Direct Tax Code (DTC): Income Tax Rationalisation on the Way

The government recently announced tax rate cut for corporates across the board.  This has been done in the backdrop of slowdown in the economy to support the corporates and to attract new investments which are moving towards other emerging economy like Vietnam. This cut is historical in last 28 years. The measure is in line with the recommendations of the much-awaited Direct Tax Code (DTC) report that was submitted to the Finance Ministry in August 2019. The report has not been made public yet.

(The Direct Tax Code aims to consolidate and amend the law relating to all direct taxes, namely, income-tax, dividend distribution tax, fringe benefit tax and wealth-tax to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Another objective is to reduce the scope for disputes and minimize litigation. All the direct taxes have been brought under a single Code and compliance procedures unified.)

After slash in corporate tax there was hope that individual tax rate will also be reduced to increase the consumption. Arvind Panagariya former NITI Ayog Chairman said that there is a strong case for a similar reform in income tax also. As per reliable sources, the DTC report has also recommended the lowering of tax rates for individual tax payers. After corporate tax now it the turn of individual taxes. Finance Minister Nirmala Sitharaman talking on the Indian economy, said that the government is working on more steps, including rationalisation of personal income tax rates, to revive the sagging economy. This may however now be taken care of in the coming budget.

Income tax slabs need to be rationalised

The DTC has suggested the rationalisation of slabs with a rate of 5 per cent for incomes of Rs 2.5 lakh to Rs 5 lakh, 10 per cent for those earning Rs 5 lakh to Rs 10 lakh, 20 per cent for Rs 10 lakh to Rs 20 lakh, 30 per cent from Rs 20 lakh to Rs 2 crore and 35 per cent for those with incomes above Rs 2 crore. If this is done this would create surplus in the hands of tax payers and help in boosting consumption and increasing household savings in different financial investments and Government scheme. Another possibility is to sub-categorise two income groups, to slice the 30% income tax slab.

Similarly, for deductions, the exemption limit can easily be raised up to Rs 4 lakh or Rs 4.5 lakh say, with higher limits on PPF, LIC, NSC under Section 80(c)) primarily to boost financial savings for households, which have otherwise been declining over the last few years. Low household savings with the financial sector adversely affects the financial institution’s ability to exercise better credit creation powers and boost investment sourced from domestic means.

Also, looking at the rise in personal cost of living  a higher exemption limit may help boost long term savings towards retirement or increase investments in private pension funds. The slab rates proposed above would rationalise the present ones and do away with surcharges. A rationalisation of the slabs, especially for taxpayers earning below Rs 50 lakh would lower their overall tax incidence to around 25 per cent, like that of corporates. This would leave more funds for households to spend and save.

The Government should also provide special exemption / relief to senior citizen and very senior citizens to enable them to spend more on the health care and increased medical requirement.  

House hold savings need to be encouraged

For a long government has not increased the limit for savings or exemption of investment to save the Income tax. The existing limit of rupees 1.5 lacs includes contribution to pf investment in PPF entry requirement towards housing loan etc. This limit is inadequate keeping in view quantum of housing loan and repayment. The government should therefore, consider the introduction of saving schemes with attractive interest rates and channelize such mobilised funds for investment in specific sectors. A deduction can be introduced for investment in long-term infrastructure bonds like those issued earlier under section 80CCF.  Inclusion of debt mutual funds would boost investments in government the above measures would help channelize a portion of the tax savings back into the economy.

Participation in equity market to be made attractive

A comprehensive review of the long-term capital gains is required. There are different periods of holding of different types of asset for qualification as a long-term asset. Property is only required to be held for two years to qualify as a long-term asset and to avail the benefits of capital gains exemption. Equity shares must be held for one year.

Processing of income tax returns and assessment

In recent years there visible improvements in Income Tax Department in processing of income tax return which has become fast and corruption free to a large extent owing to centralised processing system. There is further, scope of improvement in processing time and in making refunds. The simplification of income tax return formats has also helped individuals to file their return in their own. The government has initiated steps towards faceless e-assessment. The government has launched the e-assessment scheme on September 12, 2019 to put in place a structure to facilitate e-assessment proceedings. A ‘National e-assessment centre’ would be set up in Delhi to conduct e-assessment proceedings in a centralised manner. All notices would be issued, and information requests made by the ‘National e-assessment centre. The scheme is a major step in improving the image and relations between the taxpayer and the income tax department. A technology-driven approach would facilitate compliance, tax collections and curb high-pitched assessments.

Dividend taxation to revamped 

There huge anomaly in the present system of dividend income. The present income tax law imposes a dividend distribution tax (DDT) at the corporate level. The dividends in the hands of the investors in excess of Rs 10 Lakh are taxed at 10 per cent in the hands of the share holders.  Additionally, the profits of the corporates, out of which the dividends are paid are subject to a corporate tax consequently dividends are taxed thrice.

While Government should expand the base of tax payers, the tax should be progressive, contributory and bearable.

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                                                          - Shive Mishra