Why EPF Tax is a Bad Idea

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The finance minister Arun Jaitley wants to tax the corpus accumulated through investments made in the Employees’ Provident Fund(EPF).

As per what he proposed in his third budget speech last week, only 40% of the corpus accumulated by contributions made into the EPF after April 1, 2016, will be tax free. The remaining 60%, if withdrawn, will be taxable. If the remaining 60% is invested in annuities, the entire accumulate corpus will be tax free. The income from annuities will be taxable.

This is a bad idea at multiple levels.

a) The change applies only to those in the private sector earning more than Rs 15,000 per month. As the ministry of finance clarified on this: “The idea behind this mechanism is to encourage people to invest in pension products rather than withdraw and use the entire Corpus after retirement.” So this doesn’t apply to those earning less than Rs 15,000 per month. Why are these people not being encouraged to invest in annuities and not squander away what they have saved for their years in retirement?

Also, if you are working for the government, the entire corpus you accumulate through the General Provident Fund (GPF) or any other recognised provident fund, remains tax free. If you are working for a government owned company like Coal India and investing in the Coal Mines Provident Fund, the entire corpus on maturity remains tax free.

The question is why is a distinction being made on the basis of the employer and not the total amount of corpus that has been accumulated? This is basically an inequitable decision, where those in government are simply trying to protect their retirement savings from being taxed.

b) 100% of the accumulated corpus can be tax free, if the private sector employee uses 60% of the accumulated corpus to buy annuities. This is nothing but a conspiracy to benefit insurance companies. Annuities remain one of the worst forms of investing in India. The returns typically are in the range of 5-7% before tax. Savings accounts, of a few banks pay as well, if not more than that.

As Debashis Basu writes in the Business Standard: “Annuities are a simple information and access arbitrage enjoyed by insurance companies to rip off senior citizens. Insurers buy long-dated governments securities at eight plus per cent and hand down five-seven per cent pretax return to the annuity buyers, keeping the profits.”

So why are we forcing people to buy annuities, if there are better forms of investment available? As I said earlier, it’s nothing but a conspiracy to benefit insurance companies. At the same time all the money going into annuities will ultimately end up in government bonds, which will benefit the government.

c) The idea is to move EPF and other recognised provident funds from EEE (Exempt, Exempt, Exempt) to EET (Exempt, Exempt, Tax). Up until now, many tax saving investments like EPF have come under the EEE regime. The investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax and the final corpus is also exempt from tax.

Under EET (Exempt, Exempt, Tax), the investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax, but the final corpus is taxed. Hence, under EET, the payment of tax is only postponed.

The idea to move from EEE to EET was a part of the Direct Taxes Code(DTC) when it was first introduced in August 2009. The DTC was supposed to replace the current Income Tax Act (1961). The DTC came with other changes as well. Take the case of the tax slabs. The tax slabs were as follows:

The current tax slabs are nowhere these slabs that had been proposed. The tax rate of 10% applies for taxable income between Rs 2.5 lakh and Rs 5 lakh. The tax rate of 20% applies for taxable income between Rs 5 lakh and Rs 10 lakh. And a tax rate of 30% applies for taxable income greater than that.

Given the fact that the entire idea behind the DTC was to simplify the income tax system, it was never implemented. It would have hit people who make a living out of complicated tax laws, very hard.

d) The other big problem with the proposal to tax EPF is that it will tax the entire corpus including the principal. Further, it will not take into inflation into account. Let’s understand this in a little more detail.

Let’s say you invested in real estate in 2005 and you sold it ten years later in 2015. You need to pay a tax on the capital gains at the rate of 20%. While calculating the gains inflation is taken into account. This means that if you had bought real estate, for let’s say Rs 20 lakh, while calculating the gains this amount of Rs 20 lakh will be adjusted for inflation.

If the inflation during the period was 7% per year, then the inflation indexed amount will be Rs 39.34 lakh (Rs 20 lakh x (1.07)^10). This will be the inflation indexed purchase price. If the real estate was sold for Rs 80 lakh, then the capital gains on which tax will have to be paid will amount to Rs 40.56 lakh (Rs 80 lakh minus Rs 39.34 lakh, the inflation indexed amount). On this a 20% tax, which amounts to Rs 8.13 lakh will have to be paid. This is referred to as indexation benefit.
Other deductions which take into account the cost of maintenance of the real estate are also allowed. Further, as mentioned earlier, the principal amount is also not taxed.

