This is a collaboration with leading tax information portal Taxsutra to publish select indepth articles on legal and policy matters.
A new income tax law has been the dream of many a finance minister and government for 30 years now, albeit with little to show for it. Fifteen years ago the Kelkar Committee report and then the draft new Direct Tax Code in 2008, were the closest India has gotten to rewriting its income tax law.
Neither attempt worked. Then when the Narendra Modi government first came to power in 2014, then Finance Minister Arun jaitley said he was junking the DTC and efforts to rewrite the law. A few years later the government changed its mind and revived the project. But the resultant task force, with CBDT member Akhilesh Ranjan as its convenor, also seems to have met a dismal fate. Two years and several thousand man hours later the task force presented its 200-page report to the finance minister. It’s been five months since and the report hasn’t even been made public yet leave alone an implementation timeline.
Among tax circles the sudden government disinterest is baffling, especially as the report was finalised based on committee consensus. Yes, it does propose radical changes but its backers say it will usher in a progressive tax regime, comparable to the best in the world.
Taxsutra has spoken to those involved in the finalisation of the report and identified five fundamental changes to the law as suggested by the committee.
1. Personal Income Tax Rates
As widely speculated, the task force has indeed recommended sweeping changes to the personal income tax rates, with the creation of five slabs versus the current three:
- Rs 2.5-10 lakh: 10 percent ( with a full rebate upto Rs 5 lakh)
- Rs 10-20 lakh: 20 percent
- Rs 20 lakh-2 crore: 30 percent
- Rs 2 crore plus: 35 percent
The task force, in its report, strongly recommends doing away with the levy of surcharge, saying that surcharge should be an exception and not the rule. It also makes a case for including the rates of tax in the Income Tax Act itself, instead of specifying them via the Finance Act every year.
Infact, the committee emphasises in its report that frequent changes in tax rates reflect instability in the tax system, and any changes must be made only after a public discussion.
2. Taxation System: Territorial, Residence Based Or Hybrid?
The debate on the efficacy of a residence-based system versus territorial system continues to rage globally. The former taxes the global income of a corporation/individual irrespective of where it is sourced in the world. A territorial system, on the other hand, is based on 'source' rule i.e. tax those incomes whose source is India, irrespective of residential status of the corporation/individual.
The DTC report shows the committee debated extensively the pros and cons of both models of taxation and strongly considered adoption of territorial system of taxation in the context of the prevailing international tax environment and the general thrust on source based taxation.
The report has noted benefits of the territorial system...
- higher incentive to repatriate offshore profits
- enhanced competitiveness of Indian corporates in overseas markets
- fewer disputes over residential status
- interpretation of tax treaties
- easier compliance
However, the report also notes the limitations of a territorial system of taxation...
- Tediousness of defining the scope of 'domestic source' and ' deemed domestic source', which the report believes might lead to more litigation.
- The risk of 'double non-taxation' as intellectual property could be shifted to tax havens.
Finally, the report underlines that a territorial system or a destination-based cash flow tax ought to be adopted by all countries, else it would create complications and also not be in consonance with India's tax treaties.
And so, it has suggested continuing with the current 'hybrid' system of taxation, which combines residence and source-based tax.
3. Defining 'Source' Rule And 'Income'
The DTC report weighs against introducing any additional source rule since the current definition of the term 'income deemed to accrue or arise in India ' is quite sufficient.
But the committee is believed to have recommended redrafting of some of the existing source rules, especially calling for more clarity on income from transportation of passengers, goods and tangible properties and when they can be termed to have arisen or accrued in India. It has also suggested a tighter definition of the term 'income that accrues or arises in India' due to the perceived overlap between the current provisions pertaining to total income scope and source rule.
Further, the committee is learnt to have acknowledged the arduous task of defining ‘income’. But has equally acknowledged that the current definition is prone to litigation. So, it has recommended continuation of the existing definition with an expansion in its scope - include income chargeable to tax under the various heads of income.
4. Residence Rule
One of the most sweeping changes is proposed on this front. The report has highlighted that the current residence rules, which provide 182 days test for a person to be considered an Indian Tax Resident, are being misused by both Indian citizens and Persons of Indian Origin.
The report has explained how Indians and PIOs - whose major economic activity is in India - plan their stay overseas in a way that they can remain a non-resident forever and avoid paying taxes on their worldwide income, in India. In light of this, the committee has proposed reducing the 182 days residency threshold, to 90 days, as far as such persons are concerned.
In order to alleviate the hardship that may be caused by the new residency rule of 90 days, the committee has suggested that even under the new framework, a person ought to be considered a tax non-resident if he/she is a non-resident in any seven of the 10 preceding years.
The committee has also expressed concern on the concept of 'state-less' persons, which is now attracting attention of several jurisdictions. It has grimly noted that in 2018, India saw the fourth highest outflow of High Networth Individuals (HNIs) from the country and attributes this partly to the prevailing tax environment.
5. Tax Treaties Vs Domestic Law
This is another big ticket change proposed by the committee. Presently, a taxpayer can choose to be governed by either a Double Tax Avoidance Treaty (DTAA) or the Income Tax Act, whichever is more beneficial to the taxpayer.
In a major departure from this rule, the committee has recommended that suitable amendments be carried out to the effect that the DTAA shall be applicable 'alongwith' domestic law, essentially providing that where the tax rate under DTAA is less than under the Indian Income Tax Act, the former shall prevail.
The committee is further learnt to have proposed that the application of the Indian Income Tax Act in certain situations must be mandatory, and not at the option of the taxpayer. It has stated that the Parliament must decide the extent of primacy of the tax treaties vis-a-vis domestic law.
Arun Giri is group editor at Taxsutra.com.
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