New Income Tax Code: lower rates, fewer exemptions

Finance Minister Pranab Mukherjee stuck to his promise made in his Budget speech and has put the draft Direct Tax Code in the public domain. The government is asking for comments, before it is introduced in parliament. Over the years, the Income Tax Act, 1961, has been supplemented by several amendments, interpretations and rules. While it has become difficult to interpret even for professionals, the tax authorities have had problems enforcing it too. The new tax code seeks to simplify the whole process of understanding the tax laws, making interpretation as clear as possible and the process of calculating taxes less cumbersome.

It is too soon to give a verdict on whether it achieves this objective. The government is attempting a major overhaul of the exemption regime that will require massive doses of convincing to be done, both within and outside parliament. The government is lowering tax rates for individuals and companies. At the same time, it is overhauling the entire system of exemptions and deductions, which individuals and companies have got used to. What is not clear yet is if the net result is a lower tax outgo compared to what is being paid at present. What is clear, however, is that salaried employees in the lower to middle income bracket, whose income largely comprises salary, will find the going good.

It is a voluminous document, with the discussion paper alone going into 80 pages. We will first look at the impact on individuals and later follow up with impact on business.

Tax Rates

  • No tax on Income upto Rs 1.6 lakh, no change proposed here
  • Above Rs 1.6 lakh and below Rs 10 lakh, tax rate will be 10%. 
    Above Rs 10 lakh and below Rs 25 lakh, tax rate will be 20%. 
    Above Rs 25 lakh, tax rate will be 30%.
    Deductions from income upto Rs 3 lakh
  • The current tax structure is:
    Above Rs 1.6 lakh and below Rs 3 lakh, tax rate is 10%,
    Above Rs 3 lakh and below Rs 5 lakh, tax rate is 20%|
    Above Rs 5 lakh, tax rate is 30%.
    Deductions from income upto Rs 1 lakh

This implies substantial savings on paper. 
However, there are several changes in the law that will have an effect on the manner and the base on which tax is calculated. If your income is primarily salary income, and you have done very minimal or no tax planning, then you stand to gain substantially.

Definition of income

Salary Income
Income from employment will include all perquisites.

The deductions that are allowed are: professional tax, transport allowance upto a limit, any prescribed special allowances, and pension to gallantry awardees.

In addition, VRS compensation, gratuity on death/retirement, commuted portion of pension and superannuation fund proceeds will be exempt only if they are deposited in a retirement benefits account. Approved savings intermediaries will be allowed to open these accounts, who have been defined as life insurers, New Pension System Trust, approved superannuation funds and approved provident fund trusts. Withdrawals will be taxed as income.

Exemptions revoked
Government employees will have to pay tax on accommodation provided by the government, at par with the private sector. The leave travel concession, given twice in a block of 4 years, will go. So will the exemption on leave encashment, medical reimbursement of Rs 15,000 and free/concessional medical treatment given by an employer.

Interest on house property
At present, tax-payers can offset the interest they pay on a housing loan from their taxable income. This can allow them to deduct up to Rs 150,000 per year from their income. This will no longer be allowed.

Capital Gains – STT to go
The code proposes to have one definition for capital gains, irrespective of whether it is long term and short term. But for long term capital gains, a benefit of indexation will be allowed. Capital gains will be taxed at a flat rate of 30%. The securities transaction tax will be abolished.This is a major change. For capital gains transactions, short term capital gains was 15% and zero for long term capital gains. Now, 30% will be the applicable rate. This takes the capital gains tax regime back to the pre-STT days.

At present, one can use investments in various schemes like contribution to provident fund, LIC insurance premium, tution fees and specified bank deposits up to Rs 1 lakh. This has been replaced with a figure of Rs 3 lakh, but investments can be done only in a savings account with a specified intermediary.

EET method to be introduced – for retirement savings
Under this method, investments in specified accounts maintained with specified intermediaries will be exempt at two stages, the principal amount invested and the interest income earned but on withdrawal, it will be included in other income. The period ending on March 31, 2011 will be the last day for the current EEE regime for provident funds including the public provident fund. The balance as of this date can be withdrawn without paying any tax. The PFRDA will decide who can be a specified intermediary.

Other Income
Any income that does not fall under the main heads of income will be included here. It also specifies certain kinds of income to be included here: interest income, income from any litigation related settlement, withdrawal of principal from any investment, where the taxpayer has claimed a deduction and any advance/deposit received on leasing any investment asset. However, withdrawals/redemptions from provident funds and pure life insurance policies will not be taxed under this head. Pure life insurance policies are those where the premium paid is not more than 5% of the sum assured. This will make investment schemes of life insurance companies masquerading as insurance policies very unattractive to investors.

Medical insurance gets a breather

Mediclaim tax breaks will continue as before. The benefit has been extended, apart from self, spouse and children, the benefit for insuring parents has been carved into a separate category. So, the benefit will be Rs 15,000 for self and immediate family (Rs 20,000 for senior citizens) and Rs 15,000 for parents (Rs 20,000 for senior citizens).

Tuition fee deduction retained

This has been carved out of the current Rs 1 lakh figure and retained separately. Even pre-schooling and play schools will be included in this now. It extends to any school, college or educational institution in India.

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