Revised Direct Taxes Code 2010-A Critique On Revised Discussion Paper-VRK100-21062010

On a cool Sunday evening, a Child walks on a beach with gay abandon.
She
starts to build a castle in the sand. She collects sand and arranges it into a big
heap. She tries to mould it as per her imagination. After sometime, she
completes the sand castle and she goes around the castle merrily – laughing,
cheering and shouting.
This attracts some other people loitering on the beach. They come and start
inspecting the castle. Some applaud it and some suggest little changes to the
castle to make it more beautiful. First the child is confused about making the
changes. At last, she obliges the onlookers’ advice and makes alterations with
some tinkering to the minarets here and to the windows there.
Now, more onlookers start giving advice on making it look more wonderful. The
child listens patiently to them and makes more alterations with her tender hands.
Then a disaster strikes. The castle suddenly collapses due to too many
alterations. Disappointed by it, the child walks home with a heavy heart.
Some of you may be wondering what this is all about! The above story sums up
the predicament of the Government of India in bringing about several
amendments to the Direct Taxes Code (DTC). It may be recalled that the
Government had brought out a Revised Discussion Paper (RDP) on 15th of June
2010 making certain changes to the draft DTC Bill which was released in August
2009. The Government has apparently messed up the whole issue of bringing a
transparent DTC, which could have been understandable easily by ordinary
persons; providing stability, equality and clarity; and without any distortions. This
article provides a critical analysis of important issues in the DTC proposals.
Rama Krishna Vadlamudi, BOMBAY June 21, 2010
Please read the author’s disclaimer given at the end of this article.
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com
The impact is explained with catchy photographs!
The article is organized on the following lines:
A critical analysis of the Capital Gains tax on shares

Why flip-flops are not good for the overall tax efficiency
Background to abolition of long-term capital gains in 2003/2004
Is 25 per cent Public Shareholding a joke?
Why it is a mixed bag for individuals and salaried class
A big climb down and dilution of reforms by the Government
The following important annexures are given at the end of this article:
(A must-read for all investors, taxpayeers and market players)
Annexure I : Difference between EEE and EET methods

Annexure II : The Six Pack!
Annexure III : Types of tax exemptions that may be continued after DTC
Annexure IV : Types of tax exemptions that may be withdrawn after DTC
Abbreviations Used:
DDT-Dividend Distribution Tax PFRDA-Pension Fund Regulatory and
DTC 2009-Direct Taxes Code August 2009 Development Authority
EEE-Exempt, Exempt & Exempt LTCG-Long-term capital gains

EET-Exempt, Exempt & Tax PPF-Public Provident Fund
ELSS-Equity Linked Savings Scheme RDP-Revised Discussion Paper of DTC
of the mutual funds released by Govt on 15.6.2010
EPF-Employee Provident Fund STCG-Short-term Capital Gains
GPF-Government Provident Fund SCSS-Senior Citizen Savings Scheme
IT Act-Income Tax Act, 1961 STT-Securities Transaction Tax
LTC-Leave Travel Concession MAT-Minimum Alternative Tax
NPS-New Pension System administered ULIP-Unit Linked Insurance Plan of
by PFRDA insurance companies
NSC-National Savings Certificate
PF-Provident Fund VPF-Voluntary Provident Fund
Page 2 of 14
TWISTS AND TURNS ?
Too many flip-flops not good

Tax laws are expected to provide stability
and certainty in the minds of taxpayers. In
such a scenario, taxpayers can plan their
long-term investments properly to meet their
investment objectives – like expenses for
children’s education, health and marriage,
retirement needs, etc.
Too much tinkering with tax laws upsets the

calculations of taxpayers and it is not good
in the long-term interest of the economy.
Is long-term investment in shares losing shirt?
The way the Government is proposing to bring frequent

changes in the tax treatment of capital gains on shares
is not good for the capital markets. It impacts the public
shareholding adversely in the long run. What the
policymakers have failed to notice is that the investor
behaviour changes swiftly due to changes in tax laws.
And it is very hard to bring the public or institutions
back to the primary/secondary market. Investors who
participated heavily in primary market in 2007/2008
have lost their money. They are very reluctant to invest
in IPOs in 2009/2010. The current lackluster public
participation in initial public offers is a case in point.
Page 3 of 14
It is very clear from the present indications, that long-term

