India: Proposed Changes by Kelkar Committee vis-a-vis the Existing Provisions in the Income Tax Act

Last Updated: 12 December 2002
Article by Anjana Sahal

The process of budget making in India has always been a secret, highly sensitive mission and a special prerogative of the bureaucrats of the finance ministry. As a result, it has always been shrouded with unnecessary secrecy till the last minute and led to tremendous amount of speculation for nothing. Now, with the Vijay Kelkar committee’s report on the recommended changes needed on direct taxation made public, a new era of transparency has begun. Thus, for the first time in the independent history of the country, the citizens, the manufacturers, the traders and people in the service sector will get to know in advance the Government’s thinking and broad changes likely to take place in the budget. Another big advantage of making the task force report public in advance is that the Government will be able to assess the feedback, experts’ opinion, industry reactions, all in advance, and fine-tune the budgetary proposals.

The Kelkar Task Force (KTF) headed by Mr Vijay Kelkar have tried to increase tax revenue to GDP ratio not by increasing tax rates but by simplifying tax structures, widening the tax base and improving tax administration. The rate of central tax collection is 9% of GDP, while the budget deficit will reach 11% of GDP next year on current trends. Because of multifarious exemptions only 30m of the country's 1bn population pay taxes and most of those are middle class employees on relatively low incomes. The key to making this package revenue neutral is the removal of exemptions which will be accompanied by reduction in corporate tax rates to 30 percent and the result will be revenue neutral to the government. Since these exemptions influence domestic savings, their withdrawal could impact the overall savings projections for the Tenth Plan period which has factored in domestic savings at 26.84 % of the GDP, very much higher than the 23.31 % achieved in the Ninth Plan. If there is a shortfall in savings, the Tenth Plan's investment projections would go away. The Committee recommended two modes of policy measures for reform of the existing scheme of corporate income tax:

Option I : An immediate rate cuts and elimination of exemptions

Option II: A phase-in of rate cuts over a period of time and phase out of tax exemptions and deductions.

After comparing the merits of the two options, the committee preferred Option I for reform of the existing scheme of corporate income tax.

Following is the synopsis of proposed changes in Income Tax by Kelkar Committee and its comparison with the existing provisions

Personal Income Tax

Section

Present Position

Proposed Position

Remarks

 

 

 

 

Residence in India

Section 6(6)

Resident but not ordinarily Resident:

An individual who has not been resident in India in 9 out of 10 previous years preceding that year or has not during the seven previous years preceding that year been in India for a period of 730 days or more.

Elimination

 

Tax free income limit

Rs. 50,000

Rs. 1,00,000

It will remove the multitude of rebates, exemptions which reduce effective tax rate and administrative complexities. But on the other hand when a large number of income earners are covered through service tax and one by six scheme, the increase in exemption limit result in 80 lakhs income tax payers going out of the purview of income tax.

Tax Rate

Where taxable income is

Rs. (50,000-60,000) - 10%

Rs. (60,000-1,50,000) - 20%

More than Rs.1,50,000 - 30%

Where taxable income is

Rs. (1,00,000-4,00,000) - 20%

More than Rs. 4,00,000 - 30%

 

Standard Deduction

Section 16(i)

Where income from salary is

i) Rs.£ 1,50,000 - 33.33% of salary or Rs. 30000 whichever is less

ii)Rs. > 1,50,000 < 3,00,000 - Rs. 25000

iii) Rs.>3,00,000 < 5,00,000 - Rs. 20000

iv) ³ Rs. 500000 - Rs. Nil

No standard deduction will be available

Standard Deduction is allowed to grant some relief to employees for expenses made for completing the job In an attempt to simplify tax administration, the logical foundation of standard deduction should not be forgotten.

