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Tax incentives

12.1 Tax incentives take the form of exemptions or deductions. Tax incentives are usually classified into business tax expenditure or social tax expenditure.

12.2 Ordinarily, tax incentives are inefficient, distorting, inequitous, impose greater compliance burden on the tax payer and on the administration, result in loss of revenue, create special interest groups, add to the complexity of the tax laws, and encourage tax avoidance and rent seeking behaviour. The Parliamentary Standing Committee on Finance has recommended a comprehensive review of the tax incentives so that they are limited and confined to exceptional cases. Accordingly, all exemptions under the Income-tax Act, 1961, have been reviewed. Based on a comprehensive review, it has been decided that all business tax expenditures, other than for activities which create externalities, will be withdrawn. The social tax expenditures will, however, continue to be allowed with such modifications as are necessary to improve their efficacy.

Exemptions under section 10 of the 1961 Act

12.3 Tax exemptions either exempt persons (liable to tax) or exempt income (from a specified source). Under the Code, tax exemptions have been rationalized in the following manner :—

(a) The source specific exemptions have been separately provided under section 9 read with the Sixth Schedule ;

(b) The entity related exemptions have been separately provided under section 10 read with the Seventh Schedule ;

(c) Exemptions which relate to specific heads of income have been provided for as deductions under the relevant heads of income ;

(d) Non-profit organisations like scientific research associations, news agencies, professional association, welfare fund, education and medical institutions, religious trusts, trade unions, etc., will be allowed concessional tax treatment.

Social tax expenditures

12.4 Tax incentives for savings have been rationalized so as to encourage net savings. Accordingly, in line with the best international practice in this regard, the Code proposes to introduce the "Exempt-Exempt-Taxation" (EET) method of taxation of savings. Under this method, the contributions are exempt from tax (this represents the first "E" under the EET method), the accumulation/accretions are exempt (free from any tax incidence) till such time as they remain invested (this represents the second "E" under the EET method) and all withdrawals at any time are subject to tax at the applicable personal marginal rate of tax (this represents the "T" under the EET method).

12.5 Based on the aforesaid EET principle, the Code provides for deduction in respect of contributions (both by the employee and the employer) to any account maintained with any permitted savings intermediary, during the financial year. This account will be required to be maintained with any permitted savings intermediary in accordance with the scheme framed and prescribed by the Central Government in this behalf. The permitted savings intermediaries will be approved provident funds, approved superannuation funds, life insurer and the New Pension System Trust. The accretions to the deposits will remain untaxed till such time as they are allowed to accumulate in the account.

12.6 Any withdrawal made, or amount received, under whatever circumstances, from this account will be included in the income of the assessee under the head "Income from residuary sources", in the year in which the withdrawal is made or the amount is received. Accordingly, it will be subject to tax at the appropriate personal marginal rate.

12.7 Further, the Code also provides that the withdrawal of any amount of accumulated balance as on the 31st day of March, 2011, in the account of the individual in the Government Provident Fund (GPF), Public Provident Fund (PPF), the recognised provident funds (RPFs) and the Employees’ Provident Fund (EPF) under the Employees’ Provident Funds and Miscellaneous Provisions Act will not be subject to tax. In other words, only new contributions on or after the commencement of this Code will be subject to the EET method of taxation.

12.8 The permitted savings intermediaries would be required to be approved by the Pension Fund Regulatory and Development Authority (PFRDA). These intermediaries will, in turn, invest the amounts deposited with them in government securities, term deposits of banks, unit-linked insurance plans, annuity plans, bonds and securities of public sector companies, banks and financial institutions, bonds of other companies enjoying prescribed investment grade rating, equity linked schemes of mutual funds, debt oriented mutual funds, equity and debt instruments. The choice of instruments will, in some schemes, be with the investor and in some others with the trustees of the schemes. The pattern of investment by the latter will be as prescribed.

12.9 Further, the rollover of any amount received, or withdrawn, from one account with the permitted savings intermediary to any other account with the same or any other permitted savings intermediary will not be treated as withdrawal. Hence, such rollover will not be subject to tax.

12.10 The Government will also design a system of central record keeping by an independent agency which will serve as a depository of all information relating to investment and withdrawal from the various accounts maintained by the assessee with the permitted savings intermediaries.

12.11 An individual or HUF will also be allowed deduction for amount paid towards tuition fees for children.

12.12 The aggregate amount of deduction for payment into the account maintained with any permitted savings intermediary and for the amounts referred to in para 12.11 above, shall not exceed rupees three hundred thousand.

12.13 The Code contains provisions that are intended to promote human development. Accordingly, deductions will be allowed :—

(a) to an individual or HUF in respect of medical insurance premium for self, spouse, dependent children, or member of HUF up to a maximum of Rs.  15,000 (Rs. 20,000in the case of a senior citizen) and an additional sum in respect of medical insurance premium for parents up to a maximum of Rs.  15,000 (Rs. 20,000 if the parent is a senior citizen).

(b) to an individual or HUF for medical treatment or maintenance of disabled dependent of an amount of Rs. 50,000 (Rs. 75,000 in case of severe disability).

(c) to an individual or HUF for expenditure on medical treatment for prescribed diseases in case of self, spouse, dependent parents/children or a member of HUF up to a maximum of Rs. 40,000 (Rs. 60,000 in the case of a senior citizen).

12.14 Deduction of an amount of Rs. 50,000 (Rs. 75,000 in the case of a person with severe disability) will be allowed to an individual who is handicapped.

12.15 Deduction will be allowed to an individual for interest actually paid on a loan taken for higher education for self or spouse or children. The scope of the term "higher education" has been enlarged. Higher education will mean full time studies in a graduate or postgraduate course.