investment in equity markets is down and out!
Concept of DTC:
When it was conceived in August 2009, the proposed DTC is supposed to be a

single code for all direct taxes, like, Income Tax, Corporation Tax, MAT, DDT,
wealth tax, etc. Written in simple language and direct voice, the DTC is expected
to be more transparent compared to the existing direct tax laws. It seeks to
encourage simplification and aims for stable taxes and better tax compliance.
Some of the provisions, like the Minimum Alternative Tax (MAT) on gross assets,
introduction of EET regime and removing several tax exemptions have not been
received with enthusiasm by the affected people. After receiving several
representations from various stakeholders, the Government on 15th of June 2010
released a Revised Discussion Paper (RDP). This RDP has restored some tax
exemptions for certain schemes bringing relief to several people. It has decided
to continue with the existing system of taxing MAT on the basis of book profits.
Messy Capital Gains Tax!

However, in one area the Government has messed up a lot. That is capital gains.
The RDP proposes to change the very definition of short-term capital gain
(STCG) and long-term capital gain (LTCG). Long-term capital gain on listed
equity shares and equity mutual funds are taxed at zero rate as of now. Now, the
Page 4 of 14
RDP proposes to introduce a system of including LTCG in one’s income and

taxing LTCG at the tax rate applicable to the taxpayer, after adjusting the LTCG
with a specified discount rate. The Government has said that the specified
discount rate would be announced while introducing the DTC Bill in Parliament.
This kind of flip-flop of LTCG relating to shares and mutual funds is detrimental to
the long-term investments. Strangely, the Government seems to be encouraging
short-term gambling in equities rather than long-term investments.
Is 25 per cent Public Shareholding a joke?

The Government has recently come out with norms for making 25 per cent public
shareholding compulsory in companies listed on stock exchanges. One fails to
understand how the Government can increase the public shareholding to 25 per
cent without encouraging long-term investments in shares and mutual funds.
When tax rates are changed frequently without any predictability, it changes the
behaviour of investors and market players in a big way. Let us go back a little
and see the amendments to LTCG relating to listed equity shares and equity
mutual funds.
Taxes on STCG and LTCG before 2003:

Prior to 2003, STCG on shares was taxed at 30 per cent; and LTCG was taxed at
20 per cent with indexation benefits. There was no STT at that time.
UNION BUDGET 2003-04:

As per the Union Budget for 2003-04, long term capital gains (LTCG) on
company equity shares (listed on any recognized stock exchange in India) was
exempted from tax for shares acquired on or after March 1, 2003 but before
March 1, 2004. This was made applicable from April 1, 2004 and was applicable
for assessment year 2004-05 and for subsequent years. The intention of the then
Government behind the tax exemption for LTCG on listed equity shares for a
limited period was to “give incentive for investment in equity shares.”
The then finance minister, Yashwant Sinha, told the Parliament, during his
budget speech in his own words:
“We need to improve the industrial sector and improve the equity markets”
“I am also committed to bringing the small investors back to the capital markets
by restoring their confidence”
“In order to give a further fillip to the capital markets, it is proposed to exempt all
long-term capital gains from tax for equity shares bought for a period of one year
from March 1, 2003, and sold after a one year…”
Page 5 of 14
UNION BUDGET 2004-05: Now, you see P.Chidambaram’s, the then

