Exemption from Complications

Higher tax slab, but fewer deductions. Net result is Positive

The draft of the Direct Tax Code released by Finance Minister Pranab Mukherjee on Wednesday takes a two-pronged approach towards taxation. One, it widens the tax slabs substantially to ensure the rates, per se, do not pinch the payer and, in effect, pave way for reduction in tax evasion. Two, it gets rid of quite a few exemptions.

In order words, this code proposes some sweeping changes. And it starts with the basics. The terms ‘previous year’ and ‘assessment year’ that created confusion about the time period for which the returns were being filed, will be replaced by a unified concept of ‘financial year’. Then, income heads have been defined as income from employment, house property, business, residuary sources and capital gains.

The biggest point of discussion has been the rise in the income slabs. While retaining the basic exemption limits at Rs 1.6 lakh (for individuals), Rs 1.9 lakh (for women) and Rs 2.4 lakh (for the retired), the slabs have been hiked substantially.

Along with this, the limit of Section 80-C, which has been renamed Section 66, has been hiked from Rs 1 lakh to Rs 3 lakh. For someone earning say, Rs 14.5 lakh per year, the new numbers could look something like this: Rs 1.6 lakh (basic exemption) Rs 3 lakh (savings under Section 80C/ Section 66) Rs 9.90 lakh taxable income Tax rate for Rs 10 lakh = 10 per cent Tax liability = Rs 99,000

Looks fantastic? But it’s not that simple. For a salaried person, who gets house rent allowance, medical and other perks, he/she will not get tax benefits anymore. In fact, the value of rent free or concessional, leave travel allowance, earned leave and medical reimbursement, etc will now be included as a part of the salary.

Vikas Vasal, executive director, KPMG, says, “There were certain prerequisites that an employee enjoyed in his salary. All the perks in the direct tax code are brought under the tax net. This means the taxable income will now be higher.”

There is a big hike in the wealth tax limit as well. At present, wealth tax is charged at over Rs 30 lakh. This number has gone up to over Rs 50 crore. The tax rate: 0.25 per cent. The important change, though, is that wealth will include equities and mutual fund holdings, among others. “The finance minister has now included a whole host of assets but the limit is Rs 50 crore. This means only the wealthy need to pay this tax,” said N C Hegde, Partner, Deloitte.

Incentives for medical treatment have been retained. So, individuals will continue to enjoy tax benefits on insurance premiums up to a maximum of Rs 15,000 (Rs 20,000 senior citizens) and an additional Rs 15,000 (Rs 20,000 for senior citizens).

For medical treatment of the disabled, an amount of Rs 50,000 (Rs 75,000 for severe disability) and for prescribed diseases, an amount of Rs 40,000 (Rs 60,000 for senior citizens) will still be allowed.

Also, with the Rs 3-lakh limit, the scope of the term ‘higher education’ has been enlarged to include full-time studies in graduate or postgraduate courses.

Fewer exemptions
While hiking the limits of taxable income, savings and wealth, the government proposes to take away a whole lot of exemptions. For instance, the distinction between long-term and short-term capital gains will no longer be important. However, if any investment is transferred (read sold) after one year, there would be deduction based on the cost inflation index.

This would basically mean the long-term capital gains tax applicable for debt funds after one year and housing after three years will now be standardised at one year. So, if one sells a house after a year, he will get the benefit of the cost inflation index available to him – something presently available to him only after three years.

And if a person sells the asset, whether property or shares, the capital gains will be included as a part of their income and taxed accordingly. The new capital gains structure benefits those who conduct a higher number of transactions in the stock markets or mutual funds.

Experts say that though the changes on capital gains are quite good, internationally, a lot of countries do not charge any tax on these. “Hong Kong and Singapore have no tax on capital gains. In the US, the rates are 15 per cent, in France, 8-20 per cent, and in the UK, normal tax rates apply,” adds Hegde.

Also, while the saving limit has been hiked, the number of instruments in this universe has been brought down. Both equity-linked savings schemes and five-year fixed deposits are out now.

Home loan borrowers getting a waiver on interest payments of up to Rs 1.5 lakh would no longer get this benefit, if they are staying in their own house. The reason: the gross rent on a self-occupied house is considered to be nil. Therefore, no benefits either on capital or interest payout will be available. However, if the same house or a second house is given on rent, the person will get the tax benefits on interest payout and that too, unlimited interest payment. The calculation will be based on the highest of the actual rent or 6 per cent of the rateable value (decided by the municipal authorities) or 6 per cent of the acquisition cost minus deductions, including unlimited interest payouts.

