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Direct Tax Code DTC

The New Direct Tax Code (DTC) is said to replace the existing Income Tax Act of 1961 in India. It is expected to be passed in the monsoon session of 2010 and is expected to be enforced from 2012. During the budget 2010 presentation, the finance minister Mr. Pranab Mukherjee reiterated his commitment to bringing into fore the new direct tax code (DTC) into force from 1st of April, 2011, but same could not be fulfilled and now it will be applicable from 1st April, 2012. DTC bill was tabled in parliament on 30th August, 2010. There are big changes now in monsoon session and there is now much less benefits as compared to what were in the original proposal. Here are some of the salient features and highlights of the DTC: 1. DTC removes most of the categories of exempted income. Unit Linked Insurance Plans(ULIPs), Equity Mutual Funds (ELSS), Term deposits, NSC (National Savings certificates),Long term infrastructures bonds, house loan principal repayment, stamp duty and registration fees on purchase of house property will loose tax benefits. 2. Tax saving based investment limit remains 100,000 but another 50,000 has been added just for pure life insurance (Sum insured is at least 20 times the premium paid) , health insurance, med claims policies and tuition fees of children. But the one lakh investment can now only be done in provident fund, superannuation fund, gratuity fund and new pension fund. 3. The tax rates and slabs have been modified. The proposed rates and slabs are as follows: Annual Income Tax Slab Up-to INR 200,000 (for senior citizens 250,000) Nil Between INR 200,000 to 500,000 10% Between INR 500,000 to 1,000,000 20% Above INR 1,000,000 30% 4. Exemption will remain same as 1.5 lakhs per year for interest on housing loan for self-occupied property. 5. Only half of Short-term capital gains will be taxed. e.g. if you gains 50,000, add 25,000 to your taxable income. Long term capital gains (From equities and equity mutual funds, on which STT has been paid) are still exempted from income tax. 6. As per changes on 15th June, 2010, Tax exemption at all three stages (EEE) savings, accretions and withdrawals to be allowed for provident funds (GPF, EPF and PPF), NPS (new pension scheme administered by PFRDA), Retirement benefits (gratuity, leave encashment, etc), pure life insurance products & annuity schemes. Earlier DTC wanted to tax withdrawals. 7. Surcharge and education cess are abolished. 8. For incomes arising of House Property: Deductions for Rent and Maintenance would be reduced from 30% to 20% of the Gross Rent. Also all interest paid on house loan for a rented house is deductible from rent. Before DTC, if you own more than one property, there was provision for taxing notional rent even if the second house was not put to rent. But, under the Direct Tax Code 2010, such a concept has been abolished. 9. Tax exemption on LTA (leave travel allowance) is abolished. 10. Tax exemption on Education loan to continue. 11. Corporate tax reduced from 34% to 30% including education cess and surcharge. 12. Taxation of Capital gains from property sale: For sale within one year, gain is to be added to taxable salary. For long term gain (after one year of purchase), instead of flat rate of 20% of gain after indexation benefit, new concept has been introduced. Now gain after indexation will be added to taxable income and taxed at per the tax slab. Base date for cost of acquisition has been changed to 1st April, 2000 instead of earlier 1st April, 1981. 13. Medical reimbursement: Max limit for medical reimbursements has been increased to 50,000 per year from current 15,000 limit. 14. Tax on dividends: Dividends will attract 5% tax.

Income and Wealth Tax Rates


Increase in tax exemption on income from Rs 1.6 lakh to Rs 2 lakh, with no separate benefit for women. Income from Rs 2-5 lakh to be taxed at 10 percent; Rs 5-10 lakh at 20 percent and 30 percent thereafter. Currently, income from Rs 1.6-5 lakh attracts 10 percent tax; from Rs 5-8 lakh, 20 percent and beyond Rs 8 lakh, 30 percent. Tax exemption limit for senior citizens above 65 years to be marginally raised to 2.5 lakh per annum from Rs 2.4 lakh at present. Corporate tax to be a flat 30 %. MAT has been increased from 18 percent to 20 percent of book profit of a company. Dividend Distribution Tax will be at 15 percent. Exemption limit for imposing Wealth Tax rose to Rs 1 crore from current Rs 15 lakh. Wealth tax to be imposed at the rate of 1 percent, except on non-profit organizations which are exempt.

