The Indian Government has initiated radical tax reforms by proposing a new Income Tax Code that will replace the existing over‐four‐decade ‐old Income Tax Act. Recently the Finance Minister placed the Direct Taxes Code Bill, 2009 (Code) ‐ before the house for debate and discussion. The stated intent‐ to fulfill a long standing plan to simplify the country’s complex direct tax laws and improve efficiency and equity of the tax systems by removing distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base.

On the personal tax front, a significant reduction in tax rate is proposed by increasing the income slabs for determining tax. While the basic exemption limit continues to be INR 0.16 Million, incomes up to Rs. 1 Million will enjoy tax rate of only 10%. The highest tax rate of 30% that was earlier applicable for individuals earning above Rs 0.5 Million will now be applicable to incomes exceeding Rs 2.5 Million. At the same time, various prevailing exemptions‐ such as leave travel concession for employees, deduction on housing loan interest, etc. are proposed to be withdrawn. Also withdrawals from social security and investments schemes, which were hitherto exempt, are now proposed to be taxable on maturity/ retirement.

The corporate tax rate is proposed to be slashed to 25%, while surcharge and education cess are likely to be abolished (as against effective tax rate of 34% currently). The dividend distribution tax for domestic companies remains at 15% on amounts actually distributed as dividends, however foreign companies would be required to supplement their corporate tax liability by a branch profit tax (in place of dividend distribution tax) of 15% irrespective of whether they remit profits outside the country.

	This  reduction in  corporate  tax  rate is  balanced by removing various  exemptions    currently available.  While handful of companies in sectors such as infrastructure, oil
		and gas exploration and production, and special economic zones would be eligible for tax breaks, the formula has also been changed to investment linked incentives instead of the practice of profit linked sops used at present. Under the  new  regime the company would be able to recover all capital &

The much wished away, Minimum Alternate Tax (MAT), while remaining on the statute books has undergone a complete overhaul. It is now proposed to calculate MAT on the gross value of assets at the end of the financial year, with no credit for the MAT in future years against the present system of levy being linked to book profits. For non‐banking companies the rate would be 2% and hence asset heavy companies which sought relief from corresponding depreciation shelter would be adversely affected.

The Code proposes to eliminate the current exemption on capital gains on listed securities and introduces a new framework of taxing capital gains whereby the current distinction between long term and short term capital gains is removed and investors will have to pay capital gains tax on profits earned by them from investments at the rate of 30%. The recently introduced Securities Transaction Tax (STT) is also proposed to be abolished.

Financial intermediaries such as mutual funds, provident funds and venture capital firms will be allowed pass through status, which effectively means that there would be no direct tax costs created by such pooling vehicles.

On the anti‐avoidance front, the Code draws upon the tax avoidance measures in mature and sophisticated tax regimes. It has an entire chapter on special provisions to prevent evasions and provides for anti‐avoidance rules (General Anti Avoidance Rules ‐ GAAR). The scope and extent of what is sought to be considered as “tax avoidance” is wide and can be a cause of concern as it would place significant onus on the tax payers to defend the bona fides of a suspect transaction.

A more drastic and controversial provision relates to the treaty override provisions. Under the present provisions tax treaties that India has entered into with various countries overrides the domestic law to the extent that it is beneficial to the tax payer. It is now proposed that the changes on the domestic law can override a current treaty and the provisions of domestic law or tax treaty whichever is later would prevail thereby negating the benefits currently available under various tax treaties.

While the tax and business fraternity is not opposed to GAAR, the widely worded proposals and substantial power granted to the administration require deeper reflection. These rules are viewed by some, especially given the tax administrative set up in India, as draconian provisions which are set to contradict the settled tax jurisprudence established over more than half a century ago. The Government obviously has supported these rules as a measure to combat tax avoidance and check instances of treaty shopping, round tripping, dividend stripping and argue that similar rules are prevalent in other developed economies such as USA.

The new Code has also proposed that a foreign company which has part of its control and management situated in India shall be considered as resident for tax purposes. This is seen as a backdoor entry of Control Foreign Corporation legislation. In one stroke, the policymakers will subject to tax global operations of Indian companies, besides posing risk to foreign MNCs who meet the partial control and management test in India. There are also proposals to change India’s transfer pricing regime.

Besides promising to introduce Safe Harbour Provisions in the recent budget, the Code introduces a concept of Advanced Pricing Arrangement (APA). Given the numerous transfer pricing cases under dispute, the APA provisions should alleviate considerably the taxpayers’ uncertainty regarding pricing of international transactions.

While the Code is put forth for public debate, its implementation would not happen until April 2011. It would be interesting to see what shape the final Tax Code takes and whether it retains its current structure as it is. Amidst all the pros and cons of these proposals, the noteworthy fact is that an initiative has been taken to bring in simpler direct tax regime that can facilitate higher consumerism. The new Code is in fact a completely new tax law aiming to simplify the direct tax regime in India and has tried to capture the best international practices.