• How-to

Come April 2011, the proposed direct tax code will replace the current Income Tax Act, which dates back to 1961. The new code proposes to bring about significant structural changes to direct taxation in the country. It will consolidate and amend the law relating to all direct taxes—income tax, dividend distribution tax, fringe benefit tax and wealth tax—to create a system that facilitates voluntary compliance.

Direct taxes, as we know it, will never be the same. While the new tax code’s primary focus is to simplify matters, several of the new provisions seem draconian and will, in fact, translate into higher taxes for entrepreneurs and SMEs.

One of the proposed amendments that will impact everyone is the Minimum Alternate Tax (MAT). Today, MAT is based on the profit of a company: one picks up the book profit according to the profit and loss account, makes some adjustments, and pays tax at the rate of 15 percent.

According to the proposed amendment, MAT would be based on the company’s assets. “When one talks about the assets of a company, it primarily includes everything from fixed assets and current assets to stock. Every company will have some assets or the other in the balance sheet. And whether they make profits or not—be it startup or a loss-making company—they will end up paying taxes under MAT,” says KPMG India Pvt. Ltd.’s Tax and Regulatory Director Nabin Ballodia.

Forget about breaking even, this law implies that as soon as a startup starts doing business, it will have to pay taxes because, in all probability, it would already have some assets by then. Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the Income Tax Act. The profit and loss account of the company, on the other hand, is prepared based on the provisions of the Companies Act.

A large number of companies have been booking profits as per their profit and loss account. However, they were not paying any taxes, because their income computed as per the provisions of the Income Tax Act was either nil, negative or insignificant. In effect, such companies were showing book profits and declaring dividends to shareholders, but they were not paying any income tax. These companies are popularly known as Zero Tax companies. In order to bring them under the income tax act net, the section 115JA was introduced—and this became MAT.

While sole proprietorship doesn’t fall within the ambit of MAT, private and public companies do. “We are planning to go private soon and MAT, in its present form, will be a problem,” says Fulcrum Entertainment founder, Madhukar Kumar. “While I agree with the concept of MAT, amendments need to be made to the present structure. I also feel that tax assessment should be on the basis of one regulation, not on multiple acts like the IT Act and the Companies Act.”

Another provision that could cause some worry is profit-linked tax holidays—which small business units under the Export Oriented Unit (EOU) are currently enjoying—being changed to expenditure-linked. Till now, any export unit could claim deductions on its profit. But according to the proposed law, they can only claim deductions if they have made an investment.

As for individuals, all deductions have been done away with. Although tax slabs have been increased (but with no deduction available), the taxable income increases automatically, which could translate into higher taxes.

On the positive side, a lot of deductions have been done away with in an effort to make things simpler. Many ‘interpretation’ issues will become clearer, too. Of course, there is always the possibility of new issues and ambiguities creeping in.

Another advantage for small businesses is the carry forward of business loss. Earlier, business losses could only be carried forward for a specific time; now, they can be carried forward indefinitely.

While the new tax code will surely simplify matters and cut down the ambiguity, the onus of paying taxes will now lie with individuals—and that’s an unsettling prospect for many.

PAINS
* Under the draft code, MAT would be imposed at a rate of 2 percent of gross assets (0.25 percent for banks). Currently, MAT is charged at a rate of 15 percent (plus any applicable surcharge and cess) of adjusted book profits of corporations whose tax liability is less than 15 percent of their book profits.

* Currently, credit available for MAT paid against tax payable on normal income may be carried forward for seven years. Under the draft code, MAT would be the final tax, thus eliminating the carry forward of MAT credits.

GAINS
* The corporate tax rate will be reduced from 30 percent to 25 percent, with the same rate applying to both domestic and foreign companies (which are currently taxed at rates of 33.99 percent and 42.23 percent, respectively).
* Losses would be allowed to be carried forward indefinitely for setoff in subsequent financial years. However, losses under the head of ‘capital gains’ and losses from a speculative business would not be available for setoff against income under other heads.

©Entrepreneur October 2009

Tags:
direct tax, Income Tax Act, tax code