India Economy

DTC limits tax-saving options

Updated on: Feb 25, 2012
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The Direct Taxes Code may not be fully implemented from the next financial year. But, you will have to alter your tax strategies, depending on the changes made.

The proposed Direct Taxes Code has made significant changes to investments that you make to avail of tax deduction, under what is currently called Section 80C provision. As of now, a large basket of options, including the Employee's Provident Fund, Public Provident Fund, new pension fund, five-year tax-saving deposits, National Savings Certificate, tax-saving mutual funds and unit-linked insurance plans, besides life insurance premium and tuition fees paid for children, are all eligible for tax deduction up to Rs 1 lakh a year.

The proposed tax code, though, has significantly cut down on the basket of investments. It proposes to allow a total deduction of Rs 1 lakh for investments made in provident fund, public provident funds and new pension scheme. Simply put, only long-term retirement savings fall under this clause.

The code also allows another Rs 50,000 a year towards premium paid on pure life insurance and health insurance plans, besides children's tuition fees.

In effect, there is no mention of savings options such as National Savings Certificate, post-office senior citizens' scheme, five-year bank deposit, besides the tax-saving mutual fund and unit-linked insurance options.

Most of the investment decisions by individuals in India are driven by the tax benefits that such instruments fetch. While the traditional Provident Fund remains a good choice, other options such as bank deposits or tax-saving mutual funds act as good diversifiers and many a time also fetch better returns.

The change also leaves very few options for the non-salaried class and the senior citizens. The National Savings Certificate, with a yield of at least 12 per cent (varies across tax brackets), is an excellent investment cum tax-saving option for the self-employed, who have no option of provident fund.

The EPF is also not an option for the retired. PPF is, but it locks in much of the principal and interest amount and, therefore, is not a viable option for a retired individual looking for regular income.

A five-year bank deposit or a post-office senior citizens' scheme, on the other hand, provides tax benefit as well as regular income.

In other words, while the proposal encourages salaried people to save for retirement, it discriminates between various classes of tax payers when it comes to the number of options they have.

Given that the proposal still seals the deduction for investment option at Rs 1 lakh, the Government can consider reinstating the investment options provided this far. Schemes such as NSC and Post Office Senior Citizens has provided Rs 9000-11,000 crore of inflows to the government every year. Inflows in to the latter, in fact, jumped since it was included as a tax-saving instrument a couple of years ago.


If those are issues on the investment side, quite a bit of uncertainty lingers on deduction of expenses as well. While health insurance premium on self and dependents is currently allowed as a separate deduction of up to Rs 35,000, all insurance premia will be clubbed along with children's tuition fees with deduction capped at Rs 50,000 under the DTC. Hence, if you now have an expensive life policy and are claiming deductions under the larger limit of Rs 1 lakh, this may not be possible under the proposed DTC.

That is not all. Not the entire premium you pay on your life policy may enjoy deduction under the proposed new code. The policy you have chosen must provide a life cover that is at least 20 times the annual premium you pay (that means the premium must not be over 5 per cent of the sum assured as life cover). For instance, if you pay an annual premium of Rs 10,000, then to avail deduction, the life cover on this policy should not be less than Rs 2,00,000.

What are the implications of this? Most fancied policies such as money back, endowment or savings plans typically carry a premium far higher than the 5 per cent limit set out in the proposal. In effect, only plain vanilla life covers such as term insurance policies have low premiums.

Agreed, the intention of the code could be to incentivise only pure life covers needed by every individual and not so much the life-cum-saving plans. However, by not allowing deductions, the code is discouraging a sophisticated investor, who understands the pros and cons of these combination products.

As an investor, if you are running a ULIP, you may incur losses if you discontinue such products in the first few years for want of tax deduction. Hence, the proposal leaves existing investors stranded.

Long or short

Besides tax deductions, the first edition of the DTC disturbed investors with a proposal to tax both short and long-term capital gain on equity instruments. This, thankfully, was removed and full deduction on long-term capital gain on equities was reinstated in the second version.

But both short and long-term gains for debt schemes would be taxed at the individual's tax rate. Indexation benefit on this would be allowed for investment held over a year.

The catch here is that for the purpose of indexation benefit, the holding period of one year is proposed to be calculated from the end of the financial year the asset is bought. For instance, if you bought a 370-day fixed maturity plan from a fund house in, say, July 2012, you will enjoy indexation benefit under the current law as the holding period is over a year. But under the proposed law, it will be treated as short-term as the one-year period is calculated only from March 2013. Now this discriminates between people who buy their investments closer to the financial year end (which is March) and those buying mid-year. Even these investment decisions, therefore, run the risk of being tax-incentive driven.

Published on November 14, 2017

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