The good, the bad and the ugly
The new DTC is a watered down version of the original draft that had promised sweeping changes in the tax structure. It displays neither the reformist zeal nor the longterm vision required to break free from the archaic provisions of the Income Tax Act.
It is no different from the existing Act, only bulkier with 23 additional sections and 8 more schedules. There are some obvious reasons for the praise showered on the DTC after it was tabled in Parliament. The basic tax exemption has been hiked to Rs 2 lakh a year and the tax slabs have been raised.
Also, tax exemption for long-term capital gains from stocks and equity funds has been restored, much to the joy of the markets. But this is just a sleight of hand by Finance Minister Pranab Mukherjee.
The tax slabs are much lower than those proposed under the original DTC. Besides, the web of exemptions and deductions will continue. "The main purpose of the DTC was to simplify the tax structure and eliminate the ifs and buts that have plagued direct tax compliance in India. But the new code has retained most of the ifs and buts," says Rajiv Deep Bajaj, vicechairman and managing director of Bajaj Capital.
Experts are disappointed by the difference between the original proposals and the ones that were eventually tabled.
To be fair, there are some investorfriendly aspects of the DTC that need to be underlined. For instance, a life insurance policy will be eligible for tax deduction only if the cover is at least 20 times the annual premium. This will probably stop the purchase of life insurance policies as a tax-saving tool.
Over the next few pages, we shall look at this as well as the other changes that the DTC will bring about in our financial lives.
Tax Exemptions
Reforms on the backburner
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The original DTC had proposed an end to this monthly circus by doing away with all exemptions and taxing everything as income. The impact on the taxpayer was cushioned by a generous raise in the tax slabs. By restoring the exemptions, the revised DTC takes us back to the world of fictitious bills and revenue leakages.
"If the basic purpose of the DTC is to make it easy for the taxpayers to comply with the tax laws, the web of exemptions needs to be done away with," says K.H. Vishwanathan, executive director, RSM Astute Consulting Group, a financial consultancy firm.
Everybody benefits from a simplified tax structure. "The removal of exemptions would have helped not only taxpayers by doing away with the need to substantiate expenses, but also employers and tax officers by abolishing the arduous verification process," says Tapati Ghosh, partner in global accountancy firm, Deloitte Haskins & Sells. What's more, it would have plugged the revenue leakage resulting from reimbursement of fake bills.
The authors of the revised code have cited the continuation of exemptions to justify the scaling down of tax slabs. Under the original draft, an income of up to Rs 10 lakh would have been taxed at 10 per cent. The revised DTC brings down the threshold to Rs 5 lakh.
The only significant relief for taxpayers is the raising of the basic tax-free limit from Rs 1.6 lakh to Rs 2 lakh a year. But there's not much for female taxpayers to rejoice. They will no longer get a higher exemption. For senior citizens, the limit will go up from Rs 2.4 lakh to Rs 2.5 lakh a year.
The restoration of exempt, exempt, exempt (EEE) treatment for retiral benefits should also bring smiles. Extending EEE to annuity plans is another welcome move, one that will make the National Pension System attractive.
Capital gain
Pampering Equities
The original DTC had removed the distinction between short- and long-term gains and between asset classes.
There is no rationale for taxing returns from different asset classes-gold, stocks, bonds and real estate- differently. It may be argued that the exemption on long-term gains from equities was extended to arouse investor interest in equity markets in 2002. But that phase is long over.
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Even so, the DTC has done well to remove the distinction between short- and long-term gains for other assets. Investments in gold and property will be treated as long term after one year.
However, the period of holding will now be calculated from the end of the financial year in which the asset was bought.
So, if an asset is bought in April 2011, it will qualify for long-term capital gain treatment only if it is sold after 31 March 2013. If it had been bought in March 2011, it would have made the cut in April 2012.
"Depending on when it was bought, an asset will have to be held for 12-24 months to avail of indexation and long-term tax treatment," says Anil Rego, CEO of Right Horizons.