Tax Audit Limits


Tax Audit Limits rose from existing Rs 15 lakh for professionals to Rs 25 lakh, and from Rs 60 lakh for income from business to Rs 1 crore. Exemptions Exemption of interest up to Rs 1.5 lakh on housing loan retained. Deduction is to be considered only on the interest component and not the principal amount. EEE (exempt-exempt-exempt) mode of taxation for insurance and pension funds also maintained. Exemption on pension, Provident Fund and Gratuity Funds to be at Rs 1 lakh, while Rs 50,000 exemption provided on pure insurance, including health cover, and tuition fee payment. LTA Tax incentives on leave travel allowance to be scrapped.

For Investors
Existing provision of zero tax on long term capital gains to continue. Short-term capital gains tax for annual income up to Rs 10 lakh rationalized to benefit investors in the lower income bracket. Small investors with incomes between Rs 2 lakh and 5 lakh to pay only 5 percent capital gains tax, less than one-third of the current 17 percent (15 percent + cess). Investors in income bracket of Rs 5 lakh and 10 lakh will pay 10 percent capital gains tax. Big investors having income over Rs 10 lakh to pay short-term capital gains tax at 15 percent. Investment in equity-linked Mutual Fund schemes and ULIPs to attract 5 percent tax on the dividend paid by these entities. At present, there is no DDT applicable to equity fund schemes or insurers on income distribution to unit or policy holders.

Implication of DTC
While senior citizens benefit marginally, women would no longer be given a special status by the government for a higher exemption. Middle Class will continue to find purchasing a house a lucrative option, as exemptions on interests on home loans will continue. It will also give realtors some relief who are just emerging from a depressed patch. As for the outcome of personal exemptions, there will be a marginal rise in savings as exemptions have been increased for investment in approved funds and insurance schemes to Rs 1.5 lakh in a year from Rs 1.2 lakh currently. Raising the limit for imposition for Wealth Tax to Rs 1 crore is likely to improve compliance, which is currently very low.

But the Rs 1 crore limit is markedly low compared to the proposed limit of Rs 50 crore, which was originally proposed. The adverse impact of the new provision comes from the fact that Wealth Tax would now include companies in its ambit. So far, they were out of the net. Small and medium investors will gain substantially by way of saving on taxes on short term gains. DTC is also expected to boost investment flow into capital markets, as the government proposes to retain a zero long-term capital gain tax.

Why DTC?
As part of its financial reforms process, the government wanted to modernize and upgrade its direct tax laws i.e. the Income Tax Act and the Wealth Tax and bring them more in line with current times. DTC is expected to widen tax base, give moderate relief to tax payers, reduce unnecessary exemptions, and improve compliance thus improving collections. It also seeks to address new realities like operations of foreign companies in Indian markets, foreign institutional investors and cross-border M&As. For example, capital gains tax would be imposed on acquisitions made overseas if the acquired company holds over 50 percent assets in Indian company. This would affect companies like Vodafone Group for its acquisition of a 67 percent stake in Hutchison Essar from Hong Kong`s Hutchison Telecommunications International Ltd. The government has also clarified that foreign companies, which were regarded as resident of India if their control and management were wholly situated in India, will now be considered resident if the place of effective management is in India.

