SYNOPSIS OF SOME PROVISIONS OF DTC BILL 2010

On 12 August 2009 Government of India (“GOI”) released for public comments a Direct Taxes Code Bill, 2009 (“DTC 2009”)

along with a Discussion paper. Based on inputs received on the proposals, a Revised Discussion Paper (RDP) was released

on 15th June 2010. This has now been followed up with the introduction in Parliament of a Direct Taxes Code Bill, 2010 (“DTC

2010”) on 30 August 2010.

DTC 2010 is proposed to be made effective from 1st April 2012, and it aims to replace current direct tax laws, i.e., Income-tax

Act, 1961 (the “IT Act”) and Wealth tax Act, 1957 (the “WT Act”).

With 9 parts, 20 chapters, 319 sections and 22 schedules (including provisions covering the wealth tax), 297 definitions

(ignoring the separate sets of definitions for the terms used contained in many of the chapters) DTC 2010 is no less bulky than

the combined contents of the I-T Act, having 298 sections and 14 schedules and the Wealth Tax Act with its 47 sections and

three schedules.

While the judiciary at all levels has over the years already done an elaborate exercise of interpreting provisions of the 1961

Act, a new beginning will have to be made with DTC 2010 already factoring in quite a few of the interpretations on contentious

issues rendered by the judiciary and also introducing certain new concepts.

Since an exhaustive analysis of DTC 2009 and the first Discussion paper has already been provided by us to our esteemed

readers, an overview of some of the proposals in DTC 2010, which largely incorporates and, in some areas modifies, the

changes contemplated by the RDP, is presented hereunder:

TAX RATES

Basic threshold limit is proposed to be increased to INR 200,000 for all individuals (special limits/slabs for resident women

done away with) and to INR 250,000 for resident senior citizens.

Top rate of 30 percent applicable to income exceeding Rs. 10 lacs (vis-à-vis Rs. 25 lacs proposed in DTC 2009).

Top rate for companies raised to 30% from the proposed 25% and retained at 30% in the case of other entities.

Rates for deduction of tax at source in the case of resident deductees remain unchanged except in the case of payments

under works/service contracts and also on rent for use of machinery or plant etc raised to 2% from 1%.

MINIMUM ALTERNATE TAX

DTC 2009 proposed to charge Minimum Alternate Tax (“MAT”) as a percentage of gross assets. This proposal was widely

criticized. The DTC 2010 proposes to charge MAT with reference to book profits on similar lines as in the 1961 Act.

MAT made applicable to SEZ Developers and units in SEZ.

It would appear that a limited liability partnership firm formed under the LLP Act, 2009 is neither liable for levy of MAT nor for

dividend distribution tax, because it is not a company.

WEALTH TAX Basic exemption limit for Wealth tax reduced to Rs. 1 crore from the proposed Rs. 50 crores and the rate of tax increased to

1% from the proposed .25%.

Another significant change proposed is that only non profit organizations would be exempt from levy of Wealth Tax. This is a

roll back from the proposal in DTC 2009 to levy wealth tax only on individuals, HUF and private discretionary trusts.

Thus even foreign citizens will have to pay wealth-tax on their global wealth if resident of India, as against the existing WT Act,

where resident individuals who are foreign citizens are exempt from wealth-tax on their assets situated outside India. Under

DTC 2010, foreign citizens may become resident in India in the second year only and will have to pay wealth-tax on their

global assets.

DIRECT TAXES C O D E OCTOBER 2 0 1 0

Under the 1961 Act long term savings scheme such as provident fund, approved superannuation fund, and life insurance are

covered under the EEE method of taxation, wherein the contribution, accretion and withdrawal are all exempt from tax. DTC

2009 had proposed EET method of taxation wherein the withdrawals (i.e. the third stage) would have been taxable. DTC 2010 reintroduced the EEE regime for various saving schemes. EEE method of taxation is proposed to be restored for: (a) Provident Fund under Provident Funds Act, 1925(b) Any other provident fund set up by the Central Government and notified in this behalf(c) Approved Superannuation Fund

INCOME FROM EMPLOYMENT

Employment income is proposed to be computed as the gross salary due, paid, or allowed less the aggregate of the specified

deductions.