finance minister, spin on the rationale behind the abolition of LTCG while
presenting the Budget 2004-05 to Parliament:
“Capital gains tax is another vexed issue… I’ve decided to make a beginning by
revamping taxes on securities transactions…Our founding fathers wisely
included entry 90 in the Union List in the seventh Schedule of the Constitution of
India.
“Taking a cue from that entry, I propose to abolish the tax on long-term capital
gains from securities transactions altogether. Instead, I propose to levy a small
tax on transactions in securities on stock exchanges. The rate will be 0.15 per
cent of the value of security. My calculation shows that the new tax regime will be
a win-win situation for all concerned.”
This was done with a view to simplifying the tax structure on securities
transactions, as per the Explanatory Memorandum to the Union Budget 2004-05.
Accordingly, tax on LTCG was removed and tax on STCG was reduced to 10 per
cent. And in the place of ‘nil tax’ on LTCG on securities transactions, a new tax
called Securities Transaction Tax (STT) was introduced by P.Chidambaram.
Unfortunately, STT stays!: When the tax on long-term capital gain was
abolished by the then Finance Minister while presenting the Union Budget 2004-
05, the FM introduced STT to fill the tax revenue gap caused by the abolition of
LTCG. Unfortunately, the RDP says that STT will be revised suitably. Now, equity
investors will have to pay both the STT and LTCG once DTC comes into force,
which was not the case prior to the introduction of STT in 2004.
Current provisions: As of now, STCG on shares is taxed at 15 per cent

while LTCG is completely exempt from tax. And the RDP proposes to include
STCG in one’s income and pay tax as per rate applicable to taxpayer; and LTCG
will be given a specified discount rate and taxes as per taxpayer’s marginal tax
rate. This is completely in contrast to what the previous finance ministers,
Yashwant Sinha and P.Chidambaram had committed in Parliament while
removing LTCG on shares.
Does it mean to say that as of now public participation in capital markets has
improved compared to 2003/2004? Everyone in India knows that share of
equities in India’s total savings is at a bare minimum of between 2 to 5 per cent.
To know more on the latest amendments given in RDP, just click:
http://www.scribd.com/doc/33282656
(In fact, the RDP does not use the words, short-term capital gain or long-term capital
gain. For the sake of simplicity and better understanding, the words STCG and LTCG
are used as they have been in existence for more than five decades.)
Page 6 of 14
Sweet and Sour!
The Revised Discussion Paper is a kind of mixed bag for individuals and salaried
class. The Government has now decided to provide tax exemption at the time of
withdrawal (EEE method), even though for six types of investments only.
To know about the difference between EEE method, EET method and such
eligible investments, see Annexures I to IV given at the end of this article.
So, what’s the catch ?
In this modern world,

there are no more free
lunches! See below
for the catch!
Everything has a price. Take for example, the Indian public are very happy with
the subsidy on petrol, diesel, LPG & kerosene. But, ultimately, the entire
economy is paying the price for the subsidy as the subsidies are paid through the
Union Budget! The cost of everything has to be paid by someone, i.e., the public.
In the original DTC, the Government had proposed to remove exemptions; while
simultaneously reducing tax rates and increasing tax slabs. But due to public
outcry, Government has now said it would restore certain tax exemptions. As the
tax base comes down, the Government will not be in a position to reduce tax
rates and increase tax slabs as proposed in the original DTC in August 2009.
The net effect will be the same for public! (It may be recalled that it was
proposed, in the draft DTC of August 2009, to increase the present exemption of
Rs one lakh under Section 80C of the Income Tax Act to Rs three lakh and
increase the tax slabs – up to Rs 10 lakh at 10 per cent; above Rs 10 lakh to Rs
25 lakh at 20 per cent; and above Rs 25 lakh at 30 per cent.)
To know about the proposals of original draft DTC released in August 2009, just
click: http://www.scribd.com/doc/19542987
Page 7 of 14
It’s a big climb down by the Government!
The Government has completely

watered down the spirit of draft DTC
Bill 2009. The Indian public has lost a
big opportunity for cleaning up direct
tax laws; which are non-transparent,
vague, cumbersome and difficult to
administer. The Government has
yielded to powerful lobbies and in the
process completely vitiated the
objectives of DTC 2009.
At this stage, it would be instructive to know the original objectives of the

Government while drafting a Direct Taxes Code Bill in August 2009. They were:
1. Providing stability: At present, the rates of taxes are stipulated in the

