DTC to be implemented from April 2013: Finance Secy

India will implement the direct tax code (DTC) from April 1, 2013, Finance Secretary RS Gujral told CNBC-TV18 on Thursday.

The code, which will replace existing Indian Income Tax Act 1961, intends to cut tax rates to bring more people and companies under the tax net, phase out profit-linked exemptions for companies and replace them with investment-linked incentives.

Gujral said most parts of DTC have been finalised barring six or seven issues, which need to be resolved.

As far as GST is concerned, he said, it will need more political consensus. 

Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: You have reached out to the foreign institutional investors (FIIs). But at the end of every meeting, they come out and say while we like the fact that the government is talking to us, we are still uncertain about the fact that we don’t know what will be considered a permissible structure or jurisdiction by the government, when it comes to the matter of paying taxes and therefore, it might be a judgment call by the tax authority or a very subjective assessment which makes us very nervous. What can you assure global investors on this issue, which is qualitative in nature?

A: We have had a couple of meetings with the FIIs. I personally had a meeting for nearly about two-two and half hours with them. We did indicate to them that whatever are your concerns in terms of any interpretations of words, we will take that into account and we will address all those concerns.

But the basic issue is that it must be a permissible arrangement. It cannot be an impermissible arrangement. The FIIs asked me as to what is the impressible arrangement. My straight remark to them was that if they are based in USA, their trader is based in USA and the trading is being done on the Indian Stock Exchange based from New York and they show it on paper that it is out of one of the countries where they don’t have to pay tax then clearly that is an impressible arrangement, if they have only a post office box address.

Their next question was that okay, ‘is it going to be retrospective? Is it going to hurt us for the previous years?’ That point has been absolutely clarified to them that this is applicable only for income with effect from April 1, 2012. They still had certain concerns. They stated that there are certain clauses which give an impression as if a part tax benefit is obtained then the arrangement will be deemed to lack commercial substance. We gave them an assurance that there is no such intention.

The basic issue is that if it is a post office box type arrangement, it is clearly impermissible. It would be covered under general anti-avoidance rule (GAAR). In case it is a permissible arrangement then clearly nothing comes into play. No GAAR comes into play. It is the tax treaty which is enforced.

They then had the issue that okay if some of us are impermissible as of now, then if we do become permissible, if we make full arrangement there and we do our trading from that particular country then would it be impacted? I told them very categorically that whatever maybe the wording, we will clear in the GAAR rules that if the arrangement is permissible, if they are actually trading from there, they have their full staff, they have their full facilities there then GAAR will not be attracted. That is the point.

Thereafter, I had mentioned to them that we have already a committee which is examining the GAAR rules so that as soon as the Finance Bill is passed thereafter the GAAR rules should be notified without any delay. I did ask them to join in the deliberations of those committees. They did join. Whatever are their concerns, they have been taken on board. Categorically, it has been pointed out to them that there is no intention to trouble under GAAR, there is no intention to misuse any authorities under that. Finally, they requested one point. They said that in case we are willing to pay the 15% short-term tax because long-term in any case is not taxable then can we be assured that GAAR will not be applicable? Again this stems from their concern that in case GAAR becomes applicable then perhaps they may get leviable to perhaps 20% plus interest, plus penalty etc. So, this assurance has been given to them that we will incorporate in the rules. It is obvious from statute, but if you want a clear assurance, we will incorporate that in case tax is leviable and is paid then GAAR will not be attracted in any case.

The various safeguards that we have provided under GAAR were also all told to them in great detail. I must tell you that a lot of safeguards have been provided. First, the assessing officer has to come to a conclusion that there is an impermissible arrangement. The assessing officer has to come to a conclusion that the sole purpose is avoidance of tax or reduction of tax. In case he comes to this conclusion, he has to put up to his commissioner.

The commissioner will take an independent view whether all the proof is available that it is an impermissible arrangement. In case the commissioner, after giving notice to the party also comes to the conclusion that GAAR is invokable then the commissioner has to send it to a GAAR panel. There the request is that GAAR panel should have atleast some independent person outside the Income Tax Department. That’s a concern. We are trying to see how best we can address that. So, the GAAR panel will consist of three very senior officers. That is to also examine the whole case and come to a conclusion where GAAR is invokable.

