Why the Direct Tax Code is introduced?
After passage of the Income Tax act in 1961, it has been amended every year. Tax administrators, chartered accountants and tax payers have raised concerns several times about the complex structure of the Income Tax Act, particularly because of the numerous amendments, frequent policy changes due to changing economic environment and complexity in the market etc.
So the Direct Tax Code (DTC) seeks to consolidate and amend the law relating to all direct taxes, namely, income-tax, dividend distribution tax, Capital Gain Tax, fringe benefit tax and wealth-tax so as to establish an economically efficient, effective and equitable direct tax system. The code aims to bring all direct taxes under a single law, to facilitate easy understanding, reduced the scope of litigation, more flexibility, reduction or elimination of regulatory functions and last but not the least provision of stability.
The article showcases how the DTC will impact the income pattern, tax structure as well as wealth generation for individuals and companies.
Revised tax structure for Individuals, Women and Senior Citizens
Monetary limits for medical facilities/reimbursement provided by an employer to its employees would be enhanced.
In the first draft of DTC, the deduction available in respect of interest on loans for higher education, investment in equity-linked savings schemes, repayment of housing loan, and investment in pension plans, etc., have been capped at a maximum of Rs 3 lakh. However, there are discussions going on about whether to increase the limit or leave it as it is at Rs 1 lakh. The final figure of permissible deduction will be known only once the code is placed for final discussion in parliament.
Wealth tax will be payable by all individuals, Hindu Undivided Families (HUFs) and private discretionary trusts. The assets chargeable to wealth-tax shall mean all assets, including financial assets (that is aimed at bringing about an element of equity when assets are transferred across generation in a country that levies no inheritance tax) and deemed assets, as reduced by exempted assets. Exempted assets include stock in trade, a single residential house or a plot of land etc.
In the first draft of the direct tax code, it was proposed that the net wealth of an individual or HUF in excess of Rs. 50 crores shall be subject to wealth-tax at the rate of 0.25%. However in the revised draft code, the government has decided that the threshold limit. the tax rate as well as weather financial asset should be included or not will be revealed to the public when the bill is presented in the parliament.
Deduction for Charity
The deductions allowed for contribution towards charitable purposes may not be available once the DTC comes into force.
It has been proposed to provide the Exempt- Exempt – Exempt (EEE) method of taxation for:
- Government Provident Fund (GPF)
- Public Provident Fund (PPF)
- Recognised Provident Funds (RPFs) and
- The pension scheme administered by Pension Fund Regulatory and Development Authority (like the New Pension Scheme) and
- Approved pure life insurance products and Annuity schemes
Under this method, the first E in EET means that the contributions towards certain savings products are deductible from taxable income, the second E represents that the accumulation from the investment are exempt, and also, all withdrawals at any time are exempt from tax in case of the third E.
However other saving schemes such as ULIP (Unit Linked Insurance Plans) and ELSS (Equity Linked Saving Scheme) would come under Exempt – Exempt – Tax status i.e., they would be taxed at maturity.
However, investments made, before the date of commencement of the DTC, in instruments which enjoy EEE method of taxation under the current law (for e.g., ULIPs), would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument.
In case of any one house property, which has not been let out, an individual or HUF will be eligible for deduction on account of interest on capital borrowed for acquisition or construction of such house property (subject to a ceiling of Rs. 1.5 lakh per annum) from the gross total income. The overall limit of deduction for savings will be calibrated accordingly.
Change in definition of Short Term and Long Term
The appreciation in the property value held for less than a year will be classified as short-term gain and the profit will be added to the investor’s income. When held for more than a year, the property value can be indexed but the profit gets added to investor’s income and he has to pay tax at the marginal tax rate.
For e.g.: Suppose a investor gains Rs 1 lakh through sale of property and he is in the highest marginal tax bracket (i.e., 30%). So, he would pay Rs 30,000 as tax if property is held for less than 1 year. But if the property is held for more than one year, the value of the property will be recalculated based on inflation index.
The tax laws remain the same as regards the gain accrued, after deducting the sale proceeds for index value of property, will be added to investor’s income and taxed at the marginal tax rate of 30% (currently, capital appreciation is taxed at 20% irrespective of income slab.)
