A Financial Planner decodes The Direct Taxes Code (DTC) 2010 Sep 01, 2010

A Financial Planner decodes The Direct Taxes Code (DTC) 2010

Sep 01, 2010

The Direct Taxes Code 2010 (DTC) 2010 became a reality after good 50 odd years on Aug 31, 2010, when the FM introduced the bill in the parliament. The Income Tax Act 1961 as well as The Wealth Tax Act 1957 has finally been replaced by The Direct Taxes Code 2010. So how have things changed for the average Indian after 50 years?

Well, not much.

The original DTC Draft

When the 1st draft of the DTC was proposed almost a year back, it raised great expectations as it was supposed to herald a new era of direct taxation. The IT slabs proposed were unthinkable, unimaginable even a year back.

The corporate tax rate was proposed to be reduced in one shot from the present 33% to 25% and this move was applauded by one and all. The IT slabs proposed for individuals were supposed to be path breaking. 30% tax bracket was applicable only if your total income exceeded Rs. 25 lacs. Up to Rs. 3 lacs deduction from gross total income was proposed to be allowed.

There were also a few proposals in the original draft that ruffled a few feathers especially in the corporate world and faced lot of resistances. The Minimum Alternate Tax (MAT) was proposed on assets as against book profits and was opposed tooth and nail by the corporate. Another proposal that created disturbances was the proposal to levy tax on long term capital gains which otherwise was tax free. One more concern was that Rs. 1.50 lacs deduction available for interest payments on home loan. It was feared that this deduction might go way.

Final avatar of The Direct Taxes Code (DTC) 2010

When on Aug 31, 2010, the final avatar of DTC 2010 was revealed, some dreams got shattered and some nightmares thankfully did not come true. The biggest dream that got shattered was the revelation of the new Income tax slabs that would be effective April 1, 2012. Have a look at the graphic below.

Personal Income Tax Rates for Individuals, HUF, Association of Persons (AOP) and Body of individuals (BOI):

Income Tax Rate (%)	Current under The Income Tax Act’ 1961	As proposed in the 1st DTC draft (Aug 2009)	As per the final DTC  2010 (Aug 2010)
Basic exemption limit – Male assesses	Rs. 1.60 lacs	Rs. 1.60 lacs	Rs. 2.00 lacs
Women assesses	Rs. 1.90 lacs	Rs. 1.90 lacs	Rs. 2.00 lacs
Senior Citizens	Rs. 2.40 lacs	Rs. 2.40 lacs	Rs. 2.50 lacs
10 % tax bracket	Up to Rs. 5.00 lacs	Up to Rs. 10.00 lacs	Up to Rs. 5.00 lacs
20% tax bracket	Rs. 5.00  to 8.00 lacs	Rs. 10.00  to 25.00 lacs	Rs. 5.00  to 10.00 lacs
30% tax bracket	Above Rs. 8.00 lacs	Above Rs. 25.00 lacs	Above Rs. 10.00 lacs
Deductions from Gross Total Income	Rs. 1 lac (Sec 80C)+ Rs. 15,000 (Sec 80D)+ Rs. 20,000 (Infra Bonds) = Rs. 1.35 lacs total dedn.	Rs. 3 lacs	Rs. 1.50 lac (Sec 80C)
Corporate Tax Rate	33% (including cess & surcharge)	25%	30% (net)

As is evident from the table above, as per the draft DTC proposal of Aug 2009, one would fall in the 30% tax bracket only if your Gross Total Income exceeds Rs. 25 lacs. This would have been an extraordinary move had it been approved. Approximately 90% of Indian Income Tax payers would have fallen in either 10% or 20% tax bracket which would have improved tax compliance and consequently Govts’ revenues from direct taxes as history shows that whenever the Govt. has reduced taxes, tax compliance has improved and has resulted in increasing revenues for the Govt. coffers.

Unfortunately the final code of Aug 2010 revealed that with a Gross Total Income of mere Rs. 10 lacs, one falls in the 30% tax bracket. This is a mere Rs. 2 lacs increment over the existing tax slab as per The Income Tax Act 1961. The question that comes in mind is that this slight change could have been made in the next year’s budget. Why the need for a Direct Tax Code.

Again, the total deductions from Gross Total Income that are allowed today as per The Income Tax Act, 1961 add up to Rs. 1.35 lacs. This was proposed to be increased to Rs. 3 lacs in the Draft DTC of Aug 2009. Unfortunately, there was disappointment on this front as well. The total deductions have been marginally increased by just Rs. 15,000 from Rs. 1.35 lacs currently to Rs. 1.50 lacs as proposed in The DTC 2010. Again, why the need for a Direct Tax Code to implement a minor change.

Another disappointment is the drastic reduction in the choices available to an average Indian to claim deductions from Gross total income. While the current Income Tax Act offers a wide array of savings & investment products to choose from based on an investors profile like PPF, NSC, KVP, 5 year Bank FDs etc. for the risk averse investors; Tax Saving Mutual Funds (or ELSS) & Insurance Plans & ULIPs for those who want to have market exposure and also a deduction for principal repayment of home loans and additional deduction of Rs. 20,000 for infrastructure bonds.

