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Govt rethinks its move to an EET system
December, 05th 2006

Individuals may not have to pay tax at maturity on savings schemes that qualify for a tax break. The government, which signalled its intention to move to an exempt-exempt-taxation (EET) system for all savings instruments, is now having a rethink as it reckons that a one size fits all view may not be the best proposition.

Under EET, savings schemes are exempt from tax at two stages deposit and accrual but are taxed at maturity. Policy managers are considering tailor-made tax regimes for savings schemes that qualify for a tax deduction of up to Rs 1 lakh. These include contributions to PPF, life insurance premia, schemes for deferred annuities, investments in infrastructure bonds, repayment of principal on home loans and expenses on tuition fees.

Most of these savings plans are exempt from tax at all three stages deposit, accrual and withdrawal. EET is not frozen, but the plan now is to tax only a few savings instruments on withdrawals, said a source. This may include long-term savings instruments. PPF and insurance plans may fall in this category, though no final view has been taken. Contributions to a PPF account and the interest earned during the investment span will be exempt from tax. The tax will be levied when withdrawals take place.

Repayment of home loans and expenses on tuition fees will not be taxed at any stage. A few savings schemes may be taxed at the stage of contribution and some others at the stage of accumulation.

A panel set up to formulate a roadmap for transition to the EET regime had recommended a tax on withdrawal for all savings schemes that qualify for a tax deduction, irrespective of the tenure of the instrument. It had voted against classifying instruments into short, medium and long-term. The panel had suggested implementing the EET regime with prospective effect.

The EET system encourages long-term savings, particularly in the absence of a social security scheme. However, taxing all savings instruments at maturity may not go down well with most savers. The government, which has examined the panels recommendations, has veered around to the view that it would be administratively simpler to have customised tax regimes for various savings schemes. The EET regime is administratively complex as it involves record-keeping till the stage of withdrawal.

There wont be hassles, for instance, if an instrument is taxed at the contribution stage. This method of taxation is called tax-exempt-exempt (TEE). Here, the contributions to savings scheme are out of post-tax income. Simply put, no incentives (or deduction) will be available on contribution. The accumulated income and withdrawals will be exempt from tax. Some instruments may come under the TEE regime.

Some others may come under the exempt-tax-exempt (ETE) method. Here, savers are exempt from tax at the contribution and the withdrawal stage, but will be taxed at the accumulation stage. EET-based taxation has been introduced in the defined contribution pension scheme for newly-recruited government employees.

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