Impact of Direct Tax Code on employees


The Direct Tax Code (DTC), announced recently by the Union Finance Ministry, aims to simplify the tax system in India and lower the tax rates with a view to increase compliance. It proposes to make significant changes, in the tax regime. The new tax rates for a male taxpayer under the age of 65 years will be as follows: Up to Rs 1.60 lakh tax is zero, from Rs 1.60 lakh to Rs 10 lakh it is 10 per cent, from Rs 10 lakh to Rs 20 lakh it is 20 per cent and for income above Rs 25 lakh the tax rate is 30 per cent. The change in the slab translates into an annual tax benefit of Rs 1.26 lakh for an individual earning Rs 10 lakh. Further, there is no surcharge or education cess proposed. Employment income under DTC shall be the gross salary as reduced by the permissible deductions. The permissible deductions broadly include profession tax, transport allowance to the extent prescribed, prescribed allowances provided to meet expenses in the performance of duties to the extent actually incurred, payments received under retirement schemes (i.e. VRS compensation, Gratuity and Commuted pension to the extent the amounts are paid to a retirement benefits account). It also proposes to do away with popular exemptions such as house rent allowance, leave travel concession, leave encashment, medical reimbursement, tax borne by the employer in respect of non-monetary benefits provided to the employees, etc. Moreover, all types of perquisites are proposed to be included in salary income. As of now there is no valuation mechanism for the perquisites in the code. Hence the valuation norms for the perquisites may have to be prescribed in separate tax rules. It would be pertinent to note that the discussion paper has specifically clarified that the rules for valuation of Rent Free Accommodation (RFA) will be retained as they are, except that the same shall be extended to both public and private sector employees. Generally most organisations have a structure where salary normally comprises basic pay, house rent allowance, conveyance allowance, medical allowance, leave travel assistance, fringe benefits (from 2005-2009), etc. The final salary structures could be decided only as and when the tax rules are prescribed for valuation of perquisites. While the exemption for one Self Occupied Property (SOP) is retained in the DTC, the deduction towards interest paid on home loan for property up to Rs 1,50,000 is sought to be done away with. It means, employees who had invested in a self-occupied house property and have been availing of a tax saving of up to Rs 50,000 per annum on account of their loan interest, will no longer be eligible to the same. Taxation of retirement savings

The DTC proposes to introduce an Exempt-Exempt-Taxation (EET) method of savings maintained with permitted intermediaries (i.e. approved retirement benefit plans such as provident funds, life insurance and pension plans). Under this, contributions as well as accretions to savings schemes until such time they remain invested would be exempt. All withdrawals shall be subject to tax in the year of withdrawal at the applicable personal marginal rates of tax in the year of withdrawal. Under the current provisions, some of the retirement benefits are categorised under the Exempt-Exempt-Exempt (EEE) method of taxation wherein, contributions, accretions as well as withdrawal from retirement benefit plans are exempted from tax. However, under the DTC, retiral benefits would be exempt at the time of contribution and accretion, but the entire amount would be fully taxed at the time of withdrawal. This will entail reducing the yield in respect of such savings instruments. The discussion paper to the code provides for a grandfathering provision in relation to contributions made up to 31 March 2011 to Government Provident Fund, Public Provident Fund, Recognised Provident Fund and Employee Provident Fund. Accordingly, only new contributions after the commencement of the DTC will be subject to the EET method. It proposes to increase the deduction from taxable income in respect of savings (maintained with permitted intermediaries) and children education fees from a maximum of Rs.100,000 to Rs.300,000 per annum. However, deduction in respect of investment in equity linked savings schemes of mutual funds, term deposits with banks, housing loan repayment, etc, would no longer be eligible for the deduction. The existing deductions in respect of interest on educations loans and medical premium/expenses is sought to be continued. Conclusion In general, the proposed changes are a welcome step to simplify the tax laws. But, the impact of the changes would vary from case to case, e.g., while employees earning high-salaries may have an increase in net take-home pay (subject to taxation of perquisites as may be prescribed), retiring employees would need to pay much more taxes on their accumulated retiral benefit withdrawals. Income tax implications of the Direct Taxes Code proposals The Income Tax Act, 1961, will become history once the direct tax code Bill is approved. Here are the key proposals: Tax rates: The Bill has widened income slabs for individual taxpayers. The lowest tax rate of 10% is applicable to salary income of Rs2-5 lakh, 20% on income of Rs5-10 lakh and 30% on income above Rs10 lakh. These numbers are significantly lower than what was initially proposed in the first draft of the code, where income of Rs25 lakh and above was put in the higher tax slab of 30%. For senior citizens, tax exemption is sought to be raised to Rs2.5 lakh. However, there is no special tax exemption for women tax payers. Residential status: The requirement of being present in India for 730 days in the preceding seven years, essential for qualifying as an ordinary resident, is being dropped. However, with regard to taxation on worldwide income for a person resident in India, the condition will still be valid. So, while the status of not ordinarily resident (NOR) as defined in the Act will no longer exist, the concept will remain as first-time expatriates working in India will become taxable on their worldwide income only after they have been in India for 730 days or more in the preceding seven years. Income from salary: Key proposals for taxation of income under the head of salary are as follows. An employee friendly change is that the employers contribution to the approved superannuation fund is proposed to be exempt from tax without any cap. Under the existing Act, the employers contribution to the superannuation fund is exempt only up to Rs1 lakh. Further, reimbursement of medical expenses incurred by the employee on self and family treatment is proposed to be exempt from tax up to Rs 50,000 per year as against the current limit of Rs 15,000. This is a major bonanza for salaried employees. In addition to the above changes, the much needed exemption for House Rent Allowance (HRA) in respect of expenditure incurred on rent paid, which was not provided in the draft code, has been introduced. This will be another big relief for salaried taxpayers since the exemption for HRA accounts for substantial tax savings. However, the exemption available for leave travel allowance is proposed to be scrapped. Also, the exemption limits for gratuity, leave encashment and voluntary retirement scheme shall also be specified. Income from house property: This will be a welcome change no taxation on deemed income basis. The concept of fair market value for calculation of income from house property has been done away with. This will simplify matters. Income from the letting of house property will be computed on the basis of contractual rent, i.e. the amount of rent received or receivable for the financial year less specified deductions. Specified deductions range from municipal taxes, standard deduction on the gross rent to deduction of interest on loan paid during the fiscal year.

