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Demystifying Direct Tax Code 2011 – Draft 2

June 16, 2010

The Indian Finance ministry has unveiled Drat – 2 of the Direct Tax Code. We fail to understand if it is a Finance Bill or a High School Assignment conducted by the officials. Analysis and implications for Salaried / Small Investors after 24 hour hectic consultation with Tax Experts.

Capital Gains Taxation – Direct Tax Code -2001 [Draft] Capital gains to be treated as income from ‘ordinary sources’ for all taxpayers, including non-residents and taxed at applicable rates. The distinction between ‘ordinary source’ and ‘special source’ income in so far as capital gains in the hands of non-resident is done away with. All capital gains are now proposed to be treated as ‘ordinary source’ income in the hands of both the resident and nonresident taxpayers. Is this a Gift for NRIs ?

Gains from transfer of listed equity shares / units of MF held for more than one year Deduction will be allowed at a specified percentage of the gains, in respect of gains on transfer of listed equity shares / units of equity oriented fund held for more than one year from the end of the financial year in which these were acquired. Whilst no exemption has been provided, the proposed deduction should provide some relief, as it will reduce the effective rate of taxation of such capital gains. As per an illustration in the Paper, based on a specified deduction rate between 50 percent and 70 percent, the effective tax rate would be between 5 percent and 15 percent depending on the marginal rate applicable to the taxpayer. We have recommended the Finance minister that investment in ELSS which are already to subject to a lock-in for 3 years must be given maximum deduction rate of 70%.

Gains from transfer of other investment assets held for more than one year – In respect of other investment assets held for more than one year from the end of the financial year in which these were acquired, the indexation benefit would be available with reference to the base date of April 1, 2000. However, deduction at specified percentage will not be allowed.

Gains from transfer of assets held for less than one year – In respect of assets held for less than one year from the end of the financial year in which these were acquired, capital gains will be computed without the benefit of either a specified deduction or indexation.

Housing BenefitsThe deduction of INR 1.5 lacs in respect of the loan taken for acquisition / construction of self occupied house property has been retained. Deduction for repairs and maintenance was restricted to 20 percent of the gross rent of the property. Further, the value of house property not let out for any part of the year will be considered as NIL. However, no deduction for taxes or interest will be allowed for such house property The concept of presumptive rent has been eliminated for Rental Properties.

EEE Savings / Pensions In the absence of a universal social security system in India, the continuation of EEE regime is a welcome step as it will provide a tax free lumpsum amount to individuals to meet their post-retirement financial requirements. Schemes that qualify for this are those regulated by Pension Fund Regulatory and Development Authority. Approved pure life insurance products and annuity schemes will also be covered under the EEE method.

Investments made before the commencement of the DTC in instruments which enjoy EEE method under the existing Act, would continue to enjoy EEE method for the full duration of the financial instruments. ULIPs [Weapon of Destroying Savings] are NOT part of EEE in Draft-2 of the Code.

Employment Benefits – Current tax regime to continue and amounts received by an employee towards gratuity, commuted pension, voluntary retirement and leave encashment will continue to be exempt, subject to specified limits. You can send your comments to the Finance ministry on Direct Tax Code here.

Finally, the Finance Minister must take some measures to widen the meager Tax Payers Base.

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