Thursday, August 5, 2010


The second revised draft tax code is ready and it was unveiled recently for discussions and to get feed back so that it can be introduced in Parliament during the ensuing Monsoon session of Parliament by present Finance Minister, Pranab Mukherjee. The biggest relief, as per the revised draft, is that PPF and Bank FD will be tax free. The First draft envisaged taxes on both these items. The last date of sending suggestion by common people is 30th June 2010.

Mr. Chidambaram as then finance minister spent time and energy in creating a new code, and even guided a close-knit team of revenue officials on how to write a simplified version of an income tax code that would eventually replace five decades old Income-Tax Act. Recognising the pioneering effort, Pranab Mukherje brought in Mr. Chidambaram during last August when he unveiled the first draft tax code for the country..

But as Mr. Mukherjee launched the second version of the draft discussion paper this week( 18TH JUNE) which ultimately will be sent to Parliament for approval, there has been a paradigm shift from what Mr. Chidambaram and his team originally conceived. It’s now much simpler, but it has full of exemptions to make all stakeholders happy.

The new draft code has accommodated concerns of India Inc as companies would now pay minimum alternate tax (MAT) on book profits and not on gross assets as was originally proposed. Also, the salaried class which bears the brunt of the current tax regime has a sigh of relief as their tax savings schemes such as the public provident fund would remain intact.

These provisions would definitely mean loss of revenue for the exchequer and impact fiscal deficit situation, but the windfall of Rest 1 lakh crore from 3G and broadband auctions led the government ignore the macro economic scenario and create a feel-good situation among its constituents.

Yet upper middle class population remained unhappy as the revised draft did not exempt long term investment from Capital Gains tax.( At present there is no tax on long term capital gains) As per revised draft the long term capital gains will be applicable to all concerned at the applicable rate of income tax. This means if tax payer pay income at the rate of 10% he would have to pay long term capital gains tax at the same rate. Incase someone pay income tax at the rate of 20% or 30% his rate of capital gain tax to be charged would be at the same rate. This proposed draft provision has brought in anguish among the high middle class people. They felt investment by middle class would go down. The Indian Capital market would not take this provision kindly. The market would turn greatly volatile initially and later bull effect would not set in for quite sometime easily. Of course these are the proposal only and people can represent their case to enable Government in power to finalize the Code.

During the last few months, there were intense deliberations both inside and outside the North Block on whether tax saving retirement benefits should be done away with, as was conceived in the first draft of direct tax code. Finally, the argument that prevailed was to make a complete U-turn on the earlier provision of taxing the retirement benefits which would have forced the salaried class feel the heat.

Now, EEE (exempt) tax system on retirement benefits would surely help senior citizens in a country like India which is yet to adopt an effective social security mechanism. This provision will be applicable to select schemes like PPF, pension schemes, general provident funds, recognized provident funds, and pure life insurance and annuity schemes. Also, lesser tax burden on perks and tax exemption for single house owners are a few more positives for middle class families which have been hit hard by economic recession and food inflation during the last couple of years.

In fact, the code addressed 11 issues, including MAT, dilemma between EEE and EET, taxation of house property, capital gains tax, status of double taxation agreements and general anti-avoidance rules etc. The capital gains will now be added to an individual income, meaning that your tax liabilities from capital gains will be more than the one who has lesser income from other sources.

Also, securities transaction tax (STT) will stay though rates have not been announced so far, keeping in mind the market sensitivity over the issue. The revised paper has also attempted to end uncertainty over taxing the FIIs and tax rules regarding double taxation agreements. The first DTC draft, released in August, had proposed 10 per cent tax on the income of Rs 1.6 lakh-Rs 10 lakh, 20 per cent on Rs 10 lakh-Rs 25 lakh and 30 per cent beyond Rs 25 lakh in a year. At present, 10 per cent is levied on income between Rs 1.6 lakh-5 lakh, 20 per cent on Rs 5 lakh-8 lakh and 30 per cent over Rs 8 lakh.

The revised draft, on which the Finance Ministry has invited comments from the public till June 30, is silent on tax slabs. However, it did mention that tax slab and rates proposed in the first draft would be revised.
"The proposal in this Revised Discussion Paper would lead to a reduction in the tax base proposed in the DTC. The indicative tax slabs and tax rates and monetary limits for exemptions and deductions proposed in the DTC will, therefore, be calibrated accordingly while finalising the legislation," the revised draft had said.

Yet, the revised direct tax code has maintained silence over individual’s tax slabs making tax payers guessing whether it would be tweaked in every General Budget. Will tax payers be forced to wait for the last portion of FM’s Budget speech to know their tax liabilities?

