While the Budget 2005-06 has largely been acclaimed as a positive one by most; one segment that should be completely delighted is the investors from the small savings segment.
It was widely believed that Finance Minister P Chidambaram would take steps towards rationalising this segment, i.e. either some schemes would be scrapped or the returns would be brought in tune with market-linked ones; however none of that happened. The small savings segment was left untouched.
But the Budget document's fine print suggests that all may not be well on this front. At present the EEE (exempt-exempt-exempt) method is used for taxation of savings, i.e. contributions to specified schemes are exempt from tax, accumulation (earnings on investments) is exempt from tax.
Similarly the withdrawals/benefits from the schemes are exempt as well.
It has been proposed that the EET (exempt-exempt-taxed) method should be adopted going forward; hence while contributions and accumulations would continue to remain exempt, the withdrawals/benefits would be taxed.
The document states, "The EET method eliminates/reduces the bias inherent against savings under the income tax."
Simply put, some of the instruments could lose their 'tax-free on maturity' status.
The difficulties in shifting from the EEE method to the EET method have been recognised; also it has been stated that the design of some existing products like mandatory plans (e.g. contribution to EPF) and insurance products may not permit the transition.
It has been proposed that a committee be set up to work out a roadmap for moving towards the EET system and to examine the instruments that would qualify for the new regime.
How will investors be affected?
If the EET method of taxation is adopted, it could have an impact on schemes like the Public Provident Fund (PPF) and even life insurance policies among others. At present these schemes/instruments offer tax-free returns on maturity.
We might see a new regime wherein the operation of the abovementioned instruments is akin to those of pension plans offered by insurance companies. While contributions to pension plans fetch tax concessions under Section 80CCC, the pension receipts are taxable in hands of the policyholder.
What should investors do?
First, investors must insulate themselves from the horde of incorrect information and improper advice doing the rounds. Insurance advisors have been trying to sell policies claiming that only policies issued before April 1, 2005 will enjoy tax-free maturity benefits.
The EET regime is being contemplated and could be implemented in the future; however it is status quo at present.
Second, brace yourself for the new regime. Perhaps some instruments will be placed under the taxable regime; however that need not alter your asset allocation.
For example, being insured is vital, irrespective of the tax implications. Similarly, if you believe that PPF is best suited to your risk appetite and needs, it should continue to be a part of your investment portfolio.
While tax-planning is important, it certainly shouldn't be the driving force behind your financial planning.
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