Our income tax system is built for the non-salaried rich!

Outside the Eco-Chamber

The annual Union budget will be presented on February 1, making this the season of wish-lists. So, here’s mine. Actually, this wish-list has just one item. The government should try and make our income tax system, which is currently heavily structured in favour of the non-salaried rich, more equitable.

Different kinds of income are given different tax treatment and hence are taxed at different rates. Take the case of real estate. Profit made from selling a house more than 24 months after the date of purchase is taxed at 20%, with indexation benefits. Indexation allows the taxpayer to take inflation that prevailed during the period of the ownership of the asset into account while calculating the cost of purchase of the property. This leads to a higher home purchase price, brings down the profit made, and thus the income tax that needs to be paid. Hence, the effective rate of tax is significantly lower than 20%.

Gold and debt mutual funds are taxed along similar lines, though the indexation benefits kick-in only after a holding period of more than 36 months. Now compare this to interest earned on the humble fixed deposit. This is taxable at the marginal rate of tax. So, don’t investors in fixed deposits get impacted by inflation? And why shouldn’t they also be allowed to take indexation into account? Further, how does taxing gold at a rate lower than 20% help?

Also, the government should encourage home ownership and provide tax incentives for the same, like it currently allows the interest paid on a home loan to be deducted from the taxable income, up to a certain limit.

Nonetheless, why should indexation benefits be available to those selling a house, throughout their lifetime. This simply encourages the rich to buy more homes than the one they need to live in and keep them locked up. When they sell, they get indexation benefits. Indexation benefits can perhaps be made available once in the lifetime of every individual, and not more.

Further, a home kept locked up is a huge waste of resources -- everything from cement to steel to wood to water -- that went into the making of it. Also, it drives up home prices and thus makes things difficult for those who just want a home to live in.

Now, let’s take the case of listed stocks and equity mutual funds. The profit made from selling these after more than 12 months of ownership is taxed at 10%, over and above Rs 1 lakh of profit. The logic here is that stock ownership needs to be encouraged. Further, entrepreneurs need capital to expand their businesses and for that, investors need to be encouraged to invest in initial public offerings (IPOs).

The logic is weak simply because many IPOs these days are an offer for sale, where existing investors, such as venture capitalists and private equity companies, sell out. Hence, money is not being raised for business expansion in many cases. IPOs now simply provide an exit route for investors. Why should they get a tax-incentive for that?

Now, compare this to the fact that salaries are taxed at the marginal rate of income tax. Hence, if you are a salaried employee in the 20-30% tax bracket, chances are you are paying a higher proportion of your income as tax in comparison to the non-salaried rich. Further, over the last few years, the top rate of tax to be paid on salary has been close to 35-40%, once the surcharge is included.

Finally, a complicated tax system where different kinds of income is taxed at different rates is something which keeps chartered accountants and lawyers in business. In 2009, the Union government tried to introduce a Direct Taxes Code which simplified the income tax system majorly. Not surprisingly, it was scuttled by vested interests.

In recent years, the Union government has tried to introduce measures to make the tax law more equitable. Like earlier there was no income tax on listed shares and equity mutual funds sold after a holding period of more than one year. Now, there is. Further, resident senior citizens above the age of 60 are allowed to make a deduction of up to Rs 50,000 on interest they have earned on their bank deposits and post office deposits. This exception helps to bring down some pain of inflation and at the same time complicates the tax system further.

The government has also introduced a new tax regime which is supposed to be simpler and has fewer tax deductions. Nonetheless, in most cases, this leads to higher taxes than in comparison to the old regime.

To conclude, much more needs to be done to move towards a more equitable income tax regime. Of course, this is something that’s work in progress and is not going to happen in a single year.