Popular exemptions such as house rent allowance, leave encashment, and medical reimbursements have been retained.

The exemption for medical reimbursements is increased to INR 50,000 from INR 15,000.

Exemption for leave travel concession and tax on non-monetary perquisite borne by the employer is proposed to be

eliminated.

Exemption in respect of common retirement payment such as Voluntary Retirement Scheme, Gratuity and Commuted

Pension has been retained.

'Employer' now is defined as a person who controls an individual under an express or implied contract of employment and is

obliged to compensate him or her by way of salary only.

Perquisite valuation rules to be notified by GOI but the proposal to compute perquisite value of rent free accommodation on

the basis of its market value has been dropped.

Employers' contributions to Provident Fund will be exempt up to 12 per cent of the salary. Employee's contribution will be

eligible for deduction, subject to an overall investment deduction limit of Rs 1 lakh. The amount received on maturity will not be

taxed. Accretions and withdrawals will be exempt if the same is as per prescribed guidelines.

The DTC also exempts employer's contribution to approved superannuation funds up to Rs 1 lakh per annum. The same

holds true for employee's contribution. Withdrawals will be exempt as per the prescribed guidelines. Maturity payments on

retirement or on reaching a particular age or arising on incapacitation will not be taxed.

Life insurance premia are allowed a deduction of Rs 50,000 per year subject to a rider that the premium on none of the life

policies shall be in excess of 5 per cent of the policy amount as opposed to the extant 20 per cent norm. This will include

mediclaim payments and tuition fees for two children. Payment of fees to colleges under recognised universities will also be

eligible for deduction in this sum of Rs 50,000.

Maturity proceeds of life insurance policies will be exempt if the premium paid in any year is less than 5 per cent of the assured

sum and is received on completion of the original insurance period. Proceeds received on death are completely exempt.

Equity-linked life insurance schemes will be subject to a 5 per cent tax on distribution.

Amounts received during the term of the insurance contract under cash back policies like the endowment insurance schemes

will become taxable.

The DTC doest not allow deduction for repayment of housing loans unlike in the 1961 Act.

House rent allowance is now made deductible as under the present law.

EXEMPT EXEMPT EXEMPT CONCEPT REINTRODUCED

- archaeological collections, drawings, paintings, sculptures or any other work of art;

- wrist watches with a value in excess of INR 50,000;

- deposit in a bank located outside India;

- any interest in a foreign trust or any other body located outside India (whether incorporated or not) other than a foreign

company;

- any equity or preference shares held by a resident in a Controlled Foreign Company;

- cash in-hand in excess of INR 200,000.

Exemption currently available for ICs or PIOs repatriating back to India in respect of monies and value of assets brought into

India within a specified time for seven years is done away with.

Valuation Rules will be notified by GOI.

RESIDENTIAL STATUS

Under the 1961 Act a company is said to be resident in India if during that year the control and management of its affairs is

situated wholly in India.

DTC 2009 proposed that a foreign company will be treated as resident in India if, at any time in the financial year, the control

and management of its affairs is situated 'wholly or partly' in India. In other words, the change as proposed was that, contrary

to the existing law that, to be a resident the control and management should be wholly situated in India, a company could be

considered to be a resident in India even if its control is partly in India.

A foreign multi-national company could be held as resident in India on the ground that some activity say a single meeting of the

board of directors is held in India. Also, a foreign company owned by residents in India could be held to be resident in India as a

part of the control of such company may be in India. Accordingly, it would be liable for taxation in India on its global income.

RDP has changed the requirement from 'control and management of its affairs is situated 'wholly or partly' in India to 'place of

effective management' on the ground that it is an internationally accepted concept.

