Direct Tax Code tabled: What do experts make of it?

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Q: Your preliminary thoughts on what you are seeing on the DTC with specific reference first to these capital market components on what they are doing on short-term capital gains tax, the fact that there is dividend distribution on equity mutual funds, I think ULIPs as well come under dividend distribution tax of 5% now?

Kanabar: One hasn't had a look at it but if you break it up into three parts; if you look at dividend distribution tax and the introduction of a short-term capital gain tax as you mentioned on ULIPs etc which of course could be a bit of a dampener. But there is also an expectation that will dividend distribution tax be cascaded up to multiple levels.

So what you have today is that every time a company gives a dividend there is a dividend distribution tax and there is a reasonable expectation that the new Code will actually bring out a relief as it was in the earlier law at multiple levels and not just at one level which is the law today and one will wait to see as to how does that pan out.

Second, more important on long-term capital gains we do not know as yet as to whether the sale on the stock exchange continues to be tax exempt or not which if it does from a market's perspective would be very welcome step and we need to see how this work out.

Third and foremost is that as you look at reintroduction of capital gains tax which was one of the concerns which I always had that on a long-term if you are going to say that you are all the time going to look at how would the PEs react, how would the FIIs react. Would they want to exit for a moment and reenter and the impact that it could have on the market and the volatility and until we have all those provisions and it might be too premature to react. I do not think I would necessarily view what we have heard thus far has been very negative.

Q: A two part question on capital gains issue; one, the fact that STT could likely continue that's what the DTC seems to have. Would you infer from that that probably means that long-term capital gains tax will not come back and the graded short-term capital gains tax which is there in the Code of 5-10-15% depending on individual tax brackets. What are your initial thoughts on these two?

Kanabar: On both these things it will be very positive. I would agree with you that the fact that a securities transaction tax is going to continue is prima facie an affirmation that you might continue with long-term capital gains tax. But go back to the situation where in the first Direct Tax Code Bill what was envisaged was that the entire distinction between capital gains and business income would go away and therefore all capital gains, long-term or short-term would be at full rates.

So we seem to have come up soon circle and a recognition of part of the government that there needs to be a distinction between capital gains and business income and the fact that even in respect of short-term you are not going the whole hog in creating a business which was very widely anticipated and you just have these graded rates.

I would view it as very positive particularly because it is always an issue of what are you comparing with and if I had to compare it with what was proposed in the first bill there is a very significant and a positive change.

Q: On the issue of SEZs for now what sources indicate is that they will be allowed profit linked tax deduction. SEZs notified on March 31, 2012 will get a tax break as also those in 2014. Will this sit with what the market is expecting because there was some nervousness about what details may emerge on the SEZ front specifically from the Direct Tax Code?

Kanabar: In fact the SEZ was widely expected because that was there in the second discussion draft. What I would want to look at and which could be a huge potential upside from a market perspective is the first Code which came out, the first draft of the Code which came out even the incentives which were grandfathered, were grandfathered on the basis of investment.

Let me explain to you what this means. Some of the other incentives which were there for example on infrastructure projects the way they were grandfathered was to say that they will not continue to enjoy exemption on their income for the residual period but will only get an exemption in respect of the investment made which in effect meant nothing but an accelerated appreciation.

There is no reason why SEZs should come in for a preferential treatment compared to the other incentives. Therefore it is quite likely that the new bill will show that all the other incentives are also grandfathered on the basis of profits as opposed to investment. Should that happen, there should be significantly more than what people have been expecting thus far and I am looking forward to that provision.