Indian Direct Tax. Simplified.
As committed in the last week's Financial News Simplified, PersonalFN presents an analysis on the new Direct Tax Code, which was unveiled by the Finance Minister on August 13, 2009. The new code is likely to be effective from 2011 and will replace the existing Income Tax Act, 1961. The purpose of the new tax code is to simplify the tax laws as much as possible. The code proposes to:
- Re-define the residency rule
The Residency rule is important to determine who is liable to pay income tax in India. At present, there are three categories - Resident, Resident but not Ordinarily Resident (RNOR) and Non Resident. Resident individuals are taxed on worldwide income whereas RNOR and Non Resident Indians are taxed only on Indian income.
The Direct Tax Code has proposed to do away with RNOR category and there will be only two categories - Resident and Non Resident. An individual shall fall in the Resident category if he has stayed in India in any financial year,
(a) for 182 days or more in that year or
(b) for 60 days or more in that year and 365 days or more within the 4 years immediately preceding that year.
This would increase the number of individuals paying tax on their income outside India as individuals belonging to RNOR category will now fall in Resident Category - Change the nomenclatureAt present, if a person earns any income during the year beginning on April 1, 2008 and ending on March 31, 2009, then 2008-2009 is called the "previous year" and the income is assessed to tax in 2009-2010 which is called the "assessment year".
An unified "financial year" term will replace "assessment year" and "previous year". Financial Year is a period of 12 months beginning April 1 and ending on March 31 next year.
This, in our view, will negate the confusion created by the use of two expressions. It will simplify the multiple definitions for "year" and the process of filing tax return.- Restructure the income-tax slabs
The tax slabs for individuals will change substantially as depicted in the table below:Tax Rate Existing Proposed Tax Slabs For Individuals Nil Upto 160,000 Upto 160,000 10% 160,001-300,000 160,001-1,000,000 20% 300,001-500,000 1,000,001-2,500,000 30% Above 500,000 Above 2,500,000 Tax Slabs For Women Nil Upto 190,000 Upto 190,000 10% 190,001-300,000 190,001-1,000,000 20% 300,001-500,000 1,000,001-2,500,000 30% Above 500,000 Above 2,500,000 Tax Slabs For Senior Citizens Nil Upto 240,000 Upto 240,000 10% 240,001-300,000 240,001-1,000,000 20% 300,001-500,000 1,000,001-2,500,000 30% Above 500,000 Above 2,500,000
This we believe is the most vital reform proposed in the new Direct Tax Code. This will bring down the tax liability of an individual significantly resulting in more income in hand. Also, it will provide everyone an opportunity to save and invest more. - Tax the profits in lieu of salary and perks
The give and take policy always prevails. If the Direct Tax Code Bill proposes to enhance the income tax slabs, it also proposes to withdraw the tax deduction available on benefits like Leave Travel Allowance (LTA), Medical reimbursement and House Rent Allowance (HRA). Hence all these benefits will form a part of your salary and will be taxed as per the applicable income tax slab.
But there is some good news here as well. Food coupons, Employee Provident Fund (EPF), Transport Allowance, Gratuity etc will continue to enjoy deductions. It should be noted that Gratuity will be tax-exempt on change of jobs only if it is invested in a retirement fund.
Though this may increase the tax liability of the salaried individuals, but given that the increase in tax slabs are substantial, it could still lead to a lower tax liability under the new regime.
