The Hindu Business Line : Budget 2005: An investor's perspective

A LOOK at the implications of the changes in direct taxes in the Budget as far as they relate to individuals. The changes take effect from April 1, 2005 (assessment year: 2006-07).

Change in tax slabs/shelters: The changes will certainly lower the tax burden of the assessee. This is more so in the case of women and senior citizens. Calculations show that these categories paid a tax of Rs 9,000 and Rs 14,000 respectively, pre-Budget, in case of taxable incomes of Rs 1,25,000 and Rs 1,50,000 respectively. This has been reduced to nil by raising the exemption limits. In the event of the taxable income (after Section 80 C deductions) rising to Rs 2,50,000 they will have to pay only Rs 25,000 against Rs 44,000 previously. This is a significant saving despite the removal of the benefits of rebates under Sections 88 B and 88 C.

However, as the saying goes, the more things change the more they remain the same. The replacement of Section 88 with 80 C and 80 CCE is not as radical as one might think initially.

The investment universe for 80 C includes all those instruments which were eligible under the erstwhile Section 88 and 80 CCC, that is, expenditure towards life insurance premia, tuition fees for children, provident fund contributions, principal repayment towards housing loan, as well as investment in Public Provident Fund, small savings schemes, ELSS schemes, deferred annuity pension plans. No major new instruments/expenditures have been rendered eligible by the Finance Minister.

The two key differences are:

These expenditures/investments will now be eligible for deduction from gross income and not a rebate from the income-tax payable by the assessee;

There will be no sub-ceilings or limits on the amounts of investments/expenditures as was the case earlier.

The manner in which an investor should react to these changes will depend on a case-to-case basis. However, as a general rule, all investors/assessees who were constrained by the sub-ceilings can now breathe easier. Some instances are given below:

Mortgages whose annual housing loan repayment exceeds Rs 20,000 p.a. will benefit.

Assessees whose expenditure towards children's education exceeds Rs 12,000 p.a. per child (up to two children).

Contributions to annuity plans can be made up to Rs 1,00,000. This is a perceptible change, as the earlier limit of Rs 10,000 was abysmally low.

The changes may induce investors to move away from investments which were made purely on tax saving and security considerations. However, there is a danger that people may invest in certain instruments without realising the long-term implications.

Small savings: There may be increased interest in small savings schemes such as NSC, Post Office Monthly Income Schemes, and so on, as investors will be able to invest up to Rs 1,00,000 against the Rs 70,000 limit as was the situation earlier. Another factor in favour of such schemes is that the interest rate has been maintained at 8 per cent p.a.

The only dampener in this regard is the declared intention of the Government to migrate to an EET regime, that is, exempt the contributions from tax; and

exempt accumulations from tax and tax the withdrawals. This will mean that investors may be taxed when they withdraw the amounts from these schemes, in case this regime comes into effect.

Mutual funds: The introduction of Section 80 C will enable investors to increase their allocation to equity-linked savings schemes (ELSS) to a maximum of Rs 1,00,000. Earlier, the tax benefit was restricted to an investment of Rs 10,000 only and that, too, it was a rebate from tax payable and not a deduction from income.

No changes regarding the taxation of dividends or capital gains. Dividends declared by equity-oriented funds will continue to be exempt under Section 10 while dividends declared by debt-oriented funds will be subject to a dividend distribution tax at the fund level, but exempt in the hands of investors.

Similarly, equity-oriented funds will be exempt from capital gains as long as the units are held for 12 months or more.

The long-standing demand of mutual funds as regards the launching of gold mutual funds has been permitted albeit in the form of exchange traded funds.

These will no doubt be popular among the investing public given their affinity for the yellow metal. It will also enhance the ability to diversify their asset allocation. The amount has been kept at Rs 100 to rope in the small investor and not projects an image of such funds being available only to big-ticket investors. Being ETFs, liquidity should not be a major issue.

Stock/debt markets: There have been no changes on the dividend and capital gains front.

The Securities Transaction Tax for day traders in the stock market has been increased to 0.020 per cent against the existing 0.015 per cent. The impact of this increment is going to be minimal.

Trading in derivatives will no longer be treated as speculative transactions for the purposes of incom-tax. This will enable more tax effective hedging of open positions.

Amendment to the Securities Contract Regulation Act to include trading in securitised debt (including mortgage-backed debt). Considering the exponential growth of mortgages in the country during the past two years, this move will lead to a lot of funds being made available to housing finance institutions and enable faster rollover of funds.

SEBI has been accorded the approval to set up the National Institute of Securities Markets. It is hoped that this will lead to a new breed of advisors which will ultimately be beneficial to the investors. However, a holistic approach in advising incorporating all types of financial products viz., insurance, mutual funds, and so on, needs to be encouraged.

Withdrawal of tax benefit under Section 80 L. This will hasten the migration of investors from bank accounts and fixed deposits to liquid funds and short-term funds as bank interest will be taxable but not dividends from liquid funds.

A pragmatic approach on the fringe benefit tax is the need of the hour. The imposition of the above tax will certainly be passed back to the individuals as most of the establishments work on a cost-to-company (CTC) concept.

Hence, all the tax benefits stated earlier stand collapsed on account of this one provision.

(The author is CEO of the Association of Financial Planners based in Mumbai.)

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