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How will the Kelkar plan affect the stock markets

Utpal K Choudhury | January 06, 2003

Vijay KelkarThe report by the task force on direct and indirect taxes headed by Vijay Kelkar has raised numerous questions among the tax paying community as well as investors.

We simplify and analyse the effects of a few important recommendations of the revised report which are pertinent for investors.

Personal tax

Recommendation: The proposed personal income tax structure will make all incomes tax-free up to Rs 100,000. Between Rs 100,000-400,000, a tax rate of 20 per cent will apply for incomes above Rs 100,000.

The set-offs will stay for those in the Rs 100,000-200,000 level. At income levels above Rs 400,000, the tax rate is 30 per cent.

Impact: The new tax regime will affect those who currently keep taxes low by investing in tax-efficient options since Kelkar has recommended a winding down of tax exemptions.

Dividends

Recommendation: Dividend received from Indian companies will be fully exempt.

Impact: Investors need not pay any tax on dividend income arising from investment in equities. So, other things remaining the same, companies with dividend yields higher than the contemporary interest rate should appear as good investment bets.

Capital gains

Recommendation: Long-term capital gains on listed equity will be fully exempt.

Impact: This, along with the recommendation of tax exemption on dividends, will make equities one of the most preferred investment vehicles.

Investors who hold shares for more than one year need not pay any tax on the profit arising out of the sale of investments. Investors should opt for investing in fundamentally strong companies and hold on for the long term.

Tax rebates

Recommendation: The tax rebate schemes under Section 88 will be eliminated, but rebate under 88B (for senior citizens) and 88C (for women taxpayers below the age of 65) will continue.

Impact: The tax rebate on investing in specified instruments such as National  Savings Certificates, provident funds, tax saving units of mutual funds, premium paid on life insurance, repayment of housing loans and  infrastructure bonds of IDBI and ICICI will go.

These investments will no longer work as tax-saving instruments. This will mainly affect the middle-income groups, who use these instruments both for savings and tax exemption. This is also an incentive for investing in the capital market.

Interest income

Recommendation: The income-based deduction under Section 80L for interest income and dividends will be eliminated.

The exemption under Section 10 in respect of interest income from bonds, securities and debentures will be eliminated.

Impact: The interest income from investments mentioned under Section 88 and others such as bank deposits and specified government securities will no longer enjoy tax exemption.

These incomes will be clubbed together with the taxable income and taxed accordingly.

This recommendation, along with the recommendation of elimination of Section 88, will make small savings instruments just like any ordinary saving instruments without any kind of tax incentive.

Mortgage interest

Recommendation: The deduction for mortgage interest in respect of loans for acquiring an owner occupied dwelling will be reduced to Rs 50,000 from Rs 1,50,000.

Impact: The proposal will benefit borrowers who take home loans up to Rs 5-6 lakh (Rs 500,000-Rs 600,000) as the annual interest payment works out to below Rs 50,000.

There will be no tax deductions for interest payments above Rs 50,000 per annum.

In the existing system you enjoy maximum deduction up to Rs 1,50,000. This could impact the real estate market and housing finance companies.

Resident status

Recommendation: The residential status of 'resident but not ordinarily resident' individuals will be eliminated.

Impact: The resident, but not ordinarily resident, will be taxed on a par with the residents and he will not enjoy any tax benefit as at present.

A taxpayer is treated as resident but not ordinarily resident if he is resident in India for less than nine years out of the preceding 10 financial years or was resident in India for periods amounting to less than 730 days during the preceding seven financial years.

Medical

Recommendation: The income-based deduction under Section 80D, subject to a ceiling of Rs 15,000, in respect of medical insurance premium will be converted to a tax rebate at the rate of 20 per cent of amount spent, subject to a maximum of Rs 3,000.

Impact: At present, you enjoy a deduction from your income up to a maximum of Rs 15,000 a year. For people in the upper income brackets, the saving would be around Rs 5,000.

This is now limited to Rs 3,000. Thus medical insurance will lose some sheen as a tax saving instrument.

Corporate tax

Recommendation: Reduction in corporate tax rate from 36.75 per cent to 30 per cent for domestic companies and to 35 per cent for foreign companies.

Impact: Undoubtedly this is good news for investors, as it will increase the net profitability of companies, resulting into speedier reserve building and/or higher dividend distribution.

Double taxation

Recommendation: There will also be no tax on distribution of dividends by a company.

Impact: This will ultimately put an end to double-taxation of dividends distributed to shareholders. It's an incentive for corporates to distribute higher dividends.

Also, it will make dividends an important aspect in taking equity investment decisions.

Depreciation

Recommendation: Unabsorbed depreciation would be merged with business loss and lose its separate identity. Further business loss would be allowed to be carried forward indefinitely.

Impact: It's an incentive to corporates to invest in projects with long gestation periods. So shareholders and analysts need not worry much about any project of a company that takes a relatively longer time to break even.

The loss will be deducted from the profits of other profit making businesses till the project becomes profitable. Thus companies having such projects at hand are expected to get better valuations in the market.

MF income

Recommendation: The income of mutual funds derived from short-term capital gains and interest should be taxed at a flat rate of 20 per cent in the hands of investors.

Impact: Thus far mutual funds are not subject to any tax. Implementation of this recommendation will bring them under the tax net, though investors need not worry.

It is recommended that the dividend received by unit holders should be fully exempted. So it doesn't mean double taxation.

Sale of units

Recommendation: The short-term capital gain arising to the investor from sale of units of investment funds should be taxed at his personal marginal rate of tax, while the long-term capital gain arising to the investor from sale of the units should be exempt from income tax.

Impact: This is, indeed, an incentive for investors to invest in professionally managed mutual funds for the long term rather than investing in small savings schemes.

This measure is expected to give a fillip to industry as well as the capital market.

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