The Hindu Business Line : Teeing off with EET

TAX treatment of savings has been at the centre of controversy for well over ten years. Several committees — Raja Chelliah, Dr Shome, and so on — have gone into the matter and submitted comprehensive reports. The Kelkar Committee, for instance, took the view that a judicious adoption of the best recommendations culled from the various reports would be the best way to proceed. A tax on income is inherently biased against savings. Kelkar refers to two alternative ways of devising an income-tax which neutralises this bias:

i) Exempt exempt taxed (EET) method: Under this method, the contributions to a savings plan/scheme are deductible from the gross income, the income (accumulations) of the plan/scheme is exempt from tax and the withdrawal of the contribution along with benefits in the form of interest, dividend and so on, is subject to tax.

ii) Taxed exempt exempt (TEE) method: Here, the contributions to a savings plan/scheme are out of post-tax income (that is, the contributions are taxable), the income accumulation is exempt from tax and the withdrawal of the contribution along with benefits in the form of interest, dividend, and so on, is exempt from tax.

Budget 2005 has done away with Sections 88 and 80L of the Income-Tax Act and substituted the same with a new Section 80CCE, providing for income deduction of Rs 1,00,000 instead of the current system of tax rebate.

According to the Government, the EET method eliminates the bias against savings under the I-T law. The existing method is faulted for being distortionary, resulting in economic inefficiency. Under the EET system, contributions to a savings plan are deductible from income. Since the rebate method is inconsistent with the proposed new method, Section 88 is being replaced by Section 80C providing for income-based deduction up to Rs 1 lakh.

Chapter VI-A, which provides for deductions from gross total income, is designed to serve various social and economic objectives. Introduced in 1965, it replaced the system of rebate in the wake of the Boothalingam Committee recommendations. Originally, the chapter consisted only of four sections; now it comprises more than 32, with many of them divided into numerous sub-sections. The deduction method was abandoned in favour of the tax rebate system in 1991-92, the main consideration being tax credits are less regressive, as, for a given amount of savings qualifying for the concession, all taxpayers receive the same amount of benefit irrespective of the tax bracket. The rebate system was further fine-tuned with cascading rates — 15, 20 and 30 per cent — to reduce the regressive nature of a flat incentive.

The wheel has turned a full circle. We are now reverting to the system of straight deduction, fully conscious of the fact that the system favours the higher income brackets.

All the savings instruments cannot be treated on a par and straightaway taxed at the time of withdrawal. Insurance policies, provident funds, and so on, cannot be treated on the same footing as other savings instruments, and sums received on their maturity cannot be straightaway brought to tax. Contributions might have enjoyed exemption at 10 or 20 per cent depending on the income level of the taxpayer when the contributions were made; but at the time of withdrawal, they will normally be taxed at the maximum rate of 30 per cent.

The Expert Committee will have to take into account that at the time of switch over to the EET system, past contributions and accumulations were made on the premise of total exemption and the EET system should be made applicable only to future contributions. Unfortunately for the taxpayer, the Kelkar Task Force recommended the elimination of the tax incentives for savings under Section 88, Section 80L, Section 10(15)(i), and so on, without providing for any sunset clause. It had recommended that income-based deduction under Section 80CCC be converted into a tax rebate system. The Finance Minister has been more generous. By abolishing the sectoral caps and providing for lump-sum deduction of Rs 1 lakh instead of the differential rebate system, he has mitigated much of the hardship involved. It will be best not to tamper further with the system by referring the issue to one more expert body.

(The author is a former Chief Commissioner of Income-Tax.)

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