Deduction from house property

Section 24(b)

Where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital provided where the property acquired, constructed after 01/04/99 and such construction, acquisition completed before 010/4/2003, the amount of deduction shall not exceed Rs. 1,50,000

Deduction allowable in

Assessment Year

2004-05 - Rs. 1,00,000

2005-06 - Rs. 50,000

2006-07 - Rs. NIL

The proposed withdrawal of the incentive on housing loans will be disastrous for consumers as well as bankers. Probably, housing finance is the only growing area and banks will find no viable and safe lending opportunities. In the scenario of limited finances and lesser off-take of money from banks, demand will not increase and the economy will go even more sluggish, may be doomed.

Deduction in respect of medical insurance premia

Section 80D

Maximum amount of deduction - Rs 10,000

Rebate @ 20% subject to maximum of Rs. 3,000

 

Deduction in respect of medical treatment, etc.

Section 80DDB

In case of individual for himself / herself or dependent relative and in case of HUF for any member of HUF- Rs. 40,000

Section deleted but senior citizen will be allowed tax rebate @ 20% subject to maximum of Rs. 4000

Senior citizens with relatively less income would have to bear the burnt of the changes.

Deduction in respect of repayment of loan taken for higher education

Section 80E

Maximum deduction allowable - Rs. 40000

Deduction will continue to be allowed but on the grounds of Equity the same should be allowed as rebate @ 20% subject to maximum of Rs. 4,000

 

Deduction in respect of interest on certain securities, dividends

Section 80L

Maximum Deduction - Rs. 9,000

Elimination

 

Section 10

Interest income from Bonds, Securities, debentures etc.

Elimination

 

Dividend Tax

Section 10(33)

Taxable in the hands of receiver. TDS @ 10% and surcharge @ 5% under Section 194 to be deducted for dividend paid, credited or distributed after 01/06/2002 if such dividend exceeds Rs. 2500.

Fully exempt

Complete exemption of withholding tax on dividends at the shareholder level and no distribution tax at the corporate level would have a severe revenue impact as in the last Finance Bill discussions were held to re-introduce dividend withholding tax after abolishing the dividend distribution tax so that higher income groups are not benefited.

However, the brighter side is that it would prop up the stock market and investor sentiments.

Long Term Capital Gain on Equity

Section 112

Flat rate of income tax - 20%

If tax computed in the normal manner on listed securities/ units exceeds 10% of capital gains on the said securities, then Under section 112(1) the rate of income tax on long term capital gains rising from transfer of listed securities/ units will be 10% of the gains computed without indexation of cost which will be further increased by surcharge.

Fully Exempt

Capital gains tax rates are quite reasonable and reducing rate on equity gains will introduce large distortions and lose revenue. Perhaps reduction in rate of LTCG tax may attract household investors and would give a tremendous boost to the stock market.

Rebate on life insurance premia, contribution to provident fund etc.

Section 88

  1. 30% of Gross Qualifying Amount if
  1. Salary is less than Rs. 1,00,000 (before standard deduction) and
  2. Salary is not less than 90% of Gross Total Income
  1. If Gross Total Income is less than Rs.150000-20% of Qualifying Amount
  2. If Gross Total Income is more than Rs.150000 but less than Rs. 500000-15% of Qualifying Amount
  3. If Gross Total Income is more than Rs.500000-Nil

* Maximum Qualifying Amount - Rs. 100000

Elimination

 

Rebate of Income Tax in case of individuals of 65 years or above

Section 88B

100% of Income Tax or Rs. 15000 whichever is less.

Elimination

 

Rebate of Income Tax in case of women below 65 years

Section 88C

100% of Income Tax or Rs. 5000 whichever is less.

Elimination

 

Corporate Income tax

Option - I

One time rate cut and elimination of exemptions

Section

Present Position

Proposed Position

Remarks

Tax Rate

Domestic Companies - 35% and surcharge @ 5%

Foreign companies - 40% and surcharge @ 5%

Domestic Companies - 30%

Foreign companies - 35%

Reduction in corporate tax rate from an effective tax rate of 36.75 per cent to 30 per cent and have a differential tax rate of 35 per cent for foreign companies is a welcome measure.

