This article focuses on the impact of the forthcoming budget and the New Direct Tax code with respect to the individuals. The proposed Direct Tax Code is a combination of major tax relief and removal of most tax-exempted benefits. It is expected to usher in a new tax regime of transparency and greater compliance, and is proposed to be implemented from the year 2011. Also the forth coming budget can be expected to bring about some of the changes for a smoother transition.
The Union Finance Minister Pranab Mukherjee conveyed a message to all taxpayers when he introduced the draft Direct Tax Code (Tax Code) that archaic rules have to be replaced with new ones. The Tax Code, now open to public debate, will be introduced
as a Bill in Parliament’s winter session. If passed, it will become the new Income Tax Act, replacing the existing four decade old IT Act of 1961. The new IT Act will come into force from April 1, 2011.
The New Direct Tax Code eyes at substantial increase in the tax slabs for an individual tax assessee, and it is expected that a part of this may be implemented in the forthcoming budget. The Tax Code Bill 2009 talks of increasing the 10% slab to Rs 10 lakhs, 20% slab between Rs 10 lakhs and Rs 25 lakhs and 30% above Rs 25 lakhs. This budget may not make any sweeping changes in this area, as the New Direct Tax Code proposed taxable slabs may not be implemented in full. The new proposals are in the right direction and they will simplify regulations and reduce unnecessary litigations significantly.
Major gains
There are some major changes proposed in the Tax Code. Personal income tax, almost all salaried persons will agree, in our country is one of the highest in the world. More open and honest an employer is in terms of disclosing remunerations, worse it is for the employees because taxable income goes up. The present system thus rewards dishonesty and non-disclosure of income by way of lower tax. The Tax Code will try to address these issues by significantly lowering income tax and by disallowing all tax-free perks. It proposed exemption of income tax on specified savings up to Rs 3 lakh a year as against the present deduction limit of Rs 1 lakh for all types of savings under 80C of the IT Act. The catch, however, is that a few long term investments like public provident fund, employer’s provident fund, insurance premium in pension (annuity) schemes, Post Office National Savings Scheme etc will be eligible for tax exemption.
But contributions to fixed deposits, interest and principal payment on housing loans, educational expenses of dependents, and a host of other forms of savings will not qualify as eligible for tax savings. The thrust, clearly, is to induce long term savings for future needs.
The Tax Code also raised income tax slabs significantly, lowering the tax burden on individuals. The draft proposed exempting the general tax payer from paying tax for income up to Rs 1.60 lakh a year.
According to the proposal, a tax payer will pay at the rate of 10 per cent for income above Rs 1.60 lakh and up to Rs 10 lakh, at 20 per cent on income between Rs 10 lakh and Rs 25 lakh and at 30 per cent for income beyond Rs 25 lakh.
At present, while the basic exemption limit remains at Rs 1.60 lakh a year, the limit for tax slabs are much lower — one pays 10 per cent tax on income ranging between Rs 1.60 lakh and Rs 3 lakh, 20 per cent between Rs 3 lakh and Rs 5 lakh and 30 per cent beyond Rs 5 lakh.
Thus, for an individual with taxable income of Rs 10 lakh a year tax payment will drop from Rs 1.68 lakh to Rs 51,000, a net annual saving of Rs 1.17 lakh. The exemption limit for women and senior citizens will continue to be Rs 1.90 lakh and Rs 2.40 lakh, respectively.
Dampeners
Besides giving major relief to tax payers, the finance minister will also make sure that there aren’t many avenues to avoid taxes. So, as a rider, the Tax Code proposes to add all perquisites enjoyed by a tax payer to income for the purpose of tax calculations. In other words, allowances like leave travel, furnishings, entertainment expenses, conveyance, medical etc, will be added to income.
Similarly, the tax treatment for post-retirement benefits may prove to be a major dampener. Money saved in specified instruments like PPF and PF for getting tax exemption will become taxable when they are withdrawn later.
These investments, when accrued, were earlier exempted from tax. The Tax Code says that under the Exempt Exempt Tax (EET) system all withdrawals will attract tax because the amount withdrawn will be treated as part of the income for that year.
But in the Tax Code it is unclear if the employee’s contribution to PF and PPF will be taxed at the time of withdrawal. KPMG’s Vasal says that this is an anomaly that needs to be corrected. He believes that only the employer’s contribution and interest accrued to the account will be taxed.
Though taxing financial gains available after retirement will pinch the retired people, Vasal is of the view that the proposal is equitable as income is liable to be taxed at least once.
However, as a relief to senior citizens, tax exemption limits for them should be raised to Rs 5 lakh per annum instead of Rs 2.40 lakh at present. The Tax Code, however, specified that the tax exempt status currently available to withdrawals would continue to apply to amounts accumulated in post-retirement savings schemes like PPF, EPF, etc, up to March 31, 2011. Money that accrues from April 1, 2011 will be taxed on withdrawal
Reduction in Wealth Tax
Currently Wealth tax is at the rate of 1%, which can be reduced to 0.25% in the New Tax Code, according to the new proposal. And probably this will be implemented immediately in the next budget. The need of the hour is to increase the number of people who pay wealth tax, as the current compliance is very less.
To better the compliance the slab for the wealth tax has been proposed to be increased to a larger amount of Rs.50 crores, as compared to the current amount of Rs.30 lakhs.
A mixed bag
For the corporate world, the proposed reduction in the tax rate to 25 per cent from the existing 30 per cent is certainly good news and will help lowering the tax burden of India Inc in a big way. But at the same time the Tax Code proposes to do away with many exemptions that help lowering the tax. In a significant policy change, the Tax Code plans to discontinue all profit linked incentives for area-based investments like setting up plants in a backward area or in the north-east with investment-linked incentives in specific sectors like infrastructure, power, exploration and oil production etc.
Moreover, under the new proposal, tax holiday will not be for a specific period, as is the case now, but will be equal to all capital and revenue expenditure barring land, goodwill and debts.
Once a firm recovers the permitted investments and profits will be taxed. This change is aimed at incentivising capital formation in critical areas and remove incentives to shift profits from the taxable unit to the exempted unit.
The current budget may implement the rent reduction immediately, as this will affect those who depend on rental income as their primary source of income. However, the limit hike in the wealth tax and the service tax benefit will offset the increase in the rental income in a big way.
