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Don't derail tax reforms
March, 17th 2010

The proposed direct tax code is the right step towards rationalisation of taxes and savings schemes. To tamper with it at this stage is to blunt its objective. The issue in question is whether savings schemes like provident fund should be taxed. The answer is yes. The present exempt-exempt-exempt (EEE) mode is irrational.

This allows an investor to seek exemption when he invests, reinvests and when he closes the scheme. International practice is to tax the investment at some point. The preferred norm is EET (exempt-exempt-tax), whereby the investment is usually taxed on maturity.

The new pension scheme follows this norm. But there are few takers for the NPS since many pension plans and savings schemes that follow the EEE model continue to exist. The latter must go in the interest of rationalising norms for similar schemes. The rationalisation must follow international practices.

The principle behind taxation is to tax income if it falls in the tax bracket. Whether the income is retirement savings or proceeds from sale of property doesn't matter.

In India, the investor is allowed to seek tax exemption on the principal when the investment is made within a certain limit. He can't insist that such investment must not be taxed at any point, including when the money is withdrawn for reinvestment or consumption.

The argument that the Indian experience is unique because the state here doesn't provide social security is also flawed. Indian state does provide for services like a public distribution system for food grains, public schooling and hospitals.

Yes, the quality of these services is nothing to crow about. They must be improved. Funds needed for this purpose have to be raised by rationalising the tax system. Our system is far too complicated with its web of exemptions. The direct tax code is a step towards rationalising it.

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