Tax Savings
Throwback to Section 88
Tax planning became synonymous with financial planning.
But DTC has brought back the state-dictated model. The original discussion paper had proposed a saving limit of Rs 3 lakh a year. What the DTC offers now is a mish-mash that adds up to Rs 3 lakh, though not in the same way.
There's a Rs 1 lakh deduction for investments in PF, PPF and superannuation funds. Then there is a Rs 50,000 limit for school tuition fees, life insurance policies and medical plans. Finally, there is another Rs 1.5 lakh deduction available for interest paid on a home loan.
"The tax-saving limit of Rs 3 lakh has been cleverly achieved by classifying deductions as incentives," says Tapati Ghosh of Deloitte Haskins & Sells. She points out that under the current regime one is already eligible for a deduction of Rs 2.85 lakh, which includes Rs 35,000 for medical insurance and Rs 1.5 lakh for home loan interest. This means that the deduction limit has effectively gone up by only Rs 15,000.
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For senior citizens, it will increase by only Rs 10,000. "The inclusion of medical insurance premium in the savings limit has eroded the overall benefit. The limit for insurance and tuition fee should be raised from Rs 50,000 to at least Rs 1 lakh a year," says K.H. Vishwanathan, executive director, RSM Astute Consulting Group.
The good thing about the tax-saving investments is that a major chunk of the limit has been reserved for long-term savings.
Out go short-term investment options, such as ELSS funds, bank fixed deposits and NSCs. In comes the NPS, which will allow taxpayers to invest in stocks but won't give them the liberty to withdraw before they retire.
"The stress is on encouraging individuals to invest liberally in retirement funds," says Ghosh. The inclusion of the NPS in the approved list of tax-saving options is a positive step, especially since the annuity income has been made tax-free.
Life Insurance
Crackdown on Mis-selling
For several years now, the insurance industry has been seeking a separate tax-saving limit for life insurance. The DTC does that, but not necessarily in the manner the industry wanted it.
There is a Rs 50,000 limit proposed for premium paid for life insurance policies. But medical insurance and school tuition fee have also been bundled into this limit. In a scenario, where 75-80 per cent of life insurance is bought to save tax, not many people might be interested if their children's tuition fee crosses the Rs 50,000 mark.
That's not all. A policy will be eligible for tax deduction only if it offers a cover of at least 20 times the annual premium. This stress on a large cover is a welcome measure, which will force customers to buy life insurance for the right reasons.
"Only term plans and endowment plans with tenures of more than 20 years can avail of tax benefits. But the most sold Ulips might just lose the tax incentive," says Deepak Yohannan, CEO of myinsuranceclub. com, an insurance portal. Ulips with less than 10-year terms may not make the cut. Only if the term is 20-25 years will a plan be able to offer a large enough cover.
There is also a 5 per cent tax proposed on payouts from Ulips. This also means that the incidence of misselling is likely to come down. Already, misselling has been dealt a body blow by the new regulations, which have come into effect from September 1.
Under the new DTC, it may become more difficult. Although the revised discussion paper had clarified that the tax benefits will continue for existing plans till their full tenure, it is not clear whether the current policies will lose their tax-saving status after DTC comes into effect. If they do, the policyholders who had taken insurance only to save tax will be in a fix.
"Individuals with plans that don't fulfill the criteria will need to choose between closing these policies and continuing without tax benefits," says Tapati Ghosh of Deloitte. Some Ulips do allow investors to increase their cover, but it won't help. "Even if one year's premium exceeds the 5% limit, the deduction will be disallowed," says Vishwanathan.
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Medical Expenses
Deduction, Exemption Up
Here's some good news. The rising cost of healthcare has not escaped the notice of the Finance Minister. The revised DTC enhances the tax-free limit for medical allowance to Rs 50,000 a year, a logical step since the current limit of Rs 15,000 is barely sufficient to pay for OPD charges and medicines."This is a boon for the salaried class, given the rising medical costs," says Tapati Ghosh of Deloitte. The bigger change relates to the deduction for medical insurance. Right now, a taxpayer can claim deduction of up to Rs 15,000 a year for the premium paid for medical insurance for himself and his dependants.