Direct tax code is sincere attempt to reform the archaic tax rules and hope tax payers are greatly benefited from this revision.



It has now been decided that genuine altered cheques would continue to be accepted in Northeast beyond First July 2010. The new provision of RBI would be applicable only after the image-based cheque truncation system (CTS) is introduced here. At present, the cheque truncation project is being run only in the Delhi area with Chennai expected to move on stream soon.

The circular of RBI issued in the month of February2010 on prohibiting alteration and correction of cheque has caused ripple effect in society and in trade circleall over the country. As per the notification any alternation, correction and cutting of cheque would not be honoured by banks. This steps was taken as the fraudulent withdrawal of money was of late rampant in some cities of the country. As a precaution to stop fraudulent dealing such steps were to be taken from First of July 2010, on the basis of recommendation received from the working group constituted for standardization of cheque and for security measures.

The notification was interpreted by the social circle, trade circle and a few banks, as if, any alteration of a regular cheque by customers of banks will be punished . people of certain cities interpreted that if a bank customer had written ‘hundered’ instead of ‘hundred’ on a cheque, he should not just strike off the additional ‘e’ and issue the cheque. Instead, he should use a fresh leaf , or it could cost him Rs100-550. The trade circle made hue and cry and interpreted that the Reserve Bank of India (RBI) has notified banks in a recent circular not to accept cheques that have corrections or alterations in anything but the date. The intention of RBI actually was to “help banks identify and control fraudulent alterations”. A few banks interpreted the notification somewhat hastily and started informing customers about the policy change through mailers that no altered cheque would be accepted by bnaks with effect from First July 2010.

If a persons issue a cheque with corrections, he will be slapped with cheque return charges that are Rs100-250 for public sector banks and Rs350-550 for private banks. This interpretation has created panic in the mind of Bank’s customers.

“It is consumer protection that the RBI is looking at. Many a times cheques are stolen and encashed by other parties by making corrections,” said S Govindan, general manager (personal banking and operations), Union Bank of India .

Some of the bankers felt that the move is essential keeping in view the changes in the way cheques are dealt with now. “Earlier, banks used to tell people not to issue a bearer cheque and about some basic precautions. But now cheques get couriered. Also, they are deposited in drop boxes. So the possibility of them falling into the wrong hands is high.”

The RBI also wants to reduce and, if possible, eliminate transactions through cheques. “Now that daily interest rate calculation has come in, it works in your favour to keep money in your account for as long as possible. At least three days are wasted in the issuance of a cheque. Whereas netbanking is instant,” said a banker.

After getting notice from a few banks individual customers panicked. Some of them have written to RBI and trade circl represented their case against imposition of such a rule with out full scale debate. The situation became so tense that RBI had issued a clarification recently on the subject on June 22nd 2010.

We would like to assure the indivudal customers of banks residing in Northeast not to panic at all.
The notification issued during February have been wrongly interpreted and out of context. In fact the Reserve Bank of India has clarified that its directive to banks asking them not to honour cheques with alterations, will be applicable only for cheques cleared under the image-based cheque truncation system (CTS). At present, the cheque truncation project is being run only in the Delhi area with Chennai expected to move on stream soon.

The clarification paves the way for bank branches in metros like Mumbai where CTS is still not operational to accept corrected cheques. RBI's directive had created a flurry in trade circles and even among utilities that have been turning away cheques with any form of correction or alteration even if the changes were validated by the cheque drawer's signature.

In a notification RBI has clarified that its directive on prohibiting alterations/ corrections on cheques ``will be applicable only for cheques cleared under the image based Cheque Truncation System (CTS).

The directive given in February notification is not applicable to cheques cleared under other clearing arrangements such as MICR clearing,non-MICR clearing, over-the-counter collection (for cash payment), or even for direct collection of cheques outside the Clearing House arrangement.

It should be clearly understood that Cheque Truncation is a system of cheque clearing and settlement between banks based on electronic data/images or both without physical exchange of instrument. Here the cheque is scanned and electronically presented for settlement with the clearing house.

Our readers need to note that Assam is not under chque Truncation system hence the February notification is not applicable to Northeast. Currently, most of the clearing is done on the MICR system and banks often entertained cheques with alterations, be it the name of the party to whom the cheque is issued, or the date or the amount, provided the issuer of the cheques does is signature besides the correction.

In case any bank insists on the earlier stand the customers of bank can request the bankers to refer to the latest clarification of RBI vide their notification RBI2009-10/ and satisfy themselves.



