THE NEW DIRECT TAX CODE

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The New Direct Tax Code is proposed to be implemented from the

year 2011. For its smooth implementation, changes in the present system
have to be made on an on going basis. The forth coming budget may
thus be expected to bring about some of the changes for a smoother
transition.

Personal Income Tax Rates

The New Direct Tax Code talks of substantial increase in the tax
slabs for an individual tax assessee. A part of this may be implemented in
forthcoming budget. The Tax Code Bill 2009 talks of increasing the –
-10% slab to Rs 10 lakhs
-20% slab between Rs 10 lakhs to Rs 25 lakhs and
-30% above Rs 25 lakhs.

The difference between the current slabs and the New Direct Tax
Code is very high. The gap may be bridged at least to the mid way or
even slightly higher in this budget.

Perks to be Part of Salary

This will negate the increase in the tax slabs to some extent. The
impact will be felt by all salaried persons as currently items like Leave
Travel Allowance, House Rent Allowance and Medical Reimbursement can be
tax free (or less taxed) if supporting expenses documents are provided. This
budget may not make any sweeping changes in this area, as the New
Direct Tax Code proposed taxable slabs may not be implemented in full.

Reduction in Wealth Tax

Currently Wealth tax is at the rate of 1%. This is proposed to be

reduced to 0.25% in the New Tax Code. This may be implemented
immediately in the budget. The need of the hour is to increase the number
of people who pay wealth tax. The current compliance is very less.
 To better the compliance the slab for the wealth tax has been
proposed to be increased to Rs.50 crores. This is a huge jump from the
current Rs.30 lakhs.

80C Limit Increase

It is proposed in the New Direct Tax Code to increase the 80C limit
to Rs 3 lakhs from the current Rs 1 lakh. There may be a marginal
increase in this limit in the current budget. The increase in limit is
proposed to be applicable to individuals and HUFs (Hindu Unified Families).

EET (Exempt - Exempt - Tax)

The New Direct Tax Code talks of going for EET for most of the
favoured investment and savings avenues of Indians today. Life insurance,
provident funds and superannuation are the schemes that will be affected.
The New Pension Scheme had at the time of launch itself been under the
EET regime. The budget 2010 may include some of the others also in the
EET scheme of taxation.

The benefit to investors however is given by the making the shifting

of investment from one eligible scheme to another eligible scheme not
taxable.

Change in Rate of Capital Gains

The New Direct Tax Code proposes to remove the concept of a

separate Capital Gains Tax rate and tax capital gains at the applicable
income rate itself. This concept may be implemented during this budget
itself, incase the tax slabs are sufficiently raised.

Rent Deduction Reduction

In case of rental income 30% was the deduction allowed for

maintenance of the property. The New Direct Tax code plans to reduce this
to 20%.

Any service tax paid for receiving services related to the house
property is deductible. This is a feature which is currently not available on
any income for individuals.

The current budget may implement the rent deduction reduction

immediately. This will affect those who depend on rental income as their
primary source of income. However the limit hike in the wealth tax and the
service tax benefit will offset the increase in the rental income in a big
way.

DECODING THE DIRECT TAX

CODE
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When archaic rules have to be replaced with new ones, the changes

must be dramatic and path breaking. This is what Union Finance Minister
Pranab Mukherjee conveyed to all taxpayers when he introduced the draft
Direct Tax Code (Tax Code) last week. The Tax Code, now open to public
debate, will be introduced as a Bill in Parliament’s winter session. If
passed, it will become the new Income Tax Act, replacing the existing four
decade old IT Act of 1961. The new IT Act will come into force from April 1,
2011.   

In the foreward to the Tax Code Mukherjee explains that the aim is
to –
- eliminate distortions in the tax structure
- introduce moderate levels of taxation
- expand the tax base
- improve tax compliance
- simplify the language and
- lower tax litigations.

Initial analysis shows that most of these objectives are achievable by

tweaking of some provisions.

Talking to Deccan Herald, KPMG Executive Director Personal Taxation,

IT & ESOP Vikas Vasal said “The new proposals are in the right direction.
They will simplify regulations and reduce unnecessary litigations significantly.”
 Agreed Bangalore Chamber of Industry & Commerce (BCIC) President
K R Girish. “The Code is a completely new law and not an amendment of
the existing Income Tax Act. This is a commendable change as one has
always experienced tinkering of  existing laws, ” observes Girish.  

