19 Feb 2016

Simplifying Taxes for Investors

The government should use the budget as an opportunity to simplify taxes for investors.

Fewer Taxes

Get rid of capital gains tax, dividend distribution tax (DDT) and securities transaction tax (STT).

Income from FDs or saving bank accounts, or any other income for that matter, should no longer be clubbed with your income. You’ve paid tax on it once, and that should be enough. I don’t mind a higher marginal rate of income tax. It’s the bureaucracy that’s irritating.

This means that there’s no longer a reason to distinguish between Indian and international funds, equity and debt funds, or debt funds and FDs. It also eliminates oddities like interest from an FD being taxable even if you haven’t received it yet, while capital gains from a debt fund not being taxable until you redeem it. This is illogical since they are similar investments.

You can also stop worrying about the difference between short- and long-term capital gains, and setting off losses. Further, you won’t have to keep in mind that short-term losses can be set off against both short- and long-term gains, but long-term losses can be set off only against long-term gains. This complexity goes away.

Getting rid of capital gains tax also eliminates oddities like the same underlying investment being taxed differently based on what funds you use. For example, if you were to invest 70% of your money in an equity fund that invests in India, and 30% in a fund that invests outside India, you’d pay more tax than if you invested the money in a single fund that internally invests 30% abroad. Similarly, investing in separate equity and debt funds is currently worse than investing in a hybrid fund. These kind of artificial distinctions will go away.

Saving for Retirement

The myriad deductions under section 80C should all be removed, as well as interest on a home loan, and HRA. HRA itself is calculated based on what seems an unnecessarily complex formula that gives you the minimum benefit of three different calculations. Why does it need to be so complex? Get rid of all these deductions. Also get rid of all the retirement schemes we have — PF (both EPF and PPF), pension and NPS.

Modify ELSS by making it tax-deferred instead of tax-free. That is, you’d pay tax only when you withdraw the money, and you’d pay it on the lower of the invested amount and the withdrawn amount, at the lower income rate among the one at the time of investment and the time of withdrawal. In other words, if you have a capital loss, you pay income tax only on the remaining money after the loss. If you earned ₹3 lac, invested it, and ended up with only 2 lac, you’re really making only 2 lac, not 3 lac, so you pay tax on the 2 lac. Similarly, if your tax rate at the time of withdrawal is different from that at the time of investment, you pay tax at the lower of the two rates.

There would be no limit on the amount of money you can invest in this fund. And no lock-in. You’d get IMPS, RTGS and NEFT facilities, a chequebook and a debit card to withdraw your money whenever you want. You could also invest whenever you want, not necessarily in the same financial year in which you earned the money. If you did not take advantage of this scheme earlier, you can do so now, and claim a tax exemption on earlier years’ income. Conversely, you can invest money now, and claim exemption against future years’ income.

Further, ELSS funds would be required to invest 100% of their money in Indian equity.

ELSS funds’ expense ratio will be limited to 0.2%. Let there be fewer funds with a higher corpus each (billions of dollars) and with lower fees. That’s better than having a dozen or two ELSS funds each of which has a high fee. There would be no exit load. Fund houses will have the option of charging an entry load instead of an annual expense ratio, to encourage long-term saving. Either way, there will be only one fee, not two.


Insurance premia also enjoy tax benefits. This should change in a few ways. First, insurance premia should be tax-exempt only for what I’ll call off-the-shelf insurance. These are standardised policies sold in a supermarket or on Amazon. They’ll have a quoted price printed on the pack, and everybody will be automatically eligible, and for the same price [1]. Buying insurance should be as simple as buying noodles in a supermarket. For life insurance, everybody who’s earning should be eligible, no matter how old they are.

For medical insurance, there should be no limits on age. When someone buys insurance, it should automatically cover their ancestors and descendants (parents, grand-parents, great-grand parents, children, grandchildren), spouse, unmarried siblings, and other relatives who live with them. In other words, all insurance should be family floater insurance. 

Pre-existing conditions wouldn’t have to be disclosed, and they’d be covered from day one. There’s no limitations based on time, such as surgical procedures being covered only from the second year. There’d be no co-pay or deductible. Treatment that doesn’t involve hospitalisation for at least 24 hours would also be covered, such as emergency room visits, doctor visits, medicines, and so on. The insurance company won’t be able to exclude certain diseases from coverage. And so on.

Get rid of all the bullshit. Have simple, fair policies that can be bought off the shelf without talking to the insurance company.

Bundled products like ULIPs should be structured as separate investment and insurance products, each of which is governed by its respective rules. In other words, any form of insurance that’s eligible for tax-deduction will just be an ELSS and an insurance policy sold as a bundle.

There will be no concept of renewing a policy. Every policy will have only one payment to make, at the time of purchase. When that expires, you’ll buy another policy. Renewing will be same as buying another policy. That will simplify things. If you have an FD, when it matures, you don’t have to decide whether to “renew” the FD or book a new one. Bring the same simplicity to insurance.

Income Tax Rates

First, the government should get out of the habit of imposing cesses and surcharges. Just increase the tax rate instead. I don’t mind the marginal tax rate being increased to say 40%, if other taxes are removed. 30% is not a very high income tax rate — most countries, I’m told, have a higher maximum slab. In a country with as much heart-wrenching disparity as India, I can’t object to contributing more. This should be done only if the government can show evidence that having a higher rate produces more revenue, not as a political theater designed to make the common man feel good that the rich are paying more. Just set the tax rates to maximise revenue with the fewest slabs. Maybe there will be only two slabs, one 40% and the other lower, like 20%. I don’t know. Just have the simplest number of slabs that will produce the highest revenue for the government, while not imposing too heavy a load for the common person, like imposing 30% tax beyond 2 lacs of income.

The government should focus on simplifying taxes and its associated bureaucracy. Keep the overall tax revenue the same, but simplify the system.

[1] One concern is that young and healthy people will see their premia increase. But that can be alleviated by letting the insurance company offer a free extension to selected groups of people. That is, the policy will still have a fixed rate for everyone for 1 year, say, but some people may be covered for 1½ years for the same premium.

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