On a cool Sunday
evening, a Child walks on a beach with gay abandon. She starts to build a
castle in the sand. She collects sand and arranges it into a big heap. She
tries to mould it as per her imagination. After sometime, she completes the
sand castle and she goes around the castle merrily – laughing, cheering and
shouting.
This attracts some
other people loitering on the beach. They come and start inspecting the castle.
Some applaud it and some suggest little changes to the castle to make it more
beautiful. First the child is confused about making the changes. At last, she
obliges the onlookers’ advice and makes alterations with some tinkering to the
minarets here and to the windows there.
Now, more onlookers
start giving advice on making it look more wonderful. The child listens
patiently to them and makes more alterations with her tender hands. Then a
disaster strikes. The castle suddenly collapses due to too many alterations.
Disappointed by it, the child walks home with a heavy heart.
Some of you may be wondering what this is all about! The
above story sums up the predicament of the Government of India in bringing about
several amendments to the Direct Taxes Code (DTC). It may be recalled that the
Government had brought out a Revised Discussion Paper (RDP) on 15th
of June 2010 making certain changes to the draft DTC Bill which was released in
August 2009. The Government has apparently messed up the whole issue of bringing
a transparent DTC, which could have been understandable easily by ordinary
persons; providing stability, equality and clarity; and without any
distortions. This article provides a critical analysis of important issues in
the DTC proposals.
The impact is explained with catchy photographs!
The article is organized on the following lines:
|
A critical analysis of the Capital Gains tax on shares
|
Why flip-flops are not good for the overall tax efficiency
|
Background to abolition of long-term capital gains in 2003/2004
|
Is 25 per cent Public Shareholding a joke?
|
Why it is a mixed bag for individuals and salaried class
|
A big climb down and dilution of reforms by the Government
|
|
The following important annexures are given at the end of
this article: (A
must-read for all investors, taxpayeers and market players)
|
Annexure I : Difference
between EEE and EET methods
|
Annexure II : The Six
Pack!
|
Annexure III : Types of tax exemptions that may be continued
after DTC
|
Annexure IV : Types of tax exemptions that may be withdrawn
after DTC
|
|
Abbreviations Used:
DDT-Dividend
Distribution Tax
|
PFRDA-Pension
Fund Regulatory and
|
DTC
2009-Direct Taxes Code August 2009
|
Development Authority
|
EEE-Exempt,
Exempt & Exempt
|
LTCG-Long-term capital gains
|
EET-Exempt,
Exempt & Tax
|
PPF-Public
Provident Fund
|
ELSS-Equity
Linked Savings Scheme
|
RDP-Revised
Discussion Paper of DTC
|
of the mutual funds
|
released by Govt on 15.6.2010
|
EPF-Employee
Provident Fund
|
STCG-Short-term
Capital Gains
|
GPF-Government
Provident Fund
|
SCSS-Senior
Citizen Savings Scheme
|
IT
Act-Income Tax Act, 1961
|
STT-Securities
Transaction Tax
|
LTC-Leave
Travel Concession
|
MAT-Minimum
Alternative Tax
|
NPS-New
Pension System administered
|
ULIP-Unit
Linked Insurance Plan of
|
by PFRDA
|
insurance companies
|
NSC-National
Savings Certificate
|
|
PF-Provident
Fund
|
VPF-Voluntary
Provident Fund
|
When it was conceived in August 2009, the
proposed DTC is supposed to be a single code for all direct taxes, like, Income
Tax, Corporation Tax, MAT, DDT, wealth tax, etc. Written in simple language and
direct voice, the DTC is expected to be more transparent compared to the
existing direct tax laws. It seeks to encourage simplification and aims for
stable taxes and better tax compliance.
Some of the provisions, like the Minimum
Alternative Tax (MAT) on gross assets, introduction of EET regime and removing
several tax exemptions have not been received with enthusiasm by the affected people.
After receiving several representations from various stakeholders, the
Government on 15th of June 2010 released a Revised Discussion Paper
(RDP). This RDP has restored some tax exemptions for certain schemes bringing
relief to several people. It has decided to continue with the existing system
of taxing MAT on the basis of book profits.
