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Budget 2003-04: Highlights & Implications

This year's Budget has been a market-friendly one. While dividends from mutual funds have been made tax-free in the hands of investors, the interest rate on PPF and small-savings schemes has been slashed by 1 per cent.

Dividends from all mutual fund schemes are now totally tax-free in the hands of the investor. In place of the dividend tax a dividend distribution tax of 12.5 per cent has been introduced. While debt funds will have to pay this tax, equity funds are exempt from this tax for next one year.

Listed shares acquired after March 1, 2003, will not be subject to long-term capital gains tax.

Implications for equity funds:
Since equity mutual funds too invest in stocks, no exemption being given on capital gains tax shows that the Budget has discriminated against fund investing. Long-term capital gains tax on equity funds remains at 20 per cent with indexation, or 10 per cent, whichever is lower. For equity schemes, the dividend option is more tax-friendly as it is not subject to a dividend distribution tax. Furthermore, dividends are tax-free in the hands of the investors.

Implications for debt funds:
The growth option with Systematic Withdrawal Plan (SWP) remains the most tax-efficient option. In the case of dividend option, though the dividend is tax-free in the hands of the investors, the dividend distribution tax of 12.5 per cent will result in an overall tax of 11.1 per cent.

With this Budget, investors earning an income of more than Rs 8.5 lakh annually will have to pay the 10 per cent surcharge. This effectively increases the marginal tax rate to 33 per cent. Here the effective tax rate for SWP works out to be 1.55 per cent. On the other hand, investors earning an income of less than Rs 8.5 lakh per annum will not have to pay any surcharge. This effectively reduces the marginal tax rate to 30 per cent. The effective tax rate here works out to be 1.41 per cent.

Administered interest rates on PPF and small-savings has been reduced by 1 per cent. Interest on Relief and Savings bonds will also be reset accordingly.

This is likely to give a short-term boost to the debt market. This also indicates the government's bias towards lower interest rate regime. Shortly after the Budget, the yield on the 10-year benchmark (2013, 9.81%) fell 20 basis points (bps). The rate of interest on PPF will now be 8 per cent (previously it was 9 per cent). Even last year, the interest rate on small-saving schemes was reduced by 50 bps. In reaction to this cut, the Reserve Bank of India has announced a 50 bps cut in the repo rate (from 5.5 per cent to 5 per cent), effective March 3, 2003. It has also lowered the bank's savings account rate to 3.5 per cent from tomorrow (March 1, 2003). All this is good news for the debt market, as more money will flow into debt instruments thus pushing down yields.

With administered rates clearly on the decline investors will be compelled to look at mutual funds to boost returns.

Exemption under Section 80L of the Income Tax Act increased to Rs 15,000.
Now, more income from dividends, interest, etc. will come under this deduction. Earlier, this limit was set at Rs 12,000 (including an additional deduction of Rs 3,000 in respect to interest from government securities). Though dividend will not be taxable in the hands of the investor, the increased deduction limit will allow investors to explore other avenues, thus paving way for greater savings in the economy.

Standard deduction hiked from Rs 20,000 to Rs 30,000 per annum or 40 per cent of the salary whichever is less, for salary income up to Rs 5 lakh. And for income above Rs 5 lakh, the standard deduction applicable will be Rs 20,000.

This will benefit the salaried-class. Effectively, an individual earning upto Rs 80,000 per annum would not be liable to pay any tax (even if he or she doesn't make any tax-saving investment).