Rama Krishna Vadlamudi, BOMBAY June 20, 2010

The Government of India had come out with a Revised Discussion Paper on
June 15, 2010, with regard to the implementation of the Direct Taxes Code Bill
2009 which is supposed to replace the Income Tax Act and other acts. The
Revised Discussion Paper (hereinafter referred to as RDP) has taken into
consideration various concerns of taxpayers and other players and proposed to
make some changes to the proposed Direct Taxes Code Bill 2009. It may be
recalled that the Government in August 2009 brought out the DTC Bill and a
discussion paper with a view to making direct taxes (income tax, dividend
distribution tax and wealth tax) simpler and equitable.
Even though the RDP has touched upon a total of eleven issues, the present
article will confine itself to the impact of these provisions on individuals and
salaried class.

Abbreviations Used:

DTC 2009-Direct Taxes Code August 2009
EEE-Exempt, Exempt & Exempt
EET-Exempt, Exempt & Tax
ELSS-Equity Linked Savings Scheme
of the mutual funds
EPF-Employee Provident Fund
GPF-Government Provident Fund
NPS-New Pension System administered
by PFRDA
NSC-National Savings Certificate
PF-Provident Fund
PFRDA-Pension Fund Regulatory and
Development Authority
PPF-Public Provident Fund
RDP-Revised Discussion Paper of DTC
released by Govt on 15.6.2010
SCSS-Senior Citizen Savings Scheme
ULIP-Unit Linked Insurance Plan of
insurance companies
VPF-Voluntary Provident Fund

Please read the authors disclaimer given at the end of this article.
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What are the new proposals in the RDP?

The proposals of the Revised Discussion Paper are explained in relation to the
existing tax provisions so that readers can appreciate how their tax liability is
going to be changed in future if and when the DTC comes into force.
1. Tax treatment of savings EEE regime versus EET regime:
TABLE 1

Existing Tax Provisions Revised Discussion Paper

Many investments are under the purview In future, the EEE method is applicable
of EEE method now. These investments only to the following:
include GPF, EPF, PPF, most of the
insurance policies (except annuities), GPF
recognised PFs, NSC, ULIPs, ELSS, Recognised PFs
deposits in SCSS, 5-year bank term PPF
deposits, 5-year post office fixed NPS
deposits, etc Approved pure life insurance products*
Annuity schemes
As of now, NPS is subject to EET.

Note: To know about what EET method and EEE method are, please see Annexure I

* There is a lot of confusion as the Government has not defined what an approved pure life
insurance product is. Some experts believe that it refers to pure term insurance policies.

EEE Method: In India, we do not have any social security meaning that Government
does not provide any income to the needy persons after their retirement or old age. This
lack of social security puts a heavy burden in old age. Keeping this in mind, the
Government now says that they want to continue with the EEE method for certain
schemes as mentioned in Table 1 above. When the DTC comes into force, investments
pertaining to only these schemes will continue to enjoy tax benefits at the time of
investment, during accumulation period and at the time of withdrawal. As of now, NPS
administered by PFRDA is under the EET method, and as per RDP it will be brought
under EEE method of tax treatment.

EET Method: After reading the intent and purpose of the Government as given out in
RDP and DTC Bill 2009, it can be interpreted that the following schemes will not be
subject to tax at the time of investment and accumulation period only; but, investors will
have to pay tax at the time of withdrawal: NSC, ULIPs, ELSS, SCSS, 5-year bank term
deposits and 5-year post office term deposits. All these schemes will be subject to EET
method once DTC comes into effect.

A Consolation: Investments made, before the date of commencement of the DTC, in

instruments which enjoy EEE method of taxation under the current law, would continue
to be eligible for EEE method of tax treatment for the full duration of the financial
instrument (this is called grandfathering clause).

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2. Taxation of Retirement Benefits and Perquisites:

TABLE 2

Existing Tax Provisions Revised Discussion Paper

An employers contribution to PF, The status quo will be maintained

superannuation fund and NPS and these will continue to be exempt
are not subject to tax. Retirement benefits from tax even after DTC comes into
received by an employee are out of the effect.
tax purview subject to monetary limits.

