DirectTaxCode

Direct Tax Code May Be Deferred, Again

No Comments » Written on December 26th, 2011 by
Categories: Commentary, DirectTaxCode

The government may defer the Direct Tax Code by a year, even though Pranab Mukherjee mentioned as recently as Dec 7 that he would bring it in force from April 2012.

Dhirendra Kumar at Value Research expresses his concern about the delay – the second such one if the news is true – saying it causes unnecessary uncertainty for the regular classes:

Tax-saving patterns will change drastically when the DTC comes into effect. Broadly, the DTC tends to higher limits and a much smaller menu from which tax-saving investments have to be chosen. The lock-ins are also longer. For example, the shortest lock-in that was available was three years for ELSS, which will be gone. The NPS, which will be the only tax-saver in which money could go into equity will be locked in till retirement age.

These are very deep changes in savings patterns that we have spent our entire lives with. Unfortunately, while the new law is simpler than the existing one, it is not as simple as what was promised in the first draft of the DTC. It will take time not just for tax-payers but also accountants and tax lawyers and even tax officials to fully understand the implications of the new system. There will be the inevitable cycle of cases, appeals and clarifications. All this is going to take time and effort. And for the middle class individual without much spare resources or time, it’s going to be hard work. Fortunately, for most middle-class people, the DTC would probably have meant a lower tax outgo. The sooner that begins, the better it is.

What the DTC also means is lesser expenditure in collecting tax, lesser scrutiny ambiguities and lesser insurance/ELSS activity. The government will lose revenue but gain in terms of more compliance from simpler laws, and from the lower cost of collecting tax. But that won’t happen in a year, so the first year will be bad – a bad year, at a time the government needs revenue badly, is what might not be a good idea, it seems.

A short-term thinking government, which is pretty much what the Congress govt. is right now, will choose to scuttle the DTC. An opposition, like ours currently,  obsessed with trying to derail efforts rather than foster progress will choose to scuttle the DTC. The middle classes, whose life would be simplified by a better tax act, don’t get nada.

A bill which can actually be used to catch corruption (the anti-evasion clauses are serious and severe in the DTC) will silently die in the wake of an agitation against corruption. He who shouts the loudest is the only one heard. Push your way through, we don’t believe in merit anymore.

Posted in Commentary, DirectTaxCode

No Dividend Distribution Tax for Debt Funds?

8 comments Written on September 2nd, 2010 by
Categories: DirectTaxCode, MutualFunds

The Direct Tax Code has no DDT for debt or non-equity funds. Currently, for liquid funds, dividends are taxed at 25% plus the surcharge and cess, which adds up to nearly 28.5%. (Which I argue is still better than a fixed deposit)

So what’s the catch? Dividends will be taxed for non-equity funds, as if they are your income. Plus, there’s a dividend “withholding tax” – a sort of Tax Deducted at Source – 10% for residents (for >10K dividend), 20% for NRIs and companies.

That makes dividend income equivalent to a fixed deposit, where you get paid a certain amount of interest every year and the bank holds back 10% as TDS. It also makes life more cumbersome – you now need TDS confirmations for each non-equity mutual fund (dividend option) that you hold. (Luckily, now the system is automated, so your TDS credit is visible online. Register here.)

Impact: Growth Plans will make more sense to the investor. Even if you want regular income, just sell regularly, and that gets qualified as either a short term gain or a long term gain depending on how long you’ve held. Short term gains on non equity funds get taxed at your marginal rate too, but have no withholding tax, which is better for cash flow. Long term gains give you indexation benefits for inflation, which is great for debt funds. For a return of 8%, if 6% is inflation, you will pay tax on 2% – again, much better than FDs where you pay tax regardless of inflation.

Example: Take a fund or FD that makes 1% a month, and you put 50 lakhs in it. Assume you’re in the 30% tax bracket.

Investment Interest Withheld What you get

Tax Pd later

Net Return
Fixed Deposit 50,000 5,000 45,000 10,000 35,000
Fund (Dividend) 50,000 5,000 45,000 10,000 35,000
Fund (Growth) 50,000 0 50,000 150 49,850

This is for the first month, since your gain is very little. If you buy 500,000 units at Rs. 10 each, the NAV would have gone up to Rs. 10.1, you will sell 4950 units to get your Rs. 50,000 – that has 49,500 of principal and Rs. 500 of capital gain. Tax at marginal rate = Rs. 150.

