proactively seeking feedback on the draft Direct Tax Code (DTC) but also for responding positively to that. The first version of the code, released in August 2009, attracted plenty of interest from both professionals and lay people. The revised code, once again thrown open for a public discussion, is less rigorous than the earlier one in the crucial realm of personal and corporate taxation.

However, in the process of allaying tax payers' genuine apprehensions, it might have departed from the original objective of ushering in a simplified tax system, with low rates and minimal exemptions. Nowhere is this more evident than in the case of the tax treatment of retirement benefits.

The EET method (Exempt savings, Exempt interest on savings, but Tax withdrawals) proposed in the earlier version was meant to remove certain anomalies. Withdrawals from the retirement benefit schemes such as the provident fund and insurance schemes would have been taxed. The revised draft restores the tax exemption on the more important savings schemes, which is a welcome development in a country where high quality social security schemes are few. Promoting long-term contractual savings has been a national priority and taxing withdrawals of retirement benefits would have been a major disincentive to savers, insurance companies and others.

In another departure from the earlier draft, the tax deduction for interest paid on housing loans will remain. It will protect to some extent home-owners from the vagaries of interest rate movements.

Companies will appreciate the decision to continue with the minimum alternate tax (MAT) on book profits rather than on gross assets as was proposed in the earlier version. The code was meant to curb some sharp practices such as padding up the value of assets, but industry associations and tax professionals argued convincingly against using gross assets as the basis since that would have been unfairly burdensome on capital-intensive and long-gestation projects besides loss-making companies.

On many other debatable points, such as the powers to override tax treaties and the special concessions to the SEZs, the revised code has provided clarifications. There could conceivably be further revisions of the code before it is notified next year. In the meantime the government will do well to manage expectations. For instance, it is unlikely that individuals and corporations, having won back their concessions, will also get the benefit of considerably lower tax rates. And despite the best intentions to keep the code simple, there will still be a plethora of rules and exemptions.