Major gains for individuals

What do the major changes proposed in the Tax Code look like?
Personal income tax, almost all salaried persons will agree, in our country
is one of the highest in the world. More open and honest an employer is
in terms of disclosing remunerations, worse it is for the employees because
taxable income goes up. The present system thus rewards dishonesty and
non-disclosure of income by way of lower tax.  The Tax Code will try to
address these issues by significantly lowering income tax and by disallowing
all tax-free perks. It proposed exemption of income tax on specified savings
up to Rs 3 lakh a year as against the present deduction limit of Rs 1
lakh for all types of savings under 80C of the IT Act. The catch, however,
is that a few long term investments like public provident fund, employer’s
provident fund, insurance premium in pension (annuity) schemes, Post Office
National Savings Scheme etc will be eligible for tax exemption.

But contributions to fixed deposits, interest and principal payment on

housing loans, educational expenses of dependents, and a host of other
forms of savings will not qualify as eligible for tax savings. The thrust,
clearly, is to induce long term savings for future needs.

The Tax Code also raised income tax slabs significantly, lowering the
tax burden on  individuals. The draft proposed exempting the general tax
payer from paying tax for income up to Rs 1.60 lakh  a year.

According to the proposal,  a tax payer will pay at the rate of 10

per cent for income above Rs 1.60 lakh and up to Rs 10 lakh, at 20 per
cent on income between Rs 10 lakh and Rs 25 lakh and at 30 per cent
for income beyond Rs 25 lakh.

At present, while the basic exemption limit remains at Rs 1.60 lakh a

year, the limit for tax slabs are much lower — one pays 10 per cent tax
on income ranging between Rs 1.60 lakh and Rs 3 lakh, 20 per cent
between Rs 3 lakh and Rs 5 lakh and 30 per cent beyond Rs 5 lakh.
 Thus, for an individual with taxable income of Rs 10 lakh a year tax
payment will drop from Rs 1.68 lakh to Rs 51,000, a net  annual saving
of Rs 1.17 lakh. The exemption limit for women and senior citizens will
continue to be Rs 1.90 lakh and Rs 2.40 lakh, respectively.   
      

Not without pains

If the finance minister is for giving major relief to tax payers, he will
also make sure that there aren’t many avenues to avoid taxes. So, as a
rider, the Tax Code proposes to add all perquisites enjoyed by a tax payer
to income for the purpose of tax calculations. In other words, allowances
like leave travel, furnishings, entertainment expenses, conveyance, medical
etc, will be added to income.  

Similarly, the tax treatment for post-retirement benefits may prove to

be a major dampener. Money saved in specified instruments  like PPF and
PF for getting tax exemption will become taxable when they are  withdrawn
later.

These investments, when accrued, were earlier exempted from  tax.

The Tax Code says that under the Exempt Exempt Tax (EET) system all
withdrawals will attract tax because the  amount withdrawn will be treated
as part of the income for that year.

But in the Tax Code it is unclear if the employee’s contribution to PF

and PPF will be taxed at the time of withdrawal. KPMG’s Vasal says that
this is an anomaly that needs to be corrected. He believes that only the 
employer’s contribution and interest accrued to the account will be taxed.

Though taxing financial gains available after retirement will pinch the
retired people, Vasal is of the view that the proposal is equitable as
income is liable to be taxed at least once.

However, as a relief to senior citizens, tax exemption limits for them

should be raised to Rs 5 lakh per annum instead of Rs 2.40 lakh at
present.  The Tax Code, however, specified that the tax exempt status
currently available to withdrawals would continue to apply to amounts
accumulated in post-retirement savings schemes like PPF, EPF, etc, up to
March 31, 2011. Money that accrues from April 1, 2011 will be taxed on
withdrawal.
Wealth tax benefits

The proposed Tax Code has sought to make  major changes in

wealth tax calculations and rates.

The threshold limit for wealth tax will be raised to Rs 50 crore from
the present Rs 30 lakh and the tax rate was reduced from 1 per cent to
0.25 per cent.

But, in a smart move, to expand the scope of taxation the Tax Code
included financial assets like shares, corporate bonds, fixed deposits, etc in
wealth tax. The valuation of these assets will be done at cost or at market
price, whichever is lower. In case of capital gains tax too, the Tax Code
proposed some sweeping changes. It has done away with the present
system of short-term and long-term capital gain tax, and replaced it with a
uniform structure  and gains will be taxed at the marginal tax rate as
applicable to the tax payer. The implications of these changes are clear:
The period of holding has no bearing on the tax payable and bigger
investors will be taxed at higher rates than the smaller ones.

A mixed bag

For the corporate world, the proposed reduction in the tax rate to 25
per cent from the existing 30 per cent is certainly good news and will help
lowering the tax burden of  India Inc in a big way. But at the same time
the Tax Code proposes to do away with many exemptions that help
lowering the tax. In a significant policy change, the Tax Code plans to
discontinue all profit linked incentives for area-based investments like setting
up plants in a backward area or in the north-east with investment-linked
incentives in specific sectors like infrastructure, power, exploration and oil
production etc.