Messy
Capital Gains Tax!
However, in one area the Government has messed
up a lot. That is capital gains. The RDP proposes to change the very definition
of short-term capital gain (STCG) and long-term capital gain (LTCG). Long-term
capital gain on listed equity shares and equity mutual funds are taxed at zero
rate as of now. Now, the RDP proposes to introduce a system of including LTCG
in one’s income and taxing LTCG at the tax rate applicable to the taxpayer,
after adjusting the LTCG with a specified
discount rate. The Government has said that the specified discount rate
would be announced while introducing the DTC Bill in Parliament. This kind of
flip-flop of LTCG relating to shares and mutual funds is detrimental to the
long-term investments. Strangely, the Government seems to be encouraging
short-term gambling in equities rather than
long-term investments.
Is 25 per
cent Public Shareholding a joke?
The Government has recently come out with norms
for making 25 per cent public shareholding compulsory in companies listed on
stock exchanges. One fails to understand how the Government can increase the
public shareholding to 25 per cent without encouraging long-term investments in
shares and mutual funds.
When tax rates are changed frequently without
any predictability, it changes the behaviour of investors and market players in
a big way. Let us go back a little and see the amendments to LTCG relating to
listed equity shares and equity mutual funds.
Taxes on
STCG and LTCG before 2003:
Prior to 2003, STCG on shares was taxed at 30
per cent; and LTCG was taxed at 20 per cent with indexation benefits. There was
no STT at that time.
UNION
BUDGET 2003-04:
As per the Union Budget for 2003-04, long term
capital gains (LTCG) on company equity shares (listed on any recognized stock
exchange in India) was exempted from tax for shares acquired on or after March
1, 2003 but before March 1, 2004. This was made applicable from April 1, 2004
and was applicable for assessment year 2004-05 and for subsequent years. The
intention of the then Government behind the tax exemption for LTCG on listed
equity shares for a limited period was to “give incentive for investment in
equity shares.”
The then finance minister, Yashwant Sinha, told
the Parliament, during his budget speech in his own words:
“We need to improve the industrial sector and
improve the equity markets”
“I am also committed to bringing the small
investors back to the capital markets by restoring their confidence”
“In order to give a further fillip to the
capital markets, it is proposed to exempt all long-term capital gains from tax
for equity shares bought for a period of one year from March 1, 2003, and sold
after a one year…”
UNION
BUDGET 2004-05:
Now, you see P.Chidambaram’s, the then finance
minister, spin on the rationale behind the abolition of LTCG while presenting
the Budget 2004-05 to Parliament:
“Capital gains tax is
another vexed issue… I’ve decided to make a beginning by revamping taxes on
securities transactions…Our founding fathers wisely included entry 90 in the Union
List in the seventh Schedule of the Constitution of India.
“Taking a cue from that entry, I propose to
abolish the tax on long-term capital gains from securities transactions
altogether. Instead, I propose to levy a small tax on transactions in
securities on stock exchanges. The rate will be 0.15 per cent of the value of
security. My calculation shows that the new tax regime will be a win-win
situation for all concerned.”
This was done with a view to simplifying the tax
structure on securities transactions, as per the Explanatory Memorandum to the
Union Budget 2004-05. Accordingly, tax on LTCG was removed and tax on STCG was
reduced to 10 per cent. And in the place of ‘nil tax’ on LTCG on securities
transactions, a new tax called Securities Transaction Tax (STT) was introduced
by P.Chidambaram.
Unfortunately,
STT stays!:
When the tax on long-term capital gain was abolished by the
then Finance Minister while presenting the Union Budget 2004-05, the FM
introduced STT to fill the tax revenue gap caused by the abolition of LTCG.
Unfortunately, the RDP says that STT will be revised suitably. Now, equity
investors will have to pay both the STT and LTCG once DTC comes into force,
which was not the case prior to the introduction of STT in 2004.