Long Term Capital Gain on Equity

Section 112

Flat rate of income tax - 20%

If tax computed in the normal manner on listed securities/ units exceeds 10% of capital gains on the said securities, then Under section 112(1) the rate of income tax on long term capital gains rising from transfer of listed securities/ units will be 10% of the gains computed without indexation of cost which will be further increased by surcharge.

Not taxable

Capital gains tax rates are quite reasonable and reducing rate on equity gains will introduce large distortions and lose revenue..

Dividend Tax

Section 115O

Taxable in the hands of receiver. TDS @ 10% and surcharge @ 5% under Section 194 to be deducted for dividend paid, credited or distributed after 01/06/2002 if such dividend exceeds Rs. 2500.

No tax on distribution of dividend by a company

No distribution tax at the corporate level will have a severe revenue impact

However, the brighter side is that it would prop up the stock market and investor sentiments.

Minimum Alternate Tax

Section 115JB

In the case of an assessee being a company if the tax on total income is less than 7.5% of book profit than book profit shall be deemed to be the total income and tax payable shall be 7.5% of Book profit

Elimination

Abolition of Minimum Alternative Tax (MAT) based on book profits is a radical step as time and again the concept of MAT has been debated, introduced and restructured. Corporates have now given up on this and have learnt to stay with this book profit tax. This is a welcome step and would increase corporate retained earnings.

Carry Forward and set off of business losses

Section 72

Allowed to be carried forward for 8 assessment years immediately succeeding the assessment year for which the loss was first computed.

Unabsorbed depreciation will loose separate identity and will be merged with business loss.

Unabsorbed business loss will be allowed to be carried forward indefinitely

A radical suggestion has been made to restrict the depreciation allowance to the amount charged to the Profit and Loss Account as per the statutory books. This is estimated to bring a revenue gain. This revenue gain could only be an illusory one as the Companies Act only prescribes minimum rate to be charged as depreciation for purpose of Section 205 before declaration of dividends. Nothing prevents a company to charge a higher depreciation so as to synchronise with the tax depreciation rates or even a higher rate based on technical obsolescence.
On the other hand removal of this distinction will simplify the things and also reduce litigation.

Depreciation

Section 32

Allowable depreciation as per rates prescribed in Appendix I ( Rule 5)

Depreciation will be restricted to the allowance charged in the profit and loss account in accordance with the Companies Act.

The consultation paper has removed the distinction between depreciation provisions under the Income Tax Act and those under the Companies Act in an effort to justify the elimination of minimum alternate tax.

As a result, companies which had worked out their tax provisions at lower levels, taking advantage of the depreciation provisions, will now have to factor in a larger tax outgo.

Tea Development Account

Section 33AB

Deduction of 40% of profit from tea business

Elimination

 

Rehabilitation Allowance

Section 33B

Deduction of 60% of the amount of the deduction allowable u/s 32(1)(iii)

Elimination

 

Reserves for Shipping Business

Section 33AC

Deduction of 50% of the profits derived from the business of operation of ships as is debited to the profit and loss account and credited to a reserve account subject to maximum carried to reserve account shall not exceed twice the amount of share capital.

Elimination

 

Expenditure on Scientific Research

Section 35

Deduction shall be:

  1. Any expenditure expended on scientific research related to business
  2. One and one fourth times of sum paid to a scientific research association
  3. One and one fourth times of sum paid to a university, college or other institution to be used for social science or statistical research.

Elimination but donations to trusts, institutions etc. engaged in scientific research will continue to allowed bit in the form of a tax rebate like in the case of Section 80G.

 

Expenditure on eligible projects or schemes

Section 35AC

Deduction allowed shall be any expenditure incurred by way of payment of any sum to a public sector company or a local authority or to an association or institution approved by the national Committee for carrying out any eligible project or scheme.