The Bill proposes to reduce the standard deduction on account of repairs and maintenance from the existing 30% to 20% of gross rent. A notable omission is the deduction for service tax paid on rented commercial property which was sought to be introduced by the revised discussion paper. The deduction of interest on loan taken for self occupied property will be available up to Rs1.5 lakh. However, the Bill proposes to change the scheme of deduction for self-occupied house property vis-a-vis the rented property. In the case of self-occupied property, the deduction for interest on loans taken is available from gross total income. A welcome change in the Bill is the reinstatement of deductions for interest paid on loans during the pre-construction or preacquisition period in five equal instalments. This was missing in the draft code. Capital gains:The definition of the period of holding for non-equity assets to be considered long-term is one year from the end of the financial year in which the asset is acquired as compared to the existing definition in the Act, which is more than 36 months. In addition, definition of period of holding for equity and equity oriented funds, which have been charged to STT for long-term, is one year from when the asset is acquired. This is the same as the existing act. As per the revised discussion paper (RDP), this was to be changed to same as other assets. Further, long-term capital gains on the sale of listed equity shares and units of equity oriented funds will get 100% deduction, hence are fully exempt while short-term capital gains for shares held for one year or less deduction of 50% will be allowed. There are no special tax rates for taxation of capital gains -- short term or long term. For non-equity capital assets -- capital gains will be calculated after giving the benefit of indexation. The capital gains deposit scheme, which was proposed to be scrapped as per RDP, has been included in the DTC Bill. Tax savings:Parallel to the deduction available under Section 80C of the Act, the Bill proposes a deduction up to Rs1 lakh for contributions to various approved funds. An additional deduction of Rs50,000 has been proposed under the Bill for payments for life insurance, health insurance and childrens education. While the initial draft code had proposed the exempt-exempt-tax (EET) system, the Bill retains the existing exempt-exempt-exempt (EEE) taxation philosophy for select benefits. Wealth tax: The Bill proposes to increase the existing exemption limit for chargeability of wealth tax to Rs1 crore from the existing limit of Rs30 lakh under the Act. The Bill proposes to levy wealth tax on net wealth in excess of Rs1 crore (as opposed to Rs50 crore originally proposed) at the rate of 1%. Definition of wealth has also undergone a change to include watches, trusts outside India, equity and preference shares etc. The tax code is a significant turnaround on the originally proposed revamping of how income is to be taxed in the hands of the individual taxpayer. Hence, EEE stays and for the need to maintain the fiscal balance, government had no choice, but to pull back the liberal tax regime proposed in the initial draft.