The new Direct Tax Code certainly lives up to its promise of being completely renovated. Although, I am not sure it has got any simpler for the ordinary tax payer.
Even the changes in personal tax seem to be a zero sum game with what has been given by one hand being taken away by the other. The savings from changes in tax rates and slabs are no where near the depreciation in our real incomes as a result of the unrelentingly high consumer inflation.
Anyway, Indians cannot whine too much considering our tax rates is now possibly as good as they can get when compared with other countries.
Eventually like the proof of every pudding is in its eating, the effectiveness of this Code will eventually test the regime’s political will to implement it in a manner keeping with its noble intentions.
Varied interpretations are already being gleefully bandied indicating there is enough scope for litigation. I for one have little doubt in my mind that, I am going to need a lot of help from my friends in the accounting profession to fully appreciate its impact.
Looking back through the discussion papers, I suspect that, the earlier harsh provisions may have been a mere bargaining ploy and the sighs of relief all round seem to indicate the tactic has indeed worked well.
Honestly, knowing our penchant for populism I had all along doubted our ability to push through so drastic a change especially when it would go against the high and mighty.
Only time will tell if the promise of stability in tax laws is actually delivered.
Anyway for now, the Code has caused a lot of instability in my small dwindling world of mutual funds. This even after the long term capital gains on equity oriented mutual fund units retained their tax free status.
As a start, the Equity Linked Savings Schemes (ELSS) and Unit Linked Insurance Plans (ULIPs) too, have lost their special status as tax benefit vehicles.
However, the EEE status has been retained for all long term savings schemes used to accumulate for retirement monies like provident and super annuation funds along with the New Pension scheme will be deductible up to Rs 1 lac (not Rs 3 lacs as mentioned earlier). More on personal taxation later.
Thankfully, the income earned by a mutual fund retains its exemption in keeping with it being classified as a pass through investment vehicle.
The Securities Transaction Tax (STT) will continue to be applicable at existing rates considering the Code does not otherwise provide specific rates. STT continues to be payable by a mutual fund when it sells its units and buys/sells equity shares.
It seems we have lost the opportunity to save mutual funds from this double taxation especially when the STT on the sale of units cannot be passed to the corpus.
The impact of the Code on mutual funds is best understood when looked at separately for equity oriented mutual funds (wherein at least 65% of the corpus is deployed in equity) and all other type of mutual funds, including liquid and debt schemes.
Dividend Distribution Tax (DDT) will now be payable @ 5%, on income distributed by equity oriented mutual fund schemes. This tax will also be levied on ULIPs. However, the income distributed thereafter will continue to remain tax free in the hands of the unit holders.
On the other hand, the DDT which is currently payable on income distributed by other mutual fund schemes will not be levied under the Code. This means the tax arbitrage on account of differential DDT applicable to Liquid and Debt schemes; and between individuals and non-individuals has been eliminated.
The bad news is that, income distributed by non-equity oriented mutual fund schemes like, liquid, debt and hybrid schemes like MIPs will now be subjected to tax in the hands of the unit holders at the rate applicable to them (based on the slab applicable as per their total income).
Mutual Funds will now have to deduct tax at source (TDS) but only when the ‘total amount of income paid to an unit holder exceeds Rs. 10,000 in that, financial year (the Code has given up the term previous year for financial year i.e. 12 months beginning 1st April).
This TDS will be deducted @ 10% for individuals and HUF; and at @ 20% for others which includes Non residents.
I seem to however, have completely missed the point in making this change. After all how significant could the 5% DDT be to the exchequer, unless of course it is only to open the door for a gradual escalation of this rate in the coming years.
Also the continuation of DDT on debt schemes, albeit unified across liquid and debt categories would have saved mutual funds from this increased administrative burden resulting from the TDS regime.
These funds usually are highly transaction oriented with money moved in and out by investors to maximise their return on short term funds. Mutual funds may now have to retain TDS records for providing year end certificates, etc.
There is also a change in the way Capital Gains will be taxed on equity and units of equity oriented mutual funds.
These assets held for 12 months or more will not be taxed. However, the Code makes a subtle but what time could prove to be a significant change. Instead of the earlier ‘exemption’ these gains remain tax free as a result of a 100% ‘deduction’ from these capital gains.
I wonder if the need for recasting an ‘exemption’ as a ‘deduction’ is only to retain the flexibility to gradually bring it down so that, such gains will eventually get taxed as intended in the original version of the Code.
Similarly, other capital gains (short term) in equity and units of equity mutual funds would get a deduction of 50%. The rest is taxed at the rate applicable to the investor. Therefore the maximum effective tax rate stays at 15% although smaller investors will benefit.
In the case of ‘non-equity funds’ those held over 12 months, will be eligible for indexation benefits but on a base of April 2000. The gains post indexation will be taxed at the rates applicable to the investor. There may therefore, still be an opportunity for ‘double indexation’ benefits.
This means the gains could be taxed at 30% instead of the earlier 20%. The 10% rate applicable when indexation benefit was not availed of has been withdrawn. This change could again benefit the smaller investors.
Short term gains in this category will continue to get taxed at the rates applicable to investors based on their total taxable income.
It needs to be noted that, the period of 12 months will begin from the end of the financial year during which the relevant asset was purchased.
The Code seems to be greatly preoccupied with expanding its net to meet the challenges posed by non residents, cross border transactions, transfer pricing and foreign control over companies. The impact of these investments will have to be seen.
However, the Code does not seem to have done much to expand the domestic tax base. Like in the past, it continues to try and squeeze more juice out of the same old orange being the employed class which is already reeling from ruthless depletion of its real income.
One would have liked to see liberal inflation linked deductions on expenses incurred directly for employment. I would have liked to see this Code eventually bell the agriculture income cat.
After all, if corporates can be subjected to the MAT and there could be suggestions to tax income from house property on an irrational presumptive basis why then do our lawmakers studiously and consistently skip any discussion on taxing say the incomes from land holdings over say 2 hectares which is estimated to be about 20% of rich farming community.
It seems the Code has been a tremendous opportunity foregone.
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