Income-tax | Direct Tax Code should bring overhaul, not cosmetic changes

After over a decade of big changes in indirect taxes, the Centre has now taken up the challenge of overhauling direct taxes.

The Union government plans to revamp the Income Tax Act, which has been in force since 1961, to create a more streamlined and user-friendly tax system. The Direct Tax Code (DTC) is expected to simplify the tax structure, reduce litigation, and bring more clarity and transparency to the law.

It is said that the first draft of the Direct Tax Bill will be tabled in the Budget Session that starts on January 31.

Why the overhaul

Although the Income Tax Act is a well-crafted piece of legislation, the presence of 298 sections and around 23 chapters can make it quite complex for individuals and businesses to navigate, especially with multiple exemptions and deductions under various sections.

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Adam Smith, the renowned economist, once advocated a taxation system that is simple and easy for everyone to understand. However, in India, the tax laws have become increasingly complex over time, with numerous amendments and intricate interconnections between various sections.

For example, although agricultural income in India is exempt from tax under Section 10(1), it can be considered to determine the tax on non-agricultural income. Moreover, one has to read through 2(1A) to understand what constitutes “agriculture income” in the first place.

Further, Rules 7A, 7B and 8 treat the cultivation of coffee, rubber and tea partly as agricultural and partly as non-agricultural income. This complexity has made it difficult for the average taxpayer to navigate the system without professional help.

In recent budgets, Union Finance Minister Nirmala Sitharaman has signalled a significant shift in the country’s tax system, introducing a default tax regime aimed at simplifying the process for taxpayers. Under the new regime, taxpayers are required to forgo numerous deductions and exemptions in exchange for a lower and more transparent tax structure.

Changes from DTC

Acknowledging the complexity of the existing tax legislation, the government has directed the draft committee to simplify the language of the tax laws. This move aims to make the laws more accessible and reader-friendly, thereby reducing ambiguity and enhancing compliance.

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At present, individuals whose total income is less than Rs 3 lakh need not worry about income tax payments under the new regime. Middle-class taxpayers can look forward to much-needed relief, as the Finance Minister is expected to propose higher brackets in the new tax slabs.

With the gradual phasing out of deductions and exemptions under the old regime since Budget 2020, a likely increase in slab limits under the new tax regime may benefit individual taxpayers substantially. This will further encourage consumer spending and lead to increased GST collections.

Simplified compliance

In line with the government’s push for digital transformation, the new tax framework is expected to prioritise simplified compliance processes. Features such as easy-to-use return forms and fully digital filing systems aim to make tax compliance faster and more efficient.

The law is expected to consolidate overlapping rules, eliminate outdated exemptions, and streamline deductions to reflect the current economic environment. For example, if an employee is getting education allowance as part of his pay, he is given an exemption of only Rs 100 per month.

Provisions with respect to outdated sunset clauses must be identified and updated. For example, to attract foreign capital in developing infrastructure projects, tax incentives are expected to be extended beyond March 31, 2025, under Section 10(23FE).

Key issues

Simplifying tax laws must balance relief to taxpayers with revenue generation. The government needs to focus on simplifying the tax law and work on revenue neutrality at the same time, since a major chunk of it comes from direct taxes.

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Furthermore, the government needs to strengthen the enforcement mechanism leveraging technologies such as data analytics and artificial intelligence to prevent revenue leakage and tax evasion.

To address the massive backlog of pending tax disputes, the government already introduced the Vivad se Vishwas scheme in Budget 2024. This initiative allows eligible taxpayers to settle pending cases by paying a specified percentage of their outstanding tax dues.

Clear, precise provisions

Tax laws should not give room for subjective interpretation. Ambiguity could cause much harm, making more cases land in disputes. The provisions should be made clearer and more precise.

Changes in tax laws would necessitate preparation across multiple fronts to ensure smooth implementation. Taxpayers, practitioners, and administrative offices must be adequately equipped with the required skills and an understanding of the new theoretical provisions. The government needs to provide intuitive tax filing platforms with automated tools to help taxpayers calculate their liabilities under the new rules.

Furthermore, pre-filled tax returns and calculators may ease compliance. In addition, the government needs to think of dedicated helplines and online chat support to address taxpayer queries about the new provisions.

We must keep in mind the initial challenges that we faced when the GST was introduced in 2017. The government faced multiple challenges, including training gaps, technological issues, portal downtime, and transition difficulties. There is a need to ensure that I-T systems are thoroughly tested to handle a surge in traffic and minimize glitches in tax payments and processing refunds.

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Besides, transition costs, both operational and financial, should not outweigh the potential benefits.

An opportunity

The concern is that the new tax code might merely become “old wine in a new bottle” if it replicates the existing provisions under a different framework. If the DTC involves merely renaming sections or reorganising chapters without addressing the issues of complexity and ambiguity, it would result in a law that looks new but operates in the same way.

Drafting a new DTC, despite its inherent challenges, presents an opportunity for India to modernize its tax system. By embracing the lessons learned from past reforms, India can make the transition to the DTC a success, ultimately benefiting both taxpayers and the broader economy.