Now a foreign company will be considered to be a resident in India if its place of 'effective management' at any time in the year,

is in India.

Place of effective management is defined as (i) the place where the board of directors of the company or its executive

directors, as the case may be, make their decisions; or (ii) in a case where the board of directors routinely approve 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.

Any other person is considered to be a resident in India if its place of control and management at any time in the year is

situated wholly or partly in India.

A citizen of India or person of Indian origin living outside India and visiting India will also trigger residency by staying in India for

more than 59 days vis-à vis more than 181 days proposed earlier (also provided he has stayed in India for 365 days or more

within the four years immediately preceding that year).

The category of 'Not Ordinarily Resident' abolished and only two categories of taxpayers proposed viz. residents and non-

residents. An alternate condition of 729 days (the other being if he was a non-resident in India in nine out of ten preceding

financial years) retained only to exempt from tax overseas income from a source other than a business controlled in or

profession set up in India

The specified assets for computing 'net wealth' have been retained in line with existing taxable assets, with additional items:

rate of STT is however to be calibrated based on relevant tax regime.

After adjustment as aforesaid, income under the head Capital gains will be considered as income from ordinary sources, in

the case of all tax payers, including non-residents. It will be taxed at the rate applicable to the tax payer. Effectively, chargeable

capital gains derived from transfer of specified securities should be subject to an effective tax rate of 0-15 per cent similar to

that prevailing in the current tax law; this is a major relief for FIIs.

Roll over relief on sale of any investment asset (other than agriculture land) is to be restricted to reinvestment in residential

house and proposal of investment in a deposit account under the Capital gains Deposit Scheme has been deleted Time limit, amount to be invested, and other conditions for roll-over exemptions have been modified.

Gains arising to Foreign Institutional investors on transfer of securities would necessarily be taxed as capital gains and not as

Income from business thus finally put an end to the controversy that has seen several conflicting rulings of the Authority for

Advance Rulings.

This may enhance the tax liability in India of FIIs, which have taken a view that gains from certain asset classes (for example,

derivatives) is in the nature of trading income and consequently not taxable in India relying on favourable provisions of an

applicable Double Taxation Avoidance Agreement (DTAA).

Thus FIIs investing in other asset classes, such as debt securities, units of non-equity-oriented mutual funds and exchange-

traded derivatives will suffer higher tax even for long-term holdings; no change is proposed in this regard in DTC 2010. Gains

shall be taxable uniformly at 30 per cent with the exception that capital gains from transfer of securities held for more than one

year from the financial year end of acquisition will be determined after applying cost inflation indexation.

Transfer of an investment asset by a private company or an unlisted company to a limited liability partnership or transfer of

shares held in such a company by the shareholder in the process of conversion of such a company into a limited liability

partnership is to be treated as exempt subject to satisfaction of stipulated conditions.

TAX INCENTIVES

Aggregate deduction of INR 100,000 is now allowed in respect of investment in approved funds such as Provident Fund,

Superannuation Fund, Pension fund, or other specified fund as compared to host of other investment avenues currently

available under the IT Act.

The following key eligible investments/payments currently available for a consolidated deduction up to INR 100,000 stand

abolished:

- repayment of principal amount of housing loan;

- purchase of National Saving Certificate;

- investment in equity-oriented mutual fund;

- specified fixed deposit with the bank.

An aggregate deduction has been stipulated of INR 50,000 towards life insurance premium, health insurance premium, and

tuition fees for two children.

An additional aggregate deduction of INR 20,000 for investments in specified infrastructure bonds is eliminated.

Deduction for Interest on a housing loan on property which is not let during the financial year is allowed up to INR 150,000

The DTC has substituted profit-linked incentives with investment based incentives wherein capital expenditure incurred for

specified businesses will be allowed as a deductible expenditure. However, certain profit-linked tax incentives under the Act

are grandfathered in the DTC.

