Triple Ch'eee'rs for the Aam Aadmi
The good news is that the savings of an Aam Aadmi in certain schemes will now continue to be tax exempt even under the DTC regime.
By Rahul Kashikar, |
The revised discussion paper on the Direct Taxes Code (DTC) unveiled on 15 June 2010 has brought back some cheer for the Aam Aadmi. The good news is that the savings of an Aam Aadmi in certain schemes will now continue to be tax exempt even under the DTC regime.
As a background, the Government had introduced a draft of the DTC in August 2009 with an intention of enacting a tax law which is simple and broad based leading to lower tax rates, increased compliance and reduced litigation. One of the highlights of the DTC was the introduction of the Exempt Exempt Taxation (EET) system of taxation on savings schemes as against the prevailing Exempt-Exempt-Exempt ( EEE) system.
Under the EET system of taxation of savings, a tax payer would get a tax break on contributions to specified saving schemes (eg Public Provident Fund) as well as on any accretion/ accumulation of income in such account. However, any withdrawals would be taxed at the time of withdrawal or receipt. This would lead to drain in the savings of the tax payer when it would be required the most (eg after retirement).
Let's take an example of Mr Hiren Shah who has an annual income of Rs 600,000 during the Financial Year 2011-12 and he makes a contribution of Rs 100,000 towards an approved Provident Fund during the said financial year. Accordingly, the net taxable income of Mr Shah for the Financial Year 2011-12 would be as follows:
As a background, the Government had introduced a draft of the DTC in August 2009 with an intention of enacting a tax law which is simple and broad based leading to lower tax rates, increased compliance and reduced litigation. One of the highlights of the DTC was the introduction of the Exempt Exempt Taxation (EET) system of taxation on savings schemes as against the prevailing Exempt-Exempt-Exempt ( EEE) system.
Under the EET system of taxation of savings, a tax payer would get a tax break on contributions to specified saving schemes (eg Public Provident Fund) as well as on any accretion/ accumulation of income in such account. However, any withdrawals would be taxed at the time of withdrawal or receipt. This would lead to drain in the savings of the tax payer when it would be required the most (eg after retirement).
Let's take an example of Mr Hiren Shah who has an annual income of Rs 600,000 during the Financial Year 2011-12 and he makes a contribution of Rs 100,000 towards an approved Provident Fund during the said financial year. Accordingly, the net taxable income of Mr Shah for the Financial Year 2011-12 would be as follows:
Annual income - Rs 600,000
Less: Contribution to an approved provident fund- Rs 100,000
Less: Contribution to an approved provident fund- Rs 100,000
Net taxable income- Rs 500,000
Further, during the Financial Year 2012-13, an interest of Rs 8,000 accrues to Mr Shah in the Public Provident Fund. The same would be exempt from tax under the DTC regime as any interest accumulated to the Public Provident Fund is exempt from tax.
However, assuming that Mr Shah retires during the Financial Year 2013-14 and withdraws the balance of Rs 108,000 in his Public Provident Fund account, the entire amount of withdrawal was proposed to be taxed in his hands as per the provisions of the DTC. This could leave a deep hole in his pocket depending upon his tax bracket.
Based on the various representation received, the Government had identified the shift to EET as an issue which required further consideration, and has rightly proposed to restore the EEE system of taxation for certain key savings schemes under the revised discussion paper on the DTC.
Under the EEE system of taxation of savings, a person would get a tax break/ deduction:
• At the time of making the investment - the first 'E' of the EEE;
• At the time of any accretion/ accumulation of income to such investments - the second 'E'; and
• At the time of withdrawal of such investments - thus the third 'E'.
So in the example of Mr Shah, his withdrawals from the Public Provided Fund on retirement will not be subject to tax under the EEE system of taxation of savings.
• Taking cognizance of the impact on the Aam Aadmi, the revised discussion paper on the DTC provides that the EEE system of taxation will apply to the following saving schemes:
• Government Provident Fund;
• Public Provident Fund and Recognized Provident Funds;
• Specified pensions schemes;
• Approved pure life insurance products; and
• Annuity schemes
This move will certainly be a relief to the Aam Aadmi who would otherwise have to contend with a fairly harsh taxation system, especially in the absence of an adequate social security system. However, one should note the conspicuous absence of Unit Linked Insurance Plans ('ULIPs') from the list of investments that would qualify for EEE, given that ULIPS have in recent times become a popular avenue of investment.
Some of the other notable proposals in relation to the saving schemes are:
• Synchronizing the rules for contributions as well as withdrawal in order to give a boost to long term savings
• Investments which enjoy EEE under the current tax law, but are subject to EET under the DTC, would qualify for EEE if these investments are made prior to the date of commencement of the DTC.
To sum up, the Government has continued with the policy of EEE for certain key savings which should find not only stimulate long term savings but also be a substantial relief to the Aam Aadmi.
(The author is senior tax professional with Ernst & Young. Views expressed are personal.)
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