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No news may be good news
February, 27th 2007

Given the focus on cutting exemptions and raising compliance, very few new tax sops may be offered in the budget.

Everyone is waiting anxiously to know what the upcoming budget would have for him/her. Nervous markets have already begun a sell-off, perhaps because all the possible good news has already come. Long-term capital gains are already tax-free; short-term gains are taxed at only 10%; tax slabs have been reworked by raising the basic exemption limit to Rs 1 lakh; Sec. 80C offers deduction without sectoral caps and without discriminating against high income earners as against the earlier Sec. 88 which was closed to those having income above Rs 5 lakh.

Now, with the stated intention of the government being to reduce tax exemptions across the board and increase tax compliance, there is very little chance that additional tax sops may be offered. So, all in all, for the average investor and taxpayer, no news may be the only good news. Against this backdrop, let us see the positives and negatives that Budget 2007 could have in store.


There has been no action so far on the EET regime, which was first proposed two budgets ago. Once the EET regime is operational, all tax-saving investments, such as PPF, NSC, ELSS and life insurance etc, would become taxable at maturity. There is a possibility that instruments like insurance, PPF and bank deposits may be taxed at lower rates, essentially on account of their long-term nature. In any case, whenever the announcement does come, it is hoped that it would be applicable prospectively and not to existing investments.

Short-term capital gains tax

There are a number of investors operating in the market, who, in view of the number and volume of transactions, are more like traders than investors. And as traders, their profits should be classified as business income (taxable at slab rates) and not as capital gains where the tax rates are lower. However, the absence of clear-cut guidelines in the I-T Act makes this issue subjective and such persons are getting away with the lower tax. CBDT had even invited a public debate on its website to find the ways and means to tackle this issue. There is an apprehension that the STCG rate may be enhanced to 15%, which would amount to punishing the innocent along with the guilty.

Fringe benefit tax

Almost all of corporate India is protesting against this unfair tax. FBT is essentially an expenditure tax levied on the employer on a set of specified expenses. Corporate India contends that genuine business expenditure is getting taxed and this is unjustified.

On its part, the government feels that the remedy offered by the corporate sector of withdrawing FBT and hiking the tax rate wont be as effective as taxing fringe benefits. Once a new tax is introduced, there is very little chance of it being withdrawn (example the surcharge and cess). So, FBT will not be cancelled, however, it remains to be seen if some sort of relief, perhaps in the form of some basic exemption, is offered on this front.

House property

Rebate available in case of vacant house property (vacancy allowance) may be scraped in a move to counter spiralling property prices. Owners, in the absence of vacancy allowance, would be encouraged to rent out their properties, thereby increasing the supply in the market. Secondly, for rented properties, the full amount of interest (as against only Rs 1.5 lakh for self-occupied properties) can be deducted. This has resulted in many speculators and high net worth individuals buying multiple properties as investments. Due to the tax break (which nets off the rental income against the interest deduction), the property ipso facto almost pays for itself. Again, with the intention of increasing supply and reducing the number of superfluous tax deductions, deduction for additional properties may be limited to only one additional property.

Service tax

There may be an increase in the service tax rate from the current 12% to 14%. However, the exemption limit may be raised from the current Rs 4 lakh to Rs 10 lakh. Experts believe that the current limit is too low, and it encouraged people to misreport taxable income. On the other hand, increasing service tax is inflationary as it increases ones cost of living. So, it would be interesting to see the governments action on this front.

Senior citizen relief

Currently, a person qualifies to be a senior citizen when he or she becomes 65 years of age. The basic tax exemption for senior citizens is higher at Rs 1.85 lakh as against Rs 1 lakh applicable to the non-senior citizen taxpayer. The qualifying age for becoming a senior citizen may be brought down to 60 years. Simultaneously, the limit beyond which interest income becomes subject to TDS may be enhanced to Rs 10,000 from the current Rs 5,000. Also, medical insurance premium, for which senior citizens enjoy a higher deduction of Rs 15,000, may be further hiked to Rs 20,000.

Section 80C

There is a fair chance that Budget 2007 may raise the limit of Sec. 80C from Rs 1-1.5 lakh. Or, the additional limit may be earmarked exclusively for bank deposits. Bankers, already under the pressure of an increasing credit off-take, want to make bank deposits more attractive for the common man. They complain that they do not have a level playing field as far as savings instruments go. Bank interest is fully taxable and it just cant compete with exemptions extended to capital gains, PPF interest etc. So, I expect some action on this front, either by way of increasing the Sec. 80C limit or by offering a tax deduction to bank interest.

However, one feels that instead of increasing the 80C limit, the government should raise the basic exemption limit of Rs 1 lakh. Increasing 80C would benefit the higher income group as tax payers at the lower end of the spectrum can hardly afford to keep aside all of Rs 1 lakh during the year just for tax saving. Increasing the basic exemption limit will bring uniform quantitative advantage to all categories of taxpayers, while bringing qualitative benefit to the lower income group taxpayers.

Banking cash transaction tax

There is a very good chance that the much maligned BCTT, which is 0.01% of withdrawals over Rs 25,000 from current accounts (for individuals) and over Rs 1,00,000 for corporates, may be done away with. Brought in essentially for creating an audit trail for unaccounted-for transactions, the BCTT appears to have outlived its purpose, thanks to the annual information returns introduced recently and increased know-your-customer compliance.

Tax-free bonds

The need for infrastructure development to keep up the current pace of growth is all too well-known. This requires big ticket investment for the long-term. Consequently, commercial banks may be allowed to float tax-free long-term bonds with tenures of 10-20 years.

To sum

We will soon know how much of the above actually comes through. Watch this space for a detailed analysis of Budget 2007.

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