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UPDATE 1-Indian tax panel suggests radical reforms

By Unni Krishnan

NEW DELHI, Dec 27 (Reuters) - An Indian tax panel on Friday urged a radical overhaul of the tax system by slashing corporate taxes and abolishing dividend tax to boost market sentiment and increase revenues in Asia's third largest economy.

The panel was set up around six months ago to simplify the country's complex tax structure which resulted in a low tax-to-GDP ratio of around 14 percent and only 25 million tax payers in a country of more than a billion people.

The report is still to be accepted by the government. If accepted, the proposals are likely to be part of the 2003/04 (April-March) budget which will be unveiled in February.

The panel, headed by former IMF executive director Vijay Kelkar and adviser to the finance minister, suggested corporate tax for domestic firms be cut to 30 percent and foreign firms to 35 percent from 36.75 percent. For details click[nDEL86545}.

It said the move to lower corporate taxes should be implemented over three years starting with the next budget.

Dividends from domestic companies should be exempt from taxes and long-term capital gains on listed shares should also be fully exempt, the panel said.

Analysts said the move to abolish dividend tax and long-term capital gains would help attract the small investor back to the equity markets.

The government had decided to tax dividends in the hands of the shareholder in the federal budget presented last February, resulting in a dip in investor confidence and market sentiment.

HOUSING TO GET TAX BREAKS

However, the panel watered down an earlier proposal to withdraw tax breaks for the housing sector due to opposition within the ruling Bharatiya Janata Party because of fears of a backlash from its key middle class support base.

The panel said tax breaks would be offered on housing loan interests of up to 50,000 rupees ($1,043), down from the current 150,000 rupees.

Until the proposal was implemented, the panel suggested a two percent interest subsidy on housing loans up to 500,000 rupees be given.

The panel recommended a two-tier structure for personal income tax instead of the current three with incomes between 100,000 and 400,000 rupees being taxed at 20 percent and those above 400,000 rupees at 30 percent.

It said agricultural income should be taxed by the federal government and revenues collected be passed to the states.

Currently, farm income is exempt from tax as it is a politically sensitive measure and analysts said the panel's suggestion was unlikely to find favour with the government and its allies.

The proposals are aimed at increasing revenues for the cash-strapped government which is struggling to rein in its fiscal deficit expected to be 5.3 percent of GDP in 2002/03.

International rating agencies say the country's fiscal deficit, one of the largest in the world, holds back the economy from realising higher growth rate needed to cut poverty in the world's second-most populous nation. ($1 = 47.95 rupees)