Memorandum On Direct Tax Code


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Appeal to Reconsider Draft Direct Tax Code Bill 2009 on Voluntary Sector of India

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Memorandum On Direct Tax Code

  1. 1. Shri. Pranab Mukerjee Hon’ble Minister of Finance Government of India Room No – 132 C North Block New Delhi – 110001 Phone: 011- 23092810; 23092510 Fax: 011- 23093289 Email: Dear Sir, Subject: Appeal to Reconsider Draft Direct Tax Code Bill 2009 on Voluntary Sector of India We would like to bring to your notice the following issues in relation to the Direct Tax Code Bill, 2009 on Voluntary Sector of India for your consideration. UNFAIR AND INCONSISTENT PROCEDURE FOR DETERMINING INCOME 1.01 Under the existing Act the income which is exempted is required to be determined under Section 11(1). Under the proposed code the taxable income of charitable organisation is required to be computed under Section 87. There is a very fundamental shift which brings charities on par with any other assessee. 1.02 The proposed method of computing taxable income is legally incorrect because in case of NPOs the gross receipt of ‘voluntary contributions’ itself is income for income tax purposes. Therefore, it is appropriate that exemptions are allowed only if it is expended in specified manner. It need to be understood that under the existing law NPOs are required to spend, income which otherwise would have been taxable, in prescribed manner. Section 284(124)(g) defines ‘voluntary contribution’ as a part of income; any further deduction to such income will be in contradiction of the proposed code itself. Hence the existing manner of determining the exempted income is appropriate for NPOs.
  2. 2. Suggested Way Forward: 1.03 It is suggested that the existing procedure of first determining the taxable income and then determining the exempted income should be retained. The proposed procedure of arbitrarily and artificially determining the income of NPOs should be deleted. UNFAIR TO TREAT ALL RECEIPTS AS INCOME 2.01 The proposed code provides that all receipts (except loans) whether income or not shall be treated as income which is unfair and unconstitutional. It is also in direct contradiction with section 284(124) of the proposed code which defines income. If the proposed code becomes law then the following receipts which cannot be considered as income under any law shall be treated as income : - Receipt towards share capital or life membership fee - Legal obligations and Restricted Grants etc It may also be noted that u/s 96(h) a legal obligation has been treated as a trust. In other words restricted grant bound by a contractual obligation, being a legal obligation, should be termed as a trust and should not form a part of the total income. Suggested Way Forward: 2.02 The proposed code should suitably clarify and exclude those receipts which cannot be considered as income, even under the mandate of the proposed code. For example, it should exclude legal obligations and restricted grants, receipts towards share capital, life membership fees etc. 100% APPLICATION OF INCOME DURING THE YEARS 3.01 The new direct tax code provides that 100% of income during the year has to be applied for charitable purposes which is practically not feasible and therefore, unfair. The problems which the NPOs may face could be : - Receiving funds towards the end of the year.
  3. 3. - Receiving funds for 2-3 years together - 100% application would imply no reserves or savings for contingencies. Suggested Way Forward: 3.02 The proposed code should retain the existing option of applying the income in the next year or over next 5 years. It is not possible to apply 100% of the income during the year itself. It may be noted that upto 2002 only 75% of income was required to be applied and currently 85% of income is required to be applied during the year. 15% ACCUMULATION WITHDRAWN 4.01 The Code proposes to withdraw the benefit of saving 15% of income every year. Currently NPOs are allowed 15% of their income as indefinite accumulation. Such accumulation provides a limited benefit to the NPOs for creating reserves for its future sustainability. NPOs depend on external donations and grants and have little possibility for creating reserves for future. The existing Act is permitting a very modest 15% accumulation for future sustainability. Suggested Way Forward: 4.02 It is necessary that an enabling law is created for the NPO sector to sustain itself. The withdrawal of 15% indefinite accumulation will strangulate the sector and have a serious impact on the future sustenance of the NPOs. Therefore, the existing provision of 15% indefinite accumulation should be retained. PROHIBITION OF INVESTING IN FINANCIAL ASSETS 5.01 The new direct tax code has thrown various new concepts of assets, which are: (i) Financial asset (ii) Investment asset (iii) Capital Expenditure (asset) (iv) Business capital asset (v) Business held as asset
