Should all deductions and exemptions go?

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Deductions and exemptions have been the subject of much debate. Those opposed to them must realise that they are a significant part of the people's savings that form the bedrock of a nation's long-term investment strategy to set up the infrastructure needed to sustain economic growth for the next ten years at 8 per cent per annum, says H. P. Ranina.

With no social security scheme for the unemployed, the retired, the uneducated or the terminally ill, Indians rely heavily on savings to see them through their old age. With savings also forming the bedrock of infrastructure creation, the Finance Minister would do well to think carefully before removing exemptions. Parth Sanyal
With no social security scheme for the unemployed, the retired, the uneducated or the terminally ill, Indians rely heavily on savings to see them through their old age. With savings also forming the bedrock of infrastructure creation, the Finance Minister would do well to think carefully before removing exemptions. Parth Sanyal

H. P. Ranina

THE TREND of thinking amongst economists and the well-informed is that the tax rate should be brought down to lower levels than at present but the vast majority of exemptions, deductions and benefits should be removed or whittled down with a view to widening the tax base and increasing the tax-GDP ratio.

There is no denying that the main object of taxation is to collect revenue for the larger public good. Other countries, especially some of those in Europe, have a personal rate of income-tax that is much higher than the maximum marginal rate of 30 per cent in India.

However, the striking difference in the Indian context is the fact that the government provides no social security for the unemployed, the retired, the uneducated or those who are terminally ill.

While education and medical facilities are available to some extent in the urban areas, the quality of both falls much below desired standards. Schemes for the unemployed announced from time to time have only scratched the surface of the problem with substantial amounts not reaching the intended target population.

Indians have, therefore, to provide for their old age, their medical needs, the education of their children, and the marriage expenses of daughters. In this situation, far from there being a stigma on tax evaders, such practice is socially accepted and approved in every strata of Indian society.

It is only in the case of a dwindling class of honest tax-payers who declare their income truthfully that the question of claiming deductions, exemptions and benefits arises.

The significant deductions available from the gross total income of an individual are summarised below:

  • Contributions to certain pension funds (up to Rs 10,000), subject to certain conditions Section 80-CCC of the I-T Act.
  • Contributions to pension scheme notified by Central Government (up to Rs 10,000) Section 80-CCD.
  • Medical insurance premia (up to Rs 10,000), subject to certain conditions Section 80-D.
  • Deduction of Rs 50,000 or Rs 75,000 for a person with severe disability, where any expenditure has been incurred for the medical treatment (including nursing), training and rehabilitation of a handicapped dependant or any amount is paid or deposited under any scheme framed in this behalf by an insurer or UTI Section 80-DD.
  • Amount paid out of income chargeable to tax by way of repayment of loan or interest on loan taken from financial institution/approved charitable institution for pursuing higher education, subject to certain conditions (maximum deduction Rs 40,000 in a year for a maximum period of eight years) Section 80-E.
  • Interest on government securities, interest on NSC VI or VII Issue, interest on NSC VIII Issue, interest on notified bonds/debentures, interest on deposit under NSS, interest on deposits under Post Office (Time Deposits)/(Recurring Deposits) Schemes, interest on deposit under PO (Monthly Income Account) Rules, interest on bank deposits/deposits with financial corporation, etc. (maximum limit is Rs 12,000 with effect from assessment year 2003-04).

    In addition, special deduction of Rs 3,000 is allowed in case of interest on government securities under Section 80-L.

    A perusal of these provisions highlights two important facts:

  • a very small quantum of deduction is available to each tax-payer considering the level of investment he has to ake. It is obvious that the lower the rate of tax, the less is the impact on the tax revenues of the government;
  • all the aforesaid benefits pertain to personal needs such as medical, education, old age pensions, etc. By removing or reducing these tax benefits, there would be little impact on revenue collection, but it would leave a bitter taste in the mouth of honest tax-payers who are conscious of their duties as citizens.

    The next set of benefits is in the form of tax rebate under Section 88. One school of thought is that savings need to be increased in India.

    Therefore, the tax rebate under Section 88 needs to be enhanced so that a person is eligible to claim a benefit of 20 per cent of the amount invested up to a limit of Rs 1 lakh per annum. This would mean that the loss of revenue can be pegged at a maximum of Rs 20,000 per annum per individual.

    Further, this incentive needs to be rationalised by removing the rebate pertaining to repayment of housing loans, the reason being that no incentive should be given for creating a capital asset in the form of residential property, which can be sold at any point of time. Of course, this incentive was given by the government with a view to giving a boost to the construction industry.

    The providing of tax benefit as a stimulus to the construction industry has rightly been criticised as an inappropriate measure.

    A reduction in excise duty on cement, steel, and other building materials would be far more effective in achieving the objective by making properties more affordable.

    But knowing the impact on excise collection, the government has given an indirect stimulus in the form of tax rebate under Section 88.

    Perhaps the Finance Minister may look microscopically at the exemption of interest on certain bonds under section 10(15) of the Income-tax Act. Full tax exemption is provided on Post Office Savings account, Public Provident Fund Scheme (8 per cent per annum) and Deposit Scheme for Retired Government employees.

    In respect of other schemes, the interest is exempt up to the limit laid down in Section 80-L.

    These investments are generally made by professionals and entrepreneurs who have no other means of savings as in the case of employees who have retirement benefits in the form of provident fund, superannuation fund, gratuity, leave encashment, retrenchment or voluntary retirement compensation. The relevance of these provisions, therefore, continues unabated, considering the expectation of falling interest rates over the next 10 years.

    One significant benefit which has been removed last year is the unlimited tax exemption under section 10(15) in respect of the 6.5 per cent Relief Bonds issued by the Reserve Bank of India. The Finance Minister has before him three options:

  • Restoring the exemption of interest, but up to a limit of, say, Rs 3 lakh per individual; or

  • Exempting interest on a percentage of capital investment made each year by an individual or a Hindu Undivided Family; or
  • Removing the exemption completely but taxing such interest at a concessional rate of 10 per cent, the full amount being withheld at the time of payment annually.

    The amendment could have different permutations and combinations with the rate of interest being retained at 6.5 per cent. However, the Finance Minister would do well to keep in mind the need of citizens to save the maximum amount during their working life dictated by three significant factors in an uncertain environment:

  • job insecurity and falling employment opportunities as a result of business downturn, company re-organisations and closures;
  • fall in interest rates in the next 10-15 years bringing them on par with rates prevailing in the free world; and
  • longevity of life as a result of the mapping of 90 per cent of the human genome which will result in significant strides in medical research, eliminating many of the common illnesses and diseases.
  • Mr Chidambaram is motivated by a vision which transcends the routine Budget formulating exercise. He is determined to tread a new path in fiscal legislation and initiate structural reforms.

    To this end, he may consider enacting a new income-tax code which is simple to understand, shorn of legal jargon, which lends itself to a transparent administration reducing scope for harassment and corruption, and, above all, which instils confidence in the honest tax-payer and strikes at the root of tax evasion.

    The Finance Minister's desire to raise more revenue has to be in sync with the need of millions of honest tax-payers who wish to perform their duties as citizens.

    Savings are not only for the benefit of the individual but form the bedrock of a nation's long-term investment strategy of setting up a huge infrastructure which is part of the Government's "big-bang" policy to sustain economic growth for the next ten years at a level of 8 per cent per annum.

    (The author is a Mumbai-based advocate. He can be contacted at

    (This article was published in the Business Line print edition dated January 22, 2005)
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