Finance Act of the relevant year. Therefore, there is a certain degree of
uncertainty and instability in the prevailing rates of taxes. Under the Code,
all rates of taxes are proposed to be prescribed in the Direct Taxes Code
itself thereby eliminating the need for an annual Finance Bill. The changes
in the rates, if any, will be done through appropriate amendments to DTC
brought before Parliament in the form of an Amendment Bill.
2. All the direct taxes – income tax, corporation tax, dividend distribution tax,
minimum alternative tax & wealth tax – were brought under a single code
3. A very simple language was used in drafting the code so that an ordinary
person also can understand the provisions of the law
4. By reducing vagueness in the provisions, the Government aimed at
reducing the scope for litigation between taxpayer and tax administration
It is very sad to read the contents of Revised Discussion Paper (RDP) released a
week back. The Government has failed to provide clarity on many issues, like:
What will be tax rates and tax slabs

What is the specified discount rate for adjustment to LTCG on shares
No clarity what type of savings instruments would attract EET method
There is no reference as to whether principal paid toward instalments of
loans taken for constructing a house property would be allowed tax
deduction (The RDP has clarified that interest up to Rs 1.50 lakh would
continue to be eligible for tax exemption).
The RDP has failed to indicate what the rate of MAT would be
The refrain now is that the legislature is the ultimate authority for deciding tax
rates! It may be recalled that the original DTC 2009 had provided rates & slabs.
Page 8 of 14
How to tweak your investments?

It appears that the RDP encourages tax evasion and avoidance and it does not
bring any equity to the tax system. It fails to provide transparency and remove
distortions in the present direct taxes regime.
There are various methods to protect our interests, in a legal manner, in relation
to tax exemptions and liabilities. We need to show a little ingenuity and look for
ways to protect our interests under the existing laws.
Let us hope that the Government would provide a reasonable transition period for
investors and more clarity would exist when the real DTC Bill is presented in
Parliament in the next few months.
Look at them with fresh pair of eyes!
Any direct taxes regime that is transparent, clear and simple to understand is
very good for the economy as a whole. As taxpayers, we need to encourage any
sincere attempts by the Government to clean up the existing messy laws. We
shall be able to see the broader picture which will benefit the entire economy
rather than a few individuals or smaller groups. Tax laws have to be amended
keeping the ever changing economic and social environment in mind.
We need to look at the new Code with fresh eyes without any old baggage.
Theoretically, the concept of EET, removal of all kinds of tax
incentives/concessions, and clubbing all sums under taxable income, are sound
and beneficial in the long-term. However, India is beset with its own set of
peculiarities, lack of social security system, contradictions and problems as far as
increasing tax base and administering taxes is concerned. We need to change
our mindset – not only taxpayers, but also those in the tax administration and
implementation.
To read other important document on Direct Taxes Code, just click:
This explains why the Government seems to be encouraging PURE GAMBLING

rather than providing incentives for long-term investments in equities.
Page 9 of 14
To sum up:
The entire DTC exercise now looks very blurred!
Page 10 of 14
Annexure I
WHAT IS THE DIFFERENCE BETWEEN EEE and EET METHOD?
The present system is called ‘EEE’ meaning investments enjoy benefits in three
stages: 1). Exemption allowed at the time initial contribution, 2). Exemption
through out the accumulation period, and 3). Exemption at the time of withdrawal.
(EEE stands for Exempt, Exempt and Exempt).
It was proposed in the DTC 2009 that the EET method will apply for new
contributions made after the commencement of the DTC. The DTC 2009 had
proposed to shift to a new system called ‘EET’ whereby exemption would be
allowed at the time of initial investment and accumulation period only; but the
withdrawals will be included in the taxable income and taxed according to one’s
tax slabs. (EET stands for Exempt, Exempt and Tax).
Annexure II
The Six Pack!
As the Revised Discussion Paper released on 15th of June 2010, The

Government will continue to provide EEE method of tax treatment to the following
savings instruments:
Government Provident Fund