  4. 4. 5.02 None of the above have been defined from a NPO perspective. For instance “investment asset” has been defined as any capital asset which is not a business capital asset. The financial assets have not been defined. For the NPO sector the terms such as ‘project assets’ or ‘corpus assets’ are more relevant which have not been defined. 5.03 The section 90(e) of the proposed code specifically provides that any investments in financial assets shall not be treated as valid application of funds. In other words the unspent balances at the end of the year shall not be treated as application if converted into financial assets. Further, because of the prohibition even creating short term deposits within the year, might not be permitted which is totally irrational and unfair. Suggested Way Forward: 5.04 The proposed code should suitably clarify what a financial asset is in context of NPOs. It should be ensured that NPOs are not harrased for creating legitimate deposits and investments in instruments such as bank fixed deposits, government securities etc. UNFAIR TO DISALLOW DEPRECIATION 6.01 Presently depreciation is totally allowed as expenditure. The proposed code has completely ruled out the possibility of claiming depreciation as an expenditure because only cash expenditures are permissible. This is again a unbelievably harsh provision because it will result in natural erosion of the corpus and networth of the NPOs without any protection of depreciation deduction which is available to other assessees. Since the proposed code is considering only cash outflow and inflow various other non-cash expenditures shall also not been considered. Suggested Way Forward: 6.02 It is unfair to disallow depreciation to the NPO sectors which is available to all other assessees. The Proposed code should clarify and ensure that the networth of the NPOs is not needlessly eroded. Therefore, depreciation should be allowed as a legitimate expenditure. BUSINESS ACTIVITY OF AN NPO 7.01 Presently the incidental business activity is allowed under the Income tax Act for the specified category of NPOs.
  5. 5. 7.02 However the proposed Code has restricted the coverage of incidental business activity and has allowed only those business activities which are carried on while actually undertaking the welfare activities. In other words, the ruling of Supreme Court in Addl. CIT v. Thanti Trust [2001] 247 ITR 785 would stand nullified. Just to remind, in this case Supreme Court ruled that even unrelated activities will be treated as incidental provided the entire income is used for charitable purposes. This is a proposal in the right direction. However, after this change there is no need to deprive the sixth category NPOs from engaging in business activities. The current law and the proposed code prohibit business activities in case of NPOs engaged in ‘Advancement of any other general public utility’. 7.03 Now since the new code has redefined the incidentality of business as a result no NPO can engage in unrelated business activities. Therefore, there is no need for prohibiting one category from engaging in business activity. Because in any case all categories of NPOs have to engage in incidental business activities. If the business activity is carried as a part of the permitted welfare activities than there is no reason why all NPOs shall not have the benefit. Suggested Way Forward: 7.04 The proposed code has already addressed the issue of business income of NPOs by redefining the clause relating to incidentality of business activities. In other words, NPOs under any category cannot undertake any unrelated business activity. Therefore, there is no need to exclude and prohibit the NPOs falling under the sixth category, i.e. ‘advancement of any other general public utility’ from doing business activity. INCENTIVES TO DONORS 8.01 All the Donors’ incentives have been clubbed and covered under section 72 of the direct tax code under the chapter Tax Incentives. It seems that present incentives under section 35 AC may not be available once the Direct Tax code becomes operational. The new code proposes three types of deductions to the donor : (i) 125% of amount donated (ii) 100% of amount donated (iii) 50% of amount donated
  6. 6. 8.02 However under the proposed provisions 125% benefit will be available only to research related institutions. 100% benefits is available to specified institution and 50% incentive is available to other institutions. In other words, most of the NPOs have been deprived of the possibility of getting 100% privileges for the donor. Suggested Way Forward: 8.03 The proposed code should provide 100% benefit to the donors in deserving cases. The current legal scenario is not at all conducive for funds raising and resource mobilisation. The proposed direct tax code is a further setback in this regard. Therefore, the benefit analogous to section 35AC providing 100% deduction should be retained. We are hopeful that you will be kind enough to reconsider our appeal before finalizing. Yours sincerely, Signature Address of the organization.