A revised Budget

After presenting the Union Budget on July 8 this year, Finance Minister P Chidambaram had to carry out two amendments to the same. Finally on August 26, the Finance (No. 2) Bill 2004 was passed by Parliament.

Following are the key changes pertaining to the income tax:

Tax on NRE/FCNR deferred

Earlier the Bill had sought to tax interest on Non-Resident External and Foreign Currency Non-Resident accounts from September 1, 2004. This date has now been extended to April 1, 2005. This change has been brought about apparently to enable Non-Resident Indians rearrange their financial affairs in a suitable manner.

I don't support the proposal. But having made it, I only hope the government displays the gumption to go through with it. If it succumbs to external pressure and rolls back the proposal, in toto, the damage would already have been inflicted.

Changes in the Securities Transaction Tax (STT)

So much chopping and changing in this one area has left investors in a state of disarray. The confusion on this vital issue does not bode well for the investment climate in India. One only wishes the government had done its homework before coming out with such radical changes. Applicability of the STT and the rate thereof to various classes of investors is summarized in the table below:

The two major changes are that the STT has been made largely applicable to the seller instead of the buyer. Second, equity-oriented units have been brought within the ambit of STT applicability.

It may be noted that where the securities are held as capital asset, no deduction will be allowed for the STT in computing capital gains.

A new section, Section 88E has been introduced (into the Income Tax Act) that offers a rebate in respect of STT paid to a trader in securities. In other words, where the total income of an assessee includes business profits arising from securities transactions, he shall be entitled to a rebate from the tax liability arising from such transactions.

Such rebate would be limited to the amount of STT paid or the tax liability, whichever is lower. Also to claim such rebate, the assessee has to furnish evidence of payment of STT in the prescribed form, along with the return of income.

Long-Term Capital Gains (LTCG ) and Short-term Capital Gains (STCG) tax

LTCG arising from sale of equity shares or units on a recognized stock exchange or from redeeming units of an equity-oriented fund to the fund itself will be exempt from tax.

STCG on the above-mentioned instruments would be charged at a lower rate of 10 percent.

These changes would be applicable for transactions entered into on or after the date on which the payment of STT comes into force. Such date will be announced by notification in the Official Gazette.

Also, for a resident individual or a Hindu Undivided Family, where the total income as reduced by the STCG falls below Rs 50,000, the STCG would be reduced by the amount by which the total income so reduced falls short of Rs 50,000 and the balance of STCG would be taxed @ 10 percent. This provision is best explained in terms of an example.

Suppose an individual has a taxable income of, say, Rs 1,20,000, out of which STCG amounts to Rs 90,000. Therefore, net of the STCG, his total income would be just Rs 30,000, a full Rs 20,000 below Rs 50,000 which is the threshold below which tax is not payable. In such a case, he can use Rs 20,000 out of the STCG to make up the shortfall and only the remaining STCG, i.e. Rs 70,000 would be taxed @10 percent.

No deduction under Chapter VIA (Sec. 80DD, 80G, 80L etc.) nor rebate under section 88 would be available on such STCG.

Tax exemption on income up to Rs 100,000

This is another area where there was some confusion among investors. In the original proposal, by virtue of a new section, Section 88D, tax liability on income up to Rs 100,000 was automatically rebated. This has not changed.

All that has been done is provisions for marginal relief have been put into place so that the take-home of those having income marginally over Rs 100,000 does not become less than Rs 100,000, just on account of the tax payable.

For example, let us take a person earning Rs 1,10,000. The tax payable thereon works out to Rs 11,000. The post-tax income, just on account of the tax payable falls to Rs 99,000. Ergo, such a person would get marginal relief of Rs 1,000 such that his post-tax income would be Rs 100,000. The break-even income is Rs 111,250.

Definition of 'income' expanded

This refers to the gift tax brought about in a different form. From September 1, 2004 onwards, income of an individual or HUF will include any sum of money exceeding Rs 25,000 received without consideration. The exceptions, which were more in number earlier, have been restricted to the amounts received from the following:

(a) any relative; or
(b) on the occasion of the marriage of the individual; or
(c) under a will or by way of inheritance; or
(d) in contemplation of death of the payer.

An interesting thing in the above modification is that the exceptions have been brought about by expanding Section 56. The said section appears to provide total protection to the exceptions. In other words, income without consideration in excess of Rs 25,000 is taxable, except when received from a relative or on marriage or under a will or in contemplation of death.

However, the original proposal imposed a limit on tax-exempt marriage gifts of Rs 100,000 by virtue of a newly introduced Section 10(39). This section has been deleted in the amended Finance Act. In other words, earlier all receipts without consideration were taxable. Exception to this rule was provided by Section 10(39) which specified that an amount of Rs 25,000 and a sum of Rs 100,000 on the occasion of marriage would remain tax-free.

But now, the Rs 25,000 limit has been specifically brought into Section 56 directly, but the Rs 100,000 limit is gone, which means that any sum of money received as a wedding gift would be totally free of tax.

Incidentally, the finance minister had mentioned that the definition of the term 'relative' had been streamlined in the amendments. But it remains the same as was specified in the earlier proposal.

Last point

There exists an anomaly – this time in the arena of mutual funds.

The newly introduced Section 10(38), as well as Section 115T, defines an equity-oriented fund to mean a fund:

(i) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than 50 percent of the total proceeds of such fund; and
(ii) which has been set up under a scheme of a Mutual Fund.

It goes on to say that the percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures.

The problem is that the definitions are unable to keep pace with the rapid developments in the mutual fund industry. Investors are being offered a new product called Fund of Funds (FoF).

Now, an equity FoF would typically invest in equity schemes of the same fund house or in equity schemes of others. Whatever the case, it firmly remains an equity product. But a strict application of the term 'equity-oriented fund' defined above will make such a fund not qualify as it does not invest in equity shares of domestic companies.

Consequence? It has to bear the dividend distribution tax applicable to debt-based mutual fund schemes and also forego the exemption from LTCG now available to equity funds.

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