Recognised Provident Funds
Public Provident Fund Scheme
New Pension System (NPS) of the PFRDA #
Approved pure life insurance products *
Annuity schemes
* There is a lot of confusion as the Government has not defined what an ‘approved pure life
insurance product’ is. Some experts believe that it refers to pure term insurance policies.
# At present NPS is under EET method; after DTC it would be under EEE method
The above mentioned six instruments will continue to attract the current
favourable tax treatment at all the three stages: 1. at the time of investment, 2.
during the accumulation period, and 3. at the time of withdrawal. The investors
can continue investments in the above six even after the DTC comes into force.
Page 11 of 14
Annexure III
The following tax exemptions are likely to be continued even

after DTC:
It is interpreted from the DTC Bill 2009 and RDP, that the Government in all
likelihood will continue with the following exemptions and incentives:
A. DEDUCTIONS THAT WILL BE ALLOWED FOR SALARIED CLASS ON
THEIR GROSS SALARY:
1. Professional tax paid

2. Transport allowance as per limits
3. Allowances incurred for official purposes
4. Compensation received under Voluntary Retirement Scheme
5. Gratuity received on retirement or upon death
6. Amount received on commutation of pension
B. DEDUCTIONS THAT MAY BE ALLOWED WHILE COMPUTING TOTAL

INCOME:
As per the proposals of the draft DTC 2009 and the Revised Discussion Paper,
the following deductions may be allowed for individuals/salaried class:
Interest paid up to Rs 1.50 lakh per annum on housing loan for self-
occupied property
Tuition fee paid to a college/school in India for full-time education of two

children of an individual/HUF is eligible for deduction
An individual shall be allowed a deduction in respect of any amount actually

paid by him in the financial year by way of interest on loan taken by him from
any financial institution for the purpose of:
(a) pursuing his/her higher education; or

(b) higher education of his/her relatives.
Health insurance premium of up to Rs 15,000 (Rs 20,000 for senior

citizens) will be allowed as deduction for an individual/HUF. For health
insurance on the health of his/her parents, an additional deduction of Rs
15,000 (Rs 20,000 if the parents are senior citizens) will be allowed .
Page 12 of 14
An individual will be allowed a deduction of up to Rs 40,000 (Rs 60,000 for

senior citizens) for medical treatment of self or dependents
An individual/HUF will be allowed a deduction of up to Rs 50,000 (Rs 1

lakh for severe disability) for medical treatment of a disabled dependant
A person shall be allowed a deduction of up to 125% of donations made to

laboratories and colleges engaged in scientific/statistical/social sciences
research. A person shall be allowed a deduction of up to 100% of the
donations made to PM National Relief Fund, CM Relief Fund, etc. And in
other cases, 50% deduction is allowed for donations made to certain
organisations.
Dividends will not attract tax in the hands of the recipient if such dividend
distributed by companies has suffered Dividend Distribution Tax (DDT) at
the applicable rate. (The DTC 2009 has proposed to levy 15 per cent DDT.)
In the light of the overall tax exemptions, tax rates and tax slabs, the Government
may change any of the above tax incentives/exemptions mentioned in part A and
B above while presenting the DTC Bill 2009 in Parliament in the next few months.
As per Section 80C of IT Act, an individual or HUF is eligible to get tax exemption
up to Rs one lakh per annum in certain notified savings instruments. The draft
DTC Bill 2009 proposed to increase this limit to Rs three lakh per annum.
However, the context has completely changed with the Government agreeing to
continue with certain existing tax exemptions as per the Revised Discussion
Paper. Now, one can safely assume that the Government will definitely not be in
a position to provide a limit of Rs three lakh tax exemption.
Annexure IV
TAX DEDUCTIONS/INCENTIVES TO BE WITHDRAWN:
A careful reading of the provisions and the RDP and DTC 2009 indicate that the
Government is most likely to withdraw the following existing tax exemptions
being enjoyed by the taxpayers. One is forced to come to this conclusion
because the Government has maintained a strange silence on these issues and
these issues have not been mentioned either in the DTC 2009 or the RDP
released on June 15, 2010. So, the important deductions that are most likely to
be disallowed in future under proposed DTC could be:
Page 13 of 14
o Housing Loan instalments of up to Rs 1.00 lakh in a financial year and

