Smartly tweak tax treatment for savings

GoI is reportedly looking at providing income-tax (I-T) relief for individuals through measures like doubling the tax-exempt savings limit and raising the standard deduction for salaried employees. The existing tax-exempt limit under Section 80 C of the I-T Act is ₹1.5 lakh, while the annual standard deduction is ₹50,000. A higher tax-exempt limit would encourage savers to diversify their investments in financial assets, given that in many cases, contribution to provident fund (PF) alone accounts for a large part of the tax-exempt limit.

But this is not the ideal tax treatment for savings. It varies for assorted savings instruments. The interest earned, say, on bank fixed deposits is taxable, making it less attractive than the PPF that is tax-free. So, banks want a lower lock-in period for fixed deposits. The ideal way to remove these distortions is for GoI to adopt the exempt-exempt-tax (EET) method of tax treatment of savings.

Under EET, a savings scheme would be exempt from taxation at the time of contribution and during accumulation of the corpus, and taxed only on withdrawal. But if the accumulated saving is deployed into fresh savings, the corpus would be exempt from tax. Alongside, capital gains will be treated as income (subject to indexation). It ties up with the principle that no saving would be taxed. And that tax would be charged only on the income from that asset. GoI must muster the political will to transit to this regime that will leave more financial savings with the individual and make the tax-exempt limit superfluous.

A higher standard deduction limit – a benefit allowed to the salaried to deduct a specified amount from the taxable salary – is meant to protect against inflation as persistent inflation reduces salary in real terms. But this may seem illogical at a time when GoI direly needs revenues. The Centre’s budgeted gross tax revenue is only about 9.9% of GDP, and less than double that combined with the states. The need is for the government to launch well-designed inflation-indexed bonds.


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