The Ulips were in the news for last six months over its control on market based returns. Two regulatory authorities i.e. IRDA and SEBI fought bitterly over its control. As predicated Finance Ministry stepped in and control was given to IRDA exclusively. But the revised guidelines on unit-linked insurance products (Ulips) by the Insurance Regulatory Development Authority (IRDA) made exit an easier affair only for those who remain invested for more than five years. This follows the regulator's decision to increase the minimum lock n from the current three years to five years, to encourage long term investment and stem the high rates of surrender. This is a good move. Why customers started leaving ULIPS with premature surrender? This was because the terms of the policy was not clearly stated that till fifth year it would not earn a decment return. Customer expected higher return on buying ULIPS and found there were negative growths for first few years due to heavy cost of acquiring. That peeved the customers and they choose to leave prematurely even with a loss of capital. This happened as the dealing of advisors was not transparent.

The Government and regulatory authority did realise the unhappiness of the general public on ULIP and wanted to remedy the situation. The recent action of IRDA is pragmatic and futuristic.

We have always been advocating in our column that customers of ULIP who want to exit between five and nine years would stand to benefit .Taking note of the surrender behaviour and with a view to smoothen cap on charges, IRDA has imposed limits on charges from the fifth anniversary of the policy. The maximum reduction in yield for a Ulip after five years shall not be more than 4%, IRDA said. ULIPS have become out and out a insurance product now and young people who keep invested for longer term would be benefited with insurance cover.

“Small regular premium (Ulips) policies may become unviable. A large proportion of people who were paying a premium of less than Rs 15,000 or so a year will suffer badly. Small-ticket policies of less than Rs 20,000 a year should have higher allowance to make them viable.

In July last year, the regulator had capped the charges on Ulips. It specified that the net reduction in yield for policies less than or equal to 10 years shall not be more than 3% at maturity. Ulip is a better long-term investment product and works well with a 7-year timeframe. "It (the new rules) would encourage investors to stay on for at least five years," according to experts of Insurance. This is true. Ulip is ideal for children marriage Planning or for children’s education fund. We had advised most of our readers not to surrender ULIP before seven years as that would mean loss . We forewarned our readers of ULIPS rather to maintain the plan once entered for longer time.

In a bid to eliminate high front ending of expenses, which are as high as 30%, the regulator has mandated that they should be evenly distributed during the lock in period. However, some experts are not happy as it would mean that investor would still have to shell out the same amount albeit over a longer period. But we feel while paying early the entire money the return in initial period get effected. It would be prudent to pay the cost in installments as higher amount available for investment may return higher amount initially .

.The most important Lacuna of ULIPS, we have always maintained, were lack of transparency.With more transparency coming in and disclosure of commission to be made mandatory , investors would be better informed now.. Ulip from now onward would be purely a product of insurance .From September this year it would cover life insurance automatically and it would be a powerful tool of Personal Finance hence forth. Instead of Mutual fund and term insurane combo ULIP would turn out to be a great product by itself. As on date it is not a great product but from September 2010 it has potential to be a product of importance.

Insurance sector regulator IRDA on EARLY JULY came out with a set of guidelines directing life insurers to offer unit-linked insurance plans (Ulips) at lower cost to buyers, while also providing higher life cover, though with a longer lock-in period.

While life insurance customers will benefit, the new rules could lead to a substantial cut in commission for insurance agents and force life insurance companies to drastically cut costs, leading to lower sales.

IRDA stated that insurers would be allowed to charge up to 4% on annual premium paid on Ulips for the first five years, and thereafter charges will be reduced during the tenure of the policy. For plans of 15 years and above, the charges will be restricted at 2.25% of annual premium.
These cuts in charges would make Ulips more attractive to buyers since they will have to pay lower charges for the same premium they paid earlier. In the long run, this will add to Ulip buyers’ funds. ‘‘Lower charges will benefit customers,’’ said GV Nageswara Rao, MD & CEO, IDBI Fortis Life Insurance. However, this could mean lower commission to agents which might affect Ulip sales, he added.


The insurance regulator has ordered life insurers to offer customers a guaranteed return of 4.5% per annum on pension and annuity plans as part of its new, tighter norms for the sector, a move that is expected to force companies to slash commissions to agents and invest more in government securities.

period. Insurance officials say a guaranteed interest rate would force them to have a predominantly debt-oriented portfolio, insulated from the high market volatility that accompanies investments in equities. Until now, over 30% of new business premium for life insurers have come from pension plans, a large part of which has been invested in equities. Insurance companies also fear that the new rules will adversely impact insurance distributors in the same way a Sebi ban on entry and exit loads hit mutual fund distributors.

