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Is tax break on pension plans right step?
August, 25th 2010

Last Friday, a top tax official hinted at lower tax rates in the new Bill on direct taxes to be introduced in Parliament this week. He was not revealing a Budget secret. A year ago, the government had promised to lighten the burden for over 3.5 crore taxpayers in the country in the original draft direct taxes code (DTC).

The code, which will replace the five-decade-old Income-Tax Act, has been reworked to accommodate concerns raised by individuals and companies. Several exemptions will stay even with lower tax rates, defeating the goal of having a simple and clutter-free tax regime. A glaring example could be savings schemes that qualify for tax breaks in future.

Tax authorities have cherry-picked savings schemes that will be eligible for tax breaks of up to Rs 1 lakh a year in the new Bill. The door will be shut for bank deposits, equity-linked savings schemes (ELSS) of mutual funds and the principal amount paid on home loans.

A new window, though, will be opened for unit-linked pension plans. The tax break on pension plans will be granted on a case-to-case basis. This means an insurer launching a new unit-linked pension plan will have to approach tax authorities to get a tax break for investors.

The proposed move to empower tax authorities to take a call on granting tax breaks on pension plans is discretionary and, hence, retrograde. Besides, exemptions tied to conditions will make tax laws more complex.

Time and again, the government has acknowledged that exemptions distort tax structure and are a drain on the exchequer. Yet, our direct tax laws are replete with exemptions. This fiscal year, for instance, the government has given an extra tax break of up to Rs 20,000 for individuals investing in infrastructure bonds, saying it was an innovative source to fund long-gestation infrastructure projects. The outgo may not be huge, but the move violates the goal of ending tax exemptions.

Similarly, a few years ago, the government conceded a demand by banks to extend tax benefits to investors parking their money in fixed deposits. Here again, the logic was the money could be used to fund infrastructure projects.

Mutual funds and insurance companies too claimed that tax breaks were needed for ELSS and unit-linked insurance plans (Ulips) to spur infrastructure investment and boost retail investor participation. Net result: more instruments were added to the basket of schemes that qualify for tax breaks under Section 80C of the Income-Tax Act.

Today, there are about 16 schemes including contributions to government provident fund, recognised provident funds, PPF, superannuation funds, LIC premia, National Savings Certificates, ELSS, bank deposits, Ulips, tuition fees and the principal amount paid on home loans that qualify for tax breaks. Tax is exempt at all stages accumulation, contribution and withdrawal in most of these schemes.

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