These deductions will be available subject to the transfer being chargeable to STT, which the DTC 2010 has reintroduced, the

encashment on retirement up to specified limits.

An individual not receiving house rent allowance allowed deduction towards payment of rent upto a maximum limit of INR

2,000 per month, subject to prescribed conditions

WITHHOLDING TAX ON EMPLOYMENT INCOME

Tax on employment income is to be withheld on payment/credit whichever is earlier as compared to the 1961 Act where tax is

to be withheld on the payment basis only.

INCOME FROM HOUSE PROPERTY

Gross rent is to be calculated on the basis of actual rent received or receivable and not on a presumptive basis.

Under the IT Act, if individuals own more than one house, the notional income from the second and subsequent house(s)

(which are not let-out) is taxable. Thus, Income from House Property will be calculated only in respect of let out house

property. Consequently, interest paid on a housing loan for such properties and municipal taxes will also not be eligible for

deduction.

While interest on loan taken is deductible up to the specified amount no part of the loan taken for acquisition of the house

property is deductible.

Standard deduction for repairs and maintenance is to be 20 percent of the gross rent as against 30 percent under the IT Act.

If shares of owners of property are not definite and ascertainable, such persons are to be assessed as an association of

persons in respect of such property.

CAPITAL GAIN

There is no change in the basic proposition that only transfer of an Investment Asset will be subject to capital gains. Transfer of

business capital assets will not give rise to income chargeable to tax under the head Capital Gains.

However, the definition of 'investment asset' has been amended to include 'any security held by a foreign institutional investor'

and 'any undertaking or division of a business'.

Accordingly, gain on transfer of any security held by a foreign institutional investor and slump sale of 'any undertaking or

division of a business' would be taxed under the head Capital gains and not as income from business.

DTC 2010 has also rolled back the provisions dealing with taxation of capital gains almost to the present provisions in the

1961 Act.

Accordingly, investment assets held for less than one year from the end of the financial year would be taxed as part of income

from ordinary sources. Investment assets held for more than one year from the end of the financial year of acquisition will be

entitled to the benefit of indexation of cost. Cost of assets acquired prior to 1st April 2010 will be the fair market value thereof as

on 1st April 2010.

However, in the case of transfer of investment assets being an equity share in a company or a unit of an equity oriented fund

which is chargeable to securities transaction tax, deduction equal to 100% of the gain is to be allowed where the investment

asset is held for more than one year from the end of the financial year. A similar scaling down will be applicable even in

determining capital losses on such losses.

Where the investment asset is held for a period of one year or less the aforesaid deduction of income/loss is to be made to the

extent of 50% of the gain/loss as the case may be.

Whereas the 1961 Act allows an exemption of Rs 3 lakhs for leave encashment, the DTC grants exemption of leave

NON PROFIT ORGANIZATIONS

Expression 'charitable activity' replaces 'permitted welfare activity'.

Provisions more or less similar to those in the 1961 Act.

NPO would not require re-registration under DTC.

It is now proposed that 15% of surplus or 10% of gross revenue, which ever is higher will be allowed to be carried forward to be

used within three years from the end of the relevant financial year, pending which, and to be invested in specified modes.

NPO have been allowed a basic exemption limit of Rs. 1 lac.

DTAA OR DOMESTIC LAW WHICH EVER IS MORE BENEFICIAL TO APPLY

The rule that the provisions of domestic law or treaties, whichever are more beneficial shall apply has been restored except

where provisions relating to (a) GAAR, (b) levy of Branch Profits Tax, or (c) Controlled Foreign Corporations shall apply.

INCOME DEEMED TO ACCRUE OR ARISE IN INDIA

Income shall be deemed to accrue in India, if it accrues, whether directly or indirectly, through or from the transfer, of a capital

asset situated in India Income from transfer of share or interest in a foreign company by a nonresident outside India will not be

deemed to accrue in India if the fair market value of the assets owned (directly or indirectly) by that company does not exceed

50 percent of the fair market value of the total assets owned by that company.