As Dhirendra Kumar writes on valueresearchonline.com: “EPF returns are barely above inflation rates. To disallow indexation for inflation is a grave injustice. This is morally and principally wrong. Moreover, because this tax will be on bulk withdrawals, it will push even low-income savers into the 30 per cent tax bracket for that year. This is unconscionable.”

Also, it needs to be pointed out that long-term capital gain on stocks (i.e. stocks sold after one year of purchase) continues to remain zero. So is true for long term capital gains on equity mutual funds. The corpus accumulated through insurance policies also continues to remain tax free.

But the government in its wisdom has decided to tax the total amount of money accumulated through investing in EPF. This proposal is wrong at multiple levels and its time, the government got rid of it.

The column originally appeared on Vivek Kaul’s Diary on March 8, 2016

Why realty regulatory Bill is not a panacea it’s being out to be

India-Real-Estate-MarketVivek Kaul

The Union Cabinet cleared the Real Estate (Regulation and Development) Bill on June 4, 2013. The passage of this Bill has been heralded as a move in favour of real estate buyers. The Bill has been in the works for more than six years now, that tells us how serious the government has been on making it a law. 
There are several provisions in this Bill that point out towards the same. Real estate developers can launch new projects only once all the relevant permissions are in place. These permissions are to be displayed on the website of the developer 
and only then can construction begin.
If the promised home is not delivered on time, the buyer will be entitled with a full refund of the amount he has paid along with interest. Separate bank accounts are to be maintained for every project. Developers need to ensure that the money taken from buyers is used for that particular project and not diverted elsewhere. While advertising developers will have to use photographs of the actual site. Failure to do so will attract a penalty. 
The Bill also seeks to establish a central appellate tribunal and individual states will be responsible for establishing state level regulators. Further, the Bill does not allow developers to take more than 10% advance from the buyers without a written agreement. This provision it’s felt will help curtail the amount of black money that goes into real estate. 
All these provisions put together will help the buyers, 
seems to the major view coming out. But as the old English saying goes there is a many a slip between the cup and the lip. 
First and foremost the Bill as and when it becomes an Act will be applicable only on new real estate projects. Hence, the real estate projects which have already been launched will not come under the aegis of the Act. This means that buyers of those real estate projects which have been delayed will continue to face problems. 
The recent past has seen real estate developers launching more and more new projects and use the money thus raised to pay off their past loans. This has led to a situation where there is no money left to build the projects which have been launched. In order to get the money required to build these projects, newer projects are launched. So this modus operandi has led to a situation where projects are rarely delivered on time and are endlessly delayed. 
The buyers who are facing trouble because of this will get no relief as and when the Real Estate (Regulation and Development) Bill becomes an Act. (You can read 
a more detailed argument here). 
The Bill also talks about establishing a real estate regulator in every state. This is a very long term process. It calls for the recruitment of a lot of people who understand specific real estate regulation. The question is are there enough such people going around? 
Also, any regulator takes time to become effective. Take the case of the Securities and Exchange Board of India(Sebi), the stock market regulator, which was established in 1988 and given statutory powers in the 1992, after the Harshad Mehta scam. 
Immediately after Sebi was given statutory powers, the stock market had the vanishing companies scam, where companies raised money through initial public offers (IPOs) and disappeared. Sebi could hardly do anything about it and investors lost thousands of crores. 
Towards the turn of the century there was the Ketan Parekh scam, which again caught the stock market and Sebi off-guard. Its only in the last few years that the stock market regulator has come into its own. So its effectively taken Sebi almost twenty years to become somewhat effective. 
But even then Sebi has had huge problems dealing with Sahara. The moral of the story is that even regulators don’t stand much of a chance against big established business groups. So how will the real estate regulators go against real estate developers, who are known to be fronts for politicians? Then there is the question of whether the regulator will act in favour of consumers. The Insurance and Regulatory Development Authority, the insurance regulator, over the years has acted more in favour of insurance companies as an industry lobby than thought about people who buy insurance.
A major point in the Bill is that the developers will have to open separate bank accounts for each project and ensure that the money from the buyers goes into that particular project and not elsewhere, as is the case currently. On paper, this is probably the most important point in the Bill. But money is fungible, as anyone who has handled it will tell you. So the question is who will ensure that the money going out from the a particular project account is going towards that project and is not being used to by the developer to meet other obligations or simply being siphoned off. 
This seems to be the job of the state level real estate regulators that the Bill seeks to establish. But will state level regulators be able to manage things at such a micro level? Will they have the required expertise? I have my doubts. Implementation of laws has never been a strong point with India and Indians. 
Also this provision in the Bill has been significantly diluted over the years. As Dhirendra Kumar of Value Research writes in a column “Compared to the 2009, the government has weakened the anti-fund-diversion provisions of the Bill. In the 2009 draft, all funds collected from the buyers would have to be kept in a separa
te bank account, from which money could be taken out only for direct use of the project.” This has been diluted and the current version of the Bill allows developers to route only 70% of the money raised from buyers into a separate bank account. “This serves no purpose except to make it easier for developers to divert 30 per cent of the funds,” writes Kumar. 