Consider the example depicted in the table below. An individual whose CTC is Rs 10 lacs p.a., has HRA, LTA and medical reimbursement of Rs 2.7 lacs. In the existing tax system, Rs 2.7 lacs would be exempted from tax and the taxable income would be Rs 6.45 lacs (Rs 10 lacs - Rs 2.7 lacs - Rs 0.85 lacs of Travelling Allowance, EPF and Gratuity), which will attract income tax of approximately Rs 97,500. Whereas, under the new tax code, Rs 9.15 lacs (Rs 10 lacs - Rs 0.85 lacs) will be the taxable income. This will attract income tax of Rs 75,500. The individual is still able to save Rs 22,000 per year.Existing Proposed Cost to Company (CTC) 1,000,000 Taxable Income Taxable Income Basic 445,000 445,000 445,000 Consolidated Allowance 200,000 200,000 200,000 Travelling Allowance 9,600 EPF 55,400 Gratuity 20,000 HRA 170,000 170,000 LTA 70,000 70,000 Medical Reimbursement 30,000 30,000 Tax (Rs) 97,500 75,500 - Increase the Deduction Limit
The aggregate amount of deductions in savings schemes is proposed to be raised from Rs 1 lac (currently under Section 80C) to Rs 3 lacs.Gross
Income
(Rs)Existing Tax
after Rs 1 lac Deduction
(Rs)Proposed Tax
after Rs 3 lacs Deduction
(Rs)Savings
(Rs)Savings
(%)400,000 14,000 - 14,000 100 600,000 54,000 14,000 40,000 74 1,000,000 174,000 54,000 120,000 69 1,500,000 324,000 124,000 200,000 62 2,500,000 624,000 324,000 300,000 48 5,000,000 1,374,000 1,044,000 330,000 24 (Cess not taken into account while calculating the tax payable)
For example, an individual with an income of Rs 10 lacs will be able to save tax on Rs 3 lacs straight away by investing in prescribed saving instruments. The remaining income of Rs 7 lacs will attract tax of Rs 54,000 as compared to Rs 174,000 under the existing tax regime. This will result in savings of Rs 120,000 per year (an increase of 69%).
As is evident from the table above, the increase in tax slabs combined with the increase in the deduction limit will substantially boost the savings of individuals.
However, it should be noted that investments in equity-link savings scheme (popularly known as tax-saving mutual funds) and 5-year fixed deposit will not be exempt anymore. - Introduce the Exempt-Exempt-Tax (EET) structure
Investments in small savings like provident fund, life insurance etc will be brought at par with National Pension Scheme (NPS) i.e. they will be EET (Exempt-Exempt-Tax). This means the withdrawal amount will be taxed from April 1, 2011. The withdrawal amount will be clubbed with the individual's income and taxed as per the new slab mentioned above.
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.
Small saving scheme such as Public Provident Fund (which offers an assured return of 8% p.a.) currently enjoys Exempt-Exempt-Exempt (EEE) status. Like this there are other schemes as well which are used by many individuals to achieve their long-term financial goals like retirement, children's marriage and education. Individuals investing in them will have to set aside more funds every year to build the targeted corpus. For example, an individual who wants a retirement fund of Rs 20 lacs after 15 years will now have to set aside Rs 1.66 lacs per year instead of Rs 1.38 lacs assuming he has to pay a tax of 20% on the withdrawal amount. - Scrap the benefits on home loans
This could come as a blow to many existing and prospective home buyers. The new Direct Tax Code proposes to scrap the tax benefit currently available on home loans.
The tax benefit on home loans is used to bring down the tax liability of an individual (who has bought a home on loan) to a great extent (i.e. upto Rs 1.5 lacs on home loan interest and Rs 1 lac on repayment of home loan). But the scrapping of the same would increase the tax liability of individuals.
If this happens as has been proposed, we recommend that individuals should consider making higher down payment and taking lesser loan. - Enhance the exemption limit for Wealth Tax
The limit for wealth tax will be increased substantially from Rs 30 lacs to Rs 5000 lacs (or Rs 50 cr). The rate of taxation will be reduced from 1% to 0.25%. The scope of wealth has been expanded to include more instruments like shares, mutual fund units and fixed deposit investments and house property including self-occupied house.
Inspite of these inclusions, very few individuals will have a net wealth of more than Rs 50 cr. Furthermore, many individuals who are currently paying wealth tax will move out from this ambit. - Simplify the Capital Gains taxation
Distinction Scrapped: The distinction between short-term and long-term capital gains tax will be scrapped. This means capital gains will be taxed irrespective of the investment horizon.
Indexation benefit: One year cap remains in order to avail indexation benefits. The same will be applied to houses sold after one year. The indexation base has also been proposed to be shifted from April 1, 1981 to April 1, 2000.
Rate of Capital Gains: The capital gains will be taxed as per the tax slab applicable to the individual.
Some 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
Here the crux is that investors will no more enjoy zero tax benefit on equities held for over one year. - Abolish the Securities Transaction Tax (STT)
Since the time STT was introduced, it has been an eyesore for many traders and investors investing in the stock markets. There has been a long standing demand to abolish the same, which in all probability may happen on April 1, 2011.
This would result in bringing down the transaction cost for investors and traders. Besides bringing smiles on the faces of traders, in our view it will also help in increasing retail participation in the stock markets.
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