For the Individual Investor
With measures like revised tax structure, increase in deduction limit and medical facilities, individuals will be left with more disposable income which in turn will lead to more saving, spending and investments. Continuation of EEE on few saving schemes will also motivate individuals to save for long term. The big relief for home loan borrowers is the continuation of the tax deduction of Rs 1.5L and also if the property is held for more than 1 year will be classified as long term.
Change in the definition for calculating time period
The time period will be calculated from the end of financial year in which the asset is acquired. In case, an asset is acquired on 2 April 2011, the asset needs to be held till 1 April 2013 to qualify as long-term holding. So, the effective holding period will be 24 months. Simply put, investment during 1 April 2011 to 31 March 2012 needs to be held till beginning of next financial year i.e., 1 April 2013 to claim long-term capital gain.
Capital Gains on Equity or Equity Oriented MF investments for period longer than 1 Year
Capital gains arising from transfer of an investment asset, being equity shares of a company listed on a recognized stock exchange or units of an equity oriented fund, which are held for more than one year, shall be computed after allowing a deduction at a specified percentage of capital gains without any indexation. This adjusted capital gain will be included in the total income of the taxpayer and will be taxed at the applicable rate. The loss arising on transfer of such asset held for more than one year will be scaled down in a similar manner. But the specified rate of deduction is yet to be decided.
Let’s say if the capital gains comes to Rs.100, for tax calculation purposes it would stand reduced to Rs.50 (if the specified deduction rate is 50 percent). This capital gain amount of Rs. 50 after deduction would then be included in the taxpayer’s total income and taxed at the applicable rate. So if investor is under 10% tax bracket then he would pay tax of Rs 5 (10% on Rs 50). Similarly, if the investor incurs loss of Rs 100 in a transaction, he would be able to claim loss only up to specified percentage in the above case which is Rs 50.
Capital gains on other assets held for more than one year
The base date for calculating cost of acquisition will now be shifted from 1 April 1981 to 1 April 2000. As a result, all capital gains between 1 April 1981 and 31 March 2000 will not be liable to tax.
Capital gains on assets held for less than one year
The capital gain arising from transfer of any investment asset held for less than one year from the end of the financial year in which it is acquired will be computed without any specified deduction or indexation. It will be included in the total income and will be taxed at the applicable rate.
Securities Transaction Tax
STT is to be retained and calibrated based on the revised taxation regime for capital gains and flow of funds to the capital market. The retention of STT is not very lucrative.
Impact on Investor
The revision in capital gain tax will relieve the long-term investor. But scaling down the capital loss by specified percentage will motivate an investor to hold on to their losing position for long which can be detrimental to their overall asset allocation. Because of the behavioral trait of loss aversion, people hold on to their losing position for long and now, with new ruling of DTC that only partial loss can be set off against full loss, investor will prefer to hold and wait for markets to rise and reach breakeven even though the investment may not be suitable to their investment needs.
Minimum Alternative Tax
The basis of calculating MAT will be on book profit of the company. As a result, a loss making company will not be liable to pay MAT.
Profits from both Domestic and Foreign company will be taxed at the rate of 25%. However, foreign companies would be required to supplement their corporate tax liability by a branch profits tax of 15% on branch profits (that is, total income, as reduced by the corporate tax).
Note: Surcharge is applicable if total income is in excess of Rs 1 crore. The prevailing dividend distribution tax (DDT) at 15% is sought to be continued in respect of dividends distributed by domestic companies.
Impact on Corporate
Reduction in corporate tax and reinstatement of MAT on book profit is good for corporate sector.
Overall, we believe that DTC will be a beneficial for the growing middle class in India. The disposable income with individuals will increase and in turn benefit the economy. The apprehension of DTC with regards to removal of tax exemption on interest of housing property is removed in the revised draft letter. As mentioned above, the exemption up to Rs. 1.5 lakh is allowed which should cheer the home owners and new home buyers. In addition, the concern on charging of capital gain tax on complete gains has also been revised, and now it will be charged only at a specified percentage of capital gains. However, it is a dampener for investor because in current tax regime long-term capital gain on equity and equity oriented instrument is totally exempt. Overall, the finance ministry is taking steps to promote consumption which could lead to strong growth for economy. Clarity is yet to emerge on few of the existing saving schemes, whether they will remain status quo or will have the EET status.
The bill will be introduced in monsoon session and we have to wait and watch in what form it will be implemented.