Feb 20, 2010

How DTC is going to impact your PPF investments?


The Direct Tax Code (DTC), the new tax code proposed to be replacing the Income Tax Act, 1961 from April 1, 2011 is going to introduce EET (exempt, exempt, tax) regime having deep impact on your tax saving plans.

You may have read elsewhere that DTC is going to have an adverse impact on sale of life insurance. But The Money Quest holds a completely different view. I think that DTC is only going to encourage investment in life insurance plans (instead of giving a push to term plans) and accordingly not in the long term interest of investors.

A few days back a reader named Seeta asked, [see: PPF Investing Tips]

I want to invest in PPF. For the financial year 2010, I have already made my tax savings. So i was thinking of investing in PPF for the year Apr-2010 to Mar 2011, but as you have mentioned we need to pay tax at the time of maturity from April 2011. Please suggest what is the best option? Should i start my ppf account before Apr, 2011 to avoid paying tax at time of maturity?

Therefore, after DTC impact on life insurance, this post is going to examine the impact of new Direct Tax Code (DTC) on PPF (Public Provident Fund) investments in greater detail. So, here’s the answer to
some of the most common questions about the effect of DTC on PPF:

Q-1: How the DTC is going to affect my PPF account?
Ans: Under the current EEE (exempt, exempt, exempt) tax regime, the PPF account is exempt at all the three stages: First, when you make deposit in your PPF account you get tax deduction under section 80C (i.e., the amount of your income to the extent of deposit in your PPF account gets exempted from tax). The second stage in the accumulation of interest in your PPF account which is also tax exempt and third stage is at the time of maturity when you withdraw your money. As you don’t pay any tax at the time of withdrawal, it is called EEE regime.

Effectively, at present you get two kinds of exemption on your PPF investments: first is when you deposit your income in PPF account, it indirectly gets exempted via section 80C deduction and second is the interest earned on your PPF.

Now, DTC is going to remove both these exemptions via EET (exempt, exempt, tax) regime. The only concession allowed is the deferment of your tax i.e. the tax on your current income to the extent of deposit in PPF account gets deferred till the time you make withdrawals. Similarly, the interest amount also becomes taxable at the time of withdrawal.


Q-2: What about the existing balance in my PPF account?
Ans: As per new tax code proposed to be implemented from April 1, 2011, accumulated balance in your PPF account as on 31st March 2011 will be exempt from tax (grandfathering clause). In other words, as per the direct tax code (DTC), only new contributions made on or after the commencement of the code will be subject to tax.


Q-3: What about further interest on the existing balance as on April 1, 2011?
Ans: It is not clearly spelt out in the DTC, but based on the interpretation of the proposed provisions, it seems that any further interest on this accumulated balance would be subject to tax.


Q-4: Should I continue to invest in PPF? Can it still be considered as best debt option?
Ans: Although, it will lose much of its present appeal (8% tax free assured rate of return in addition to section 80C deduction), but you won’t have much choice. Even keeping in view the implementation of EET regime under DTC, it still makes sense to go for PPF due to following reasons

1. It will still maintain its relative superiority over other tax saving options under the new tax code.

2. It is quite probable that there is some dilution in the proposed harsh provisions (particularly the EET regime) of DTC.

3. Even if DTC comes into operation in its present avatar, the option will always be open to you to change your investment strategy in future. Your existing investments won’t get affected.

4. Last of all, tax deferment by investing in PPF makes sense because hope will always be there that government may have a change of mind in the near or distant future not to tax our retirement savings.

So, without any second thoughts you can open your PPF account or keep continuing investing in existing PPF account.


Q-5: Any other changes regarding PPF?
Ans: Yes, recycling strategy will no more be useful.


Q-6: What if any body doesn’t claim tax deduction (u/s section 66 of DTC) on the amount deposited in PPF? Then what?
Ans: This is one of the major draw back of the DTC provisions and will result in double taxation.


Q-7: Finally, how would I reduce my tax outgo under DTC regime? Is there any way out?
Ans: Yes, there are two ways:

1. First is withdrawing amount in installments rather than at one go. This will be particularly useful for those falling in the lower tax brackets.

2. Second strategy is to make contribution in the PPF account of your minor child (I hope that the government will continue to allow tax benefit on the contributions so made…) and make withdrawals once he becomes a major. Now, if the child has attained majority, then the PPF withdrawal would be deemed as his income and accordingly taxed in his own hands. And, if the child doesn’t have any other income at that time, one can avoid paying any tax by limiting the total amount of withdrawal below the basic exemption limit / lowest tax slab.

Finally, as you must be already aware that it is very doubtful that DTC will be implemented in its present form (EET is also one of the controversial provisions). Let’s see what new changes are in store.

What do you think? Are you continuing with your PPF investments? Or, do you have any other apprehensions about DTC?


Also see:

1. PPF FAQs
2.
DTC – Tax Calculator
3.
DTC Tax Rates / Slabs

7 comments:

  1. Dear Fisher,

    I being a Science graduate, after reading your articles, I am learning the intricacies of Finance control and planning. I also feel I am becoming Master in Personal Finance Mgmt, day by day.

    Before reading this article I was unaware of the terms DTC EEE & EET.
    Thanks and keep going.
    -
    ParthO

    ReplyDelete
  2. The second strategy you have suggested (investing in the name of minor child and withdrawing it only when he attains majority) is really good. Keep up the good work !
    Raveendran

    ReplyDelete
  3. YES, I AGREE WITH YOUR VIEWS ON PPF. PPF IS VERY GOOD SINCE WITHDRWALS CAN BE DONE ONLY DURING THE YEAR WHEN THERE IS NOT MUCH INCOME
    THANKS TO MONEY QUEST FOR UPDATING OUR KNOWLEDGE

    ReplyDelete
  4. You mention PPF A/C for a minor child just to make the maturity proceeds tax-free (since the child would be major without other income so his tax assessment would make the maturity income within/under-slab-taxBracket); correct?

    This would also be true if the PPF was in my name (Major in age and salared now) and would be jobless/retired when my PPF matures?

    I was worried as I opened an account in my and my wife's name when I had 2 minor children!
    +shashi

    ReplyDelete
  5. MahavirsinhMarch 05, 2010

    minor Account is a better Choice. If DTC implement in its original form without any change.

    ReplyDelete
  6. FISHER...U R A DUDE!!! UR ARTICLES, SPECIALLY SOLUTIONS TO THE QUERIES R OUTSTANDIN.YOUR ARTICLES ARE MAKING A LOT OF US YOUNGER GENERATION BECOME RESPONSIBLE WITH OUR MONEY AND BEST THING IS YOUR ARTICLES DONT SCARE AWAY FIRST TIME READERS,LOVE THE WAY U KEEP IT SIMPLE. ITS JUST MY FIRST VISIT TO YOUR SITE AND I AM ALREADY HOOKED!!!
    HOW ABOUT SOME BASIC ARTICLES FOR YOUNGER GENERATION WHO HV JUST STARTED EARNING/REALISE THE IMPORTANCE OF SAVING BUT DONT HV A CLUE HOW TO GO ABOUT IT..

    PS:SORRY,I KNOW I AM NOT STICKING TO THE TOPIC HERE.
    THANX.
    AL.

    ReplyDelete
  7. Hi,

    As per the new provisions in DTC, PPF would not be taxble. Kindly update the info here.

    ReplyDelete

You’re welcome to post a comment if you’d like to air your views, or if you’ve any further question to ask, but please stick to the topic and don’t forget to write your name.