In a move that is going to affect NRIs as well as Indian residents alike, the Indian tax laws are due to undergo an extensive facelift. The forty eight-year-old Indian Income Tax Act (ITA) is set to be replaced by a new Direct Tax Code (DTC) from the April 1, 2011. Indeed, the ball is already in play.
A draft of this new DTC has been released by the government for public debate. Comments and suggestions from taxpayers and other stakeholders would be taken into consideration by the government before enacting the draft into the final law that would be the Direct Tax Code.
The rationale behind this measure as per the authorities was that the existing Income Tax Act passed way back in 1961 has undergone numerous amendments over the years. This in turn has rendered the legislation extremely complex and incomprehensible to the average taxpayer.
Besides, there have been frequent policy changes due to changing economic environment, complexity in the market, increasing sophistication of commerce, development of information technology and attempts to minimize tax avoidance. The problem has been further compounded by a multitude of judgments (very often, conflicting) rendered by the courts at different levels.
Clubbing provisions under income tax
The new DTC is expected to result in a higher tax-GDP ratio, reduce compliance costs, lower administrative burdens, discourage corruption and most importantly improve equity (both horizontal and vertical).
Whether NRIs and PIOs will agree - especially with the last point is a moot question – for a finer reading of the DTC seems to suggest that it's the diaspora who seems to have been the most adversely affected constituency under the DTC.
But before that the good news. The current tax exemption on NRE and FCNR interest is proposed to be continued under the DTC.
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However, all other interest income (including NRO interest) will be taxed at a flat rate of 20% without even the shelter of the basic exemption limit.
For example, say an NRI currently earns Rs 2,00,000 as NRO interest. With the protection of the basic exemption limit of Rs 1,60,000, only Rs 40,000 will be taxed @ 10% resulting in a tax liability of Rs 4,000. Under DTC, straightaway a flat rate of 20% tax would apply thereby resulting in a tax payable of Rs 40,000 - ten times the earlier amount.
And wait for the real shocker - hitherto fully exempt long-term capital gains on equity and equity mutual funds are slated to be taxed at a flat rate of 30%!!
In fact, under the new regime, there will be no distinction between long-term and short-term gains as is practiced currently. All capital gain income of an NRI has to be aggregated and taxed at a flat rate of 30%. It must be said that the same is applicable even for residents; however, with a big difference.
For residents, the shelter of slab rates is available i.e. income between Rs 1.60 lakh and Rs 10 lakh is to be taxed @ 10%, between Rs 10 lakh and Rs 25 lakh is to be taxed @ 20% and only income beyond Rs 25 lakh is to be taxed @ 30%.
In other words, Indian residents will pay 30% tax on capital gains only if such gains are above Rs 25 lakh. This tiered system of tax isn't available to NRIs under the DTC!
The other measure under the DTC that could have wide ranging implications is to do with tax laws dealing with property.
Readers would know that currently under the ITA, one self-occupied property is free of tax. The second property onwards is taxed on the actual rent received.
Even if the same is not rented out, tax is payable on the notional rent (known as 'deemed let our property' under ITA). Interest payable on housing loans is deductible with a ceiling of Rs 1.50 lakh for self-occupied properties. There is no ceiling applicable in the case of let out or deemed let out properties.
Now, under the DTC, one self-occupied property continues to be tax-free. The interest deduction of Rs 1.50 lakh will no longer be applicable. Even the Sec 80C deduction on the principal portion of the EMI stands cancelled under the DTC.
However, what will come as a blow to most NRIs and investors in property is that even for let out or deemed let out properties, tax will be payable on the higher of the actual or 'presumptive rent'. This presumptive rent is a new concept under the DTC. Presumptive rent is fixed at 6% of the ratable value fixed by the local authority. Where no ratable value has been fixed, 6% shall be calculated with reference to the cost of construction or acquisition of the property.
An example will clarify the point. Take the case of a tenant who is paying a rent of Rs 25,000 per month on a property that costs say Rs 1 crore. Rs 25,000 per month translates into an annual rent of Rs 3 lakh or 3% of the property cost. Now, under the DTC, irrespective of the fact that the landlord is receiving Rs 3 lakh as rent, he will have to pay tax as if he is receiving Rs 6 lakh (6% of a Rs 1 crore).
The other change under the DTC is that there is no relief even if the property lies vacant. Currently, no tax is payable for the period in which rent is not received on account of the fact that the property was not let out or there was no tenant. Not so any more under the DTC.
This lack of 'vacancy allowance' which is currently available under the ITA is significant. Buying property as an investment will become extremely expensive. On the other hand, actual consumers who intend to use the property as a roof over their head can look forward to some dip in prices on the back of a reduced demand.
Apart from the interest (covered above), taxes levied by a local authority and tax on services, if actually paid will be allowed as a deduction. Secondly 20% (as against the present 30%) of the gross rent will be allowed as a standard deduction towards repairs and maintenance.
To Sum
Clearly, the above provisions of the DTC will have a substantial impact on the property and the stock market. In the case of property, elimination of tax deductions and the presumptive rate of taxation will adversely impact potential investors.
However, on the other hand, since ownership of more than one property (or investment properties) will become significantly more expensive, it will indirectly benefit real consumers by driving down prices.
The harshest blow as it were has been reserved for equity investors. In most cases, the jump would be from a zero tax regime directly to paying tax @ 30%.
Currently, one of the key attractions of India is a tax friendly capital market system. If this is taken away, there is no saying the extent of collateral damage that will take place. Possibly reinstating the STT and taxing short-term gains at a flat rate of 30% while exempting gains for holding over one year would not only encourage long-term investing but would also augur well for the health of the Indian market and its economy.
The authors may be contacted at wonderlandconsultants@yahoo.com