Experts, though, are not completely happy with these new guidelines. Some feel the basic exemption limit for the retired could have been hiked to Rs 5 lakh. “This, because, the method of EET would hit them quite hard,” explains Vasal.

There is discriminatory treatment in a lot of areas as well. In the case of the public provident fund, there will be the EET (Exempt-Exempt-Tax) method now. On the other hand, proceeds from a pure life plan have been kept tax-free. Both being capital receipts, which means consumers’ save over time to create an accumulated corpus, but the government seems to be nudging the consumers towards life insurance. “The different treatment can lead investors to put more money in life insurance,” added Hegde.

As Finance Minister Pranab Mukherjee wrote in the foreword, “The thrust of the code is to improve the efficiency and equity of our tax system by eliminating distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base.”

By all those parameters, the draft code looks quite impressive. Importantly, for individual taxpayers, life would be much simpler because the process of tax-planning will no longer give them headaches. As Hegde puts it: “It has plugged all provisions and leaves no scope for tax-planning for an individual.”

INCOME TAX

Change in nomenclature: A unified ‘financial year’ term replaces ‘assessment year’ and ‘previous year’

Rise in tax slabs: The 10 per cent tax bracket raised up to Rs 10 lakh, 20 per between Rs 10 and 25 lakh and 30 per cent for over Rs 25 lakh.

Salary perks as part of income: Would include perks like house rent, leave travel allowance, medical imbursement

Gratuity on change of jobs: Will be tax-exempt on change of jobs only if it is invested in a retirement fund

Income from ordinary source: Would include income from employment, house property, business and so on.

Income from special source: Would include capital gains on equity and equity oriented funds, income of any other nature

WEALTH TAX AND 80 C

Wealth limit: Increased substantially from Rs 30 lakh to Rs 50 crore. Will not apply to private discretionary trusts

Rate of taxation: Reduced from 1 per cent to 0.25 per cent

More instruments: Will include equity, mutual fund units purchased and fixed deposit investments

80C limit: From Rs 1 lakh at present to Rs 3 lakh for a hindu undivided family (HUF) or individual

Less instruments in 80C: Equity-link savings scheme and 5-year fixed deposit will not be included

Definition of higher education expanded under 80C: Higher education will now include graduation and post graduation studies and the tuition fees will be exempt

INSURANCE

Medical insurance: Existing exemptions retained for individuals, senior citizens and the handicapped

Tax-free: Pure life insurance and policies whose premiums less than 5 per cent of sum assured, even on bonuses

Exempt-Exempt-Tax (EET): New tax regime for all provident funds, superannuation funds, life insurance and New Pension Scheme (NPS). These investment to be taxed on withdrawal

Grandfathering Clause: Withdrawal of any amount invested in retirement and superannuation schemes as on March 31, 2011 will not be taxed

Relief on rollover: The rollover of money withdrawn from one account of the permitted saving to another will not be treated as withdrawal.

HOUSING

Housing Deduction: The deduction of Rs 1.5 lakh for housing loan interest payment removed for a self-occupied residence

Gross Rent Calculation: The gross rent for calculating income tax will be based either on the rent that the house owner has contracted or on the “presumptive rent”, whichever is higher.

Presumptive Value: Presumptive rent to be considered as actual rent or 6 per cent of the rateable value of a property fixed by local authorities, or 6 per cent of the cost of buying or building the property

Joint Ownership: If two people own the house, the tax will be levied based on the proportion of their ownership

Rent Deductions Capped: The deduction from gross rent for any repair work or municipal taxes is capped at 20 per cent from the earlier 30 per cent

CAPITAL GAINS

Distinction Scrapped: The distinction between short- and long-term capital gains tax scrapped

Indexation benefit: One year cap remains to avail indexation benefits. The same applied for house sold after one year

Rate of Capital Gains: The rate of capital gains tax as per income slab of the person

Equity Investment: Investors will not enjoy zero tax on equity held for over one year

Dividend: Dividends paid out on equity investment are fully tax exempt

Exceptions : Capital gains will not apply to transfer of assets on partition of Hindu undivided family, gifts, transfer under an irrevocable trust, of any investment asset, other than sweat equity share