Impact of Direct Tax Code on employees

It proposes to make significant changes, in the tax regime. The new tax rates for a male taxpayer under the age of 65 years will be as follows: Up to Rs 1.60 lakh tax is zero, from Rs 1.60 lakh to Rs 10 lakh it is 10 per cent, from Rs 10 lakh to Rs 20 lakh it is 20 per cent and for income above Rs 25 lakh the tax rate is 30 per cent.

The change in the slab translates into an annual tax benefit of Rs 1.26 lakh for an individual earning Rs 10 lakh. Further, there is no surcharge or education cess proposed.
Employment income under DTC shall be the gross salary as reduced by the permissible deductions. The permissible deductions broadly include profession tax, transport allowance to the extent prescribed, prescribed allowances provided to meet expenses in the performance of duties to the extent actually incurred, payments received under retirement schemes (i.e. VRS compensation, Gratuity and Commuted pension to the extent the amounts are paid to a retirement benefits account). 

It also proposes to do away with popular exemptions such as house rent allowance, leave travel concession, leave encashment, medical  reimbursement, tax borne by the employer in respect of non-monetary benefits provided to the employees, etc.  Moreover, all types of perquisites are proposed to be included in salary income. As of now there is no valuation mechanism for the perquisites in the code. Hence the valuation norms for the perquisites may have to be prescribed in separate tax rules. It would be pertinent to note that the discussion paper has specifically clarified that the rules for valuation of Rent Free Accommodation (‘RFA’) will be retained as they are, except that the same shall be extended to both public and private sector employees. Generally most organisations have a structure where salary normally comprises basic pay, house rent allowance, conveyance allowance, medical allowance, leave travel assistance, fringe benefits (from 2005-2009), etc. The final salary structures could be decided only as and when the tax rules are prescribed for valuation of perquisites.

While the exemption for one Self Occupied Property (‘SOP’) is retained in the DTC, the deduction towards interest paid on home loan for property up to Rs 1,50,000 is sought to be done away with. It means, employees who had invested in a self-occupied house property and have been availing of a tax saving of upto Rs 50,000 per annum on account of their loan interest, will no longer be eligible to the same.

Taxation of retirement savings

The DTC proposes to introduce an Exempt-Exempt-Taxation (EET) method of savings maintained with permitted intermediaries (i.e. approved retirement benefit plans such as provident funds, life insurance and pension plans).  Under this, contributions as well as accretions to savings schemes until such time they remain invested would be exempt.  All withdrawals shall be subject to tax in the year of withdrawal at the applicable personal marginal rates of tax in the year of withdrawal.

Under the current provisions, some of the retirement benefits are categorised under the Exempt-Exempt-Exempt (EEE) method of taxation wherein, contributions, accretions as well as withdrawal from retirement benefit plans are exempted from tax. However, under the DTC, retiral benefits would be exempt at the time of contribution and accretion, but the entire amount would be fully taxed at the time of withdrawal. This will entail reducing the yield in respect of such savings instruments.

The discussion paper to the code provides for a grandfathering provision in relation to contributions made upto 31 March 2011 to Government Provident Fund, Public Provident Fund, Recognised Provident Fund and Employee Provident Fund. Accordingly, only new contributions after the commencement of the DTC will be subject to the EET method.
It proposes to increase the deduction from taxable income in respect of savings (maintained with permitted intermediaries) and children education fees from a maximum of Rs.100,000 to Rs.300,000 per annum.  However, deduction in respect of investment in equity linked savings schemes of mutual funds, term deposits with banks, housing loan repayment, etc, would no longer be eligible for the deduction. The existing deductions in respect of interest on educations loans and medical premium/expenses is sought to be continued.

Conclusion

In general, the proposed changes are a welcome step to simplify the tax laws. But, the impact of the changes would vary from case to case, e.g., while employees earning high-salaries may have an increase in net take-home pay (subject to taxation of perquisites as may be prescribed), retiring employees would need to pay much more taxes on their accumulated retiral benefit withdrawals.

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