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Revised draft of Direct Tax Code (DTC) released – The changes and how they impact you

The revised draft of the Direct Tax Code (DTC) has been unveiled. Let’s see what the changes are, and let’s understand what it means for you – what is good and not so good in this new DTC.

The first draft of the Direct Tax Code (DTC) had been released for public discussion in Aug 2009. Now, after listening to the feedback, the government has released the revised draft of the DTC.

(To know what the original draft of the DTC proposed, please read “Highlights of the draft Direct Tax Code”)

This would be tabled in the monsoon session of the parliament, and would be implemented from 1st April 2011 if it is passed as a law.

Let us have a look at the provisions that have changed in the revised draft of the DTC, and how it impacts you.

(This article discusses the various changes from the original draft of the DTC and their implications. To see the actual revised draft text, please download “New Discussion Paper on the Direct Tax Code (DTC)” – file size 250KB)

(You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)

 

Treatment of Long Term Capital Gains

 

What the original draft suggested

The Securities Transaction Tax (STT) that is currently levied on transactions in equities would be abolished. Instead of the STT, the long term capital gain (LTCG) tax would be reinstated.

(To know more about capital gains, please read “Long Term and Short Term Capital Gain – Income Tax Calculation”)

 

What the revised draft says

The Securities Transaction Tax (STT) would be abolished. Long term capital gain from sale of listed securities (shares and mutual funds – MF) would be added to your income, and taxed as per existing income tax slabs.

(Check out “Income Tax (IT) Slabs / Brackets and rates” for the latest applicable income tax slabs)

However, the entire LTCG amount would not be added to your income. A deduction from the capital gain amount would be allowed, and it would be graded – the longer you have held the securities, the more would be the deduction allowed from the capital gain. Thus, the lower would be the amount added to your income that would be taxed.

Also, no indexation would be allowed in calculation of LTCG.

 

Implications for you

Effectively, the distinction between short term capital gain (STCG) and LTCG has been eliminated.

Reintroduction of tax on LTCG is bad news for serious equity investors who invest in stocks for the long term, as currently, LTCG from sale of securities is completely tax-free.

(Equity investment should always be for the long term – check out “Stocks – The winning bet for the long term” and “Equity Investment is Risk Free – Here’s the Proof”)

However, this is definitely an improvement from the original proposal where it was proposed that the entire LTCG would be added to your income and taxed.

Now, the longer you hold your shares / MFs, the more would be the deduction (that is, lower would be the share of the LTCG that would be added to your income), and therefore, the lower would be the tax outgo.

  • The longer you hold the shares / MFs, the lower would be the effective tax on the long term capital gain

The exact deductions for specific periods of holding have not been mentioned in the draft DTC. They would be published through a notification, or would be incorporated in the final DTC.

 

Example

Your LTCG is Rs. 10,000 after holding the shares for 6 years. Let’s say the deduction allowed for holding securities between 5-7 years is 40%. Thus, only 40% of LTCG, i.e. only Rs. 4,000 would be added to your income and taxed. If the IT slab applicable to you is 30%, the tax on Rs. 4,000 would be Rs. 1,200. Thus, the tax on a long term gain of Rs. 10,000 would only be Rs. 1,200 (Please note that the deduction rate is assumed)

 

Treatment of savings (EEE / EET)

 

What the original draft suggested

Proceeds from various savings schemes like Provident Fund (PF), Public Provident Fund (PPF), life insurance, annuities, etc. would be taxed as per EET regime – withdrawals from these would be taxed.

(Please read “Taxation Regimes – EEE EET ETE TEE – What do these mean” for more about various taxation regimes)

 

What the revised draft says

Such withdrawals would continue to remain tax exempt.

 

Implications for you

This means a huge benefit for you – implementation of the original proposal would have meant a big loss to you in the form of deduction of income tax at the time of withdrawal.

These savings avenues would continue to remain under the current EEE regime, which means a triple tax benefit for you – you would get tax saving for making the investment, the interest would be tax free, and the withdrawal too would be tax free.

Please note that the New Pension Scheme – NPS – administered by Pension Fund Regulatory and Development Authority (PFRDA) has been brought under the EEE regime.

However, in the case of insurance products, the EEE regime is applicable only in the case of “pure” insurance products. This means that Unit Linked Insurance Plan (ULIP) would be covered under EET regime – proceeds from ULIPs would be taxed. This makes ULIPs far less attractive once DTC comes into effect.

(To know more about ULIPs, please read “ULIP v/s Endowment Plan for Life Insurance” and “Are ULIPs a costly form of term insurance plus MF investments”)

Please note that death benefits received from ANY insurance policy would remain tax-exempt.

 

Treatment of retirement benefits

 

What the original draft suggested

Employer’s contribution to various retirement benefit plans (like provident fund, superannuation fund and new pension scheme – NPS) would be treated as perks, would be added to your income, and would be taxed accordingly.

 

What the revised draft says

Such contribution by employers (within the limits prescribed – currently proposed limit is Rs. 3 Lakhs per year) would remain tax-exempt, and would not be counted as a part of the salary for income tax purpose.

 

Implications for you

The implementation of the original proposal would have increased your taxable income and therefore your tax outgo. Now, a status-quo is being maintained, and you wouldn’t have to pay any extra tax.

Retirement benefits received by you will also be tax exempt, subject to certain limits. This includes gratuity, Voluntary Retirement Scheme (VRS) proceeds, commutation of pension and encashment of leave at the time of retirement.

 

Treatment of home loan interest

 

What the original draft suggested

Tax benefit for payment of interest on a home loan would be withdrawn.

(There are more tax benefits of a home loan – please check out “Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage”)

 

What the revised draft says

The current tax benefit on interest payment on home loans would remain.

 

Implications for you

The implementation of the original proposal would have nullified any tax benefit that you were availing. Again, the status quo is being maintained – the income tax benefit on payment of interest on a home loan stays.

 

Income tax slabs / brackets

 

What the original draft suggested

Tax for income upto Rs. 1.6 Lakhs would be 0%, between Rs. 1.6 Lakhs and Rs. 10 Lakhs would be 10%, between Rs. 10 Lakhs and Rs. 25 Lakhs would be 20%, and over Rs. 25 Lakhs would be 30%.

 

What the revised draft says

The revised draft doesn’t talk about income slabs and corresponding tax rates.

 

Implications for you

The revised draft of the DTC doesn’t talk about slabs and rates – these would be finalized once the bill is tabled in the parliament.

However, it would be safe to assume that the slabs would be far less attractive than those proposed in the original draft.

The very liberal slabs came along with EET regime and many other measures that would have increased your taxable income. Now that EEE regime is being continued, and many other tax benefits (like that on home loan interest) are also staying, the government can’t afford to have the same tax slabs – it would mean a significant loss of revenues for the government.

So, in all probability, some moderation in the proposed slabs would be done. But still, the slabs should be much better than what exists today.

(Check out “Income Tax (IT) Slabs / Brackets and rates” for the current income tax slabs)

The tax rates for various slabs should be retained at the same levels – 0%, 10%, 20% and 30%.

 

Your opinion about the revised DTC

So, we discussed the various changes in the Direct Tax Code (DTC), and their implications for you. Please leave your comments below to let other readers know your opinion.

You can also have a say in the finalization of the DTC – to express your opinion about the DTC to the finance ministry, please submit your comments at http://finmin.nic.in/dtcode/comments.asp. Comments would be allowed till 30th June, 2010.

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