How new tax code affects individuals

What does the proposed Direct Taxes Code hold for the common man? A look at visible effects and implications of the proposals on our monies.

The draft of the Direct Taxes Code bill 2009 and the Discussion paper have been made public recently. In the words of the finance minister "the thrust of the code is to improve the efficiency and equity of our tax system by eliminating distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base".

A very valuable input from the finance minister has been "It will specially meet the aspirations of our young and professionally mobile population. So what exactly is all the excitement about and will it really "change" things as they are?

What does it say about income tax rates?

The most remarkable point which would be a great cheer for all individuals is the revision in the income tax rates. The change is not only in terms of the slabs but also the simplicity in calculations. The Code proposes to create 4 slabs for the sake of income tax calculations.

For Men

Slab 1: Total income is lesser than Rs 160,000

The income tax for the above slab is proposed to be nil. This is what currently exists and hence does not in any way change anything for individuals earning below 160,000.

Slab 2: Income is between 160,001 and Rs 10,00,000

This is the most drastic change proposed. The tax for the above slab is proposed to be 10 percent of the amount by which the total income exceeds 1, 60,000. Meaning, if your income is 572,000/- then, the income tax would be 10% of (Rs 572,000-Rs 160,000). Although for individuals who were earlier earning between Rs 160,000 and Rs 300,000 this does not bring about any change, it brings great cheer for individuals earning between Rs 300,000 and Rs 500,000 as they straight away save 10% of any income that exceeds Rs 300,000, but is lesser than Rs 500,000. Today they have to pay 20% on this amount!

For individuals who are today earning above Rs 500,000, this would bring even more cheer as they save a flat Rs 20,000,plus 20% of any amount above Rs 500,000 and lesser than Rs 1,000,000!

Example: Ram's income today is Rs 7 00,000

Income tax as per present rates = Rs 118,450 (excluding surcharges and any cess)

Income if new code comes into effect = Rs 54,000, a saving of Rs 61000

Slab 3: Income is between Rs 10,00,001 and Rs 25,00,000

The code proposes the income tax for this slab to be Rs 84,000 (10% of 840,000) plus 20% of any amount above Rs 10,00,001 but lesser than Rs 25,00,000. This would also bring about happy tidings for people who are currently earning above Rs 1,000,000 as they save around Rs 100,000 plus 10 per cent of any income which exceeds 10,00,000.

Slab 4: Income exceeds Rs 25,00,000

The code proposes the income tax for this slab to be Rs 384,000 plus 30% of any amount exceeding Rs 25,00,000. People currently earning above 25,00,000 would expect savings of over 40% of their current tax liabilities.

Away with 'assessment and previous year'

The new code has proposed to do away with the concept of using 'previous year' to denote the year in which you earned the money and 'assessment year' the year in which you pay the self assessment tax and file your return.

The new proposal is to use the simpler terminology of Financial Year (FY). For example if you earned income in FY09-10 then, your pay advance tax in FY09-10 and any balance tax and returns in FY10-11.

Source of income defined:

The income is proposed to be bifurcated into 'special sources' and ordinary sources. The special sources include items like lotteries, games and non residents etc which will be charged on the basis of a rate schedule.

Thus while calculating the total income we will have to add total income from ordinary sources and total income from special sources.

Source based versus Residence based taxation:

Source based taxation is a process in which the income tax is calculated on the basis of the source of income whereas residence based taxation calculates income on the basis that individuals are taxable in the country or tax jurisdiction in which they are residing.

The debate has been for long on which methodology to use. The new code proposes to use residence based taxation for residents and source based taxation for non-residents.

It states 'a resident in India will be liable to tax on his worldwide income and a non-resident will be liable to tax in India only in respect of receipts in India'.

What this means is that if you have been out of India for more than 183 days you would be treated as a non-resident and you need not pay tax on income which has already been taxed in the country where you get the income from and also if it's not taxed there.

But, in case of residents the income which has not been taxed in another country will be taxed in India upon repatriation.

Capital gains

The new code proposes two important ideas.

The concept of long term and short-term defined by the period of holding of a capital asset will be removed.

Instead, for any capital asset which is transferred, to get a gain, anytime after one year from the end of the financial year in which it was acquired, the cost of acquisition and cost of improvement wil be adjusted on the basis of cost inflation index to reduce the inflationary gains?

The base date for calculation of cost of acquisition of a capital asset has been proposed to be shifted from 01-01-1981 to 01-04-2000. This would be a big disadvantage to people who had brought the assets very long ago.

The reason is that you would have brought it for very low prices but the capital gains will be calculated based on the price of the asset on 01-04-2000.

The above discussions are some of the very visible proposed changes in the Direct Taxes Code which would affect individuals. The idea behind the whole exercise is for the public to give their feedback regarding their views before the discussion document is presented to the parliament.

If you have any comments/suggestions you could mail to the IT department at: directtaxescode-rev@nic.in and hopefully the finance minister might consider it important to be a part of the new code!

- BankBazaar.com

Mirage In The Markets

There are 2 opposing sentiments that need to play out in world stock markets in general. The bulls believe that the world is returning to ‘normal’, while the bears believe that the world can still come to an end. At the moment, the bulls have an upper hand, but I have certain behavioural indicators that suggest that the bears may have a point. You can’t increase global Money Supply by an estimated 25 per cent, take the Fiscal Deficit to 12-15 per cent in major countries, and not increase inflationary expectations. Ignore this at your own peril….

