The year 2009 was a landmark year for Indian taxes. In this year, the government introduced the landmark Bill, The Direct Taxes Code Bill. It is going to affect all of us as it will not only alter the tax you pay, but will also impact your investments, borrowings, and expenses. Here is how it will affect all of us.

Changes in tax slabs

The biggest impact of the new tax system is the significant widening of income slabs. According to this, people with annual income not exceeding 1.6 lakhs will not have to pay any tax. For those with an annual income from Rs. 1.6 lakhs to Rs. 10 lakhs, you pay tax at 10%; for incomes from Rs. 10 lakhs to Rs. 25 lakhs the tax is 20% and 30% for incomes exceeding Rs. 25 lakhs. So if your annual income is Rs. 2 lakhs, you fall in the 10% tax slab. These rates and slabs would be applicable from the financial year 2011-12. However with this move the government plans to make most of your allowances taxable. Hence if you are a high earner, earning a lot of allowances, your tax liability will go up significantly.

Effect on Capital Gains

As per the new tax code, both the short-term and long-term capital gains are treated equally. It recommends making both the contribution and return from your investments tax-free but proposes to tax the maturity proceeds. This will affect your stocks and equity mutual funds. This is different from the present system, in which the maturity proceeds are tax-free.

Impact on tax savings

With the introduction of this code, the government has eliminated the various tax breaks. However the government has hiked the tax savings limit to Rs. 3 lakhs per annum, while restricting the available investment alternatives. So now you can invest only in PPF, EPF, life insurance, superannuation funds and NPS. Besides you can also claim tax benefits on your children's education. But no more tax benefits for investing in NSC's, Senior Citizens Savings Scheme, tax-saving bank FD's and ELSS.

Impact on home loans

As of now, if you have taken a home loan, the interest payments up to Rs. 1.5 lakh and up to Rs. 1 lakh towards principal repayment are eligible for tax benefit. But this is set to end once the new code comes into effect. So if you have paid Rs 3 lakhs as interest and Rs 2 lakhs as principal, you will not get any tax benefit. But if you have rented out a home, you can still avail of the tax benefits for taking the home loan.

The exemptions allowed

With the code, the government aims to tax the maturity proceeds of PPF as well as insurance. However in case of insurance, deduction will be given only for the sum obtained only if the premium payable is not more than 5% of the sum assured and the sum assured is obtained only when the insurance term is over. For PPF, the balance in the account as of 31st March 2010 won't be taxed on withdrawal.

Here is a simple example to help figure the effect of the new tax code

Rahul is a salaried employee. His annual salary is Rs. 5 lakhs. He has invested Rs. 50,000 in mutual funds, Rs. 20,000 in insurance and Rs 40,000 in PPF. Moreover he has taken a home loan of which he has already paid Rs. 80,000 as principal and Rs. 1 lakh as interest. Let us see how his situation will change once the new tax code comes into effect.

Rahul's present situation: Currently Rahul gets tax benefit on the amounts he has invested in PPF, mutual funds, insurance as well as on the principal repayment of his home loan. The limit on this amount is Rs 1 lakh. Besides Rahul has also paid interest on his home loan. So the total amount tax exempted is Rs. 2 lakhs (Rs. 1 lakh tax exemption under section 80C and Rs. 1 lakh as interest on home loan.).

Hence now Rahul's taxable amount is Rs. 3 lakhs. (Rs 5 lakhs of salary - Rs. 2 lakhs of amount exempted). So the total tax that Rahul will pay on the amount of Rs. 3 lakhs is Rs. 15,000 (Rs. 3 lakhs - Rs. 1.5 lakhs = Rs. 1.5 lakhs is the taxable amount and the tax rate applicable is 10%). So as of now, he is paying Rs. 15,000 as tax. Rahul's situation after the new code: Rahul's total amount exempted from tax is Rs. 1.1 lakhs (total of his amounts invested in mutual funds, PPF and insurance) + Rs 1 lakh paid towards home loan interest. So his tax exempted amount goes up to Rs. 2.1 lakhs. His total taxable income now becomes Rs. 2.9 lakhs. Ultimately he ends up paying Rs. 13,000 (Rs. 2.9 lakhs - Rs. 1.6 lakhs = Rs. 1.3 lakhs that is taxed at 10%).

Rahul will now save Rs. 2000 in tax. He can do this because with the new tax code, the government plans to hike the tax slabs. While the original tax slab for which tax was not applied was 0-Rs. 1.5 lakhs, the upper limit after the tax code comes into effect goes up to Rs. 1.6 lakhs. Moreover the new code has hiked the tax exemption limits to 3 lakhs from present limit of Rs. 1 lakh.

Source: Bankbazaar.com