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New Tax Code Heavy on Savings

The emphasis is on making the citizens of the country save as much as possible to avoid paying tax

There’s a lot that is genuinely new in the new direct tax law that has been proposed, but the part about beating a drum stays. I guess there are some traditions that won’t go away. According to the draft document, when the Income Tax Department has to make a proclamation about the sale or attachment of a defaulter’s property, it shall do so  ‘by beat of drum’. It’s good to see that even though this document is said to be written afresh from scratch, it refuses to abandon our centuries-old traditions — Raja Todar Mal’s tax collectors would feel right at home beating drums to issue proclamations. Anyhow, drums are fine, I guess. You wouldn’t really expect the tax department to tweet its proclamations, would you? But there are no more details about the drum-bearing. Are there taxmen who are specially trained for drum-beating? Are these drums department property or are they rented for the occasion? Is there some particular tune that is customary or is just loud banging deemed appropriate?

I hope I never have a chance to find out first hand.

Percussive proclamations apart, the new Tax Code is clearly a revolution in the making. While there’s a lot for tax lawyers to discuss, the law will also affect savings and investment behaviour in a big way. On the face of it, the biggest change is quantitative. The annual tax saving investment limit (which used to be under Section 80C and will now be under Section 66) has been raised from Rs 1 lakh to Rs three lakh. Not only is that’s a big bump, it also takes this limit up into the territory where it could well account for the entire savings potential of a middle class family. At Rs 25,000 a month, many Indian households will now find it hard to exhaust this tax saving limit, effectively making their entire savings tax exempt. It will also drive them to save more because there is a natural urge to save as much tax as possible by reaching as close to the limit as possible.

One curious change that has been made is the dropping of mutual funds from the list of ‘permitted savings intermediaries’ which qualify as tax exempt savings. Even though this is not a big thing quantitatively (tax savings funds are not a dominant part of the equity fund universe, but they do total up to about Rs 16,000 crore currently), there doesn’t seem to be any reason to specifically drop such funds. What is missing from the draft code is any mention of time limits for the (new) Section 66 investments. How long will these investments have to stay locked in? We don’t know yet. Section 66 also forbids tax breaks for amounts that are withdrawn from one tax-break investment and invested in another. Coupled with the fact that withdrawals of tax-saving investments will now not be tax free and the New Pension System has a central role in the new scheme of things, the entire thrust seems to be on savings for retirement.

However, given the decades-long periods involved in retirement savings, lack of transportability could be damaging to savers’ interests. Over a long period, some particular investment could turn sour. Even though a saver doesn’t want to withdraw the money, he may be forced to switch to another tax-saving investment. Since withdrawals now have a tax implication, the law should allow such switches without them being considered withdrawals. But this is just one point. The new code is so different in approach from the old one that it will be a few years before we adjust to it.