Income tax implications of the Direct Taxes Code proposals

Income tax implications of the Direct Taxes Code proposals

The Income Tax Act, 1961, will become history once the direct tax code Bill is approved. Here are the key proposals:

Tax rates: The Bill has widened income slabs for individual taxpayers. The lowest tax rate of 10% is applicable to salary income of Rs2-5 lakh, 20% on income of Rs5-10 lakh and 30% on income above Rs10 lakh.

These numbers are significantly lower than what was initially proposed in the first draft of the code, where income of Rs25 lakh and above was put in the higher tax slab of 30%. For senior citizens, tax exemption is sought to be raised to Rs2.5 lakh. However, there is no special tax exemption for women tax payers.

Residential status: The requirement of being present in India for 730 days in the preceding seven years, essential for qualifying as an ordinary resident, is being dropped. However, with regard to taxation on worldwide income for a person resident in India, the condition will still be valid. So, while the status of not ordinarily resident (NOR) as defined in the Act will no longer exist, the concept will remain as first-time expatriates working in India will become taxable on their worldwide income only after they have been in India for 730 days or more in the preceding seven years.

Income from salary: Key proposals for taxation of income under the head of salary are as follows. An employee friendly change is that the employer’s contribution to the approved superannuation fund is proposed to be exempt from tax without any cap. Under the existing Act, the employer’s contribution to the superannuation fund is exempt only up to Rs1 lakh. Further, reimbursement of medical expenses incurred by the employee on self and family treatment is proposed to be exempt from tax up to Rs50,000 per year as against the current limit of Rs15,000. This is a major bonanza for salaried employees.

In addition to the above changes, the much needed exemption for House Rent Allowance (HRA) in respect of expenditure incurred on rent paid, which was not provided in the draft code, has been introduced. This will be another big relief for salaried taxpayers since the exemption for HRA accounts for substantial tax savings. However, the exemption available for leave travel allowance is proposed to be scrapped.

Also, the exemption limits for gratuity, leave encashment and voluntary retirement scheme shall also be specified.

Income from house property: This will be a welcome change – no taxation on deemed income basis. The concept of fair market value for calculation of income from house property has been done away with. This will simplify matters. Income from the letting of house property will be computed on the basis of contractual rent, i.e. the amount of rent received or receivable for the financial year less specified deductions. Specified deductions range from municipal taxes, standard deduction on the gross rent to deduction of interest on loan paid during the fiscal year.

The Bill proposes to reduce the standard deduction on account of repairs and maintenance from the existing 30% to 20% of gross rent. A notable omission is the deduction for service tax paid on rented commercial property which was sought to be introduced by the revised discussion paper.

The deduction of interest on loan taken for self occupied property will be available up to Rs1.5 lakh. However, the Bill proposes to change the scheme of deduction for self-occupied house property vis-a-vis the rented property. In the case of self-occupied property, the deduction for interest on loans taken is available from gross total income. A welcome change in the Bill is the reinstatement of deductions for interest paid on loans during the pre-construction or pre-acquisition period in five equal instalments. This was missing in the draft code.

Capital gains: The definition of the period of holding for non-equity assets to be considered long-term is one year from the end of the financial year in which the asset is acquired as compared to the existing definition in the Act, which is more than 36 months. In addition, definition of period of holding for equity and equity oriented funds, which have been charged to STT for long-term, is one year from when the asset is acquired. This is the same as the existing act. As per the revised discussion paper (RDP), this was to be changed to same as other assets.

Further, long-term capital gains on the sale of listed equity shares and units of equity oriented funds will get 100% deduction, hence are fully exempt while short-term capital gains for shares held for one year or less deduction of 50% will be allowed. There are no special tax rates for taxation of capital gains -- short term or long term. For non-equity capital assets -- capital gains will be calculated after giving the benefit of indexation. The capital gains deposit scheme, which was proposed to be scrapped as per RDP, has been included in the DTC Bill.

Tax savings: Parallel to the deduction available under Section 80C of the Act, the Bill proposes a deduction up to Rs1 lakh for contributions to various approved funds. An additional deduction of Rs50,000 has been proposed under the Bill for payments for life insurance, health insurance and children’s education. While the initial draft code had proposed the exempt-exempt-tax (EET) system, the Bill retains the existing exempt-exempt-exempt (EEE) taxation philosophy for select benefits.

Wealth tax: The Bill proposes to increase the existing exemption limit for chargeability of wealth tax to Rs1 crore from the existing limit of Rs30 lakh under the Act. The Bill proposes to levy wealth tax on net wealth in excess of Rs1 crore (as opposed to Rs50 crore originally proposed) at the rate of 1%. Definition of wealth has also undergone a change to include watches, trusts outside India, equity and preference shares etc.

The tax code is a significant turnaround on the originally proposed revamping of how income is to be taxed in the hands of the individual taxpayer. Hence, EEE stays and for the need to maintain the fiscal balance, government had no choice, but to pull back the liberal tax regime proposed in the initial draft.

Sonu Iyer is tax partner, Ernst and Young. Views expressed are personal.

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