Weigh DTC provisions while choosing tax saving instruments
Amarpal S Chadha
Tax Partner, EY
Senior tax professional, EY
It is that time of the year when people make investments for tax saving. As an investor, when you think about investments, you have to keep in mind that the existing tax laws will undergo a major change by April 2012, with the implementation of the Direct Tax Code (DTC).
DTC has suggested some major changes in the way tax saving instruments are positioned. One has to ensure that the investments which are eligible for 'tax saving' under the existing tax laws would also continue to reap benefits under the DTC.
The avenues available for tax saving investments are less under the DTC compared to the existing tax laws. Following are some of the key proposals under the DTC which could impact your investment decisions.
Under the existing tax laws, the umbrella limit of Rs 1,00,000 is available as a deduction for a host of investments which includes payment of life insurance premium, ELSS, unit-linked insurance plans (Ulips), tuition fees of children, five-year bank deposits, and provident fund contributions etc.
The revised discussion paper on DTC has proposed to provide EEE (Exempt-Exempt-Exempt) method of taxation on the following investment instruments:
- Government provident fund
- Public provident fund
- Recognised provident funds
- Pension schemes (administered by the Pension Fund Regulatory and Development Authority)
- Approved pure life insurance and annuity schemes
Under the DTC, the deduction of Rs 1,00,000 is restricted to Government Provident Fund, Public Provident Fund, recognised provident funds and pension schemes. Investments made before the commencement of the DTC, which enjoy EEE method of taxation under the existing tax laws, would continue to be eligible for the EEE method of taxation for full duration of the instruments.
An additional deduction of 50,000 has been proposed to cover payments such as life insurance premium (annual premium shall not exceed 5% of capital sum assured), tuition fees for children and contribution to health insurance, which are currently under the limit of Rs 1,00,000.
National Saving Certificates, five-year term deposits with banks or post offices or deposits in senior citizen savings scheme and non-pure life insurance premiums will no longer be a choice of tax saving investments under the DTC. Also, repayment of housing loan principal amount and contribution to long-term infrastructure bonds will no longer yield tax saving under the DTC.
Listed equity shares or units of equity-oriented funds held for a year or less would be taxed after allowing 50% of capital gains as notional deduction. The main object of the computation of adjusted capital gains is to benefit the lower and middle income group taxpayers, as the effective tax rate would be lesser in case of taxpayers falling under the lower tax rate.
Listed equity shares or units of equity-oriented funds held for more than a year, would be taxed after allowing 100% of capital gains as notional deduction.
In the case of non-equity shares or non equity-oriented mutual funds, period of holding will be considered from the end of the financial year in which they are acquired; where as, the holding period is calculated from the date of purchase of investments under the existing tax laws.
A snapshot of some of the key positive, negative and neutral proposals from a tax saving perspective under the DTC is given below:
An additional deduction of 50,000 is available for life insurance, tuition fees for children and health insurance premium
- Contribution to employee provident fund, PPF, superannuation fund, pension schemes are subject to deduction with a maximum ceiling of 1 lakh
- Continuance of NIL tax on capital gains from sale of equity shares/equity-oriented units held for more than a year
- Continuation of EEE method of taxation
- The following investments will not be eligible for tax saving - ELSS, national savings certificate, five-year bank fixed deposits, Senior Citizens' Savings Scheme, post-office time-deposits, principal component of home loan repayment, contribution to long-term infrastructure bonds
- In the case of non-equity shares or non equity-oriented mutual funds, period of holding will be considered from the end of the financial year in which they are acquired
To conclude, diversification always reduces risk and may increase returns, too. So, one could balance his/her portfolio and maintain a fair balance of investments in both government and private securities. The focus for investors will need to move towards investments that provide for a 'real' wealth accumulation and not only a tax savings play. Let's keep our fingers crossed for the DTC to be implemented by April 2012 as it will provide more clarity and a long-term view on the investment horizons.