Economic Environment

Direct Tax Code: Impact on

Corporate India

Submitted by:

Dinesh PA (ePGP-02-026)

Swati Sharma (eMEP-09-040)

Pramodh N (ePGP-02-052)

Narayanswamy Ganeshan

(ePGP-02-043)

Abhishek Ranjan ((ePGP-02-001)

Sudheer K ((ePGP-02-078)

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan
Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and
Abhishek Ranjan
 Why Direct Tax Code

Taxation of income in India, till now, is governed by the fifty years old Income Tax Act
(IT Act) which came into legislation in 1961. But this Act has been criticized for being
economically inefficient, incompatible with the current requirements and inequitable to
all tax payers. It was neither cost effective nor was able to encourage voluntary
compliance. So, in August 2009, the Ministry of Finance came out with the draft of
Direct Tax Code (DTC) bill with the purpose of replacing the existing IT Act and also
invited the public for discussions and feedback on the draft proposal. It will be a key tax
reform by the government aiming at widening and deepening the tax net; and increasing
tax revenue. But the draft bill had received lot of criticisms on certain amendments or
changes in relation to the removal of existing tax subsidies, and modifications in the tax
rate structure that it sought to introduce. So, in June 2010, the ministry again issued a
new revised direct tax code bill, incorporating all the criticisms, and presented the draft to
the Union Cabinet. As per the news reports, on 31st August 2010, the draft bill has been
approved by the Cabinet as well as the Parliament and the new DTC will come into force
from 1st April 2012.

The rationale for introducing DTC is to increase the efficiency and equity of the tax
system by eliminating the plethora of tax exemptions or subsidies that create distortions.
Its major policies include replacement of profit-linked exemptions with investment linked
incentives, particularly for export units, and reduction in the tax rates to bring more
people and companies under the tax net.

The salient features of the New Revised Direct Tax Code bill that would mostly have an
impact on the financial status of the salaried class and corporates

Tax Payers and Tax Administrators Concern:

• Numerous amendments have made the current system complex to implement and
understand
• Litigations have increased as there is a difference in interpretation
• Conflicting judgments by courts has complicated the matter further

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan
Timelines and Background:
• In 2005-06 government made its intention to undertake reforms
• In 2007-8 budget the proposal was released to public for discussion
• Proposal to implement simplified taxbill

Key Messages

• Improve efficiency in current system by removing the distortions

• Make the act easier to understand to the common man
• Increase tax base by moderating the tax rates
• Remove ambiguity to foster voluntary compliance
• Provide stability on tax regime based on international practices

The original discussion paper specified a foreign company to be a resident in India if the
management and control of its affairs are either “wholly” or “partly” situated in India at

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan
anytime during the financial year. The inclusion of the word “partly” led to much
ambiguity and outcry by businesses and stakeholders that the residency test was not in
tune with international concepts like place of “effective” or “central” control and
management.

The new DTC has proposed a corporate tax rate of 30% (with or without surcharge and
cess) for a domestic company which is less than the existing rate of 33.22% including
both surcharge and cess. As per the news reports, the tax rate for foreign companies will
now be same as domestic companies instead of 40% as per IT Act.

• About Minimum Alternative Tax (MAT) rate, the new revised DTC has recommended
to impose MAT on the adjusted book profits of the company, as it is designed now.
However, the latest reports suggest that the rate of MAT may be higher at 20% per
annum, from the existing rate of 18% (or 19.93% including surcharge and cess).

• For Special Economic Zones (SEZs), the new revised bill has further extended the
duration tax sops that allow a 100% tax exemption on the profits, for two years further,
after it will come to legislation i.e. till 1st April 2014. There was, however, a discussion
earlier about discontinuing with most of the export linked exemptions, which are
considered as distortionary.

In a major relief to the tax payers, the DTC reinstates the current well established
principle – the provisions of domestic law or Double Taxation Avoidance Agreement
(DTAA), whichever is more beneficial to the tax payer should prevail.

However this principle will not be applicable in certain conditions including:

• When the General Anti Avoidance Rule is invoked.

• When Controlled Foreign Corporation provisions are invoked.
• When branch profits tax is levied.

The latest measure comes after stakeholders raised several arguments against the
provisions in the original discussion paper that in the event of a conflict between the
provisions of a tax treaty and the provisions of the DTC, the “later in time” doctrine
would apply.