Current
provisions:
As of now, STCG on shares is taxed at 15 per
cent while LTCG is completely exempt from tax. And the RDP proposes to include
STCG in one’s income and pay tax as per rate applicable to taxpayer; and LTCG
will be given a specified discount rate and taxes as per taxpayer’s marginal
tax rate. This is completely in contrast to what the previous finance
ministers, Yashwant Sinha and P.Chidambaram had committed in Parliament while
removing LTCG on shares.
Does it mean to say that as of now public
participation in capital markets has improved compared to 2003/2004? Everyone
in India knows that share of
equities in India’s
total savings is at a bare minimum of between 2 to 5 per cent.
To
know more on the latest amendments given in RDP, just click:
(In fact, the RDP does not use the words, short-term
capital gain or long-term capital gain. For the sake of simplicity and better
understanding, the words STCG and LTCG are used as they have been in existence
for more than five decades.)
Sweet and
Sour!
The Revised Discussion Paper is a kind of mixed bag for
individuals and salaried class. The Government has now decided to provide tax
exemption at the time of withdrawal (EEE method), even though for six types of
investments only.
To know about the difference between EEE method, EET method
and such eligible investments, see Annexures I to IV given at the end of this
article.
Everything has a price. Take for example, the Indian public
are very happy with the subsidy on petrol, diesel, LPG & kerosene. But,
ultimately, the entire economy is paying the price for the subsidy as the
subsidies are paid through the Union Budget! The cost of everything has to be
paid by someone, i.e., the public.
In the original DTC, the Government had proposed to remove
exemptions; while simultaneously reducing tax rates and increasing tax slabs.
But due to public outcry, Government has now said it would restore certain tax
exemptions. As the tax base comes down, the Government will not be in a
position to reduce tax rates and increase tax slabs as proposed in the original
DTC in August 2009. The net effect will be the same for public! (It may be
recalled that it was proposed, in the draft DTC of August 2009, to increase the
present exemption of Rs one lakh under Section 80C of the Income Tax Act to Rs
three lakh and increase the tax slabs – up to Rs 10 lakh at 10 per cent; above
Rs 10 lakh to Rs 25 lakh at 20 per cent; and above Rs 25 lakh at 30 per cent.)
At this stage, it would be instructive to know the original
objectives of the Government while drafting a Direct Taxes Code Bill in August
2009. They were:
1.
Providing stability: At present, the rates of taxes are stipulated in the Finance Act of
the relevant year. Therefore, there is a certain degree of uncertainty and
instability in the prevailing rates of taxes. Under the Code, all rates of
taxes are proposed to be prescribed in the Direct Taxes Code itself thereby
eliminating the need for an annual Finance Bill. The changes in the rates, if
any, will be done through appropriate amendments to DTC brought before
Parliament in the form of an Amendment Bill.
2.
All
the direct taxes – income tax, corporation tax, dividend distribution tax,
minimum alternative tax & wealth tax – were brought under a single code
3.
A
very simple language was used in drafting the code so that an ordinary person
also can understand the provisions of the law
4.
By
reducing vagueness in the provisions, the Government aimed at reducing the scope
for litigation between taxpayer and tax administration
It is very sad to read the contents of Revised Discussion Paper
(RDP) released a week back. The Government has failed to provide clarity on
many issues, like:
Ø
What will be tax rates and tax slabs
Ø
What is the specified discount rate for adjustment to LTCG on
shares
Ø
No clarity what type of savings instruments would attract EET
method
Ø
There is no reference as to whether principal paid toward
instalments of loans taken for constructing a house property would be allowed
tax deduction (The RDP has clarified that interest up to Rs 1.50 lakh would
continue to be eligible for tax exemption).
Ø
The RDP has failed to indicate what the rate of MAT would be
The refrain now is that the legislature is the ultimate authority
for deciding tax rates! It may be recalled that the original DTC 2009 had
provided rates & slabs.
How to
tweak your investments?
It appears that the RDP encourages tax evasion
and avoidance and it does not bring any equity to the tax system. It fails to
provide transparency and remove distortions in the present direct taxes regime.
There are various methods to protect our
interests, in a legal manner, in relation to tax exemptions and liabilities. We
need to show a little ingenuity and look for ways to protect our interests
under the existing laws.
