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Revised Direct Taxes Code
August, 11th 2010

Though the tax exemption for long-term capital gains from equities was taken away, there were other rewards waiting for patient investors.

What could possibly be wrong with a bill that exempts retirement savings from taxation, charges tax at a lower rate on certain capital gains and restores the tax-free status of some allowances? The revised Direct Taxes Code (DTC) does this and more. Yet, the average taxpayer stands to lose from the watereddown provisions of one of the most important tax reforms in decades.

Goodbye to simplicitY:
When the original DTC was made public in August 2009, one of its main objectives was to simplify the rules and make the tax structure more equitable. It proposed to remove the distinction between long-term and short-term gains and tax all types of income-from stocks, bonds, gold, real estate or artifacts-at a uniform rate. Though the tax exemption for long-term capital gains from equities was taken away, there were other rewards waiting for patient investors.

The DTC offered indexation benefits for equity investments. Indexation adjusts the purchase price of an asset with inflation during the holding period, thus reducing the capital gains and tax payable on this. Also, investors could carry forward losses and adjust them against future gains.

However, the revised DTC has proposed a complex calculation for tax on long-term capital gains from equities. Investors will be allowed a deduction on the long-term gains and the balance amount will be taxed at the marginal rate. Worse, investors will no longer be allowed to claim indexation benefits or carry forward losses from equities.

What's wrong with eee? The DTC proposal to tax retirement savings at the time of withdrawal had evoked loud protests. The shift from the exemptexempt-exempt (EEE) regime to the exempt-exempt-tax (EET) model was perceived as radical and insensitive. The critics missed the woods for the trees.

The EEE model encourages premature withdrawals. If there were a tax on withdrawals, an investor would think twice before taking money from his retirement corpus while he is still in the high-income bracket. By reverting to EEE, the revised draft goes against the basic principle of retirement planning: investments gain from the power of compounding.

Penny wise, pound foolish:
To ease the burden on taxpayers, the DTC had introduced very liberal tax slabs. For a person earning Rs 12 lakh a year, the tax would be only Rs 74,000, an effective rate of about 6%. But the government may now be forced to tweak the slabs to account for the shortfall in revenues due to the EEE regime and lower tax on capital gains. If the slabs are changed, taxpayers may lose more than they gain.

Even so, the revised draft has some good points. Till now, income from pension products was taxable. It will now be exempt, which renders NPS and other pension plans attractive.

Secondly, it has clarified that income from insurance plans shall be taxed with prospective effect. It has also restored the tax deduction on home loans, which must come as a relief for millions of borrowers who had factored in the tax savings before going in for a home loan.

 
 
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