As the gains increase, the tax amount goes up, steadily (since now more of the return is gain). But after about 24 months – the longest you need to hold for going into the “long term” bracket – you get the first 6% free of tax due to indexation, and are only taxed on what’s above that (again, at your marginal rate). In the 25th month, the same 50,000 will consist of 10,600 gain and remaining as principal – yet, the long term gain concept keeps that tax at only 2,500. That is far cheaper than the mutual fund (dividend) or FD, where the total tax is Rs. 15,000 every month.

That means: Monthly Income Funds need to be relooked. So does every non-equity fund where dividend was used as an option. With the 10-20% equity kicker in them, they make sense for a reasonable income plan, but the monthly income as dividends will be taxed at a high rate. You might want to use the growth plans instead.

Downside: You need to have the discipline to sell every month, and you’ll need some work in the year to calculate your tax liability. The difference, though, is substantial, even at the 10% marginal tax bracket.

Posted in DirectTaxCode, MutualFunds

India Direct Tax Code Bill Tabled in Lok Sabha

18 comments Written on August 30th, 2010 by
Categories: DirectTaxCode, IncomeTax

The Government introduced the Direct Tax Code Bill today. After some serious amount of searching, I found the bill online, after struggling with pages timing out, debugging communication messages and guessing IP addresses. (Read: It was darn easy in the end, but I had spent so much time I needed to make it look like it was a bloody difficult job).

What matters is not that I found it. What matters is what is in it.

First, this bill of the DTC applies from 1 April 2012, so heave a sigh of relief.

For salaried income: Deductions are Employment Tax, Travel allowance (currently Rs. 800 a month), actual reimbursements, employer’s contribution to pension [upto 10% of salary], retirement or provident fund [upto 12%].

Housing rent allowance is fully exempt, without the complex formula – now it is limited to the rent actually paid. Nice.

Property income: Only rent actually received is taxable. You get to deduct local taxed and 20% of the gross rent, plus all interest paid on a loan for that property. If you take on a loan before the property is ready, you get to amortize the interest paid before possession over the subsequent five years, equally.

Securities Transaction Tax stays. We will now pause for a minute to pray for the arbitrageurs that died after that sentence.

Capital Gains: First calculate the gain as selling price minus cost price minus all intermediate costs. For shares and equity mutual funds on which STT is paid and held over a year, ZERO. Rejoice.

Shares and MFs with less than one year of holding – 50% of the gain (or loss) is “ditched” and the rest added to income.

For debt MFs or shares transferred off-market or Gold ETFs or things like that: To qualify for LTCG (Long Term Capital Gains) you have to hold the asset for “one year from the end of the financial year in which the asset is acquired”. If you buy on April 1, 2012, you have to hold it till after March 31, 2013 – that’s two years at the extreme. Then, you get to index the costs to inflation. If you’ve bought the asset before 2000, then you must assume indexation from 2000, but you get the option – and I mean it’s your choice to do this if it works in your favour – of using the price on April 1, 2000. This is incredible, for me, because my family owns shares held for over 20 years.

Any other short term capital gains are simply added to income.

There will be a Capital Gains Deposit Scheme where you can dump the proceeds (not just the gains, the entire proceeds) of capital asset sales (long or short term) and not pay tax. You can buy a house or agricultural land to offset cap gains taxes, within a year after the sale or use the Cap Gains Deposit Scheme, to park money upto three years to invest in such a tax-offsetting asset. You get to do this for max two residential properties for a person.

Deductions: Everyone gets a Rs. 100,000 deduction for money put into “approved funds”. What we don’t know – are ELSS mutual funds “approved”? Are "ULIPs” approved? Most likely no to both. They do mention that approved funds are –

  • PF, retirement or gratuity funds
  • Pension funds
  • Any thing else specifically approved

An additional Rs. 50,000 is deductible under 3 heads – 50K is the limit for all of them added up.

  • Pure life Insurance – defined as any policy where the premium is less than 5% of the sum assured for ALL years of the policy,
  • Health insurance
  • Two children’s tuition fees (including pre-school fees). But no donations or “development fees”.

Housing: This gets interesting. First, no principal deduction. Second, interest is only deductible if the house is completed within three years of the loan commencement. (And the pre-completion interest is amortized forward over five equal yearly installments. You don’t get the deduction during the pre-completion phase) The interest deduction limit is Rs. 150,000.

Higher Education loan interest is deductible for seven years, but it’s gotta be from a bank or FI (not relatives) and for a course the govt. recognizes. (Sorry, IIPM. Perhaps even ISB will not qualify!)

Medical expenses get a 40K deduction if you actually spend the money on medical treatment. 60K for treatment of senior citizens. Oh, and if you get insurance, that much is not counted.