Further, it is provided that proportionate gains would be taxable in India where any income is deemed to accrue to a non-

resident by way of transfer of share or interest in a foreign company PE defined in the same way as in treaties and includes

one day Service PE, (substantial) equipment PE and insurance agent PE Insurance premium including reinsurance premium

payable in respect of insurance covering any risk in India included in the definition of 'income deemed to accrue or arise in

India'.

ANTI AVOIDANCE MEASURES

CONTROLLED FOREIGN CORPORATIONS

In line with internationally accepted practices, it is proposed to introduce provisions dealing with Controlled Foreign

Corporations. It is proposed that passive income earned by a foreign company which is controlled directly or indirectly by a

resident in India, and where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to

have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received

from the foreign company.

CFC has been defined to mean a foreign company:

- that is a resident of a territory with lower rate of taxation (i.e. where taxes paid are less than 50 percent of taxes on such profits

as computed under the DTC

- whose shares are not listed on any stock exchange recognised by such Territory

- individually or collectively controlled by persons resident in India (through capital, voting power, income, assets, dominant

influence, decisive influence, etc.)

- that is not engaged in active trade or business (i.e. it is not engaged in commercial, industrial, financial undertakings through

employees/personnel or less than 50 percent of its income is of the nature of dividend, interest, income from house property,

capital gains, royalty, sale of goods/services to related parties, income from management, holding or investment in

securities/shareholdings, any other income under the head income from residuary sources, etc.)

- has specified income exceeding INR 2.5 million

case of SEZ units, grandfathering extended for units commencing operations on or before 31 March 2014

BUSINESS INCOME, EXPENDITURE AND DEPRECIATION

No change in the rates of depreciation as compared to DTC 2009 except that 100% is prescribed in respect of machinery and

plant installed in a water supply project or water treatment system and used for the purpose of business of providing

infrastructure facility.

Depreciation to lessee in case of a finance lease and payments for lease rent to be treated as payment towards principal and

interest.

Many new Block of Assets/categories introduced such as rails, scientific research assets, family planning assets, etc.

Allowance of depreciation even where all the assets in the block of asset are demolished, destroyed, discarded or transferred.

Initial depreciation shall not be allowed if the asset

- is installed in any office premises or any residential accommodation including a guest house

- is in nature of any office appliance

Rate of deduction for scientific research and development allowance increased from 150% to 200 percent.

DEFERRED REVENUE EXPENDITURE

DTC 2009 provided for depreciation on specified class of deferred revenue expenditure.

This has been modified and it is proposed that deduction for deferred revenue expenditure will be allowed over a period of six

years except in the case of expenditure on prospecting for minerals etc where the period of amortization is ten years.

Preliminary expenditure and any loss on account of forfeiture of any agreement has been added to the list of specified

deferred revenue expenditure. Amortisation of preliminary expenses: (Expenditures incurred before the commencement of business or in connection with

extension of business or setting up of a new business are eligible for deduction in six annual installments commencing from

the year in which the business is commenced or the extension of business or the setting up of business, is complete).

Amount lost in the course of business on account of forfeiture as per any agreement is deductible in six equal annual

installments commencing from the year in which the loss was incurred. The amount gained on account of forfeiture is however

taxable in the hands of the recipient in view of Section 33(2)(xix) of the DTC. (At present, any loss in the course of business is

deductible as business loss and any such forfeiture loss relating to capital transaction is viewed as capital loss by the income-

tax law):

Other items of expenditure falling in this category are :Non-compete fee: Premium for obtaining any asset on lease or rent;

Amount paid as per the scheme of VRS; Expenditure towards business reorganisation; Loss on account of forfeiture as per

agreement:

TAX ON INCOME DISTRIBUTED BY MUTUAL FUNDS

DTC 2009 gave complete tax exemption to mutual funds and its investors. DTC 2010 provides for taxing dividend from

mutual fund investments in the hands of the unit-holders except in the case of equity-oriented funds dividend on which would

be subject to a distribution tax of 5 per cent (as against present 12.5 per cent or 20 per cent according as the unit-holder is an

Grandfathering of profit-linked incentives under the Act to continue for SEZ developers notified on or before 31 March 2012. In

“Consideration on transfer of Carbon Credit has been added as an item of income to be taxed under the

hear income from business.”

