R. Y. Narayanan

WHILE the salaried middle-class is understandably elated over the Finance Minister, Mr P. Chidambaram's largesse in direct taxes, many tax payers seem to have missed his real message the country is moving towards an Exempt, Exempt, Tax (EET) mode.

Under the EET system, the full import of which is yet to sink in, while at the time of contribution and accumulation the savings under various schemes enjoy tax concession, they would be subject to tax at the time of withdrawal.

This has a profound implication for the Indian salaried middle class long used to depending on its lifetime's savings, nurtured by contributions and tax savings during the accumulation phase, to see through its post-retirement life.

In his Budget speech, Mr Chidambaram said that the "Tax treatment of savings is a complex issue but we can benefit from the best international practices in this regard.

We have already introduced EET-based taxation in the defined contribution pension scheme applicable to newly recruited government servants. Before we fully migrate to the EET system for all kinds of savings, it is necessary to resolve a number of administrative issues.

Hence, without making any change for the present, I propose to set up a committee of experts that will work out the road map for moving towards an EET system... "

Significant observations because they show that the Centre has now decided to go with the Kelkar Task Force (KTF) recommendations in all seriousness.

In the Finance Bill, the intentions have been made more specific. It says: "The existing method of taxing financial savings is highly distortionary resulting in economic inefficiency and inequity. With a view to removing such distortionary effects, it is proposed to adopt the EET method as the most preferred option." The Bill says that the expert committee to be constituted "will also examine the mix of savings instruments that would qualify under the new EET system."

While recommending zero tax for incomes up to Rs 1 lakh, the KTF had suggested that incomes in the Rs 1-4 lakh slab be taxed at 20 per cent (of income in excess of Rs 1 lakh) and for income above Rs 4 lakh, the tax recommended was Rs 60,000 plus 30 per cent of the income in excess of Rs 4 lakh.

While the Finance Minister accepted the recommendation for the first slab, he introduced three slabs Rs 1-1.5 lakh at 10 per cent, Rs 1.5-2.5 lakh at 20 per cent and above Rs 2.5 lakh at 30 per cent.

The KTF had recommended elimination of tax rebate allowed under Section 88 of the IT Act for investment in specified schemes/instruments and the deduction under Section 80 L withdrawn. Both have bee done in the budget.

The Finance Minister's statement to set up a committee of experts to workout the road map for moving towards an EET system indicates a commitment on its part.

Whether the KTF's recommendations would be accepted in full or modified, as was done in case of the IT slabs, will be known might after some time. But a move towards an EET system looks inevitable.

In such a situation, what options do the people have? As tax exemptions for savings at the time of maturity might go, it would be prudent to take full advantage of the current rules as long as they are in force.

The best investment opportunity lies in Provident Fund and insurance schemes because these were left untouched by the Kelkar Committee and the Finance Minister also has not made any announcement about taxing the payment at the time of their maturity.

As for the other investment options covered by Section 88 of the IT Act but now brought under Section 80 C, there is no word yet as to how the withdrawals would be treated, implying that these would be covered by the existing rules for now.

If at all EET is introduced, it should be made applicable only to the high- income group and not to low or middle- income groups. And it may be harsh to give it a retrospective effect.

(This article was published in the Business Line print edition dated March 28, 2005)
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