New Draft Direct Taxes Code may cause

disappointment – The Economic Times

16 Aug 2009, 0228 hrs IST,

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
country’s 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 spiraling
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.
 It 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!

Some 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.

There 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.

In 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.

Some 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

In 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.

The 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.