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R. Y. Narayanan

THE frequent tinkering with the tax laws on long-term investments in securities and in tax-free bonds has become a nightmare to those who want to plan for a stable income in the winter of their lives. While it is easy for those in authority to talk about aligning administered interest rates with the market rates, it makes life difficult for those thinking of the distant future.

Long-term investments — made from five to 15 years — mean locking up of one's resources with certain specific targets in mind and if the rules of the game are changed frequently, all the planning is rendered useless.

The latest Budget is an example of the lack of a long-term vision of the policy-makers insofar as taxation laws relating to investments go. It is not merely the cut in interest rates on savings products but the frequent changes in the tax treatment that worry the investors. The Budget seeks to provide a positive outlook for capital market investments but the different tax treatments of different investment options only lead to needless confusion.

On the issue of giving relief from long-term capital gains tax for different investment instruments the Finance Minister, Mr Jaswant Singh, has sought to apply different rules though the basic objective is the same: To move the investors from government-backed deposit schemes to risk-based investments.

While equities bought after March 1, 2003 and held for a year are exempt from long-term capital gains tax, the benefit is denied to securities bought earlier and held for more than a year. The reason advanced: Markets may sink if the investors choose to take advantage of any rally. Hardly convincing, particularly when global economy is still shaky. In fact, how many will feel that this is the right time to lock on to securities? An investment should be treated as long or short term depending on the duration of its holding rather than on the basis of the date of acquisition. Similarly, on the issue of taxing dividends paid by companies, there is only ad hocism. While the demand was to remove taxation of dividend both at the hands of the companies and the investors, as it amounted to double taxation, the Government has chosen to shift the burden to the former from the latter, which would have to now pay a 12.5 dividend distribution tax. This may only result in companies paying lesser dividend than otherwise.

The reason for treating listed securities and equity-based mutual funds differently on the issue of long term capital gains tax also has not been spelt out and investments in equity-based MFs made after March 1,2003 and held for a year or more will not be treated on a par with equities. The mutual fund route is preferred by those who have neither the time nor the expertise to invest in the stock market directly and this purpose would be served better if both segments of the capital market are treatedalike. And why should they be treated differently when only the mode of investment differs?

A similar approach is evident in the way the equity-oriented MFs and debt funds are treated for tax purposes. While the former do not have to pay any dividend distribution tax and the dividends received by the investors are tax free, the latter would have to fork out a 12.5 per cent dividend distribution tax. Investors who shift from dividend to growth plan or vice versa because of tax implications incur a cost because of the entry load — usually 2 per cent — at every switch.

After a hue and cry over the ceiling of Rs 2 lakh on annual investment in the five-year, 8 per cent interest bearing RBI Tax Free Bond announced last year, the Government said that this ceiling would not apply to investment of retirement benefits. Another 7 per cent interest bearing GoI Relief Bond of six-year tenure was launched last year without any cap on investment. But now the government has announced a five-year tax-free savings bond at 6.5 per cent interest without any cap on investment. This scheme is only the return of the earlier six-year bond but with a sharply reduced interest rate. There will be only one tax-free bond of five-year tenure. However, the Government has announced another five-year tax-free bond carrying 6.75 per cent interest exclusively for those investors in US-64 scheme opting to convert their investments in the unit scheme. Now, a large number of investors who may have invested significant part of their savings/retirement benefits in the five-year tax-free bond earlier may heave a sigh of relief that reports that the bond may become taxable have not become a reality yet, though there are reports that the RBI may re-launch the erstwhile 8 per cent tax free bond scheme as taxable bond which, however, would work against the earlier investors.

The tax treatment of housing loans has also been subject to intense scrutiny. When the previous Finance Minister, Mr Yashwant Sinha, introduced a deduction of up to Rs 1.50 lakh from taxable income for the payment made towards home loan interest for self-occupied houses, it served as a boost to housing activity and a large number of borrowers locked themselves to a 15-year home loan commitment.

But with the Kelkar Committee recommending withdrawal or phase out of this concession, there was a danger of the borrowers losing a huge tax advantage. Though Mr Jaswant Singh has left this untouched, it is not clear how long the tax concession will continue. But there seems to be little consideration for the home loan borrowers who had committed themselves to servicing such a long-term debt on the basis of the concession extended by a government and how this can be reneged mid way through the loan tenure?

Mr D. Balasundaram, former President, Coimbatore Stock Exchange (CSX), said the present low interest rate regime is not sustainable because of the high inflation expectation and the looming war. He pointed out that if investors put their money in tax-free bonds at a lower interest rate now and if the interest rates move up subsequently, they would end up in loss. Already, Tamilnad Mercantile Bank (TMB) has announced that its 12-18- month FD would carry 7.5 per cent interest which is higher than most of its competitors. The Government is probably sticking to the low interest regime because of the comfortable forex position.

Instead of the Government deciding the interest rate on small savings instruments, he said, it should allow the market forces to decide the rate. In the early years, to wean people from such unproductive investments as real-estate or gold, the government offered a far superior yield on small savings. But the market dynamics have changed completely and the real yield (the interest rate minus the rate of inflation) is low.

Mr K. Annamalai, also a former President of the Coimbatore Stock Exchange, said ordinary investors were not able to make definitive long-term investment plans because of the frequent changes in interest rates and the tax laws. Even investments in debt funds and index funds have proved to be risky in such a uncertain milieu.

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