India's Direct Tax Code and How it Will Impact Wealth Creation From Next Year

India is soon going to have a new set of rules for direct taxes, which will replace the 50-year-old Income Tax Act.

The so-called Direct Tax Code, which is scheduled to come into force from financial year 2011-12, had prescribed removal of almost all tax rebates in individual investments but also proposed raising the income limits for various tax slabs drastically.

However, the proposals drew sharp reactions and after reviewing some 1,600 public suggestions/comments, the government on Tuesday unveiled a more polished version of the code, which toned down some of the proposals.

As per the revised paper, provident funds and pure life insurance products will continue to enjoy the so-called exempt-exempt-exempt - suggesting tax exemptions in the three stages of investment, accrual of gains and withdrawal of investment - a status they now enjoy.

"It is proposed to provide the EEE (exempt-exempt-exempt) method of taxation for government provident fund, public provident fund and recognised provident funds..." the discussion paper said.

The paper clarified that the EET (exempt-exempt-tax) regime should be restricted to new savings instruments after DTC comes into effect, and the same should not apply to existing saving instruments.

Ulips or unit-linked insurance plans - which have been at the centre of a public debate of late - have been brought under the EET regime after the DTC comes into force.

Similarly, stocks investors will no longer be able to enjoy tax-free gain from long-term investment in equities as the DTS proposes to treat both short-term capital gains as well as long-term capital gains for tax calculation purposes.

Moneyguruindia tax experts analysed the proposals threadbare and came up with a detailed analysis of the tax incidence on various investment instruments as proposed under the new rules.

PAY AND PERKS:- The proposal to bring in perquisites like government accommodation to be part of salary has also been dropped. All perks will continue to be taxed as per existing norms. First draft didn't not find favour with the salaried class

INCOME TAX SLABS:- Revised DTC silent on personal income tax rates and slabs. First draft suggested 10% tax on income from Rs 1.60-10 lakhs and 20% on income between Rs 10-25 lakhs and 30% beyond that. Revenue secretary says these slabs are only illustrative and they will be fixed at the time of notifying the tax code

HOME LOANS:- Government decides to continue with the major tax incentive on housing loans. Revised draft says home buyers will continue to get tax benefit on payment of interest on home loans up to Rs 1.5 lakh annually. Actual rental income will be taxed.

INSURANCE AND ULIPS:- No tax proposed on life insurance products under exempt-exempt-exempt norm. New Ulips issued after DTC becomes operational will be taxed on maturity or withdrawal. Existing Ulips will be exempt from tax either on maturity or withdrawal midway.

EQUITY MUTUAL FUNDS: - The draft DTC proposes long-term capital gains tax on units of equity funds. At present, equity funds that lock in investments for more than three years enjoy tax exemption as there is no long-term capital gains tax. The draft DTC proposes to compute long-term gains on equity and equity funds after allowing a deduction at a specified percentage of capital gains without any indexation.

STOCKS INVESTMENT: - The difference between long-term and short-term capital gains has been eliminated. Capital gains will be treated as income from ordinary sources and taxed at applicable rates. Specific rate of deduction for capital gains is to be finalised. But not tax on capital gains from savings schemes.

PROVIDENT FUND: - The proposal to tax government provident fund (GPF), public provident fund (PPF) and pension funds withdrawals has been dropped. It is proposed to provide the EEE (exempt- exempt-exempt) benefit to GPF, PPF and recognised provident funds. First draft had proposed to tax all savings schemes including PF's at the time of withdrawal.

PENSION PRODUCTS: - Revised draft puts pensions administered by PFRDA, including pension of government employees recruited since January 2004, under EEE treatment, means no tax any stage. "In the absence of adequate social security benefits, taxation of withdrawals from retirement benefits would be harsh," says the revised DTC.

By UDAY SHANKAR