The Direct Tax Code (DTC) aims to modernise India's tax system by replacing the Income Tax Act of 1961. The DTC simplifies tax laws, reduces exemptions, and aligns with global standards. This article outlines the key differences between the DTC and the Income Tax Act, including their objectives and evolution.
The Direct Tax Code (DTC) is set to replace the Income Tax Act of 1961, with the goal of simplifying India’s tax structure. The Income Tax Act has become complex due to multiple amendments over the years, making compliance difficult for taxpayers. The DTC will modernise the system, reduce exemptions, and improve compliance, making it easier for individuals and businesses to navigate. This article explores the main differences between the Income Tax Act, 1961 and Direct Tax Code, 2025 and their impact on the taxation system.
What is Direct Tax Code?
The Direct Tax Code (DTC) is a proposed legislation aimed at reforming India's tax system by replacing the Income Tax Act of 1961. The DTC focuses on simplifying tax provisions, reducing exemptions, and broadening the tax base. It introduces a modern approach to taxation that is easier for taxpayers to understand and comply with. The DTC also aims to reduce litigation by providing clearer guidelines and eliminating ambiguities. By aligning India’s tax laws with global standards, the DTC is expected to create a more efficient and transparent tax system for individuals and businesses.
Why was Direct Tax Code 2025 introduced?
The Direct Tax Code 2025, a comprehensive reform of India's tax laws, has been in development for over a decade. Initially drafted in 2009 and presented in 2010, its implementation faced significant delays. The impetus for this reform arose from the increasing complexity of the Income Tax Act of 1961, which had become cumbersome and difficult to navigate due to its numerous sections, exemptions, and deductions.
To address these challenges and modernise the tax system, the government aimed to simplify tax laws, enhance compliance, and expand the tax base. The Direct Tax Code 2025 seeks to achieve these objectives by providing a clearer and more efficient framework for taxation. By streamlining the tax code and reducing ambiguities, it is expected to encourage greater tax compliance and increase the number of taxpayers, thereby contributing to the nation's economic growth.
What is Income Tax Act?
The Income Tax Act of 1961 governs the taxation of income in India. It sets out the rules for calculating income tax, specifying taxable income categories, tax rates, and exemptions. Over time, the act has become more complex due to frequent amendments, resulting in a system that can be difficult for taxpayers to navigate. The Income Tax Act defines income from various sources, including salaries, business profits, capital gains, and other forms of income. The complexity of the act has prompted calls for reform, leading to the development of the Direct Tax Code to simplify tax compliance.
Also read: Income Tax Slabs for FY 24-25
Difference between Income Tax Act and Direct Tax Code
Direct Tax Code (DTC) 2025 vs Income Tax Act 1961 - A comparative analysis:
Parameter |
Income Tax Act 1961 |
Direct Tax Code 2025 |
Residential Status |
Resident and Ordinarily Resident (ROR), Resident but Not Ordinarily Resident (RNOR), and Non-Resident (NR) |
Resident and Non-Resident |
Tax Audit |
Conducted by a Chartered Accountant (CA) |
Conducted by a CA, CS, or CMA |
Conceptual Terms |
Previous Year and Assessment Year |
Financial Year |
Taxation on Dividends |
Dividend Distribution Tax (DDT) at 15% |
Taxed at 15% without DDT |
Tax on Distributed Income |
Income from LIC, mutual funds, etc., is exempted |
Taxable at 5% |
Tax Rate for High-Income Individuals |
30% + 15% surcharge |
35% |
Capital Gains |
Taxable at a special rate |
Part of normal income |
Heads of Income |
Income from Salary, Income from Other Sources |
Employment Income, Income from Residuary Sources |
Structure and Complexity |
298 sections, several sub-sections, clauses, and sub-clauses, and 14 schedules |
319 sections and 22 schedules, simplified structure without clauses and sub-clauses |
Evolution and objective of Direct Tax Code 2025
The Direct Tax Code was introduced to replace the Income Tax Act of 1961, which had become overly complex due to numerous exemptions and deductions. The idea for the DTC first emerged in 2009, when the Indian government proposed a draft of the legislation aimed at simplifying the tax structure. The key objectives of the DTC are to reduce the number of exemptions, broaden the tax base, and align India’s tax system with international practices. The DTC also aims to promote equity by ensuring that all taxpayers contribute fairly to the economy, reducing the scope for tax evasion and litigation.
