plannning for new direct tax code

planning for stt and capital gain differential if you sell and buy now you would get away with just paying .125% stt. if you are early enought to qualify for indexation for next year if you happen to sell shares you could take indexation benefit too.

A major change in income-tax calculation is in the offing with the Direct Tax Code Bill, 2009, proposed to replace the Income-Tax Act of 1961. On the face of it, the new code would seem to offer a bonanza to taxpayer, by broadening tax slabs and cutting rates. A detailed reading of the code suggests that investors may have to rejig their investments substantially if they are to prepare for the proposed changes.

One fact that investors have to note is that they may move into a higher tax slab, if they are on the border-line of the Rs 10-lakh-a-year slab now. The code proposes to do away with many of the exemptions and include certain heads of income such as house rent allowance, leave travel allowance and medical reimbursement in the gross income of an individual.

Individuals also need to review their decision to buy a home or make other investments for tax savings.

Here, we attempt a few tax planning ideas to prepare for the eventuality, if the Direct Tax Code is implemented in its current form.

Home loans

Investors planning to buy a new house over the next few years should not rush to enlarge their monthly commitments on the strength of current tax breaks. These may be set for major changes if the new tax code is implemented.

As buying a home is an aspiration for many middle-income earners, many home buyers factor in the tax shelter available on property to stretch their home-purchase budget.

Under the deduction under section 24, any interest paid on money borrowed to buy a home is allowed as a deduction from an individual’s total income to the extent of Rs 1.5 lakh a year. This apart, under section 80C of the I-T Act, a deduction is available for the repayment of the principal portion of the loan with the maximum permissible deduction at Rs 1 lakh a annum.

The Direct Tax Code proposes to do away with both these popular tax shelters on interest and principal repayments if the house is self-occupied. But the Direct Tax Code does allow interest deduction if the home is let out. The impact of this move may vary with the size of income one earns.

Let us take the simple case of an individual earning Rs 10 lakh a year who has availed a home loan and pays an interest of Rs 1.5 lakh and repays principal of Rs 1 lakh year. According to the current tax structure, after accounting for the tax deduction on interest and principal, his yearly tax outgo will be Rs 1.29 lakh.

But in the changed environment, without any benefits on the loan repayment, his total income will be taxed at 10 per cent and the outgo will be Rs 84,000; an effective saving of Rs 45,000 under the new code. Let us take another case where the husband and wife are working and together earn Rs 10 lakh. If they availed a joint loan and are repaying principal and interest together, they can utilise Rs 1.5 lakh each and principal of Rs 1 lakh each as tax exemption for repaying the loan; in which case their total tax outgo currently is Rs 15,000. But under the new scheme, the tax outgo will be Rs 65,000; an effective loss of Rs 50,000.

If a person has leveraged the tax incentive for repayment, the monthly budget will be squeezed to that extent.

Under the proposed tax regime, renting out the house will be a good tax planning exercise, as compared to self-occupation. If the house is rented out, the interest paid on capital borrowed will be deducted from gross rent paid, for calculating income from house property. Such home buyers will, therefore, be able to claim a “loss from house property” that will be deducted from their gross income.

Assuming in the above case that the couple lets out their house and earns an rental income of Rs 1,20,000 an annum. Out of this rental income, 20 per cent will allowed as deduction (currently 30 per cent) as an expenses for repair and maintenance.

Taxes paid to the municipal corporation are also allowed as deduction from gross rentals. Assuming this amounts to Rs 6,000, taking the standard deduction into account, the income from rent will moderate to Rs 90,000. Though there is a rental income on top of their salary, the tax outgo will be Rs 44,000 and the net effective tax saving is Rs 21,000.

Small Saving Schemes

The new tax code will also have implications for your choice of investments. A majority of the tax saving instruments such as NSC, five-year bank deposits, equity-linked saving scheme (ELSS), ULIPs and the senior citizen’s scheme are not included under section 80C investments under the Direct Tax Code.

The investments that are permitted under the new Section 66 (replacing Sec 80 C) are employee’s provident fund, new pension plan, super annuation and pure insurance (if the premium paid is one-twentieth of the sum insured).

Therefore, though the overall investment deduction is enhanced to Rs 3 lakh from Rs 1 lakh, investors may have fewer instruments that are eligible for this tax exemption. Investors may have to refrain from locking into regular premium payments or instalments on current instruments until clarity emerges from the Direct Tax Code.

What this also suggests is that investors may be better off maximising their savings through provident fund.

Under the Exempt Exempt Taxed regime, if you save money towards goals such as children’s education or marriage you can withdraw the money and pay tax according to your tax slab at the time of withdrawal, which is likely to be lower than at the time of retirement. Hence, fresh investment into tax saving instruments should be put on hold till the proposals in the Direct Tax Code are confirmed. As a stopgap arrangement, it may be advisable to park money in bank short-term deposits.