Tax slabs: Upto 200,000 a year, no tax.
Rs. 200,000 to 500,000: 10%
Rs. 500,000 to 10 lakhs: 20%
> 10 lakhs: 30%.

It’s progressive, and slabbed. For senior citizens (65+), the first slab is 250,000. For companies, the rate is 30%, and Minimum Alternate Tax is 20% (but you can claim it back within 15 years)

Dividends and Insurance income distribution from “Equity Oriented Insurance Schemes” (ULIPs) get taxed – at 5%. The 15% dividend distribution tax stays. That means to go through equity mutual funds you actually pay a lot – first companies pay 15% tax on dividends, then the mutual funds get a tax hit of another 5%.

Wealth tax: 1% of whatever’s above 1 crore rupees, every year. But not including the house you live in. This is just horrible, but amounts to just 1% more income tax, if you look at it. But if someone has money in illiquid assets like multiple houses, or equity, they’ll find the going tough. Think of the promoters of Indian companies!

With about 35 lakh crores under private sector ownership, that alone will give the government more than 30,000 cr. of wealth tax revenue.

But the section actually doesn’t count assets like shares and bonds! This needs lawyer input but it seems like for wealth, they consider land, farm houses, cars/yacht/aircraft, jewellery and bullion, antiques and paintings, expensive watches, cash, and shares held in foreign companies. Nothing about Indian company shares, or bonds, or mutual funds.

EEE or EET: NPS goes Exempt on withdrawal – commutation of pension (lumpsums) upto 1/3rd or 50% of the amount in different cases.

Life insurance paid on death is exempt. This is still a great way to transfer assets without a will.

All exemptions for donations to non-profits, political parties etc. stay.

Nothing much changes, really, other than a few exemptions gone, and wider tax slabs. Retaining LTCG at zero for equity markets is good, of course, but it won’t last that long. Wealth tax can be a huge issue or a non-issue, if there is clarity on whether it applies on share/bond holding.

To me this is no big deal – just business as usual. But the equity markets have reason to rejoice.

Posted in DirectTaxCode, IncomeTax

Reader Comments: Cannot Offset Long-term Capital Losses

7 comments Written on July 21st, 2010 by
Categories: DirectTaxCode
Thanks very much for all your comments on the earlier post about the Direct Tax Code keeping equity gains tax free till Mar 2011. I'd then asked if losses would be grandfathered - i.e. should we book them before and carry them over. Reader Sirka Pyaaz says:
If you held a share for more than one year and sell it in the open market, the capital gains are exempt. So the law says 'hey, im not taxing you on the gains, so im not gonna let you take the benefit of accumulating your losses'. Which is fair enough. This means both profits AND losses will be out of the picture. To overcome this, sell your stocks for a loss in an offmarket transaction. In that case, gains are taxable so losses will be allowed.
This seems to be consensus. But reader PX points out that the taxman won't be very happy allowing an "off-market" transaction designed just to avoid tax, even if it's a legal loophole. Remember that since this year, anything of the sort created to avoid tax, with no other intention, is likely to be disallowed just on that basis.

Best perhaps to wait for the final DTC draft. Still, excellent conversation, thanks.

Posted in DirectTaxCode

Direct Tax Code Will Keep Equity Gains Tax-Free till April 1, 2011

11 comments Written on July 19th, 2010 by
Categories: DirectTaxCode
NDTV says there's a good thing in the new Direct Tax Code: (HT: Samarth Modi)
Equity investors should remain invested despite the new direct tax code proposing the return of the long term capital gains tax. At least that’s what the government wants investors to believe, finance ministry officials have told NDTV.

Investors holding long term shares till March 31, 2011, will not be subjected to the long-term capital gains tax. And April 1, 2011 may become the new cutoff date, to begin the calculation of the long-term capital gains.

This means, stock prices as on April 1, 2011 will be the new base price for computing capital gains tax.

Implications - you don't have to do the sell-and-buy-back to avoid capital gains tax, since any gains upto April 1, 2011 will be tax free.

Of course, only if this is confirmed - we have to hear directly from the FinMin.

Note that this also means any stocks in which you have losses will be valued as if they were bought on April 1, 2011. So if you bought Airtel at 400 and it is at 300 on April 1, your purchase price is assumed to be 300. Then, if you sell at 400 later, the Rs. 100 will be a gain - even though you just broke even. (Correct me if I'm wrong)

So in case you have accumulated losses, is it possible to sell them before March 31 and buy the shares back, so you can offset such losses against future long term profits? I don't know if you can carry forward long term capital losses in shares; much check this out. Anyone know?