DEFINITION OF INTEREST

Definition of interest has been widened to include any service fee or other charges in respect of the money borrowed or debt

incurred or in respect of any credit facility which has not been utilised.

TRANSFER PRICING PROVISIONS

No major change in the proposals contained in DTC 2009.

BUSINESS REORGANISATON

Capital gains on transfer by way of slump sale of an undertaking/division would be subject to capital gains tax. Under the

earlier DTC draft, the same was proposed to be treated as business income.

SETTLEMENT COMMISSION

Provisions dealing with Settlement Commission have been re-introduced by DTC 2010.

per IFRS, GAAP or Accounting Standards notified under the Companies Act, 1956. The said net profit will be increased by any

provision for unascertained liabilities or diminution in the value of assets, reduced by interim dividend paid and prior year

losses before the application of specified attribution formula.

The accounting period will be the period ending on 31 March or the period it regularly follows for tax laws of the Territory or

reporting to shareholders The resident taxpayer will have to furnish details of investments and interest in entities outside India

in the prescribed form and manner.

The amount received from a CFC as dividend in a subsequent year will be reduced from the total income to the extent it has

been taxed as CFC income in any preceding previous year CFC provisions applicable to taxpayers notwithstanding the

provisions of the DTAA that may be more beneficial.

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 and for the period such percentages are held. This will be taxed as income from a residuary source.

CFC provisions not triggered in case the foreign company is listed on a stock exchange or is engaged in "active trade or

business" (subject to certain conditions) or specified income does not exceed Rs 2.5 mn.

A stringent definition of the concept of "active trade or business" has been provided in the Twentieth Schedule both in terms of

active participation in business and composition of class of income and its source.

Value of shares held in a CFC to be included in taxable wealth of the resident tax payer.

Underlying foreign tax credit mechanism however not provided.

GENERAL ANTI-AVOIDANCE RULES

The DTC contains General Anti-Avoidance Rule provisions which provide sweeping powers to the tax authorities. The same

are applicable to domestic as well as international arrangements GAAR provisions empower the CIT to declare any

arrangement as “impermissible avoidance arrangement” provided the same has been entered into with the objective of

obtaining tax benefit and satisfies any one of the following conditions:

? It is not at arm's length? It represents misuse or abuse of the provisions of the DTC? It lacks commercial substance? It is carried out in a manner not normally employed for bona fide business purposes

Section 123 contains the General Anti-Avoidance Rule. Section 124 contains elaborate definitions of relevant terms. Section

125 declares that an arrangement shall be presumed to have been entered into for the main purpose of obtaining a tax benefit

unless the tax payer demonstrates that obtaining tax benefit was not the main objective of the arrangement.

CIT to determine the tax consequences on invoking GAAR by reallocating the income or disregarding/recharacterising the

arrangement.

Meaning of 'tax benefit' widened to include any reduction in the tax base including increase in loss..The only safety valve in GAAR provisions now provided in DTC 2010 is that the Rules will have to be enforced as per the

guidelines to be framed by the Central Government.

The forum of Dispute Resolution Panel available in cases wherein GAAR provisions are invoked.

While the rule that the provisions of domestic law or treaties, whichever are more beneficial shall apply has been restored this

is subject to the rider that GAAR will override Tax Treaty provisions.

The income attributable will be based on the net profit as per the profit and loss account of CFC for the accounting period as