So, then what explains the rally so far? Call it the return of ‘animal spirits’, people who have just got tired of waiting, and who don’t know what to do with their freshly-earned cash; maybe the stimulus money waiting to go somewhere. Or just late-stage momentum…? The return of the stock market ‘tipster services’, the revival of brokerages and the quick resurgence of day-traders tells me that this is a late-stage bull rally already, with little change by way of fundamentals. That would suggest that market (volatility) risk has gone up dramatically.

Let us look at how fundamentals have changed since 2007. First, the Asian savings glut. China is no longer buying US Treasuries, and the US Current Account Deficit has halved (to $400 bn). So the supply of limitless liquidity with low inflationary expectations has gone; it has been temporarily replaced by the promise of Government Fiscal Stimulus, which will fuel inflationary expectations if they actually happen. Governments are already working hard at promising Bond markets that these funds will never be let loose, otherwise the world is headed for a 1971-like inflationary shock. Look at what the G8 just said; no further talk about pumping cash, but some pious statements about how to pull them back in, once things return to normal.

If China is no longer there to drive down Treasury yields, who subscribes to those US Bonds at the margin? The US citizen now has a 5 per cent savings rate, but he expects inflation at 3-5 per cent, which means T-bills go at 7 per cent. That is above the historical average, in the middle of the worst recession since 1929. Hardly the stuff that promises recovery…!!! More important, if the supply of T-bills continue, it could fuel inflationary expectations, driving the US into a hyperinflation loop with a Dollar collapse.

The DXY Index is falling, despite a halving of the Current Account Deficit. That suggests capital flight, and we can see where the money is going: to commodities (like oil) and Emerging Markets, especially those who are seen as ‘commodity currencies’ like Brazil and now Russia. India, one of the beneficiaries of low oil prices, could see one of the false rallies, as oil prices go back up, the Current Account Deficit balloons and its invisibles account sees a dip because of the weakening purchasing power of the Dollar (which reduces IT flows).

A key threat to the Dollar’s destiny is the Bond market’s view on the $12 tn (83 per cent of GDP) that the US Fed has committed. The Fed now has to convince the Bond markets that this money will never be released, else there will be a run on the Dollar. This is the key theme running through currency markets just now. Contrarians are punting on the possibility of the Fed actually raising rates just now (even with 9+ per cent unemployment) to get back some Dollar strength. If the dam breaks on the other side, it may be impossible to retrieve Dollar credibility. Will the Fed do it? Let us look at what happens if it doesn’t. You will have a clear bubble in oil, even with falling demand. This will anyway fuel inflation and affect growth, puncturing the famous India story, for example. It will also push global stagflation, hardly the stuff recoveries are made up of.

Why should you worry about Dollar weakness? A desperate Euro, with 9.6 per cent unemployment and 2 sovereign defaults within its community, is trading at a 2-Sigma high (it has been higher only 5 per cent of the last 5 years). Does this look normal?

The traditional formula of increasing Money Supply only works till people feel that money is valuable. At some inflexion point, if people lose that faith, you become a Zimbabwe. This is called Rational Expectations Theory, and is the exception to the Keynesian “pay money to dig holes” prescription for coming out of a recession.

There is a point at which you need to focus on building the credibility of the currency, like Paul Volcker did when he triggered the 1987 recession with 14 per cent government bond rates, but clearly stood on the side of a ‘strong Dollar’. This credibility was subsequently destroyed by Greenspan. Maybe the cycle has to repeat itself….

So is there a genuine demand-led recovery anywhere in the world, which needs to be discounted in its stock markets? I can’t see it anywhere, despite the specious media arguments that ‘we are an exception’. This is no different from the ‘India Shining’, ‘India Decoupled’ and ‘India Great’ arguments, where a cricketing victory has been seen as indirect evidence of future Indian greatness, justifying a bull market.

The property market is even more ridiculous, mainly because more people have property than have shares. This last property boom-bust was larger, more widespread and deeper than ever before. Why would the cycle be shorter than ever before? It normally takes 3 years to run out inventory; this time, if anything, it should take longer because of weaker incomes and lesser availability of good credit.

This bull market is more the creation of the mutual fund industry and the media than anything else I have ever seen. If you can trade your way out of this shallow and artificial ‘bull run’, go for it. If you have the courage and the skills, get in with a trader’s eye, and ride a big spike in stock prices that could leave you richer but unhappier than before. A trader’s life is not a good one, because you have to learn to live with losses.

Most retail investors lose money to the markets. Japan, Korea and Taiwan, even China have seen huge economic growth, but volatility in the stock markets has never created wealth for its citizens, just as Las Vegas has never made the gamblers rich. Long-term wealth in stock markets is created for the retail investor only by good companies that grow without volatility, like the “FERA companies” created wealth for our parents through a generation of bonuses and dividend payouts. Remember Colgate and HLL? The difference is made by Corporate Governance and a culture of sharing with minority investors, not the absolute amount of profits generated. This is missing in Asian companies, but thankfully, we have some honourable Indian exceptions (like the Tatas, Infosys and Bharti).

Warren Buffet has fed the notion that long-term investors in general make money. This is not true, unless you have the skills and perspicacity of Buffet. With the exception of GE, no company has lasted long enough to make sustainable money for its investors. Yes, markets may appreciate over the long term, so investors who invest in Index Funds might make money, but not buy-and-sleep investors who invest in cos.

If you think this rally is for real, you are making a mistake and should get out as soon as possible. If you lost money in 2007-08, then history is not on your side….

- ValueResearchOnLine