Moreover, under the new proposal,  tax holiday will not be for a
specific period, as is the case now, but will be equal to all capital and
revenue expenditure barring land, goodwill and debts.

Once a  firm  recovers the permitted investments and  profits will be

taxed. This change is aimed at incentivising capital formation in critical areas
and remove incentives to shift profits from the taxable unit to the exempted
unit.
On the mat

The Tax Code has also proposed changes in the calculation of

minimum alternate tax (MAT) payable by corporates. MAT will now be levied
at 2 per cent of the value of gross assets of a firm in case of all
companies except for banks which will pay tax at 0.25 per cent. This shift
in  MAT from book profits to gross assets is aimed at encouraging  optimal
utilisation and increased efficiency of assets.

But Ernst & Young Partner- Tax & Regulatory Services, Sudhir
Kapadia feels that this proposal seems to run counter to the objective of
encouraging of capital investments for productive growth. Vasal of KPMG
also of the view that changes in MAT rule will cause hardship to loss
making companies as they will have to pay tax on assets.

Carrot and stick

If the Tax Code is generous in giving relief to tax payers, be sure, it

will also make life miserable for those who evade tax through fraudulent
means. As the Tax Code prescribes stiff penalties and prosecution for non-
compliance with the tax laws, it proposes that every tax offense under the
Code will be punishable by both imprisonment and fine. 

Apart from defaulters, the Tax Code proposes to punish tax

consultants who help in tax evasion. It gives sweeping powers and blanket
protection to Income Tax officials for initiating court proceedings on matters
relating to tax offences.
New DTC Bill - lost its original fizz?
The new DTC bill that is likely to be passed in the parliament on Monday was expected to introduce a sea
change in the ways taxation took place in the country, while the final proposal does not translate to the hype
much, feel most salaried tax payers.

However, the Government has stressed that though in terms of savings there may not be a drastic change as proposed
earlier, the New Direct Tax code will effectively replace the old tax system and offer a much simpler format in the
collection of taxes.

Also, the earlier proposal of introducing taxation upon withdrawal (EET) instead of the existing tax free (EEE) status for
certain instruments like PPF etc. had earlier been withdrawn in a revision. If that were to be implemented perhaps the tax
slabs could have led to a dramatic saving for all the individuals in different tax brackets. So overall there have been
adjustments all around to create a balance in accumulating government revenues from tax.

Let's take a quick look at how the salaried class will be affected post the implementation of the New Direct Tax code in its
latest avatar.

New Direct Tax code Slabs

FOR MEN
2L -5L - 10%
5L - 10 L - 20%
Above 10L - 30%

Slab 1: Total income is lesser than Rs 2, 00,000/-

The income tax for the above slab is proposed to be nil. Earlier this was restricted to individuals earning below 1.6 Lakhs.

Slab 2: Income is between 2, 00,001/- and Rs 5, 00,000/-

The tax for the above slab is proposed to be 10 percent of the amount by which the total income exceeds 2, 00,000/-.
Meaning, if your income is 4, 72,000/- then, the income tax would be 10% of (Rs 4, 72,000-Rs 2, 00,000/-). This brings
cheer for individuals earning between 3-5 lakh as they straight away save 10% of any income that exceeds 3 lakhs but is
lesser than 5 lakhs. Today they have to pay 20% on this amount! So if you are income is say Rs.4L, then your tax
savings would roughly work out to Rs.7000 once the new DTC is implemented.

Slab 3: Income is between 5,00,001 and 10,00,000

The code proposes the income tax for this slab to be Rs 30,000/- (10% of 3,00,000/-) plus 20% of any amount above
5,00,001 but lesser than 10,00,000. So for instance if you are earning Rs.7L, your tax saving post New DTC will be
roughly around Rs. 10,000 and if you are earning exactly Rs.10L, you can approximately save around Rs. 18,500
compared to the current tax outgo.

Slab 4: Income exceeds 10,00,000/-

The code proposes the income tax for this slab to be Rs. 1,30,000 plus 30% of any amount exceeding Rs 10,00,000/-.

The maximum tax saving to be had if the earlier proposal was implemented would have worked out to a super save of
around Rs.2L, while currently this would only work out to around Rs.26,000 in a financial year for a woman earning a little
above Rs.10 L.

Senior citizens and women will enjoy a higher exemption of up to 2.5 lakh. Currently the exemption limit is Rs.1.9L for
women and Rs.2.4L for Senior Citizens.