As per RDP, the Government has clarified that the following will be exempt from
tax, subject to specified limits, for all employees:

amount of gratuity received,

amount received under a voluntary retirement scheme,

amount received on commutation of pension linked to gratuity received

amount received from encashment of leave at the time of superannuation

(In the original DTC 2009, it was proposed to include them under salary and a
Retirement Benefits Account RBA was proposed to be created to enjoy tax
benefits. Now, the idea of creation of the RBA was scrapped as per the RDP.)

Valuation of Perquisites: It was proposed in the original DTC 2009, that the
perquisites provided by the employer to the employee relating to lease housing
accommodation, leave travel concession, encashment of unavailed earned
leave, medical reimbursement and cost of medical treatment will be included in
the salary of the employee and taxed accordingly.

As per the RDP, the Government has now clarified that the method of valuation
of perquisites will be appropriately provided in the rules. It is proposed that
perquisites in relation to medical facilities/reimbursement provided by an
employer to its employees shall be valued as per the existing law with
appropriate enhancement of monetary limits. It is clarified that the DTC does not
propose to compute perquisite value of rent free accommodation based on
market value. The revised RDP has provided partial relief to the salaried class as
far as taxation of retirement benefits and perquisites is concerned.

In real life, it so happens that what is not stated explicitly is more important than
what is stated. Investors will probably be shocked to know that many existing
exemptions will be withdrawn once the DTC comes into force. For such
exemptions to be withdrawn, please see Annexure II given at the end of this
article.

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3. Taxation of Income from House Property:

The DTC 2009 had proposed that income from house property would be
calculated as gross rent less specified deductions. The gross rent would be
higher of the following:

(i). the amount of contractual rent for the financial year

(ii). the presumptive rent calculated at 6% pa of ratable value fixed by the
local authority

The DTC 2009 had proposed to withdraw tax exemption of Rs 1.50 lakh for
interest on borrowed capital relating to self-occupied property.

The above proposals have received criticism from various quarters. Taking these
views and criticism into consideration, the Government has now proposed the
following modifications as per the RDP:

In case of let out house property, gross rent will be the amount of rent
received or receivable for the financial year

Gross rent will not be computed at a presumptive rate of six per cent of the
rateable value or cost of construction/acquisition

In case of any one self-occupied property, an individual or HUF will be

eligible for deduction on account of interest on capital borrowed for
acquisition or construction of such house property subject to a ceiling of
Rs. 1.50 lakh from the gross total income

The above modifications have been widely welcomed by the public.

As far as Rs 1.50 lakh deduction from the gross total income is concerned, the
Government says it would retain the existing tax provisions. However, the
Government has stated that the overall limit of deduction for savings will be
revised accordingly. Which means, the Government is likely to revise the tax
rates and tax slabs that were proposed in the original DTC 2009.

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4. Taxation of Capital Gains:

As per the RDP, income under the head Capital Gains will be considered as
income from ordinary sources in case of all taxpayers. It will be taxed at the rate
applicable to that taxpayer.
(A). Long-term capital gain for listed equity shares and equity mutual funds
TABLE 3
Existing Tax Provisions Revised Discussion Paper

If a listed equity share or equity MF is held
for more than one year, any gain from sale
of such asset will be treated as long-term
capital gain or LTCG.
As of now, LTCG attracts zero tax rate.
If a listed equity share/equity mutual fund
is held for more than one year from the
end of the financial year in which it is
acquired, the gain from sale of it
will be considered as LTCG.
A specified deduction will be allowed
without any indexation benefit. Such
adjusted LTCG will be included in ones
income and taxed at the applicable rate. *

* The Revised Discussion Paper (RDP) does not mention any specified deduction rate, but
gives some illustrations based on 50, 60 & 70% specified deduction. The Government states that
the specified deduction will be decided later keeping in view the overall tax rates. This is a BIG
NEGATIVE for investors who have accumulated substantial long-term capital gain over a period
of several years. The Governments flip-flop is causing severe heartburn to long-term investors.

