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Decode the Direct Tax Code
June, 21st 2010

Anagha and Arun, a working couple employed with a private sector firm, have investments in mutual funds and equity markets. They have been hearing of changes being introduced by the Direct Tax Code in bits and pieces, but are yet to figure out how it would impact their investments. Let us look at the changes proposed in revised draft of the DTC and assess what will be the likely impact on investments made in stocks and equity-oriented mutual funds:

Short-term capital gains

Definition: It has been revised to gains made on investments held for less than a year after the financial year in which the investment is made. For instance, if Anagha has made an investment in an equity-oriented mutual fund on May 30, 2010 and sells it before March 31, 2012, it will be categorised as short-term capital gains.

Tax treatment: Currently short term gains are taxed at a flat rate of 15 per cent, but this is set to change. According to the DTC discussion paper, short-term capital gains will be added to income, and be taxed at the marginal tax rate. So the amount of tax will depend on the tax bracket you fall in. For instance, if Anagha falls in the highest tax bracket that attracts a tax of 30 per cent and had a short-term capital gain of Rs 1,00,000, then she will have to shell out Rs 30,000 as tax as against Rs 15,000 currently. However, if Anagha falls in the 10 per cent tax bracket, she will have to shell out only Rs 10,000 as per DTC and not Rs 15,000 as mandated now. Therefore, she will gain more. So

individuals in the lower tax bracket will benefit from this new move.

Long-term capital gains

Definition: Gains made on investment held for at least a year after the financial year in which the investment is made will be categorised as long term. So for Anagha's investment to qualify as long term, she will have to hold her investment in equity mutual funds at least up to 31st March, 2012, in case investment is made in 2010.

Tax treatment: Long-term capital gains will also be clubbed with the income of the investor and taxed at the marginal tax rate. However, the income tax department will not levy tax on the total profit earned. The revenue department plans to introduce a deduction rate, which will be announced later. The deduction rate which will be a per cent of your capital gains will be tax free. If Arun had a long-term capital gain of Rs 1,00,000 and the deduction rate is, say, 40 per cent, then he will not have to pay tax on Rs, 40,000. The balance Rs 60,000 will be added to his income and will be taxed depending on the income tax slab he falls in. If Arun is in the 30 per cent bracket, he would have to pay Rs 18,000 as tax which is an effective rate of 18 per cent. However, if he was in the 10 per cent bracket, the tax he would have to pay would be Rs 6,000 which is an effective rate of 6 per cent. So investors in the lower tax bracket stand to benefit vis-a-viz the higher tax bracket investors.

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