Also, There will be no surcharge or cess on companies, thereby bringing the corporate tax rate to 30% from the current
34%. Also, this will be uniform across both foreign and domestic companies.

Q+A - India's proposed direct tax code

The cabinet approved a new direct tax code on Thursday that will replace archaic income and wealth tax
laws in the country, a key reform initiative that is aimed at widening the tax net and increasing federal
revenues.

The direct tax code bill will now be placed before parliament for approval on Monday. The government aims
to implement it from April 1, 2011.
Here are some questions regarding the tax reform.

WHAT IS THE DIRECT TAX CODE ALL ABOUT?

India wants to modernise its direct tax laws, mainly its income tax act which is now nearly 50 years old. The
government, wants a modern tax code in step with the needs of an economy which is now the third largest in
Asia.

The new tax code is expected to widen the tax base, end unnecessary exemptions, moderate tax rates and
add to the government's coffers.

The federal budget has estimated about $92 billion in direct tax receipts for the year that ends in March
2011.

WHY IS IT IMPORTANT FOR INDIAN FIRMS AND FOREIGN INVESTORS?

One of the key aims of the new tax code is to provide a system which takes into account increased cross
border mergers and acquisitions by Indian corporates over the last few years.

The new code is also expected to streamline tax rates and administration for foreign institutional investors,
for whom India is a top destination.

Despite the crisis in the euro zone, capital flows have been robust this year with an inflow of $8.5 billion so
far.

WILL IT PROVIDE GREATER STABILITY TO INVESTORS?

The code aims to provide greater tax clarity and stability to investors who want to invest in Indian projects
and companies.

These officials have said the government would not like to tinker with tax rates every year to provide a
greater degree of tax certainty to corporates, investors and individuals.

WHAT WILL BE THE IMPACT ON INDIAN AND FOREIGN CORPORATES?

On the face of it, the corporate tax rate has been reduced from a little over 33 percent to 30 percent. But tax
experts say whether a company pays more tax or less will also depend on a key provision called the
minimum alternate tax (MAT).

MAT is applicable to those companies who do not show book profits liable to tax, as they claim a plethora of
exemptions on account of being in capital intensive industries. The MAT rate has now been increased from
18 to 20 percent in the new code.

Foreign corporates today pay a higher rate of tax. However, the new rate of taxation for foreign corporates is
not yet known.

WILL IT BE REVENUE POSITIVE FOR THE GOVERNMENT?

The government has marginally lowered the tax burden for individuals and has effectively left corporates with
largely similar tax rates as before, hoping that these changes will make the new code revenue positive.

Though the exact impact is not yet known, finance ministry officials have said the new code will help shore
up the tax GDP ratio significantly from around the current 11 percent level.

WILL THE ANNUAL BUDGET BE LESS IMPORTANT?

An important part of the budget every year has been the detailing of the tax rates. However, with the
introduction of the new direct tax code, the tax rates will not be part of the budget presented to Parliament
every year.

DTC's wider tax slabs to benefit all

In what could be a big relief to individual taxpayers, the government has proposed a widening of the three-
tier slab structure, with the lowest rate of 10% for Rs 2-5 lakh taxable income, 20% for Rs 5-10 lakh and 30%
for higher income.

The current slabs are Rs 1.6-5 lakh, Rs 5-8 lakh and above Rs 8 lakh respectively. Tax experts said this
would bring significant benefits to taxpayers across the slabs.

The Direct Taxes Code (DTC) Bill cleared by Cabinet on Thursday also proposed a 30% corporate tax rate
(for domestic companies) sans surcharge or cess. Though this falls short of the proposal in the DTC draft
released earlier to bring down the rate to 25%, there would still be nearly a 4 percentage point difference
from the current rate which is inclusive of surcharge and cess.

The DTC Bill will now be introduced in Parliament.

The effective tax rate (ETR) for most companies is in the range of 18-20% at present, thanks to depreciation
and other forms of expenses allowed. According to Ajit Krishnan, partner, Ernst & Young, in the DTC
regime, the ETR would not change substantially for most companies in the manufacturing industry, while
some infrastructure companies could see their tax liability going up a bit on account of the removal of
exemptions. But oil and gas companies have little to worry about as the government has committed to retain
the capital subsidy scheme for them.

The DTC regime would, however, bring IT companies on par with other firms as the tax holiday for export
income could go.

Current corporate tax rate is also 30%, but inclusive of a 10% surcharge and a 3% education cess, the tax
rate works out to be 33.99%.

After the Cabinet meeting, finance minister Pranab Mukherjee said: "The whole objective (of DTC) is that a
plethora of exemptions will be removed. (Income) tax slabs will be three. Rate of taxes will be taken in the
schedule (of the bill) so that they need not be changed every year."