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Q: You are making some important points about permissible arrangements, would it be fair to assume then that for establishments that are based out of Mauritius or our post box establishments as we termed them would not be part of the permissible arrangement scheme? That is a big concern in terms of flows coming into the country and the fact that a majority of it is routed through Mauritius for tax relief issues or bases.

A: Let me be clear from the outset, GAAR is not directed towards any particular country. That should be absolutely clear. Second, it is not directed towards FIIs, it is directed to all assesses who are liable to pay tax in India whether it be foreign parties or whether it be Indian companies. Having said that, if you are saying that there is a PO Box and there is no other establishment and work is being done from somewhere else, obviously it is impermissible. I don’t think there should be any doubt about it.

Q: That is what is at the heart of the confusion. As you would know yourself, a fair amount of the portfolio money, which comes in to India, is routed through the Mauritius channel. Many of them may not stand up to the scrutiny that you are talking about in terms of being a permissible arrangement. In that case, will the Finance Bill lay out in black and white that the interpretation of that would be that they are impermissible and in that case, would they be paying short-term capital gains tax or business income tax of 42%?

A: As I told you, it is not for a Finance Bill to lay this out. This is so obvious a point, if you yourself are saying that it is a PO Box company and no other establishment is there, it is clearly impermissible, everyone understands it. Their point now is okay, assuming that we are impermissible, suppose we start our trading now from that place where we are currently located and it is then a proper business establishment, our trading is done from there, would GAAR then be invoked? They had certain concerns regarding a few words in particular clauses which I assured them that it is not the intention.

If they have a full establishment, if that is a permissible establishment today then we will not look into the fact that they have moved for trading to that place solely for the purpose of reduction of tax or avoiding tax altogether. That is the basic issue is that the onus on our assessing officer is to prove both these assets. One, it is an impermissible arrangement and second that it is solely for the purpose of avoiding tax.

Having said that, if it is impermissible, yes, GAAR will get invoked. If GAAR is invoked and it pertains to short-term capital gains tax then clearly it will be short-term capital gains tax plus it will be the interest and the penalty thereon. That is their concern. So, their last point made to the committee and what they have also represented in writing to the ministry is that if we pay the short-term capital gains tax, would GAAR still be invoked? Our straight answer to them was no, if they pay tax, GAAR will not be invoked.

Q: GAAR would have come in in case with the implementation of the direct tax code (DTC). But you chose to do it one year before the implementation of DTC. Some people have inferred from that that probably means that you are not very confident that DTC might get implemented even in April 2013 else you may have waited for DTC to come in. Could you tell us what is the right influence to draw from the fact and where implementation of DTC stands in your eyes today?

A: This is absolutely false impression. DTC as you are aware had been introduced in Parliament two years ago. It was pending with the Parliamentary Standing Committee. Parliamentary Standing Committee submitted its report only on the 9th. Now by that time the Finance Bill had already all been prepared and the Budget proposals were all there.

It was a conscious decision that in normal course the expectation was that DTC would have come in operation from April 1, 2012. Since the standing committee’s report had not been made available, a view was taken that we have to move towards DTC. Consequently a large number of actions were taken in the Budget and Finance Bill to move towards DTC.

Let me just list out a few of them. The personal income tax rates have been made as per the original DTC. The cascading effect of the Dividend Distribution Tax, which was there in the DTC, has been sought to be eliminated. Profit linked deductions have to be eliminated under DTC. Consequently, certain profit linked deductions have been allowed to sunset in the current Budget. GAAR is one of the aspects.

But one of the positive aspects of giving comfort to the people is also Advance Pricing Agreements in terms of transfer pricing. That also we have brought-in in the current Budget. Some concessions pertaining to R&D in in-house facility, there we have extended the same up to March 2017. Life insurance policies where earlier they were more in terms of investment policies and Insurance Regulatory and Development Authority (IRDA) had been recommending that they must be brought in as life insurance policies where earlier it was up to 20%, we have now reduced it to 10%. Whereas in DTC the proposal is up to 5%.

So, we have taken certain steps including presumptive tax where the limit has been increased to Rs 1 crore. Clearly only about seven-eight items are leftover as per original DTC which need to be brought-in in the final DTC. Now that we have the report of the Parliamentary Standing Committee, immediately after the Budget session we will tackle that, go through all the various recommendations. We are obviously looking into those recommendations where we have already introduced the provisions in the Finance Bill including GAAR. You can be rest assured that DTC will be in operation from April 1, 2013.

