Direct Tax Code review and analysis

Direct Tax Code  review and analysis


The government has released a comprehensive discussion paper and draft of the new Direct Tax Code that seeks to revamp and simplify the Direct Tax Law and its administration in the country through several radical changes. The code, which the government plans to enact and implement FY2012 onwards with suitable changes if required, envisages meaningful reduction in the tax rates while simultaneously being revenue neutral for the government. It aims to achieve this by increasing the tax base and rationalising the myriad tax incentives prevalent under the current law. In our view, the overall changes proposed will be quite beneficial for a number of sectors and companies, albeit definitively withdrawing tax holidays being currently enjoyed by different sectors, something that has been contemplated and proposed often in the past and therefore should not come as a major negative surprise.

MAT provisions a key negative

MAT provisions a key negative


The tax code proposes a radical change in the MAT provisions. Under the new system, MAT will be paid at a specified percentage of Gross assets of a company (broadly equates to capital employed, although it is unclear whether Net or Gross Current Assets will be considered for computation). The specified percentage is 0.25% for banking companies and 2% for all other companies. Although intended to widen the tax base by reducing tax evasion, the new MAT proposals appear onerous on several counts:


- Companies suffering genuine losses or sub-normal RoCE due to initial gestation period or cyclical downturn would also have to pay MAT at 2% of gross assets.
- Moreover, MAT credit will not be available, making the provisions all the more onerous.

Reduction in Corporate Tax rate a positive; withdrawal of tax incentives on Exports, etc. not a surprise

Reduction in Corporate Tax rate a positive; withdrawal of tax incentives on Exports, etc. not a surprise

Reduction in the Corporate Tax rate from 33% (including surcharge) to 25% will benefit companies across sectors but sectors, especially in FMCG and Banking where the effective tax rates are close to 33% for most companies. Moreover, business losses will be allowed to be carried forward indefinitely, unlike 8 years at present. The reduction in tax rates is intended to be compensated by a withdrawal of various tax incentives available to sectors such as exports, infrastructure, area-based tax holidays, etc. Moreover, the allowable Depreciation rate on plant and machinery is also proposed to be brought down to 15%.

Our analysis indicates that out of a total sample of 5,041 companies with a Market Cap of Rs48.4lakh crore, the latest effective tax rate was about 26%. However, this includes profits from businesses such as infrastructure, exports, etc. presently exempt from taxation under various provisions such as Section 10A, 10AA, 10B, 10BA, etc. While existing projects will not lose these benefits, over the next few years as these profit-based incentives on existing projects expire, broadly effective tax rates for the Corporate Sector as a whole are expected to normalise at similar levels as at present Sector, whole, present, making the proposed changes largely tax revenue neutral, albeit leading to a convergence in effective tax rates across sectors.

However, the code does provide for some investment-based incentives. In respect of revenue and capital expenditure on scientific research and development, deduction to the extent of 150% of the expenditure will be allowed to all companies. Under the new provisions, tax liability will accrue in various specified infrastructure sectors only after 100% of the capital expenditure is recovered, allowing these companies to postpone the tax liability. Sectors to be covered include:


- Generation, transmission and distribution of Power
- Specified infrastructure projects
- Hospitals
- Food processing, packaging, cold storage, agricultural warehouse
- Oil and Gas
- SEZ

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