In June this year, the government brought out a revised discussion paper on DTC in which it addressed a lot
of concerns raised by the original draft released last year.

For companies, the biggest relief was withdrawal of minimum alternate tax (MAT) based on gross assets and
restoration of MAT regime linked to book profit. It was also clarified that savings in Public Provident Fund
(PPF), other employee provident funds, New Pension Scheme and pure life insurance products and annuity
schemes will not be subjected to tax at any stage.

The much-sought incentive for SEZ units was, however, not granted. Only limited relief was given in terms of
grandfathering of profit-linked incentive for existing SEZ units which will be operational at the time of
implementation of the code.
Top 5 saving options
The interest rates are rising. It is good news for some - those who look at making deposits; bad news for
some - those who are looking at taking loans. Savings however have to be channeled carefully so that the
maximum can be gained from the deposits. Here are the top 5 savings instruments in a rising interest rate
regime.

In today's scenario the top 5 savings instruments are:

1. Debt Mutual Funds
2. Mutual Fund Monthly Income Plan - Growth Option
3. Company Deposits
4. Post Office Recurring Deposit
5. Post Office Monthly Income Scheme

Debt Mutual Funds

These are managed funds that invest the funds from the investors predominantly in debt and debt oriented schemes.

There are a number of advantages that these mutual funds give compared to a direct deposit. The most apparent is the
fact that this is a managed fund and the returns can be better as the manager has access to more information and will
leverage that compared to individual investors. There is no TDS or tax on the interest. The returns will be processed as
capital gains.

Returns from this fund are expected to be good. The top five debt mutual funds have given compounded returns in the
range of 10.50-14.50% in the last 3 years. This is much better than the normal bank deposit or company deposit. The
advantage is that debt mutual funds can create capital gains when the interest rates go down.

Mutual Fund Monthly Income Plan - Growth Option

For people who have a higher risk quoitent during the short term, monthly income plan (MIP) of mutual funds is good.
Here a small portion (generally not more than 20%) of the funds is invested in equity. So the returns can be better than
the normal debt mutual fund when the market is rising. The typical returns in the last 3 years are 12% to 14% for the top
5 funds.

However caution needs to be taken when choosing the growth option. This is due to the fact that if we start to receive the
monthly payouts there may be months when the principal is used for the payout. This will drain the fund particularly when
the market goes down.

Being largely a debt oriented mutual fund, the tax treatment is the same as the debt mutual fund.

Company Deposits

Companies that offer deposit schemes to consumers tend to offer rates that are in-between bank deposit rates and bank
lending rates. This is a win-win situation for the company and the person saving.
The bank has to make a profit when borrowing from the public and lending to companies. So they have an interest rate
difference (spread) of about 4.5%. In effect, the deposit holders are paid less and the borrowers are charged more.
When a company has direct access to the depositor, both benefit. The depositor gets a better rate than what the bank
can offer and the company is able to borrow at a lesser rate when compared to a bank interest rate.

However, it is in the best interest of the borrower to do his research thoroughly and double check how good the credit
rating of the company is before investing. On an average estimates show that one can easily get 11% - 12% on reputed
companies' deposits for a 3 year term.

The returns will be taxed as interest and will have TDS.

Post Office Recurring Deposit

This is a 5 year scheme where one invests on a monthly basis. However, there does exist an option for the fund to be
closed after 3 years, which comes with a penalty of 1%. The advantage with the postal recurring deposit over the bank
recurring deposit is that the minimum monthly investment is only Rs.10/- with no upper limit. In case the payment is
made once is 6 months or on a yearly basis, there are discounts for that too.

The limitation is that the interest rate is fixed at 7.5% only and auto-debit to bank account is not available.

There are no tax benefits from the scheme. However Post Offices have not been deducting TDS.

Post Office Monthly Income Scheme

For the retired people, the Post Office Monthly Income Scheme is a good savings instrument. The interest is 8% divided
on a monthly payout basis. The payout if not required can be channeled to a recurring deposit. The effective returns
increases by almost 10% by doing this.

The interest can be credited to a savings account of any bank too. The account can be closed after 1 year with a 5%
penalty and after 3 years without any penalty. The limitation however is that the maximum investment for any individual is
only Rs.6 L.

The ranking of the above 5 savings schemes have been done based on their returns, the convenience factor to close
and change to another savings scheme (important when the interest rate is rising) and the safety for investments. Of all
the options the debt mutual funds appear to score the highest due to their flexibility and returns. This is closely followed
by the mutual fund MIPs.