Elimination but expenditure on projects already approved will continue to enjoy tax benefit in the form of rebate @ 20%.

 

Expenditure by way of payment to associations and institutions for carrying out rural development programmes

Section 35CCA

Deduction allowed shall be payment of any sum

  1. to an association or institution which has as its object the undertaking of any programme of rural development
  2. to an association or institution which has as its object the training of persons for implementing programmes of rural development
  3. to a rural development fund set up and notified by the Central Government
  4. to the National Urban Poverty Eradication Fund set up and notified by the Central Government

Elimination

 

Expenditure by way of payment to associations and institutions for carrying out programs of conservation of natural resources

Section 35CCB

Deduction allowed shall be payment of any

  1. to an association or institution which has as its object the undertaking of any programme of conservation of natural resources or afforestation
  2. to such fund for afforestation as maybe notified by the Central Government

Elimination

 

Interest on borrowed capital

Section 36(1)(iii)

Allowable deduction is the amount of interest paid in respect of capital borrowed for the purposes of the business or profession

Elimination

Borrowing cost on acquisition, construction or production of capital asset will be capitalised as per AS-16. Other borrowing cost will be allowed as deduction u/s 37(1) of the Act.

Provision for bad and doubtful debts

Section 36(1)(viia)

In respect of a scheduled bank, an amount not exceeding 5% of the total income and an amount not exceeding 10% of the aggregate average advances made by rural branches of such bank computed in the prescribed manner.

Deduction will be restricted to the amount of provision debited to profit and loss account as audited subject to the maximum amount of provisioning permitted under the prudential guidelines issued by the RBI

 

Newly established undertaking in free trade zone etc.

Section 10A

Deduction allowed is

  1. 90% of profits and gains from the export of articles or things or computer software for a period of 10 consecutive assessment years.
  2. In case of an undertaking which begins to manufacture articles or things or computer software during previous year commencing on or after 1/4/2003 in special economic zone, deduction shall be 100% of profit of profits and gain for 5 assessment years and then 50% of profits for 2 assessment years.

Elimination

Removal of deduction under Section 10A and 10B of the Income Tax Act could change the investment scenario both in the IT services and ITES sector which is slated to grow at 30 per cent. Also, all the FDI proposals in the BPO sector would immediately dry up and one needs to take a serious look at this suggestion as the ramifications are widespread severely impacting employment generation potential.

Newly established hundred percent export oriented undertakings

Section 10B

Deduction allowed is 90% of profits and gains from the export of articles or things or computer software for a period of 10 consecutive assessment years.

Elimination

 

Deduction in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, etc.

Section 80IA

i)Deduction of 100% of profits and gains from such business for 10 consecutive assessment years.

ii) Deduction up to 100 per cent of the profits derived by these undertakings is eligible up to first 5 assessment years and thereafter at 30 per cent for the next 5 assessment years.

Elimination

With these fiscal incentives India has hardly seen any substantial investments in infrastructure development. Removal of these fiscal incentives at this juncture might not be a wise move.

Deduction in respect of profits and gains from certain industrial undertakings other than infrastructure development undertakings

Section 80IB

Deduction of 30% of Profits and gains from such business 10 consecutive assessment years

Elimination

 

Deduction in respect of profits and gains from business of collecting and processing bio-degradable waste

Section 80JJA

Whole of such profit for a period of 5 consecutive assessment years beginning with the assessment year relevant to the previous year

Elimination

 

Deduction in respect of employment of new workmen

Section 80JJAA

30% of additional wages paid to the new regular workmen employed by the assessee in the previous year for 3 assessment years including the assessment year relevant to the previous year in which such employment is provided.

Elimination

 

Deduction in respect of inter corporate dividends

Section 80M

Deduction of an amount equal to so much of the amount of income by way of dividend from another domestic company as does not exceed the amount of dividend distributed by the first mentioned domestic company on or before the due date.

Elimination

 

 The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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