The corporate tax rate for both domestic and foreign companies is proposed at 30%,
higher than the 25% tax proposed in the original discussion paper. Also, it has been
proposed to lift the surcharge & cess on corporate tax, thereby bringing the effective
corporate tax rate to 30% from the present highest rate of about 33.2% for domestic
companies and about 42% for foreign companies, including the present surcharge and
cess.

The DTC also proposes a new branch profit distribution tax of 15%. This will be over
and above the tax rate of 30% proposed for the foreign companies.

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan
The original discussion paper specified a foreign company to be a resident in India if the
management and control of its affairs are either “wholly” or “partly” situated in India at
anytime during the financial year. The inclusion of the word “partly” led to much
ambiguity and outcry by businesses and stakeholders that the residency test was not in
tune with international concepts like place of “effective” or “central” control and
management.

The “Place of effective management” is defined as:

• The place where the board of directors of a company or its executive directors
make their decisions; or
• If the board of directors routinely approves the commercial and strategic decisions
made by the executive directors or officers of the company, the place where such
executive directors or officers of the company perform their functions.

The original discussion paper stated that passive income earned by a foreign company,
which is controlled directly or indirectly by a resident in India will be taxed as dividend
on an immediate basis in India, irrespective of actual distribution.

Indian companies are increasingly setting up International Holding Companies (IHC) for
overseas investments to get commercial and fiscal benefits (e.g. tax exemption for
dividend income). For example, where a Dutch IHC is set up to hold investments in
European companies (OPCO) any dividend income received by the IHC is exempt from
Dutch tax. The IHC could utilise such amount for further overseas expansion of the
group. If repatriated to India (either by Dutch IHC, or by OPCO, if it were directly held
by the Indian company), such amount would generally suffer full tax in India.

In line with this rationale the DTC has the CFC provisions to avoid such tax evasions.
Some of the significant aspects of the CFC provisions are - CFC provisions are attracted
when a foreign company is controlled by Indian resident tax payers. Control has been
defined where one or more persons resident in India, individually or collectively, directly
or indirectly, hold shares carrying not less than 50% of the voting power or capital of the
company. An additional condition is that the entity is a resident of a country with lower
level of taxation, i.e. the amount of tax payable in foreign country is less than 50% of the
corresponding tax payable under the DTC.

The net profit earned by the CFC will be attributed (and not only the passive
income) to the resident tax payer based on the percentage holding)..

CFC provisions are not applicable in cases where the foreign company is listed on a stock
exchange or is engaged in "active trade or business" (certain conditions provided) or its

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan
specified income does not exceed Rs 2.5 mn. Underlying foreign tax credit mechanism
has not been provided the proposed DTC
The Direct Tax Code has introduced a General Anti-Avoidance Rule (GAAR), in line
with the proposals of the discussion papers, to deal with instances where a taxpayer
enters into an arrangement to obtain a tax benefit and

• The arrangement is in a manner not normally employed for genuine business

purposes.
• The arrangement is not at arm’s length.
• The arrangement abuses the Direct Tax Code.
• The arrangement lacks commercial substance.

Stakeholders argued against the proposals in the discussion papers; stating

• The proposed GAAR is sweeping in nature allowing it be used in a potentially

arbitrary manner.
• The proposed GAAR does not distinguish between tax mitigation and tax
avoidance i.e. any arrangement to obtain a mere tax benefit could be deemed to as
avoidance.

Despite the protests, the Indian government has not changed GAAR but clarified that not
every arrangement that would mitigate tax liability would be classified as an avoidance
agreement and it has proposed that the Central Board of Direct Taxes will issue
guidelines to provide for such circumstances and thresholds under which GAAR could be
invoked.

In addition, the government also clarified that the Dispute Resolution Panel would be
made available when the GAAR is invoked against a taxpayer.

India Direct Tax Code: Minimum Alternate Tax (MAT)

In a very positive measure the DTC rolled back the proposed asset based Minimum
Alternate Tax, which will now be applicable on “book profits” and not on the “gross
assets”. Gross asset based MAT was proposed by the original discussion paper in 2009,
which proposed the MAT to be imposed at a rate of 2% of gross assets and also shifted
the base for computing the MAT from book profits to the "value of gross assets".

Offsetting the good news of withdrawal of the proposed minimum alternate tax (MAT)
on gross assets, It is proposed to raise the MAT on book profits to 20% from the current
18%. However, it may be noted that the highest MAT rate including the surcharge and
cess is presently 19.93%.

Dinesh PA , Swati Sharma, Narayanaswamy Ganeshan, Pramod N, Sudheer K and

Abhishek Ranjan