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SURPRISE IN A CAPSULE

There was a little line framed by the Union finance minister in his budget speech this year. It was hidden in clause 6. The little insertion we are talking about is subclause (k) that proposed to add a new clause (33) in section 10 of the Income Tax Act which is related to incomes not included in the total income.

The finance bill clarifies it as: “to provide that any income arising from the transfer of a unit of Unit Scheme, 1964 where the transfer takes place on or after the 1st day of April 2002, shall be exempt from tax. This amendment will take effect retrospectively from 1st April, 2003 and will, accordingly, apply in relation to the assessment year 2003-2004 and subsequent years.”

Some income exemption indeed. Let us penetrate this sugar-coated pill. A practical case would serve to illustrate the best. Over the years, one particular gentleman acquired as many as 25,000 units of US-64 at an average cost of Rs 14.50 per unit. The rate of interest offered was then around 10 per cent.

Then came the scandal. US-64 units were held by millions of individuals. These people can be divided into three categories. One, the poor who never had taxable incomes, and were thus ruined. Two, members of the medium to large income groups, that is the honest tax payers who even paid tax on their income from US-64 units. They were also ruined. Three, members of the medium to large income groups who never bothered about income tax matters, especially that from US-64. They also lost a chunk of their hard-earned evasion gains.

Despite the ruination of the first category and the losses of the third, the new clause does not affect their income tax status, as they have none. But it affects the second. Our gentleman, proud of his honesty, belongs to this category. Look at the prize he has won. The average nominal cost of one unit of his US-64 was Rs 14.50. The “indexed cost” rose to, approximately, Rs 18 for his 25,000 units. After April 1, 2002, he “repurchased” 5,000 units at the special offer price of Rs 11. He thus lost (5,000 x 18) - (5,000 x 11) = Rs (90,000-55,000 )= Rs 35,000 in the deal. Nonetheless, he was entitled under the existing IT provisions to “set off” this long term capital loss against his long term capital gains. Thus he could lower his tax burdens by 20 per cent of Rs 35,000 or Rs 7,000. He planned accordingly.

For 2003-04, his plan was that on redemption of his remaining 20,000 units at the assured price of Rs 10, he would incur a further loss of 20,000 x (18-10) = 20,000 x 8 = Rs 1,60,000. He would again set it off and reduce a further tax burden of 20 per cent or Rs 32,000. The benediction of 6(k) is that all such incomes on transfers in 2002-03 retrospectively and in subsequent years, will be exempt incomes. Thus no question of any gains, and therefore losses too, for incomes so generously exempted.

Our gentleman proposed to get some consolation by setting off the loss of Rs 35,000 and Rs 1,60,000, against his present and possible future gains, subsequently lowering his tax burdens by Rs 7,000 + Rs 32,000 = Rs 39,000. The god of 6(k) disposed otherwise. He lost a good part of his invested capital. The existing provisions for setting it off is also axed.

This is a rough estimate, but a cautious and representative one. Probably, noting the number of investors “repurchasing” the units at the special price during 2002-03, the finance ministry shuddered to foresee the colossal losses at the hands of taxpayers. This would surely be claimed in their income tax return in July-October 2003 as also in the eight subsequent years. The severity of the loss to the exchequer compelled them to debar it in a roundabout way.

In the “explanatory memorandum”, however, the command is rather straightforward. “Exemption of capital gains on transfer of...units of US-64... in relation to the assessment year 2003-04 and subsequent years.” Let us look at the possibility of a gain in general. Millions of investors acquired the units directly from UTI at a price declared by it. Is there a single individual who acquired units at less than Rs 10' The minimum price was Rs 10 during the first few years — indexed to Rs 50 now. One can sell the first 5,000 units at Rs 12 maximum, the rest at Rs 10. A big joke of exemption of capital gains.

All sources in the Income Tax Act deal with revenue income. Only capital gains concern capital incomes. Though it is believed that the capital gain tax has been removed, it is still very much alive, except for two cases. One has already been analysed above. The other needs some browsing of the clause 6(I). A new clause (36) proposed in it tempts the investor to do the following: purchase as many specified equity shares as possible during between March 1, 2003 to February 29, 2004; two, hold them for one year; three, then sell them out and four, pay no tax on the capital gains with effect from the assessment year 2004-05. But look before you leap. Not only our gentleman, but thousands of others will rush to acquire the shares during the stipulated period ignoring the then obvious rise in price. A one-year wait. Again a rush to sell for a fat tax-free gain! But the rush now leads to a price-crash. The so-called tax-free capital gains too turns into a tax-free and set-off-free capital loss! What is the idea behind the inclusion of the clause' To camouflage the stab from US-64'

S ection 47(ii) of the IT Act says any transfer of an asset under an irrevocable trust is not considered as a transfer, and hence attracts no capital gains or losses. One wonders if this applies to the UTI situation. Otherwise, what was the need of introducing 6(k)' It is a boon to the exchequer. Who knows, sections 49, 49(2) and so on may also be blocked later when millions opt for the 6.75 per cent tax-free US-64 bonds and subsequently sell or redeem them.

There is, however, no better way to gear up the revenue. One may recollect a recently discussed measure. The long unaltered IT slabs are: first Rs 50,000: nil; next 10,000 (that is, up to Rs 60,000): 10 per cent; next 90,000 (up to Rs 1,50,000): 20 per cent and then, from Rs 1,50,000 to infinity: 30 per cent. Why not spare the dying at the bottom and make one more slab above Rs 5 lakh or even Rs 10 lakh, with a few points extra taxation (33 per cent-35 per cent)'

A joke I remember may be relevant. A newcomer in an asylum rushed into the office crying loudly and begged for his immediate release. “Why'” asked the superintendent, “You’ve only come the day before yesterday”. The new entrant answered, “Yes, sir. On my arrival they presented me a nice little comb. The next morning, that is yesterday, they shaved my head! There was a present in the afternoon again — a cute toothbrush. And this morning they have uprooted all my teeth. And just now, sir, they have presented the third one — an expensive pair of briefs!”

Paragraph 39-40 of the budget speech accords much respect for our senior citizens. The maximum tax rebate under section 88B has been increased from Rs 15,000 to Rs 20,000. However, widespread cuts are also being effected in bank and all the small savings interest rates — the major source of their income and their livelihood. Some relief indeed. But one wished the government had stabbed us on our chest, not on the back.

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