New Tax Code set to revolutionise investment behaviour

The new Direct Tax Code is set to revolutionise India’s savings and investment behaviour. While all the changes that are there in the proposed document are for the better, the new tax code constrains the mobility of your investments making them less manageable and potentially less profitable. The new framework continues to account for these savings as individual investments rather than as an investment account. Let me explain. Today you make investments and the invested amount is not counted in your taxable income. The investment is locked in for a certain period, which is three years currently. When you redeem the investment, you don’t pay any taxes in the current system. Under the new system, you will have to pay taxes when you redeem. (Properly speaking, the tax exemption in the new system will not be an exemption but a deferment.) However, this taxability could prove to be a deterrent to proper long-term management of these savings. Suppose you are putting away the tax-sheltered savings for a long period. At some point in the future, you may realise that the investment performance has declined. Or perhaps you are getting older and you’d like to move some assets from an equity-oriented to a debt-oriented scheme. Now, you want these savings to be shifted to another investment. You don’t actually need the money - you just need to shift the money to another investment of the same type. The new Code does not let you do this without taking a financial hit. When you redeem one investment to switch to another one, the tax regime marks that as the time to charge the taxes that had been deferred originally. At this point, some of the money that would otherwise have kept earning for you will have to be paid as tax. Remember, the whole point of tax deferment is that the later you pay taxes, the more you make on your investments. If the switch you need to make has come early in the planned life of the investment, then you may even decide to continue with the less suitable investment just to defer the tax. Given this tax structure, I think it’s only fair that the government should introduce the concept of a tax-deferment account rather than stick to the outdated concept of individual tax-deferment investments. Basically, taxpayers should be allowed to switch between different tax-saving investments without this switch being treated as a redemption that triggers tax. Only when the money is finally withdrawn for consumption or for switching to some other type of investment should it trigger actual taxation. In the precomputer era, this kind of an account would have been impossible to track but now, with PAN numbers and central information repositories, the accounting would hardly be a serious issue. It's important to note that this concept is not a blue-sky idea. In some form or another, it exists in many countries. Not just that, the same structure already exists within the New Pension System. Members of the NPS can switch between different asset mixes and investment managers that the PFRDA (Pension Fund Regulatory and Development Authority) provides without that switch being treated as a withdrawal. If the new tax code is not to become a millstone around the neck of your investments, then such a system is also needed for non-pension savings. – www.economictimes.indiatimes.com, September 29, 2009.