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The era of the almost five-decade-old Income Tax Act
February, 02nd 2010

Budget 2010, which is less than a month away, will have a historical angle to it. It will mark the end of an era - the era of the almost five-decade-old Income Tax Act, 1961.

Financial year 2010-11 will be the last year to which the Income Tax Act will apply; from April 1, 2011 we will be following the Direct Tax Code!

Annual Budgets should normally be a statement of government finances. However, customarily, in our country, the Budget has become a forum where the government also declares its intended taxation and fiscal policy for the year.

This year, however, could be an exception. The new Code with its sweeping changes is anyway going to be applicable from next year, so there is no point in ringing in big-ticket changes on the taxation front.

With the markets doing reasonably well and corporate results fairly healthy, I am sure all fingers and toes are being crossed that the Budget doesnt bring in its wake any dampeners.

However, given that the combined central and state fiscal deficit is upwards of 10%, the headroom that Mr. Mukherjee has is extremely limited. So it will be interesting to see how the FM walks the tight rope.

That being said, if the finance minister indeed desires his second Budget in this term to be a memorable one, he would do well to pay special attention to the salaried class. I have said it before and I will say it again it is unfathomable why governments turn a blind eye to this significant constituency.

In fact, it is this constituency that prepays its taxes to the government month in month out through the system of TDS. It is said that a good government should treat its citizens as customers.

In which case, the salaried should form the list of the most important customers - those who not only pay up but prepay their dues year after year. So, if there are five things that Mr Mukherjee can do this year to bring a smile to his customers face these would be:

1. Reinstate standard deduction. Home owners / landlords get a 30% standard deduction. Businessmen can set-off every expense they incur to earn income. Then why treat the salaried differently?

2. Raise transport allowance deduction. This has remained at an absurd level of Rs 800 per month. This is almost insulting to the employee.

3. Increase deduction for medical expenses. Spiraling healthcare costs are a reality and there is no system of government-sponsored health plans. In such circumstances, having a paltry limit of Rs 15,000 in which the employee is expected to cater to the medical expenses of his entire family borders on the farcical.

4. Separate deduction for education allowance. Education allowance for children has remained static for over twelve years now at Rs 100 per month per child for a maximum of two children. Ditto for hostel allowance at Rs 300 per month per child. The tuition fees deduction is included in an already overcrowded Sec 80C. For manytaxpayers, statutory payments like provident and superannuation contributions, home loan installments and insurance premiums make up the limit. There is no room left to claim the deduction for fees. A separate deduction for the same would be welcome.

5. Raise rent deduction for self employed. There is actually one area where the salaried are better off than the self employed (at least those who stay in rented places). Most of the salaried get HRA and the consequent HRA deduction. But if a self employed person were to pay rent, the rent deduction available to him is a paltry Rs 24,000 per year. Most people pay this much rent (if not much more) per month!!
This was as far as tax incidence is concerned. Now let us turn to another issue. Over the past few years, interest rates have been on the decline. This has hit the common man where it hurts the most.

The average rate of interest offered by banks on fixed deposits is in the range of 5.50% p.a. to 7% p.a. depending upon the tenure of the deposit. This is fully taxable. If you factor in the tax, the rates fall to 3.8% to 4.8% p.a. Then of course, there is inflation. Real returns on FDs are in the negative, even if you consider official inflation, which is much less than the actual inflation rate.

While the current rates on small savings provide some succour, the more popular amongst them such as Post Office MIS or PPF or even the Senior Citizens Savings Scheme come with their own ceiling beyond which an investor cannot go.

What the common man, especially senior citizens require is some sort of a tax-free investment avenue. It was in July 2004 that the 6.5% tax-free bonds were discontinued. Simultaneously, Sec 80L that offered a tax break on interest from investments was also dropped.

So now, citizens are tackling the triple whammy of low interest rates that are fully taxable without any relief from either inflation or taxes.

It is common knowledge that India needs infrastructural development to continue and further boost its growth. This in turn requires big ticket investment for the long-term. A move that will be win-win for all is to allow commercial banks to float tax-free long-term bonds with tenures of 10 to 20 years.

To sum
There are a few other issues such as applicability of exemption on capital gains to buybacks and open offers, taxation treatment of derivative transactions, distinction between a trader and an investor (as tax treatment for both differs) etc., that have long been left unaddressed.

These are essentially legacies of previous years budgets where rules were changed but certain indirectly affected constituents of the system were left out.

What will actually pan out only time will tell. However, when it does, watch this space for a comprehensive analysis. By the way, though the Income Tax Act will be redundant next year onwards, it will always be a part of my book shelf.

After all, its not everyday that one comes across a book that contains everything from action, drama, comedy, adventure, mystery and sometimes even horror. Occasionally, its even difficult to distinguish between fact and fiction! To that extent the Income Tax Act, 1961 is truly a masterpiece.

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