New Draft Direct Taxes Code may cause disappointment
August, 17th 2009
As promised by the finance minister in his Budget Day speech in July, the New Draft Direct Taxes Code was released for public discussion on August 12. The stated intent is to fulfil the long-standing and ambitious plan of simplifying the countrys complex direct tax laws to make it simpler and easier for tax payers to comply with. The stated focus of the code is to improve the efficiency and equity of the Indian tax system, by introducing moderate levels of taxation and expanding the tax base. The code also brings all other direct taxes like wealth tax under its purview. If enacted in the current state, the code will come into effect from April 1, 2011.
This article highlights the key proposals which would directly impact individual taxation. Though the tax rates largely remain the same, the income slabs have been significantly increased to take into account realistic income levels (see table). The highest tax rate of 30% now kicks in only if taxable income in a year exceeds Rs 25 lakh. Further, the good news is that surcharge and cess, which used to add another 2-4% to the tax rates, are proposed to be abolished.
The proposed changes would immediately increase the levels of take-home pay or net income to all categories of tax payers. Of course, the extent of savings would differ in different categories of income ranges. This move is welcome as it would put more cash into the hands of the individuals to spend thereby increasing consumption and giving a boost to the economy.
Another important proposal is to increase the maximum limit for tax deductions on account of savings in prescribed instruments (under the popular Section 80C) from Rs 1 lakh to Rs 3 lakh. However, the list of investments eligible for such deductions has shrunk. Included are insurance premiums, contributions to approved provident fund, new pension system trusts and approved superannuation fund. The most interesting new item in this list is payment of tuition fees towards children education (for two children). This would serve as a big relief to households struggling to meet and balance the spiralling education costs of their children. Some of the investment avenues currently available under Section 80C that are absent in the proposals are: deposits with banks, repayment of principal for any housing loan taken, and investment in PPF etc.
There are several clauses in the code which will give reason to the taxpayer to smile. On the other hand, there are some proposed reductions/removals in the existing deductions as well, which are bound to cause disappointment.
nIt is proposed that tax deduction which is currently available to employed persons on account of House Rent Allowance (HRA) provided the employee actually pays rent be removed. This proposed removal of exemption on HRA will be a point of considerable disappointment to many salaried employees and is surely going to generate a lot of debate!
It has so far been an important source of tax savings to persons living in costly cities who do not own homes. With the deductions on home loans also going away, employed individuals will find housing costs suddenly going up with no tax breaks on either rented homes or loans taken to buy properties!
nSome other allowances and reimbursements which are at present fully or partly tax-free and are sought to be taxed under the code are: leave travel allowance, medical reimbursement, etc. While doing away with these items would cause most of us some degree of misery, we should recall that the finance minister has been fairly generous in increasing the slab rates to more than compensate. In fact, this is squarely in line with the general direction of eliminating tax exemptions and deductions along with rationalising tax slabs and rates.
nThere are a few important changes proposed in the case of rental incomes from house property, the current deduction rate of 30% of gross rent for repairs etc is proposed to be reduced to 20%. In addition, the deduction granted of interest on housing loan in case of self occupied house property is sought to be removed (currently, interest cost not exceeding Rs 150,000 is allowed as a deduction). Hence there are no benefits available for loans taken for self occupied house property.
nIn terms of long-term savings for retrials, the code aims to introduce the concepts of EET-based taxation. Savings would be exempt (E) at the time of investment, the accumulations to it would also be exempt (E) through the terms of the investment, but on withdrawal, the entire amount would be taxed (T) in the hands of the taxpayer. This change does not compare favourably with the existing regime of an Exempt-Exempt- Exempt (EEE) structure for savings such as Provident Funds.
The code also provides that any amount received under the scheme of voluntary retirement, gratuity received on retirement or death, commuted pension would be exempt if the same is transferred into a fund designated as the Retirement Benefits account. The amount deposited would then be taxable only in the year in which it is withdrawn.
Hence, while these retirement savings are exempt up to prescribed limits now, they would become fully taxable in the year of withdrawal once the code comes into force. However, it has been clarified that the amount of accumulated balance as on March 31, 2011, in the account of an employee participating in an approved provident fund and any accretion thereto shall be excluded from taxation.
As this proposal would have far reaching impact on almost the entire working population of the country (including blue-collared workers), it is likely to be a matter of considerable debate and discussion. It remains to be seen how it finally takes shape.
nSome significant changes are proposed in the area of capital gains tax. Security transaction tax (STT) is proposed to be abolished and all capital gains would now be taxable as any other regular income! Therefore, persons indulging in the stock market may need to shell out more taxes!
Other changes proposed are:
Firstly, distinction between short-term investment asset and long-term investment asset is sought to be eliminated. Next, assets held for more than one year are entitled to indexation benefit (currently for shares /security the period of holding is one year, and for other assets the period is three years). Further, losses under the head capital gains would not be allowed to be set off against income under other heads. Finally, such loss would be allowed to be carried forward indefinitely.
nIn terms of wealth tax ( now brought under the Code itself), Individuals, HUF and private discretionary trusts liable to wealth tax on specified assets. Net wealth in excess of Rs 50 crore (substantially up from the current Rs 3 lakh) to be chargeable to wealth-tax at the rate of 0.25% (as compared to the current 1%). However, the definition of wealth has been extended to include amongst others, financial assets like shares and securities.
nThe due date of filing of tax returns has been advanced to June 30 from July 31 for individuals so watch out for more work to be done in April and May!
Let us take the example of three persons at different levels in an organisation. As seen from the table, the new tax code offers substantial relief from taxes for these three categories of tax payers. Hence, the proposed code does provide the tax payer substantial relief by increasing the slabs, but at the same time, it also takes away the exemptions and deductions which were available to the common man and which we have become so used too!
All in all, there may be a need to review implications at an individual level and relook at the current portfolios and potential tax impact though we will all be waiting to see what the final code looks like and when it gets cleared by the Parliament.