DRAFT ON DIRECT TAX CODE DRAFT ON DIRECT TAX CODE

DRAFT ON DIRECT TAX CODE DRAFT ON DIRECT TAX CODE

LIKELY TO BE APPLICABLE BY 1 LIKELY TO BE APPLICABLE BY 1

APRIL 2011

APRIL 2011

IMPORTANT ISSUSES RELATEDTO DIRECT TAX CODE (DTC).

1.Direct Tax Code: Implications for housing, insurance and equities investors

2 .Deduction of specified percentage from long-term capital gains is a relief

3. Chartered Accountants are likely to advise selling equity assets whenever opportunity to book profits

4. Insurance: Work your terms

5. Ulips and endowment plans expected to come under EET

6. Mutual Funds: Get Debt, Go

1. Direct Tax Code: Implications for housing, insurance and

equities investors

At first sight the revised proposals under DTC give an impression that exemptions are back where they were. But a closer look at the details reveals that there is a twist in the tale. While it is a positive for housing, the same holds out a mixed bag for

investors in insurance & equities.

The revised discussion paper on DTC has softened the blow on long-term equity investors. The earlier version of the code had proposed a long-term capital gains tax on sale of long-term investments.

If the proposals in the revised draft are implemented, a specified percentage will be deducted from long-term capital gains (instead of factoring in the indexation benefit) before adding the same to the individual’s income for computing tax as per the

applicable slab rate.

2. Deduction of specified percentage from long-term capital gains is a relief

“Compared to the earlier draft, the proposal to deduct a specified percentage from long-

term capital gains is a huge relief,”

For instance, say you had purchased a stock for Rs 10 in 2000 and the indexed cost of acquisition rose to Rs 20, approximately and you sold the stock for Rs 100 making a gain of Rs 80 (100-20). Under the first draft, the entire Rs 80 will be subject to tax. However, under the revised draft, the long-term capital gain so computed

could be just Rs 45, that is, 90 minus 45 (assuming 50% is the specified percentage).

Therefore, the newer version will reduce your tax outgo, since the long-term gain will come down from Rs 80 to Rs 45. If your slab rate is 10%, the effective tax rate on this gain will be 5%, as per the revised draft. The loss from sale of such assets will be scaled down in a similar manner, according to the revised discussion paper.

On the flipside, securities transaction tax (STT) has been reintroduced, which the first

draft had sought to abolish.

3. Chartered Accountants are likely to advise selling equity assets whenever opportunity to book profits

It is likely that chartered accountants will advise their clients to sell equity assets

whenever there is an opportunity to book profits, before the revised code comes

into effect from April 1, 2011.” At present, there are no taxes on long-term gains

from equity.

Another change is that in the new regime, any equity asset that is held for a period of more than one year from the end of the financial year in which it is acquired will be termed a long-term investment while earlier any asset held for more than 12 months was considered long-term

The revised draft has offered to provide for a transition regime for tax on long-term

capital gains. However, the clarity on this count is yet to emerge. This apart, under the

revised draft, non-residents will be treated at par with residents for taxation of such

capital gains.

4. Insurance: Work your terms

At first look it appears that existing tax breaks will continue on life products under

the revised Direct Tax Code. But a closer reading shows that this is not the case.

In the earlier code, it was proposed to tax maturity benefits of life insurance policies. Revised code reverts to existing exemptions but specifies that these are available only for ‘pure’ insurance plans. Since no definition is provided for a ‘pure’

insurance plan there is confusion

If implemented, the changes in the tax system will be prospective in nature and products that are bought after April 1, 2011, will be subject to the proposed tax system.

At present maturity proceeds of a life insurance policy are tax-free in the hands

of the individual. Life insurance has been, therefore, popular as an investment

vehicle because of this three stage tax exemption (tax breaks for investing, tax

benefits on gains by the fund and tax free maturity benefits).

5. Ulips and endowment plans expected to come under EET

Under DTC II, if it is a non-annuity investment product, the maturity proceeds will be added to the income of the individual and taxed at a marginal rate.

Investment products such as unit-linked insurance plans and endowment plans

are expected to come under EET regime

“Ulip is offered similar tax treatment that of a mutual fund as both of them offer similar solutions to investors. However, there is a need to have some clarity for better interpretation,” says Satish Mehta, MD & CEO,

personalfn.com, a financial planning and advisory web portal.

An industry expert is of the opinion that the government may specify a certain minimum ratio of premium paid to maturity benefit for a product to qualify as

‘pure’ insurance plan.

Annuity products are also allowed EEE tax treatment. This proposal, if it goes

through, will encourage long-term savings aimed at better retired life for individuals. In the absence of social security benefits, even individuals employed in the unorganized sector need some support and the current proposal on annuity plans is a better

solution. But the annuity received from an insurer in the hands of the annuitant is

taxable

6. Mutual Funds: Get Debt, Go

Currently as per Section 80C of the Income-Tax Act, an individual can claim a

deduction of Rs 1 lakh for a wide cross section of investments, including equity-

linked mutual funds.

As per the new tax regime, this is proposed to be raised to Rs 3 lakh per annum. Added to this, till now this investment could go only in equity-linked

mutual funds, however, in the new Direct Tax Code, you can invest this amount in debt-oriented mutual funds also.

This flexibility will help financial planners recommend debt products also to investors who do not have an appetite for equity products. Above all, this is a

positive move for the mutual fund industry, which could witness higher fund flows.

In terms of capital gains, there is one change. “Capital gains will be calculated for

the asset held for a period of more than one year from the end of financial year in

which asset is acquired,” says Ranjit Dani, a financial planner. While earlier long-

term capital gains would be 366 days, now it could be from 366 days to 730 days,

depending on the period when the purchase was made in the financial year

7. Lower income groups to gain

Capital gains will be included in the total income and taxed at the applicable rate,”

says Sandip Mukherjee, executive director, PwC.

Capital gains arising from sale of 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. Therefore, if the “capital gains”

before the deduction at the specified rate comes to Rs 100, it would stand reduced to Rs 50 (if the specified deduction rate is 50%).

This capital gains would then be included in taxpayers’ total income and taxed at

the applicable rate. While those in the lower tax bracket will benefit, since short term

capital gains currently stands at 15%, those in the uppermost tax bracket will not

gain. However, as there will be a shift from nil rate of tax on listed equity shares and

units of equity-oriented funds held for more than one year, an appropriate transition

regime will be provided, so that the markets are not disturbed

8. Housing: Scoring a home run

The revised Direct Tax Code proposals should bring cheer to home-buyers and home owners alike. DTC II has done away with the concept of

presumptive/notional rent and any house property not let out for any part of the year will be considered to have nil value.

However, no deduction for taxes or interest will be allowed for such housing property. “The removal of taxation based on presumptive rent is in line with the international practice of taxing real/actual income instead of notional income,”

says Vikas Vasal, executive director, KPMG.

As per the earlier draft of DTC, the gross rent from house property was

proposed to be determined at higher of contractual rent or presumptive rent. As

per the earlier draft of the DTC, the presumptive rent was to be determined at

the rate of 6% of the value fixed by the local authority or the cost of

PRESENTED BY

MANJEET MEHRA

BCOM(H),CA-FINAL

EMAIL:[email protected]

SOURCE:-ECONOMICS TIMES.