India’s New Direct Tax Code

June 25, 2010 Posted by India Briefing Reading Time: 4 minutes

Jun. 25 – The Indian government has proposed significant changes to its tax code, which is to be amended by the revised discussion paper due to be submitted, following extensive consultations, to Parliament soon. In this article we discuss the background to the tax code, the proposed changes and what they mean for the India-based business.

Background
The existing Income Tax Act of India was enacted in 1961. It replaced the first Income Tax Act of 1922. Thus, historically, the first Income Tax Act was operational for almost 40 years and the existing one has been in place for almost 48 years. Little change has been made during this time – up until the current proposals.

Over the years, India’s tax laws have become more complicated and difficult to administer or even understand. Litigation is at an all time high in the country with tribunals and courts swamped with tax disputes being challenged by the taxpayers and the tax department. The present Income Tax Act contains more than 400 sections and even more sub‐sections, provisos and explanations. For the general tax payer, it is virtually impossible to decipher the act.

The Indian government is seeking to initiate radical tax reforms by proposing to enact a new Direct Tax Code which will replace the existing Income Tax Act and come into effect on April 1, 2011 (for the fiscal year 2011‐12). The Direct Taxes Code Bill was placed by the Finance Minister for public debate and discussion on August 12, 2009. The code seeks to combine the law relating to all direct taxes (income tax and wealth tax) under one roof. The proposed DTC has been designed with the objective of simplification of the provisions of tax laws by having a fresh look at the provisions of the act. After taking into consideration the representations received on the proposed provisions of the DTC, the government has now proposed to modify the DTC and issued a revised discussion paper to this effect on June 15.

The Direct Tax Code seeks to take a fresh look at the taxation of all heads and sources of income. In the existing Income Tax Act, the entire mechanism of taxation revolves around various heads of income under which there would be different sources of income. This is graphically depicted below:

Step 1

Step 2

Step 3

In the new DTC, the methodology for computing income has been revised. Firstly, the sources of income are divided into two categories: ordinary sources and special sources. Under each source, there are different heads of income, while under each head of income, there can now be different sources of income. This is graphically depicted below:

The steps for computing income under the new DTC:

Step 1 (similar to existing Step 1)

Step 2

Step 3

Step 4

The aforementioned Steps 1 to 3 would also be applicable for Income from Special Sources. At the end of the Step 3, one would have the gross total income from special sources. The aggregate of this gross total income for all the special sources would constitute the total income from special sources.

Thereafter, the following step needs to be followed:

These changes pertaining to the computation of income, however, comprise only a fraction of the many changes proposed in the new Direct Tax Code.

We will keep India Briefing readers updated with other aspects of the proposed overhaul in the Indian taxation system.

Dezan Shira & Associates is based in Mumbai and can provide information and advice to foreign investors concerning India’s tax and investment laws. Please contact us at india@dezshira.com.