Industry officials said the tighter norms on capping of expenses will have far-reaching consequences for the industry, as small regular premium policies will become unviable. It will especially hit a large proportion of policyholders paying premiums of less than Rs 15,000 or so a year. The new rules on commissions will hit distributors’ incomes.

“I hope we don’t land up in a situation where the product is very good but no one is willing to sell it,” said Kamesh Goyal, MD of Bajaj Allianz Life Insurance.



The revised draft tax code has stipulated that though the pension to be received by individual, interest to be received from PPF and dividend paid out of equity or mutual funds would be free of income tax yet the capital gains would be taxed at the same rate of the income tax from individual tax payer. That means capital gain tax will be realized at 10%,20% and 30% as the case may be. At present capital Gains is exempt from tax after one year of investment.

The new provision is going to be harsh news for any middle class investors. There are many investors who do not prefer dividend option because they would rather like to have more money in future than during the present time. Why many people do not want dividend option? They do not prefer dividend option because during the working life they continue to get steady income from their employment or from business and profession. An employee of private institute gets salary monthly and that would be sufficient for them to cover their monthly expenses. They would need extra money only after they retire for their livelihood then. Though all government employees, teachers of Colleges and schools, now a days, get pension to take care of their life after retirement yet non governmental professionals including journalist, lawyers, doctors, artists, singers, Painters and nurses in non governmental organization do not get any pension. These people always invest and opt for growth mode for they want larger income after retirement. The new revised draft tax code has demolishes and ignores this perception of Middle class. How?

The tax on capital gains from long-term equity holdings, as described above, bound to drastically reduce the returns of equity. This reduction will go far beyond the actual percentage of tax that will be paid. For example, over a ten year period, an effective capital gains tax rate of ten to fifteen per cent could reduce a typical investor's returns by above 40 per cent , perhaps at times it would be much more than that . If investors are to limit the damage, then they will have to understand how this tax will actually affect them. Can middle class investors be able to avoid this stipulation? Prima facie it would be difficult unless they switch to Dividend option. But that is no solution since they do not need the money presently.

How a long-term capital gains tax rate of just 10/15 per cent can cause far greater damage to their returns? This is because over the years all the mutual funds or shares do not perform consistently all the time. Magnum vision fund was doing exceedingly well till 2006 . But thereafter it became a laggard fund due to various reasons. Many investors switched to Magnum contra fund for better returns without any harm to their investment. This is how even a long-term investor would need to switch between investments at some point. Today, as long as investors do hold a stock (or an equity mutual fund) for more than a year, the gains are tax-free and so he can happily sell his holdings and put the money in another investment.

But once the long-term capital gains tax, as per the revised tax draft, is implemented, investors are bound to get a tax hit on the returns every time he redeem the investment. A fine example has been illustrated by Value research. Let us analyse the example. “Consider a ten year investment that is yielding 20 per cent an year. In ten years an investment of Rs 1 lakh at this rate would grow to Rs 6.19 lakh. If the long-term capital gains are taxed at 15 per cent for your income bracket, you would end up with Rs 4.41 lakh post tax returns, an effective rate of return of 18.3 per cent. But if this investment was switched to a different share or fund just twice in those ten years, the final post tax return would be just Rs 2.24 lakh “. How our readers would like that? Is it not a kind of robbery? Person who opted for dividend would get much more return .The person preferring for growth mode would get less. So in the process the money set aside for his old age would get robbed due to new tax burden. So under the circumstances what is to be done? I have a definite suggestion to our readers in case revised tax code is implemented and Capital gains tax is taxed as stipulated.

While selecting Mutual funds or shares please ensure that you subscribe to the funds/shares which have given consistent returns( opt for four star or five star funds) for over last five years at least. Please do not change the boat of investment in mid stream. Select only a few shares or a few Mutual funds. The portfolios should not be more than six funds and/ or six shares. Hold on to those shares for a period of ten years. You would be able to gain that way. If you do not switch more than once you would gain substantially as per the example given above. One our readers asked me whether do I have any alternative suggestion? Yes, here is an alternative suggestion:

The middle class people can opt for Dividend option and whenever he gets dividend the same amount can be saved in his PPF account up to the limit. In that event he neither have to pay tax either in case of equity dividend or incase of PPF. He would be the winner all the way. That is why when you invest in modern time you should have your own financial advisor or read books on Personal Finance that would guide you to steer clear of the hurdles of investment hassles.

The statement of Value research is prophetic that the real gains of long-term investments come from compounding of returns, and repeated taxation would have a strong de-compounding effect. This pattern of taxation would reward not long-term investment per se, but only being long-term in the very same investment. However, keep it in mind two suggestions given by us to tackle your investment and you would be the winner surely