Unfortunately, and this is one of the biggest disappointment from the DTC 2010 from a financial planner’s perspective that the proposed set of savings & investment avenues allowed under The DTC 2010 is just half of the choices already available today. Have a look at the graphic below:

Also, while currently, women assesses are given preferential treatment by having a higher exemption limit of Rs. 1.90 lacs v/s Rs. 1.60 lacs for male assesses, The DTC 2010 has removed this distinction and has a common exemption limit of Rs. 2.00 lacs for both male & female assesses. This comes as a disappointment for the women.

Comparison of Deductions allowed:

Types of Deductions available	Currently under The Income Tax Act 1961	As proposed in The DTC 2010
Traditional savings instruments	PPF, GPF, EPF, NSC, KVP, 5 year Bank FDs, Post Office Schemes etc.	Approved Funds like PF, GPF, EPF, PPF etc, superannuation or gratuity funds, Pension Funds & other funds approved by the GOI.
Market Linked Investments	Tax Saving Mutual Funds (or ELSS) & ULIPs	None
Pension Schemes	The New Pension Scheme (NPS)	The New Pension Scheme (NPS)
Expenditure allowed	Tution Fees of max. 2 children & Repayment of Home Loan principal	Tution Fees of max. 2 children only
Medical Premia	Available separately u/s 80D with a limit of Rs. 15,000 over and above Rs. 1 lac available u/s 80C (Rs. 20,000 in case of Mediclaim for parents who are senior citizens)	Medical Premia payments made for family clubbed with other deductions & no separate limit given
Life Insurance	Life Insurance Premia payable for insurance policies of family allowed; all products	Premia payable on only pure life insurance policies (where amount of premium paid < 5% of sum assured) allowed.
Infrastructure Bonds	Investment in Infra bonds issued by infrastructure NBFCs approved by GOI up to a max of Rs. 20,000 over and above Rs. 1 lacs u/s 80C & Rs. 15,000	No deductions for Infra Bonds
Interest expenses on Home Loan	Deduction up to Rs. 1.50 lacs allowed	Deduction up to Rs. 1.50 lacs allowed
Total Deductions allowed >>>	Rs. 1.35 lacs + Rs. 1.50 lacs = Rs. 2.85 lacs	Rs. 1.50 lacs+ Rs. 1.50 lacs = Rs. 3.00 lacs

As is clear from the above table, the incremental deduction allowable under The DTC 2010 over the existing Income Tax Act is mere Rs. 15,000. Much ado about nothing…

Also, a whole host of investment avenues like NSC, KVP, Post Office Schemes, 5 year Bank FDs, Tax Saving Mutual Funds, and Insurance plans are no more eligible for tax deductions.

From more than a dozen savings and investment avenues available today, the DTC 2010 proposes to reduce the choice to less than half a dozen. This according to me is the biggest disappointment from the retail investor’s perspective. A wonderful investment avenue like Tax Saving Mutual Funds (or ELSS) no more figures in the allowable deductions. Even traditional favorites like NSC, KVP, Post Office Schemes do not have a mention in The DTC 2010.

One pain area though is the levy of 5% dividend distribution tax (DDT) ie; dividends paid by companies on shares as well as dividend payments by mutual funds shall both be subject to a 5% dividend distribution tax (DDT). As of now, dividends are tax free. This move was uncalled for as many investors, especially senior citizens, currently invest in Mutual Funds so as to earn regular dividend income from them for their daily needs. This dividend income will now be affected adversely.

So what is good about The DTC 2010

However, there is a silver lining in The DTC 2010. Certain nightmares did not come true. The biggest nightmare was disallowing the Rs. 1.50 lacs deduction for interest payments on home loan. The stock market was terrified at the prospect of levy of a tax on long term capital gain which as of now is tax free. Fortunately, both the above nightmares did not come true. The deduction of up to Rs. 1.50 lacs for interest payments on home loan is going to be allowed under The DTC 2010 & long term capital gains continues to be tax free under the DTC regime. There was one more positive surprise in the DTC. The reduction in rates levied on Short Term Capital Gains (STCG).

As of today, STCG are taxed @ 15% irrespective of our tax slabs. Thus a person in 10% tax bracket is taxed @ 15% on his STCG as also a person who is in 30% tax bracket. This was not being fair with the guy in the 10% tax bracket. This anomaly has now been done away with in The DTC 2010. Have a look at the graphic below.

Taxation of Capital Gains

Particulars	Currently under The Income Tax Act 1961	As proposed under The DTC 2010
Tax on Short Term Capital Gains
10% tax bracket	15%	5%
20% tax bracket	15%	10%
30% tax bracket	15%	15%
Tax on Long Term Capital Gains	Tax free	Tax free

As is evident from the table above, under The DTC 2010, you shall now have to pay a much reduced tax on you Short Term Capital Gains @ 50% of your tax bracket. This is a very welcome move and the FM should be applauded for the same.

Conclusion

When the current congress Govt. took charge, an ambitious Minister announced mega plans of building 20KMS of National Highway every day. We all know what the reality is today and are aware of the huge gap between actual road building and mega plans announced then.

Something similar has happened with The Direct Taxes Code 2010. It was announced in Aug 2009 with great fanfare and promises of a new era in direct tax collection. Exactly 1 year later, The DTC 2010 has turned out to be a big dampener and looks like the twin brother of the existing Income Tax Act 1961 and nothing more. In our opinion, The Direct Tax Code 2010 is an opportunity missed and the only plausible reason seems to be the lack of political will. One more minister succumbs to political pressure and fails to walk along the unbeaten path.

To sum up, the New Direct Taxes Code is Very Old Wine in not so New Bottle……