Over time, several versions of the DTC were proposed, with input from various stakeholders. In 2014, a revised version of the DTC was introduced, incorporating feedback from the public and experts. The final version of the DTC aims to streamline tax administration, reduce compliance costs, and promote transparency in the tax system. By doing so, the DTC seeks to make India’s tax system more efficient and fair, improving the overall ease of doing business in the country.
Main objectives of Income Tax Act 1961
The Income Tax Act, 1961, is a comprehensive legislation designed to achieve several key economic and social objectives:
1. Macroeconomic stability
Price stability: The Act contributes to price stability by regulating direct taxation, which can influence aggregate demand and inflationary pressures.
Cyclical stabilisation: By adjusting tax rates in response to economic cycles, the Act aims to mitigate the impact of economic fluctuations.
2. Economic growth and employment
- Stimulating demand: Lowering tax rates can boost disposable income, stimulating consumption and investment, thereby fostering economic growth and job creation.
3. Social equity
- Progressive taxation: The Act promotes a progressive tax system, where higher-income individuals are subject to higher tax rates. This helps to redistribute wealth and reduce income inequality.
4. Trade and balance of payments
Import duty: By imposing customs duties on imported goods, the Act encourages domestic production and reduces reliance on foreign goods, thereby contributing to a favourable balance of payments.
Also read: Income tax return extended date for AY 2024-25
Important events
2009: The first draft of the Direct Tax Code was released for public consultation.
2010: The government issued a revised discussion paper, incorporating feedback from stakeholders.
2014: A revised version of the Direct Tax Code was presented, incorporating further recommendations.
2024: The government announced that the Direct Tax Code would replace the Income Tax Act by April 2025, marking a significant reform in India’s tax system.
Salient features of the DTC
Simplified residential status: only resident and non-resident categories.
Unified tax rates for domestic and foreign companies.
Capital gains included in normal income.
Fewer deductions and exemptions for streamlined tax compliance.
Modern tax structure aligning with global practices.
Features of Income Tax Act 1961
The Income Tax Act, 1961, a cornerstone of India's tax code, outlines several key features:
- Direct taxation: Income tax is a direct tax, levied directly on the taxpayer's income, and cannot be shifted to another entity.
- Central government authority: The Central Government of India exercises authority over the imposition and administration of income tax.
- Previous year basis: Income tax is assessed on income earned during the preceding financial year (known as the previous year).
- Progressive tax rates: The Income Tax Act employs a progressive tax system, wherein higher income levels are subject to higher tax rates.
- Deductions and exemptions: The Act provides for various deductions and exemptions, allowing taxpayers to reduce their taxable income within specified limits.
By understanding these fundamental aspects, individuals and businesses can effectively navigate their tax obligations and optimize their tax planning strategies.
Tax structure under Direct Tax Code 2025
The Direct Tax Code 2025 is a significant reform aimed at simplifying India's tax system. By reducing the number of sections and introducing a more streamlined structure, the Code aims to enhance tax compliance and minimise complexities.
Key changes:
- Simplified taxpayer classification: The Code simplifies taxpayer classification by eliminating terms like ROR and RNOR. Taxpayers will be categorised as either residents or non-residents.
- Rationalization of deductions and exemptions: To promote fairness and transparency, most deductions and exemptions will be removed. This will create a more equitable tax system.
