It is a taxation regime, the unveiling of which has been in the works for a while. The government had signalled its intention to move towards a taxation method, which would exempt from tax contributions to savings schemes and the interest earned on it but tax the investor only at the last stage - pay-out.
This exempt, exempt, taxed (EET) method of taxation is bound to transform the way in which individuals handle their investments in the future. Assuming that such a regime kicks in soon, even if not immediately, the impact could vary for people in various income categories.
Although a road map for EET is yet to be unveiled, investors may have to be prepared for a future marked by taxes being paid at the time of redemption of their investments. Among the first of the investment products which could be impacted in the proposed new regime are the Public Provident Fund and the National Savings Certificate. Once the EET method is adopted, the amount received on maturity (tax-free so far) would be taxed.
Insurance schemes would also be covered under this method, besides pension schemes. Other expenses like tuition fees and return of capital on a housing loan could remain unchanged because these are not investments but they are actually expenses being incurred.
But it should be understood that while moving into the EET regime, the finance minister is expected to change the tax structure as well in order to soften the blow. ET has sketched three cases of investors having varying income levels and the possible impact an EET regime could have on them:
This is an individual with annual salary earnings of close to Rs 3 lakh. Of this Rs 25,000 goes towards provident fund as the employees share. Besides, there is an additional saving of around Rs 40,000 for the purpose of taxation under Section 80C by investments in PPF and NSC. There is also the tax paid for the remaining amount. How does this person rework his math in a changed tax regime marked by EET?
Well, there is very little he or she can do on the provident fund part. However, on investment in PPF, it has to be borne in mind that in the future when the scheme matures, tax would have to be paid. Similarly, the impact of investment in NSC could also be severe at the time of maturity, which could mean a sharp drop in the overall returns on these instruments. The option then in such a situation would be to switch the money towards equity-oriented funds or even pension avenues.
This is an individual who earns close to Rs 6.5 lakh a year. This person fully utilises the Rs 1 lakh benefit under Section 80C by putting away money in the provident fund, by additional contributions to the voluntary provident fund besides buying into insurance and equity-linked savings schemes.
Like in the first scenario, the individual who fits into the income bracket mentioned above cannot cut down on the provident fund part. But contributions to the voluntary provident funds could be stopped. Instead, this money could be deployed to more productive areas. Among the other investments, this individual could persist with the equity linked savings scheme as an investment option.
Insurance should be adequate to provide the necessary cover. However, in an EET regime, there will have to be some evaluation of the insurance if the aim is to earn returns. This is because the net impact here could be quite severe due to the drop in the figure owing to taxation at the terminal stage.
This is a person with an annual income of Rs 14 lakh. This individual enjoys several benefits which come along with earnings. In this case, we have assumed that the person has bought a home for which a loan is being paid. There is a large insurance cover that he is expecting to take and invest into a unit-linked policy for earning some returns while a part of the amount also goes towards tuition fees of children during the year. The entire amount of Rs 1 lakh under 80 C is utilized for the purpose of reducing the tax burden.
So how does this person go about handling his finances in a new regime? To start with, the overall investment plan is not likely to be impacted much. Wherever there is a housing loan that is being repaid, then there is little to worry about in terms of the impact of the new system because the repayment of the housing loan will be outside this coverage. Similarly tuition fees will be out of the EET impact.
Insurance from now on would have to be restricted for the purpose of ensuring that there is adequate coverage for the person and the remaining one may have to be curtailed depending on the exact impact of the new system and the way in which this might affect the overall returns.
Finally, if there is any amount tucked away in other debt investments that will be impacted, it would be better to stop it and divert the same towards, say, a pension scheme of a mutual fund. Since the money comes in a regular fashion there might be a route for the purpose of ensuring that the taxation impact is limited for the investor. But it is also quite evident that the impact on this section of the investing population will be quite less.