The Bill does not allow developers to take more than 10% advance from the buyers without a written agreement. This it is said will help in controlling black money. This to me seems like someone’s idea of a joke. When has any agreement prevented Indians from transacting in black money? Scores of developers across this country continue charging money in black separately for car parking, despite there being a Supreme Court order against the same. 
The Bill also says that buyers will be entitled to a full refund along with interest if the developer does not deliver the project on time. This may not be of much help because even with the compensation, the buyer may not be able to buy a home. Home prices may have risen in the meanwhile. Also, after a project is delayed, you cannot expect the buyer to put money in a fresh project, which again promises to deliver a few years later, like the original developer did. 
Buying a fully ready home may turn out to be expensive and beyond the budget of the buyer, even with the compensation. Given this, the buyer should be compensated either the price of buying a similar home in the open market, as promised by the builder, or refunded his money along with interest, whichever is higher. 
Also, it is one thing to make a law which calls for the developer to pay up in case a project is delayed, and it is totally another thing to expect him to pay up. Take the case of DLF. The company was fined Rs 630 crore for abusing its dominant market position by the Competition Commission of India (CCI). 
As an article in Governance Now magazine points out The CCI pronounced DLF guilty for grossly abusing its dominant market position in the relevant market and imposing unfair conditions in the sale of apartments to home buyers in contravention of the provisions of the Competition Act, 2002. The CCI also imposed a penalty of whopping Rs 630 crore.” 
But there has been no damage to DLF. “Ever since the order came out, DLF has paid zero to CCI. Not only that. They have launched four different projects since then, despite of our continued objections to the CCI,” Amit Jain of the federation of apartment owner’s association (FAOA) told Governance Now. So if DLF can get away without paying a regulator, where is the question of developers paying the 
aam aadmi for delayed projects? 
The politicians have already tweaked the provisions of the Bill in favour of the developers. In fact, in the 2009 version of the Bill only those projects which were less than a 1000 square metres and had less than four dwelling units were exempt from the provisions of the Bill. The current version of the Bill is applicable only to projects over 4000 square metres in size with no limit on the number of dwelling units. Also there is a twist in the tale. As Kumar writes “Even more alarmingly…when a project is executed in phases, then each phase will be considered separately. This means that even very large projects could just be broken up into sub-4000 meters phases and escape much of the regulatory oversight of the Bill and the regulator.” So all we know, the developers might exploit this loophole to the hilt. 
To conclude, India does not have independent regulators. And people who head regulatory bodies report to politicians. Even the real estate regulators will report to politicians. And many politicians have significant interest in real estate, ensuring that developers will do what they want to do. The law of the land be dammed. Or as the old saying from the Hindi heartland goes “jab saiyyan bhaye kotwal to darr kaahe ka?(when my lover is the police inspector, what do I have to fear?). So deep runs the politician-builder nexus. 
And the
 Bill does very little to address this. To be fair, one cannot expect any law to end the nexus. But if the Indian real estate scenario has to improve it is this nexus that needs to be broken. And that is not going happen anytime soon. 
(The article originally appeared on www.firstpost.com on June 6, 2013) 
(Vivek Kaul is a writer. He tweets @kaul_vivek)