Posted in DirectTaxCode

Direct Tax Code: Book Profits and Buy Back?

11 comments Written on March 3rd, 2010 by
Categories: DirectTaxCode, IncomeTax, Stocks, TaxSaving

With the Budget revealing that the Direct Tax Code will be implemented from April 2011, a few choices have to be made now. The DTC brings in capital gains tax back again – even long term capital gains, which don’t get “preferential” treatment as they have in the last few years. Long term capital gains – where the purchase is over a year ago – is currently NOT taxed, and earlier they were only taxed at 10% max.

From April 1 2011, all capital gains booked will be added to your income and taxed appropriately in your tax slabs. (Upto 1.6 lakhs – no tax, 1.6 to 10 lakhs – 10%, 10-25 lakhs – 20% and above that, 30%).

Then why is capital gains any different from other income? Answer: Long term gains are “indexed” – meaning, the government understands that when you sell an asset, you should consider inflation. If you bought something for Rs. 100 three years ago, and inflation was an average of 6% in the last three years, then the Rs. 100 is actually worth Rs. 118 today – three years of simple 6% inflation. (Note: the actual number will be slightly higher due to compounding effects). So if you were to sell that asset for Rs. 140 today, your gain isn’t Rs. 40 – it’s only Rs. 22; since you are only taxed on gains, it lowers your tax incidence by 50%!

For more details on indexing read: http://blog.investraction.com/2006/12/long-term-capital-gains-ltcg-applies.html.

The wider slabs, too, give you a lower tax payout. Yet, some of us have held stocks for a LONG time. Maybe 5 or more years. The gains are probably huge – some of them above 50%. If we sold them anytime after April 1, 2011, then we’d pay tax on the entire gain! This is of course unacceptable, given there is a cheaper way out.

You can sell all these shares today and buy them right back. Then, the gains will be assumed to be booked today – on which there is a capital gains tax of ZERO. That sorts the past gains. From here onwards, only the gains from the NEW purchase price to whenever-you-sell will count for taxation post April 1, 2011.

Example: In my family we own some shares of Hero Honda bought in the nineties. The effective cost price today, after all their bonuses, is about Rs. 12 per share. The share is at Rs. 1750+. Even if I indexed everything like crazy, my cost price won’t go beyond Rs. 100 per share – we have to pay taxes on about Rs. 1600 per share if we decide to sell after April 1, 2011!

The right thing to do then is to sell shares, get the money and buy them right back, because we want to be invested in Hero Honda. That takes care of the full gain till now – no tax on the 1600 rupees – and if Hero Honda goes to 2000 when we sell, we’ll only pay tax on Rs. 250.

And there’s another thing: if we sell now, before March 31, 2011 and buy shares back, we will get TWO years of indexation; indexing laws work such that each financial year of purchase is counted for indexing, which means a purchase tomorrow and a sale in April 2011 gives me two years of indexing – 2009-10 and 2010-11 – so I can get the advantage of two year’s inflation before my gains are counted.

To put it simply: If I sell now and buy back before March 31, I will save 12% of future gains as well. If Hero Honda went to 1960 and I sold it in April 2011, I will pay ZERO tax. Not bad at all, in a thirteen month scenario.

Another thing to think about: if you want to buy stocks for the long term, buy them before March 31. No matter when you sell them you get an additional year of inflation adjustment and saves you tax.

Downside notes:

  • Selling and buying back involves payment of commissions and STT. That, for me adds up to less than 1% of the entire transaction value  (not just the gains). Considering the huge gains we have, we are better off than the potential tax of 10% on the whole deal. But to you it may be huge if the gains are not quite as much.  For example if you own 100 shares of Reliance at Rs. 800 for two years and it’s at 1000 today; your indexed gain if you sell now is just Rs. 100 per share, assuming 6% inflation. If you’re in the 20% bracket next year that would only result in a tax of Rs. 2,000. But a 1.5% transaction cost on selling and buying back 100 shares (@ Rs. 1000) today will cost you Rs. 3000. So do the calculations carefully before logging on to your broker’s web site.
  • You need a two day break before you can buy again. The T+2 settlement system ensures that if you sell today you only get money after two working days. That means a “buy again” can only happen then. In the meantime the share could fluctuate in value, so there’s a risk.

The sell and buy back makes sense if you have very high gains and don’t want to pay tax on them.

Posted in DirectTaxCode, IncomeTax, Stocks, TaxSaving