June 18, 2010

Recently, Government of India released the revised Direct Tax Code (DTC) for public debate and discussion. The bill is expected to be introduced in the Parliament after considering the responses to the revised discussion paper.

We have tried to analyze the impact of revised DTC on various investment solutions. The brief of the same is as under:

Structure of the note:

1. Definition of Long Term and Short Term Capital Gain.

2. Tax rate on income from Capital Gain

3. Shares/ Equity and Balanced Mutual Funds

4. Debt Mutual Funds

5. Real Estate

6. PPF/ EPF/ Specified Pension Schemes/ Pure Life Insurance products/ annuity schemes

7. ULIP/ Endowment Insurance Policies/ Money back Insurance policies

8. Action to be taken by investors

1) Definition of Long Term and Short Term Capital Gain:

Present:

• Financial Assets - Capital Gain arising from sale of assets after 1 year (365 days) qualifies as long term.

• Real Estate - Capital Gain arising from sale of assets after 3 years qualifies as long term.

• Only those investments will qualify for long term capital gain which has completed one year from the end of financial year in which the asset was acquired.

Example – If you are investing in Equity mutual fund today (18/06/10) then it will qualify for long term capital gain on 01/04/2012. In the given example, your end of financial year in which you acquired asset is on 31/03/2011 so you have to hold asset for one more year from 31/03/2011 till 01/04/2012.

2) Tax rate on income from Capital Gain:

Present:

• Income from capital gain is not treated as ordinary income and has different tax rates depending upon the type of investment. For example – Long term capital tax rate for Equity is 0% and for debt mutual fund it is 10%.

• Income from Capital Gain will be treated as ordinary Income and will be taxed as per the income tax rates (slab rate) applicable to the respective tax payers.

• For NRIs, the Capital Gain will be taxable @ 30%.

3) Shares/ Equity and Balanced Mutual Funds:

Long term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets after 1 year (365 days) is tax free for investors.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Capital Gain shall be calculated after allowing a deduction at a specified percentage of capital gains. Indexation benefit will not be available. The effective tax rate on capital gain will reduce as per the deduction available and the slab rate of tax payer. The deduction rate is yet to be declared by Government. Example of effective tax rate calculation is as under:

Effective Tax Rate
Deduction for Computing Capital Gain (Assumed)	Investor’s Slab Rate
	10%	20%	30%
50%	5%	10%	15%
60%	4%	8%	12%
70%	3%	6%	9%

Short term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets before 1 year (365 days) is taxed at the rate of 15%.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Gains will be calculated without any specified deduction or indexation.

Dividend Tax:

Present:

• Dividend Income is tax free for investors.

Revised DTC:

• No information or comments on Dividend taxation.

4) Debt Mutual Funds:

Long term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets after 1 year (365 days) is taxed at the rate of 10% without indexation or 20% with indexation whichever is less.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Capital Gain will be calculated after allowing indexation benefit.

Short term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets before 1 year (365 days) is taxed as per the income tax rates applicable (slab rate) to the respective tax payers.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Gains will be calculated without any specified deduction or indexation.

Dividend Tax:

Present:

• Dividend Income is taxed at the rate of 12.5% for individual investors and 20% for corporates.

Revised DTC:

• No information or comments on Dividend taxation.

5) Real Estate:<

Long term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets after 3 years is taxed at the rate of 10% without indexation or 20% with indexation whichever is less.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Capital Gain will be calculated after allowing indexation benefit.

Short term Capital Gain tax:

Present:

• Capital Gain arising from sale of assets before 3 years is taxed as per the income tax rates applicable (slab rate) to the respective tax payers.

Revised DTC:

• Capital Gain will be taxable as per the income tax rates (slab rate) of the investor.

• Gains will be calculated without any specified deduction or indexation.

6) PPF/ EPF/ Specified Pension Schemes/ Pure Life Insurance products/ annuity schemes:

Present:

• Exempt, exempt, exempt (EEE) method of taxation.

Revised DTC:

• Exempt, exempt, exempt (EEE) method of taxation to continue. Maturity proceeds will continue to be exempt from tax.

7) ULIP/ Endowment Insurance Policies/ Money back Insurance policies:

Present:

• Exempt, exempt, exempt (EEE) method of taxation.

Revised DTC:

• Exempt, exempt, Tax (EET) method of taxation will become applicable. Maturity proceeds will become taxable.

8) Action to be taken by investors:

• The Revised DTC is yet to be finalized. Investors should wait and watch for the final draft.

• Be careful with fresh investments. If time horizon for investment is long then ensure that your investment qualifies for long term capital gain as per DTC.

• Increase exposure in investments which have EEE benefit like PPF and EPF.

• For existing investments, book profit before the DTC becomes applicable.