An additional deduction of Rs 15,000 is available if he insures his parents. This is enhanced to Rs 20,000 if the parents are senior citizens. These benefits, under Section 80D, have helped encourage taxpayers to buy medical insurance for themselves and their parents.
However, the DTC has bundled medical insurance with life insurance and tuition fees under a combined limit of Rs 50,000 a year. This can prove counterproductive. Though medical insurance is important, many people buy it for the wrong reason-tax saving.
Bigticket expenses, such as life insurance and tuition fees, are likely to crowd medical insurance out of the budget of the average taxpayer. "The increase in the tax-free limit of medical reimbursements is a good move, but we would have preferred a separate deduction for medical insurance," says Anil Rego, CEO of Right Horizons.
Of course, there is another way to look at the hike in the exemption limit of medical reimbursements. The original DTC had proposed to tax all reimbursements as income to prevent the leakage of revenue due to fake bills.
"It is not uncommon to see salaried people buying personal care items from chemist shops and getting them billed as medicines," says Sudhir Kaushik, director of tax portal Taxspanner.com. Others strike a deal with shopkeepers and get fake bills after paying a 5 per cent kickback.
Such tax evasion will not only continue but become more widespread after the limit is hiked.
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Housing
Pragmatic Approach
Although home loan repayment will not qualify as a tax-saving instrument, the revised DTC has restored the tax benefits on the interest paid, which must be a relief for millions of borrowers. This is only fair because such drastic changes in rules should be made with prospective effect.What's more, the tax benefits are important to make home loans more affordable for borrowers, especially in these times of hardening interest rates. "The tax incentive reduces the effective cost of the home loan," points out Rajiv Deep Bajaj, Vice-chairman and managing director, Bajaj Capital.
The DTC has also retained the existing provision of allowing unlimited interest deduction if a house is given out on rent. However, experts feel that the removal of the principal repayment as a tax-saving option can upset the calculation of some taxpayers. "The people who have committed large EMIs may face problems because they will have to find money for other tax-savings investments," says K.H. Vishwanathan, Executive Director, RSM Astute Consulting Group.
Even so, the DTC has other friendly measures for homeowners. It does away with the presumptive taxation of property not given out on rent (see Presumptive Anomaly Removed). This has been a big deterrent to buying a second house.
Paying tax on your earnings is bad enough, but having to pay tax on the income you haven't received is worse. The DTC has fixed this. Also, advance rent received from a tenant will be taxed in the year to which it relates, not when it was received. This is a pragmatic change as in some cities, landlords take up to 6-12 months rent in advance.
Security deposits will be treated as residuary income and can be claimed as deduction when the sum is returned to the tenant at the end of the lease. For those living on rent, the exemption on HRA will continue as before.
The original draft had done away with this exemption but the lowering of the tax slabs made it necessary for it to be restored. According to a recent survey by ICICI Securities, Indians spend roughly 11.5 per cent of their household incomes on rent.
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Wealth Tax
Tax the Super Rich
"The raising of the exemption slab will keep small investors out of the tax net," says Sunil Shah, partner in Deloitte. Wealth tax of 1 per cent is levied on unproductive assets, such as gold jewellery, more than one residential property, cash and indulgences like yachts, works of art, expensive watches, helicopters and private jets, if their combined value crosses the threshold.
Financial assets, such as stocks, bonds and deposits, are kept out of the ambit. The original DTC had included these assets as well, but had raised the threshold limit to Rs 50 crore and reduced the tax to just 0.25 per cent.
This had effectively exempted nearly 99 per cent of the Indian population. Only the superrich would have been taxed, and that too, on the cost of the asset, not its current value. Mukesh Ambani's stake in Reliance Industries is worth Rs 1,47,000 crore, but he would have been taxed only on the basis of its book value.
The revised DTC has excluded financial assets, but included overseas deposits and investments in foreign trusts and companies.
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