One important feature of RDP is the definition of long-term capital gain itself. The
distinction is stated in Table 3 above. The Revised Discussion Paper states that a
long-term capital gain is gain from sale of a listed equity share or equity mutual fund
that is held for more than one year from the end of the financial year in which such
listed equity share or equity mutual fund is acquired. For example, if you buy a share
on April 1, 2011 and sell it on or before March 31, 2013; any gain from such share
will be considered as STCG. Suppose, if you sell it on or after April 1, 2013, any gain
from such sale will be considered as LTCG. Effectively, the holding period for LTCG
consideration can be between 366 days and 729 days. The Government has created
unnecessary confusion among public with such revised definitions.
STT stays: When the tax on long-term capital gain was abolished by the then
Finance Minister while presenting the Union Budget 2004-05, he introduced
Securities Transaction Tax (STT) to fill the tax revenue gap caused by the abolition
of LTCG. Unfortunately, the RDP says that STT will be revised suitably. Now, equity
investors will have to pay both the STT and LTCG once DTC comes into force,
which was not the case prior to the introduction of STT in 2004. In toto, the
Government has messed up the provisions relating to capital gains tax.
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, if required, claims the Government as per the RDP.

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(B). Long-term capital gain for assets other than listed equity shares and
equity mutual funds @
TABLE 4:

Existing Tax Provisions Revised Discussion Paper

Long-term capital gain for assets like
house property, land, gold, etc (other
than listed equity shares or equity MFs)
is gain that arises from sale/transfer of
such asset after holding it for more than
three years from the date of purchase.
If such asset like house property, land,
gold, etc (other than listed equity share or
equity MFs) is held for more than one
year from the end of the financial year
in which it is acquired, gain arising from
sale of such asset will considered as
LTCG.

Such LTCG at present is being taxed The LTCG will be adjusted with indexation
at 20% after providing indexation benefits; and such adjusted LTCG will be
benefits based on cost of inflation index. included in ones income and taxed at the
applicable rate. $

@ Such assets include house property, land, gold, etc.

$ The base date for determining the cost of acquisition will now be shifted from 1.4.1981 to
1.4.2000. As a result, all unrealized capital gains on such assets between 1.4.1981 and
31.3.2000 will not be liable to tax. The capital gains will be computed after allowing indexation on
this raised base.

The existing Capital Gains Account Scheme will be discontinued as per the RDP.

One important feature of RDP is the definition of long-term capital gain itself. The
distinction is stated in Table 4 above. The Revised Discussion Paper states that
a long-term capital gain is gain arising from sale of an asset like house property,
land, gold, etc (other than listed equity share or equity mutual fund) that is held
for more than one year from the end of the financial year in which such asset is
acquired. The Government has created unnecessary confusion among public
with such revised definitions.

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(C). Short-term capital gain for assets including listed equity shares, equity
mutual funds, house property, land, gold, etc:

TABLE 5:

Existing Tax Provisions Revised Discussion Paper

For shares and equity MFs:
Short-term capital gain is the gain that
arises from sale of a listed equity share or
an equity MF after holding it for less than
1 year. Such STCG is taxed at 15%.
For assets other than listed equity
share or equity mutual fund:
As per RDP, the tax treatment of all assets,
(whether shares, mutual funds, immovable
property, gold or others) will be the same.
Short-term capital gain is the gain from sale
of an asset holding it for less than 1 year
from the end of the financial year in
which the asset is acquired.

STCG is gain from sale of house,

land, gold, etc, after holding it for less Short-term capital gain will be taxed at
than three years. Such STCG is included the rate applicable to taxpayer. No
in ones income and taxed at the rate specified deduction or indexation will be
applicable to the taxpayer. allowed while calculating STCG.

One notable feature of the RDP is that it treats all assets as same as far as
treatment of short-term capital gains is concerned. As mentioned in Table 5
above, under existing tax provisions, the tax treatment of short-term capital gains
for listed equity shares or equity mutual funds; and other assets like, immovable
property or gold is different.
Another important feature of RDP is the definition of short-term capital gain itself.
The distinction is stated in Table 5 above. The Revised Discussion Paper states
that a short-term capital gain is for assets that are held for less than one year
from the end of the financial year in which the asset is acquired.
(In fact, the RDP does not use the words, short-term capital gain or long-term capital
gain. For the sake of simplicity and better understanding, the words STCG and LTCG
are used in this article as they have been in existence for than five decades.)
Other issues covered in the Revised Discussion Paper:

 Minimum Alternative Tax (MAT) will be based on book profits as is the current
practice. However, the Government has not given any MAT rates.
 Non-profit organizations can carry forward unused grants for three years
 Wealth tax will be paid by all taxpayers except non-profit organizations
 Existing units in Special Economic Zone (SEZ) will enjoy profit-linked deductions
just like the developers of these zones for a limited period when the new Code
comes into force

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Annexure I

WHAT IS THE DIFFERENCE BETWEEN EEE and EET METHOD?