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Q: What specifically was the conversation between yourself and the FIIs and the legal experts with regards to P-Notes? Our own channel checks indicate that at this point participatory notes have been halted completely and for the ones that were open, there was a withholding tax of 40% being slapped. Has there been specific question to that regard and conversely any clarification from your side?

A: They did raise the issue that is it that P-notes will be covered by GAAR and the tax authorities would start looking into the people behind P-notes? What I had mentioned to them is that the issue of P-notes and the people behind that is an issue, which has to be tackled by Securities and Exchange Board of India (SEBI) and the department of economic affairs. There is no relationship with GAAR.

Under GAAR, the investor in India is the FII. Consequently, the tax liability or the permissible or the impermissible arrangements is to be seen with reference to the FII. If the FII is found to be in a permissible arrangement then clearly there is no invocation of GAAR. It would be the treaty which would be enforced. In case, the FII is impermissible, it will be the FII who will be liable to tax after invoking GAAR and there is no question looking back into the P-notes. So, that was a clear clarification that we had given to them.

Q: The thorny issue of goods and services tax (GST) has been pending for some time. On that, apparently the centre and the states have not been seeing eye-to-eye on the compensation formula for the states. But yesterday Sushil Modi made a comment saying that things are on their way to getting mended. They are working on a CST (Central Sales Tax) compensation formula and then he is hopeful that by April 2013 we could look at implementation of GST. Has the government changed its stance and relented on the compensation formula so that we can hope that things may thaw and we actually see GST implementation sooner than we thought earlier?

A: For GST, the Constitution Amendment Bill has already been introduced. Clearly, unless there is convergence amongst the different political parties, the Constitution Amendment Bill would be difficult to pass. If that doesn’t get passed then clearly GST cannot come in. CST compensation is only one element towards GST.

Let me take you back to the logic. CST is the initiating state getting the right to tax, whereas under GST, it is the destination based. Consequently, CST and GST are not compatible. That is why decision was taken that CST must be slowly removed from 4% to 3%, 3% to 2%, 2% to 1% and 1% to 0%. By April 1, 2010 the expectation was that GST would come in force and CST compensation would not be required.

At the initial time, when CST compensation was spoken of, at that time what was mentioned was that certain non-monetary measures need to be taken by the states so that the level of compensation gets reduced. Those steps had been mentioned. For example, there was value added tax (VAT) on tobacco, there was VAT on textile, there was VAT on sugar and these were additional excise duty (AED) items where Government of India was to remove from AED, allow the states to collect VAT. Whatever is the increase in revenue to the states on that account, that was to be deducted.

Similarly, deform was discontinued whereby the central government incurred a loss, states got a certain saving, that was to be deducted. Another point, which was mentioned, was that the lower rate of VAT should be increased from 4% to 5% and then from 5% to 6%. This was discussed in 2007. This was discussed in 2008. This was categorically mentioned by the then Finance Minister, agreed by the empowered committee.

Earlier, the states had not increased the lower VAT rate from 4% to 5%, but many of the states have increased in this last year. Consequently, for the 10-11 compensation we had taken a view that the 4-5% enhancement, the loss on that account needs to be deducted from the state’s amount.

Second was the issue that you can’t endlessly pay compensation, unless you see light at the end of the tunnel for GST. This was a point which obviously has to be taken up with the various political parties. Yes, Mr Modi had met the Finance Minister. He did mention that the BJP is committed in its manifesto for GST. He did feel that light at the end of the tunnel would be there. Therefore, the Finance Minister must keep an open mind towards compensation.

FM was very emphatic that if there is light at the end of the tunnel, I do have an open mind. I will discuss the issue once again. So that’s the point. The meeting had ended well. Mr Modi did address the Empowered Group of Finance Ministers of the states. He did mention these points there. Let us see how we take it forward now.

Q: You have mentioned that the assessing officer will have to prove that the transaction is solely for tax purposes. At this point, the provisions of the GAAR seem to suggest that the onus is on the tax payer. Are you suggesting that there has been a change in stance and the decision now lies or rests on the shoulders of the revenue department not on the assessee?

A: The wording as it stands today indicated that the onus for nearly all the points lay on the assessing officer and barring one point where it was on the assessee. The representations, which are there, are that the onus should be squarely on the shoulders of the department. This is an issue we are considering; let us see how best we can address this concern.