While work on the final direct taxes code (DTC) continues to remain work-in-progress, reports suggest the finance minister may bring in a DTC that is in more in keeping with what the Parliamentary Standing Committee has recommended and which will, to a large extent, be in line with what his predecessor Pranab Mukherjee had worked into his version of the DTC. If this is indeed what happens, it will be unfortunate since the idea of the original DTC—brought out when P Chidambaram was finance minister—was to eliminate all exemptions. In the case of corporate taxes, for instance, while the existing nominal corporate tax rate is 33%, the effective rate is 23%—the reason for the large difference is the presence of various exemptions for different type of investments. So, in the original DTC, the idea was to remove exemptions and cut the nominal rate to 25%. If, however, Chidambaram is to retain the 30% rate Pranab Mukherjee and the Standing Committee are in favour of, this means he will retain a large part of the R75,000 crore or so of corporate tax exemptions in FY14.
Similarly, in the case of personal income taxes, the prevalence of R50,000 crore of likely tax exemptions in FY14 means there is a huge difference between the actual income tax for each income bracket and the rate that is effectively levied. Reports suggest the FM is likely to go along with the Standing Committee’s recommendation that savings never be taxed even at the time they are encashed—Chidambaram’s original DTC, however, had envisaged what is called an EET (Exempt it from the income in the year of investment, Exempt the interest income each year, but Tax when it is encashed) while the Standing Committee is in favour of EEE (exempted from income tax even when it is encashed). This is a bad idea since, apart from making it difficult to figure out when the lower corporate or personal income taxes are due to evasion and not just tax planning, the presence of tax benefits also distorts savings habits, and forces savers to invest in instruments that have EEE instead of those that offer higher returns. Given DTC is an attempt to clean up the taxation mess, the finance minister would do well to not bring in a DTC if it is going to retain all manner of tax concessions.