As of now, individuals enjoy several tax benefits of course, subject to certain

quantitative limits on their investments in a variety of savings instruments;
namely, EPF, VPF, PPF, GPF, NSC, insurance policies, ULIPs, ELSS, bank
fixed deposits, post office deposits, housing loan instalments, interest paid on
housing loan, etc. The present system is called EEE meaning investments enjoy
benefits in three stages: 1). Exemption allowed at the time initial contribution, 2).
Exemption through out the accumulation period, and 3). Exemption at the time of
withdrawal. (EEE stands for Exempt, Exempt and Exempt).

It was proposed in the DTC 2009 that the EET method will apply for new
contributions made after the commencement of the DTC. The DTC 2009 had
proposed to shift to a new system called EET whereby exemption would be
allowed at the time of initial investment and accumulation period only; but the
withdrawals will be included in the taxable income and taxed according to ones
tax slabs. (EET stands for Exempt, Exempt and Tax).

Simply put, under the proposed EET regime, tax savers will be postponing their
tax liability for future or till the date of retirement. Is retirement the best time to
pay our taxes by avoiding payment of taxes during our earning years?

Logically, EET system is sound in principle and good for the economy. However,
in India, we lack a social security system and as such, some concessions are
required for the needy persons.

Annexure II

TAX DEDUCTIONS/INCENTIVES TO BE WITHDRAWN:

A careful reading of the provisions and the RDP and DTC 2009 indicate that the
Government is most likely to withdraw the following existing tax exemptions
being enjoyed by the taxpayers. One is forced to come to this conclusion
because the Government has maintained a strange silence on these issues and
these issues have not been mentioned either in the DTC 2009 or the RDP
released on June 15, 2010. So, the important deductions that are most likely to
be disallowed in future under proposed DTC could be:

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o Housing Loan instalments of up to Rs 1.00 lakh in a financial year and

allowed as deduction under Section 80C of existing IT Act may not be
allowed as deduction under the proposed DTC 2009

o Contributions made to Equity Linked Savings Schemes of Mutual

Funds

o Notified Bank Time Deposits for a term of 5-years or more

o Accrued Interest on NSCs

o Contributions made under Unit Linked Insurance Policies

o Under DTC, bonuses or sums received from life insurance policies

may not be allowed for deduction in case: (1). Annual premium paid is
more than five per cent of the sum assured; and (2). If the policy is
surrendered before the maturity date (as per clause (a) of sub-section
3 of section 57 of DTC 2009)

References:

1. Revised Discussion Paper released by Ministry of Finance, GOI

dated June 15, 2010

2. Direct Taxes Code Bill and discussion paper released by Ministry of Finance,
GOI in August 2009

3. Newspapers

Authors Disclaimer: The authors views are personal. The above article is
written for information purpose only. Every care has been taken to provide
authentic information as far as possible; however, the author is not responsible
for any inadvertent discrepancies that may have crept in. Readers should consult
their own certified tax consultants or experts to correctly interpret the provisions
of tax laws or other matters.

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To read other important documents on Direct Taxes Code, just click:

Revised Direct Taxes Code 2010-

Criticism of the Revised Discussion Paper
www.scribd.com/doc/33286075

Direct Taxes Code-DTC-Its impact on Salaried Class

and Individuals
www.scribd.com/doc/33282656

Direct Taxes Code 2009-DTC-Its impact on individuals, etc

www.scribd.com/doc/19542987

Direct Taxes Code 2009-DTC-Its impact on Long-term

Capital gains and short-term capital gains of shares/MFs
www.scribd.com/doc/23804443

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