The Direct Taxes Code Bill, 2009, could soon set the tone for all our future wealth-creation decisions. If enacted, the bill will not only change the amount of tax you pay, but also transform how you invest, borrow and spend your money.
While most tax breaks may be taken away, the process of filing taxes will be simpler.
The new tax slabs
One of the hallmarks of the new tax system is the substantial expansion of income slabs. For example, for an individual, annual income up to Rs 1.6 lakh (Rs 160,000) would be tax exempt, a 10 per cent tax rate would be applicable for income between Rs 1.6 lakh and Rs 10 lakh (Rs 1 million), 20 per cent for income between Rs 10 lakh and Rs 25 lakh (Rs 2.5 million), and 30 per cent for income above Rs 25 lakh.
The tax rates under the Direct Taxes Code Bill, 2009 -- if cleared -- would be applicable from the financial year 2011-12. While the income slabs have been stretched, bringing down the tax liability, the exempted allowances and benefits such as Leave Travel Allowance (LTA) and medical reimbursements become fully taxable under the code.
The deduction for House Rent Allowance (HRA) may also go under the new regime.
The new direct tax code does not distinguish between short- and long-term capital gains. In fact, it suggests that the contribution of and return from all investments be made tax-exempt with maturity proceeds being taxable -- an exempt-exempt-tax or EET system.
Like other investments, this proposal will impact your stocks and equity mutual fund investments.
At present, if you sell units of equity-oriented MFs after a year, you do not need to pay any capital gains tax. But if the code comes into effect, you will need to do so when you sell your MFs -- be it equity or debt.
The gains get added to your income and will be taxed as per your income slab. However, in case of gains made after one year, the code will allow you the indexation benefit before adding the gains to your income.
Indexation is a facility offered by the income tax laws to adjust the cost price of your investment (in a security) for inflation over the years. This enables you to inflate your cost price in order to reduce the difference between your selling price and the cost price.
This is done because it is presumed that the price you paid for acquiring an asset years back is worth much more today because of inflation. The lower this difference, the lower is your tax liability.
For investments in equity shares, mutual funds, physical gold, gold exchange-traded funds (ETFs) and real estate that are less than one year old, the capital gains will be added to the taxable income without indexation benefits.
Gains from investments in these assets for more than a year will be added to the taxable income after allowing for indexation benefit.
The code may have done away with the numerous tax breaks, but it still has provisions for tax-saving investments.
Guess what the limit has gone up to? It's Rs 3 lakh (Rs 300,000) per annum now. But the trick is that you will be permitted to invest only in certain options -- Public Provident Fund (PPF), Employees' Provident Fund, life insurance, superannuation funds and National Pension System (NPS), besides claims for children's tuition fee expenses.
This simply means no more tax breaks for National Savings Certificates, Senior Citizens Savings Scheme, tax-saving bank fixed deposits and equity-linked savings schemes (ELSS) of mutual funds.
The existing tax breaks for health insurance, with the annual limits of Rs 15,000 and Rs 20,000 for senior citizens, as well as those for interest repayment for educational loans and notified donations continue in the new regime too.
The present tax benefit on home loans that stands at Rs 1.5 lakh (Rs 150,000) for interest payments and up to Rs 1 lakh (Rs 100,000) for principal repayments may end if the new code comes into force.
But if you have rented out a house, you will continue to get the existing tax-break for interest payments on the loans taken to acquire it.
It has been proposed that the maturity proceeds of PPF and insurance be taxed. In case of insurance policies, an exception has been made.
Deduction will be allowed in respect of any sum received under a life insurance policy, including any bonus, only if the premium payable for any of the years during the term of the policy does not exceed 5 per cent of the capital sum assured and the sum is received only upon completion of the original period of the contract of the insurance, or upon the death of the insured.
In case of PPF, the balance in the account till 31 March 2010, whenever withdrawn, will not be taxed.