Amongst the various provisions of the Budget 2007-08, the following are some of the more significant ones that would directly affect the common man:
Basic Exemption Increase: Flattering to deceive
Yes, the basic exemption has been raised by Rs 10,000 for all categories of taxpayers. However at the same time, the education cess has also been increased. Both these cancel each other and the taxpayer comes back to square one. The cut off, as it were, is Rs 510,000, Rs 520,600 and Rs 893,000 for non-senior males, ladies and senior citizens, respectively.
To put it differently, those earning lower than the above-mentioned income levels would be marginally better off and those earning higher would end up actually paying more tax. Note that the highest tax rate has now climbed to 33.99%.
Stock Options: Expensive on both employer and employee
Stock options, now under Fringe Benefit Tax, will be taxed at 33.99%. The finance minister has gone on record stating that the authorities have yet to give details on how to determine the value of stock options and how to tax the same, yet, a plain reading of the law suggests that the difference between the Fair Maket Value and the Exercise Price will be taxed at 33.99% on the date of exercise.
Simultaneously, when the employee sells his stock option shares, capital gains would be applicable in the normal course.
Dividends become more expensive
Dividend Distribution Tax (DDT) on corporate dividends has been hiked to 15% from 12.5%. After surcharge and cess, the effective tax rate climbs to 16.995%
A couple of issues arise. Taxing corporate dividends does amount to double taxation. Dividends are declared by the company from its post-tax income. Now if the investor is taxed again (DDT is akin to taxing the investor at source), the same stream of income is being subjected to an effective tax rate of 50.98% (33.99% + 16.99%).
Secondly, foreign investors (NRIs, FIIs, etc) have to pay tax in their host country too on such dividends received. As DDT is not a tax envisaged under the Double Taxation Avoidance Agreements (DTAAs), such investors would end up bearing triple tax on the one income.
Liquid Funds: Also become more expensive
DDT for all categories of investors in Money Market Mutual Funds (MMMFs) and liquid funds has been doubled to 25% as against the earlier 12.5%. Again, the effective tax rate is actually 28.325%.
This has apparently been done to cut the arbitrage opportunity between income tax rates and distribution tax. However, here it may be mentioned that even now, arbitrage does exist as the effective tax rate works out to actually just 20%. Let me explain.
I will take a base DDT of 25% (not included surcharge and cess for simplicity) and assume a dividend to be distributed of Rs 100. So the mutual fund concerned will actually pay Rs 80 to the investor and pay Rs 20 as distribution tax. Rs 20 is 25% of Rs 80 (which was the dividend distributed). However, as far as the investor is concerned, he has borne a tax of Rs 20 on a gross income of Rs 100 which works out to just 20%.
Look at it the other way. Had the investor actually received Rs 100 in hand, he would have been asked to pay Rs 25 (25% of Rs 100) as tax. Just on account of the mutual fund paying the tax on the investor's behalf, the effective rate works out lower.
In any case, these amendments will take effect from April 1, 2007.
TDS limit for interest hiked
Amongst good news for the small investor, Bank and Post Office interest was subject to TDS over Rs 5,000. This limit has been doubled to Rs 10,000.
Extra deduction for medical insurance
Deduction in respect of medical insurance premium under Section 80D has been increased to Rs 15,000 from Rs 10,000 for non-senior taxpayers. For senior citizens, the limit has been enhanced from Rs 15,000 to Rs 20,000. Also, premium payments made by electronic mode, credit card, etc. will be allowed.
Education gets cheaper
This is indeed a salutary move. Deduction of interest payable on loan taken for higher education under Section 80E was available only to the individual taking the loan. This was a problem since the student taking the loan hardly had any taxable income and if the parent takes the loan for his or her child, the deduction was not available.
However, now, the deduction has been made applicable even in case the loan is taken for one's spouse or children.
Note that this deduction is available only for loans taken form a financial or charitable institution. Loans from employer or from other private sources aren't eligible for the tax deduction.
54EC Bonds: Elusive at best
The limit of Rs 50 lakh on capital gains bonds stays. However, it is not the limit that one is worried about -- the worry is the fact that these issues are capped. So when you sell your property, forget the limit, the bonds may just not be available --- so what was needed was to make the bonds available on tap, throughout the year --- which has not been done.
RBI Bonds: Now subject to TDS
Interest on the immensely popular RBI 8% Savings Bonds was taxable but free from TDS. Effective 1.7.2007, any interest over Rs 10,000 from such bonds would be subject to a TDS of 10%. Similarly, professional fees were subject to a TDS of 5% which has now been increased to 10%.
Service Tax: Marginal Increase
The service tax rate has actually increased from 12.36% from 12.24% on account of the additional cess. It is the declared intent of the government to increase the service tax rate eventually to 16%, however, the inflation sword has precluded an increase this time.
The basic exemption has increased from Rs 400,000 to Rs 800,000, however, this essentially benefits the small service provider but not the common man who is the receiver of the service.
Making commercial rentals subject to service tax would only make office space still more expensive.
IT companies put on the MAT
MAT, or Minimum Alternate Tax, is 10% of 'book profits.' Which means this is the least amount a company has to pay as tax. The Income Tax Act lays down the way to compute such 'book profits.' Till last year, the book profit could be adjusted for incomes and expenses related to Section 10A and 10B.
However, Budget 2007-08 intends to take Section10A and 10B out of the purview of MAT benefit thereby increasing the computed book profit to that extent.
The impact, including surcharge and cess, would be 11.33%. Therefore, those companies (especially the SMEs in the IT sector) whose effective tax rate was less than 11.33% would be directly affected.
Section 80-IA controversy
There was some confusion in the markets related to the Budget treatment of Section 80-IA. The Section 80-IA provides for a ten-year tax benefit to a company (enterprise or undertaking as it is called in the tax law) engaged in infrastructure development, Industrial Parks, SEZs, etc.
The government has clarified that Section 80-IA was a tax break intended for the original enterprise which was engaged in infrastructure development and not for companies who were merely executing the civil construction work or any other works contract on its behalf.
Thus, in a case where a company itself makes the investment and executes the development work it will be eligible for the 80-IA deduction. However, a company or a developer who merely enters into a works contract will not be eligible for the tax benefit under section 80-IA.
An immediate fall out of this measure has been a free fall in the share prices of constructors and developers who essentially were works contractors and were never intended to be benefited by this deduction.
The other news that has taken industry by surprise was that this amendment is retrospective in nature and is being made effective from 1st April, 2000
Other announcements
There are other miscellaneous announcements like the issue of tax-free bonds, dedicated infrastructure funds to be launched by mutual funds, etc. However, the details haven't yet been announced. Watch this space for further details.
The writer is Director, A N Shanbhag NR Group. He may be contacted at sandeep.shanbhag@gmail.com