12.16 The deduction will be allowed only if the loan is taken from a banking company or any other financial institution notified by the Central Government.

12.17 Deduction will be allowed to a company for both capital and revenue expenditure incurred by a company for promoting family planning as well as for preventing HIV/AIDS amongst its employees.

12.18 Deduction will be allowed to an individual, who is self-employed, for rent actually paid for his residence, in excess of ten per cent of his gross total income from ordinary sources. However, there will be a ceiling of rupees two thousand per month on the amount allowed as deduction.

12.19 The case for providing tax concessions for donations to non-profit organizations (charitable organizations) is based on two considerations. The first argument is that such donations usually create positive externalities. Secondly, such donations increase the flow of public goods and mitigate the burden on Governments. Therefore, the Code provides incentives for donations to non-profit organizations as follows :—

(a) Deduction to all donors at the rate of 125 per cent. of donations made to the following institutions :—

(i) scientific research association or National Laboratory ; and

(ii) university, college or other institution for research in social science, scientific research or statistical research ;

(b) Deduction to all donors at the rate of 100 per cent. of donations made to the following institutions :—

(i) Prime Minister’s National Relief Fund ;

(ii) Chief Minister’s Relief Fund ;

(iii) The Army Central Welfare Fund, The Indian Naval Benevolent Fund and The Air Force Central Welfare Fund ; and

(iv) such other funds as are enumerated in Part B of The Sixteenth Schedule.

(c) Deduction to all donors at the rate of 50 per cent of donations made to any other non-profit organization.

Business tax expenditure

12.20 The case for tax holiday for certain businesses is based on the consideration that these businesses entail extremely high risk, lumpy investment, and a long payback period.

12.21 However, profit-linked incentives are inherently inefficient. Essentially, a profit-linked incentive is regressive in nature. Consequently, there is an inbuilt incentive for laundering and shifting of profits to the exempted activity. Since profit is the basis for exemption, there is no incentive for investment and upgradation during the period of tax holiday. Such profit-linked incentives also lead to significant loss of revenue and encourage rent-seeking behaviour. Hence, the Code substitutes profit-linked incentives by a new scheme. Under the new scheme, a person would be allowed to recover all capital and revenue expenditure (except expenditure on land, goodwill and financial instrument) and he would be liable to income-tax on profits made thereafter. The period consumed in recovering all capital and revenue expenditure will be the period of tax holiday. The new scheme will apply to the following :—

(a) Business of exploration and production of mineral oil or natural gas ;

(b) Business of developing a special economic zone ;

(c) Business of generation, transmission or distribution of power ;

(d) Business of developing, or operating and maintaining, any infrastructure facility ;

(e) Business of operating and maintaining a hospital in any area, other than the excluded area ;

(f) Business of processing, preservation and packaging of fruits and vegetables ;

(g) Business of laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of the network ;

(h) Business of setting up and operating a cold chain facility ; and

(i) Business of setting up and operating a warehousing facility for storage of agricultural produce.

12.22 The provisions of the Income-tax Act, 1961, that allow profit-linked incentives and other tax incentives contrary to the new scheme contained in the Code will be grand fathered.

12.23 The case for area based exemption is based on the consideration of balanced regional development. However, such area based exemptions create economic distortion, i.e., allocate/divert resources to areas where there is no comparative advantage. Such exemptions also lead to tax evasion and avoidance. Besides, there is a huge cost of administration. Hence, the Code does not allow area-based exemptions. Area-based exemptions that are available under the Income-tax Act, 1961, will be grand fathered.

12.24 Deduction will be allowed to a resident individual, being an author, in respect of royalty received for the assignment or grant of any of his interest in the copyright of any book of literary, artistic or scientific nature and in respect of any textbook certified by the prescribed authority for an amount up to a maximum of Rs. 3,00,000.

12.25 Deduction will be allowed to a resident individual, being a patent holder for income received by way of royalty in respect of a patent registered on or after the 1st day of April, 2003, under the Patents Act, 1970. The deduction will be up to a maximum of Rs. 3,00,000.

12.26 Co-operative societies are formed for the promotion of thrift and self-help among agriculturists, artisans, crafts persons, etc. The case for tax exemption to co-operative societies is based on the principle of mutuality, i.e., no one can make a profit out of himself. In the context of cooperative societies, the surplus (profits) is essentially the return of what members have contributed to the society. Therefore, the surplus accruing to it cannot be regarded as income, profits or gains and subject to income-tax.

12.27 Deduction will be allowed to cooperative societies which are essentially formed for self-help amongst agriculturists, artisans, craftsmen, etc. The salient features of such deduction are as follows :

(a) The profits derived from the business of providing banking or credit facilities to its members by the Primary Agriculture Credit Societies and Primary Co-operative Agriculture and Rural Development Banks will be entitled to 100 per cent. deduction.

(b) The profits derived from agriculture or agriculture related activities by a Primary Co-operative Society will be entitled to 100 per cent. deduction. For this purpose, "Agriculture-related activities" are defined to mean the following activities :

(i) purchase of agricultural implements, seeds, livestock or other articles intended for agriculture for the purpose of supplying them to the members of the society ;

(ii) the collective disposal of,—

(a) agricultural produce grown by the members ; or

(b) dairy or poultry produce of the members ;

(iii) fishing or allied activities, that is to say, the catching, curing, processing, preserving, storing or marketing of fish or the purchase of materials and equipment in connection therewith for the purpose of supplying them to the members of the society ;

(c) In the case of any other primary cooperative society engaged in activities other than those specified in (a) and (b) above, the profits derived from such activities will be entitled to 100 per cent. deduction up to a maximum amount of Rs. 1,00,000.