- Expanded TDS/TCS applicability: The Code extends the applicability of TDS (Tax Deducted at Source) and TCS (Tax Collected at Source) to a wider range of income types. This measure will ensure timely tax payments and deter tax evasion.
- Uniform taxation of capital gains: Capital gains will be taxed as ordinary income, aligning them with other income types. While this may impact certain taxpayers, it promotes a more consistent and equitable tax regime.
These reforms are expected to modernise India's tax system, making it more efficient, transparent, and taxpayer-friendly.
Major changes in Direct Tax Code 2025
The Direct Tax Code 2025 introduces significant reforms to the Indian tax system. Here are the key changes:
1. Simplification of tax filing:
- Elimination of assessment and previous year concepts: The code transitions to a single financial year basis, simplifying tax calculations and compliance.
- Unified company tax rates: A single tax rate will apply to both domestic and foreign companies, fostering a level playing field and attracting foreign investment.
2. Revised tax structure:
- Capital gains tax changes: Capital gains will be treated as regular income. Short-term capital gains on financial assets will be taxed at 20%, while long-term capital gains will be taxed at 12.5%.
- Simplified residential status: The RNOR category is eliminated, simplifying tax residency determination.
- New income category names: Income categories are renamed for clarity and consistency.
- Expanded tax audit roles: CS and CMA professionals can now conduct tax audits, along with CAs, enhancing accessibility.
3. Enhanced tax compliance:
- TDS and TCS on most income: TDS and TCS will apply to a broader range of income, ensuring timely tax payments. Rates for many payments will be reduced, and e-commerce operators will benefit from a significant reduction in TDS rates.
- Fewer deductions and exemptions: The code simplifies tax filing by reducing the number of deductions and exemptions. However, the standard deduction for salaried employees in the new tax regime has been increased to Rs. 75,000.
Why do we need a new Income-Tax Act?
1. Keeping it relevant
The Income-Tax Act, 1961 (I-T Act) was enacted in the early years of independent India. While it has undergone numerous amendments to adapt to evolving economic conditions, its complexity persists. With a labyrinthine structure, including intricate provisions like Explanation 1 to Section 2(42A) and Section 47, the I-T Act presents challenges for both taxpayers and tax administrators.
2. Impact of the Direct Tax Code, 2009
The Direct Tax Code (DTC) aimed to modernize India's direct tax system, incorporating international best practices. Several key provisions from the DTC, such as the Place of Effective Management (POEM) and general anti-avoidance rules, have been integrated into the I-T Act.
3. Fewer personal income tax slabs
A reduction in the number of personal income tax slabs is desirable. The government's focus on the new tax regime offers an opportunity to either increase the exemption limit or optimize tax slab rates. A similar approach was adopted in the Direct Taxes Code Bill, 2010, which significantly increased slabs for incomes up to Rs. 25 lakh.
4. Streamlining taxation of savings
The choice between EET and EEE tax regimes is a complex policy decision influenced by economic maturity. The government continually assesses these regimes to align with evolving economic objectives.
5. Global tax avoidance rules
Global tax reforms, particularly those addressing the digital economy and minimum tax rates, are gaining momentum. While these reforms aim to curb tax avoidance, concerns exist about their potential impact on developing countries. India, as a prominent voice in the Global South, is expected to advocate for a more equitable framework.
6. Pending reforms in corporate tax
The government's focus on corporate tax reform centres around simplifying the regime and reducing the corporate tax rate. Group tax consolidation is one area that could be explored to enhance efficiency. Additionally, the recent overhaul of the capital gains tax regime has streamlined the classification of assets and applicable tax rates.
Conclusion
The Direct Tax Code represents a major reform in India’s tax system, replacing the Income Tax Act of 1961 to simplify compliance, reduce litigation, and promote transparency. By reducing exemptions and aligning with global standards, the DTC is expected to create a fairer and more efficient tax system, benefitting both individuals and businesses. Its implementation will mark a significant shift in India’s tax landscape, encouraging better compliance and long-term economic growth.
