Restoration of the Income Tax Act

The Direct Taxes Code (DTC) seems to be going the Income Tax (IT) Act, 1961 way even before it has become law.

The Code seeks to replace the Act, which remains beyond the comprehension of most taxpayers despite more than 3,000 amendments over the 50 years that it has been in vogue.

A draft DTC was first put in the public domain in August last year. Finance minister Pranab Mukherjee had said then, “The thrust of the code is to improve the efficiency and equity of our tax system by eliminating distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base. The attempt is too simplify the language to enable better comprehension… The new code is designed to provide stability in the tax regime.”

Mark the emphasis on “stability” and “moderate”. Ironically, in the revised discussion paper on DTC released recently, these two words stand compromised.

The DTC released in August had proposed a basic income-tax exemption limit of Rs 1.6 lakh for a male aged less than 65 years. For taxable income between Rs 1.6 lakh and Rs 10 lakh, the code proposed a tax rate of 10%; for income between Rs 10 lakh and Rs 25 lakh 20%; and for income of Rs 25 lakh and above 30%. This was meant to introduce stability into our tax system where the limits are decided year on year.

But these slabs have now been done away with. “The indicative tax slabs and tax rates and monetary limits for exemptions and deductions proposed in the DTC will… be calibrated while… finalising the legislation,” says the revised discussion paper on DTC.

This means income tax rate will continue to be decided year on year. Also, the income tax rates will no longer be moderate, as the finance minister had originally suggested.

The finance minister had also hoped to simplify the tax regime. As a part of that process, the distinction between various kinds of income, such as salaried income and capital gains income, had been done away with. All kinds of income would have been lumped together and taxed at the marginal rate of tax.

The distinction between short term capital gain and long term capital gain had also been done away with in line with the focus on simplification. The revised paper on DTC reintroduces this distinction and in fact makes the calculation of long term capital gain a tad more complicated.

Let us say you sell shares bought four years ago for Rs 40,000 at Rs 1 lakh. You end up making a capital gain of Rs 60,000 (Rs 1 lakh - Rs 40,000). Under the current regulations, there would be no tax on this gain. But as per the revised DTC, you will be allowed a deduction allowed on this capital gain and the remaining gain will be lumped on to your income for the year and taxed at the marginal tax rate.

The revised paper does not specify this rate of deduction. But let us say this rate is at 50%. In your case, the deduction will be Rs 30,000, while the remaining Rs 30,000 (Rs 60,000 - Rs 30,000) will added to your income for the year and taxed accordingly. If you come in the 30% tax bracket, this would mean a tax of Rs 9,000 (30% of Rs 30,000).

Then, the rate of deduction too has not been specified and would be decided year on year, as the income tax rates currently are. This complicates the tax structure and makes it unstable as well.

“The proposed scheme is therefore specially beneficial to low and middle income category of taxpayers as they are to be taxed at their applicable marginal rate of 10 percent or 20 percent after the specified deduction for computing adjusted capital gains,” says the revised discussion paper.

But then, only a small proportion of low and middle income category of taxpayers invests in the stock market or has other kind of capital gains. Given this, the change ends up catering to people from the upper strata of the society who should actually be paying tax at the top rate.

What could offer relief to the low and middle income category tax payers is the continuation of housing rent allowance deduction, which the draft DTC had done away with. However, the discussion paper is silent on this.