Let us hope that the Government would provide a
reasonable transition period for investors and more clarity would exist when
the real DTC Bill is presented in Parliament in the next few months.
Look at
them with fresh pair of eyes!
Any direct taxes regime that is transparent,
clear and simple to understand is very good for the economy as a whole. As
taxpayers, we need to encourage any sincere attempts by the Government to clean
up the existing messy laws. We shall be able to see the broader picture which
will benefit the entire economy rather than a few individuals or smaller
groups. Tax laws have to be amended keeping the ever changing economic and
social environment in mind.
We need to look at the new Code with fresh eyes
without any old baggage. Theoretically, the concept of EET, removal of all
kinds of tax incentives/concessions, and clubbing all sums under taxable
income, are sound and beneficial in the long-term. However, India is beset
with its own set of peculiarities, lack of social security system, contradictions
and problems as far as increasing tax base and administering taxes is
concerned. We need to change our mindset – not only taxpayers, but also those
in the tax administration and implementation.
To read other important document on Direct Taxes Code, just click:
This explains why the Government seems to be encouraging PURE
GAMBLING rather than providing incentives for long-term investments in
equities.
To sum up:
The entire
DTC exercise now looks very blurred!
WHAT IS THE DIFFERENCE
BETWEEN EEE and EET METHOD?
The present system is called ‘EEE’ meaning investments enjoy
benefits in three stages: 1). Exemption allowed at the time initial
contribution, 2). Exemption through out the accumulation period, and 3).
Exemption at the time of withdrawal. (EEE stands for Exempt, Exempt and
Exempt).
It was proposed in the DTC 2009 that the EET method will apply for
new contributions made after the commencement of the DTC. The DTC 2009 had
proposed to shift to a new system called ‘EET’ whereby exemption would be
allowed at the time of initial investment and accumulation period only; but the
withdrawals will be included in the taxable income and taxed according to one’s
tax slabs. (EET stands for Exempt, Exempt and Tax).
The Six Pack!
As the Revised Discussion Paper released on 15th
of June 2010, The Government will continue to provide EEE method of tax
treatment to the following savings instruments:
|
Government Provident
Fund
|
Recognised Provident
Funds
|
Public Provident Fund
Scheme
|
New Pension System
(NPS) of the PFRDA #
|
Approved pure life
insurance products *
|
Annuity schemes
|
|
* There is a lot of confusion as the Government has not defined what an
‘approved pure life
insurance product’ is. Some experts believe that it refers to pure term
insurance policies.
# At present NPS is under EET
method; after DTC it would be under EEE method
The above mentioned six instruments will continue to
attract the current favourable tax treatment at all the three stages: 1. at the
time of investment, 2. during the accumulation period, and 3. at the time of
withdrawal. The investors can continue investments in the above six even after
the DTC comes into force.
The following tax exemptions
are likely to be continued even after DTC:
It is
interpreted from the DTC Bill 2009 and RDP, that the Government in all
likelihood will continue with the following exemptions and incentives:
A. DEDUCTIONS THAT WILL BE ALLOWED FOR
SALARIED CLASS ON THEIR GROSS SALARY:
|
1. Professional tax paid
|
2. Transport allowance as per limits
|
3. Allowances incurred for official purposes
|
4. Compensation received under Voluntary Retirement Scheme
|
5. Gratuity received on retirement or upon death
|
6. Amount received on commutation of pension
|
|
B. DEDUCTIONS THAT MAY BE ALLOWED WHILE
COMPUTING TOTAL INCOME:
As per the proposals of the draft DTC 2009 and the Revised
Discussion Paper, the following deductions may be allowed for individuals/salaried
class:
ü
Interest
paid up to Rs 1.50 lakh per annum on housing loan for self-occupied property
ü
Tuition fee paid to a college/school in India
for full-time education of two children of an individual/HUF is eligible for
deduction
ü
An
individual shall be allowed a deduction in respect of any amount actually paid
by him in the financial year by way of interest on loan taken by him from any
financial institution for the purpose of:
(a)
pursuing his/her higher education; or
(b) higher education of
his/her relatives.