allowed as deduction under Section 80C of existing IT Act may not be
allowed as deduction under the proposed DTC 2009
o Contributions made to Equity Linked Savings Schemes of Mutual
Funds
o Notified Bank Time Deposits for a term of 5-years or more
o Accrued Interest on NSCs
o Contributions made under Unit Linked Insurance Policies
o Under DTC, bonuses or sums received from life insurance policies
may not be allowed for deduction in case: (1). Annual premium paid is
more than five per cent of the sum assured; and (2). If the policy is
surrendered before the maturity date (as per clause (a) of sub-section
3 of section 57 of DTC 2009
Note: 1. Capital Gains Savings Scheme will be scrapped..
2. STT will continue along with LTCG on shares.
3. Grandfathering Clause: In certain types of investments, only new contributions

on or after the commencement of the new Code will be subjected to EET
References:
1. Revised Discussion Paper released by Ministry of Finance, GOI

dated June 15, 2010
2. Direct Taxes Code Bill and discussion paper released by Ministry of Finance,
GOI in August 2009
3. Newspapers
Photo courtesy: bing.com, bbc.com, AP and author.
Author’s Disclaimer: The author’s views are personal. The above article is
written for information purpose only. Every care has been taken to provide
authentic information as far as possible; however, the author is not responsible
for any inadvertent discrepancies that may have crept in. Readers should consult
their own certified tax consultants or experts to correctly interpret the provisions
of tax laws or other matters.
The article you are reading is also available on SCRIBD at:

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On a cool Sunday evening, a Child walks on a beach with gay abandon.

Rama Krishna Vadlamudi, BOMBAY June 21, 2010

The impact is explained with catchy photographs!

The article is organized on the following lines:

A critical analysis of the Capital Gains tax on shares

Annexure I : Difference between EEE and EET methods

EEE-Exempt, Exempt & Exempt LTCG-Long-term capital gains

TWISTS AND TURNS ?

Too many flip-flops not good

Too much tinkering with tax laws upsets the

Is long-term investment in shares losing shirt?

The way the Government is proposing to bring frequent

It is very clear from the present indications, that long-term

When it was conceived in August 2009, the proposed DTC is supposed to be a

Messy Capital Gains Tax!

RDP proposes to introduce a system of including LTCG in one’s income and

Is 25 per cent Public Shareholding a joke?

Taxes on STCG and LTCG before 2003:

UNION BUDGET 2003-04:

UNION BUDGET 2004-05: Now, you see P.Chidambaram’s, the then

Current provisions: As of now, STCG on shares is taxed at 15 per cent

Sweet and Sour!

So, what’s the catch ?

In this modern world,

It’s a big climb down by the Government!

The Government has completely

At this stage, it would be instructive to know the original objectives of the

1. Providing stability: At present, the rates of taxes are stipulated in the

What will be tax rates and tax slabs

How to tweak your investments?

Look at them with fresh pair of eyes!

To read other important document on Direct Taxes Code, just click:

This explains why the Government seems to be encouraging PURE GAMBLING

The entire DTC exercise now looks very blurred!

WHAT IS THE DIFFERENCE BETWEEN EEE and EET METHOD?

The Six Pack!

As the Revised Discussion Paper released on 15th of June 2010, The

Government Provident Fund

The following tax exemptions are likely to be continued even

1. Professional tax paid

B. DEDUCTIONS THAT MAY BE ALLOWED WHILE COMPUTING TOTAL

Tuition fee paid to a college/school in India for full-time education of two

An individual shall be allowed a deduction in respect of any amount actually

(a) pursuing his/her higher education; or

Health insurance premium of up to Rs 15,000 (Rs 20,000 for senior

An individual will be allowed a deduction of up to Rs 40,000 (Rs 60,000 for

An individual/HUF will be allowed a deduction of up to Rs 50,000 (Rs 1

A person shall be allowed a deduction of up to 125% of donations made to

TAX DEDUCTIONS/INCENTIVES TO BE WITHDRAWN:

o Housing Loan instalments of up to Rs 1.00 lakh in a financial year and

2. STT will continue along with LTCG on shares.

3. Grandfathering Clause: In certain types of investments, only new contributions

1. Revised Discussion Paper released by Ministry of Finance, GOI

Photo courtesy: bing.com, bbc.com, AP and author.

The article you are reading is also available on SCRIBD at:

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