ü
Health insurance premium of up to Rs 15,000 (Rs
20,000 for senior citizens) will be allowed as deduction for an individual/HUF.
For health insurance on the health of his/her parents, an additional deduction
of Rs 15,000 (Rs 20,000 if the parents are senior citizens) will be allowed .
ü
An individual will be allowed a deduction of up to
Rs 40,000 (Rs 60,000 for senior citizens) for medical treatment of self or
dependents
ü
An
individual/HUF will be allowed a deduction of up to Rs 50,000 (Rs 1 lakh for
severe disability) for medical treatment of a disabled dependant
ü
A
person shall be allowed a deduction of up to 125% of donations made to
laboratories and colleges engaged in scientific/statistical/social sciences
research. A person shall be allowed a deduction of up to 100% of the donations
made to PM National Relief Fund, CM Relief Fund, etc. And in other cases, 50%
deduction is allowed for donations made to certain organisations.
ü
Dividends will not attract tax in the hands of the
recipient if such dividend distributed by companies has suffered Dividend
Distribution Tax (DDT) at the applicable rate. (The DTC 2009 has proposed to
levy 15 per cent DDT.)
In the light of the overall tax exemptions, tax rates and tax
slabs, the Government may change any of the above tax incentives/exemptions
mentioned in part A and B above while presenting the DTC Bill 2009 in
Parliament in the next few months.
As per Section 80C of IT Act, an individual or HUF is eligible to
get tax exemption up to Rs one lakh per annum in certain notified savings
instruments. The draft DTC Bill 2009 proposed to increase this limit to Rs
three lakh per annum. However, the context has completely changed with the
Government agreeing to continue with certain existing tax exemptions as per the
Revised Discussion Paper. Now, one can safely assume that the Government will
definitely not be in a position to provide a limit of Rs three lakh tax
exemption.
TAX DEDUCTIONS/INCENTIVES
TO BE WITHDRAWN:
A careful reading of the provisions and the RDP and DTC
2009 indicate that the Government
is most likely to withdraw the following existing tax exemptions being enjoyed
by the taxpayers. One is forced to come to this conclusion because the
Government has maintained a strange silence on these issues and these issues
have not been mentioned either in the DTC 2009 or the RDP released on June 15,
2010. So, the important deductions that are most likely to be disallowed in future under proposed DTC
could be:
o
Housing
Loan instalments of up to Rs 1.00 lakh in a financial year and allowed as
deduction under Section 80C of existing IT Act may not be allowed as deduction
under the proposed DTC 2009
o
Contributions
made to Equity Linked Savings Schemes of Mutual Funds
o
Notified
Bank Time Deposits for a term of 5-years or more
o
Accrued
Interest on NSCs
o
Contributions
made under Unit Linked Insurance Policies
o
Under
DTC, bonuses or sums received from life insurance policies may not be allowed
for deduction in case: (1). Annual premium paid is more than five per cent of
the sum assured; and (2). If the policy is surrendered before the maturity date
(as per clause (a) of sub-section 3 of section 57 of DTC 2009
Note: 1. Capital Gains Savings Scheme will be
scrapped..
2.
STT will continue along with LTCG on shares.
3.
Grandfathering Clause: In certain
types of investments, only new contributions
on or after the commencement of the new Code will be subjected to EET
References:
1. Revised Discussion Paper released by Ministry of Finance, GOI
dated June 15, 2010
2. Direct Taxes Code Bill and discussion paper released by
Ministry of Finance,
GOI in August 2009
3. Newspapers
Photo courtesy: bing.com,
bbc.com, AP and author.
Author’s Disclaimer: The author’s views are personal. The
above article is written for information purpose only. Every care has been
taken to provide authentic information as far as possible; however, the author
is not responsible for any inadvertent discrepancies that may have crept in. Readers
should consult their own certified tax consultants or experts to correctly
interpret the provisions of tax laws or other matters.
To read this document in a reader-friendly PDF document, just click:
http://www.scribd.com/doc/33286075
