Last month, news reports stated all savings, including mutual fund schemes, fixed deposits and small savings schemes could come under the proposed taxation method called Exempt-Exempt-Taxed.

We have since been flooded with mails from readers who wanted a clearer picture.

This is what it means.

The tax on withdrawal

When you look at the taxability of a certain investment, there are three aspects to consider:

1. Tax when you make the investment

2. Tax on the income you earn from such an investment

3. Tax on the maturity of the investment

For example, if you invest in a pension fund, the annuity (the amount the insurance company pays you regularly as income) may be taxable. But your returns from a Public Provident Fund are not.

This obviously creates a bias in the minds of the investors against the taxable investment option.

In order to remove this bias, the tax department has proposed to move towards EET.

If the EET basis of taxation is made applicable, then the investment would become taxable at the time of receipt/ withdrawal.

In a move towards the EET basis of taxation, Section 88, which offered a tax rebate, was replaced by Section 80C.

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Section 80C

Section 80C was introduced in the last Budget (February 2005).

Under this section, you are eligible to claim deductions from your income for certain investments. 

• Provident Fund
• Public Provident Fund
• Life insurance premium
• Pension plans
• Equity Linked Saving Schemes of mutual funds
• Infrastructure bonds
• National Savings Certificate

Payments towards the principal amount of your home loan too qualify for deduction under this section.

The overall limit to this section is Rs 100,000.

Let's say your taxable income is Rs 100,000. You invest Rs 70,000 in the PPF. Your taxable income drops to Rs 30,000 (Rs 100,000 - Rs 70,000).

Under the earlier Section 88, the rebate varied depending in your income slab. Under Section 80C, all income slabs can avail of the tax benefit.

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The effect of EET

Let's take the example of EET on PPF.

Most probably (can't say anything for sure at this point) only the amount you invested since the year in which EET is implemented would be taxed on withdrawal.

Let's say you invest Rs 10,000 every year in PPF. After 15 years, you receive a lumpsum of, say, approximately Rs 215,000 (original principal invested as well as interest earned on it). Every year, you are eligible for a deduction of Rs 10,000 from your income and thus save tax on it.

With EET, whatever amount you receive on maturity, your deposits of Rs 1,50,000 (Rs 10,000 every year x 15 years), will be taxable out of the total amount. 

This can be termed as Deferment of Tax, not saving of tax.

In other words, you will defer (postpone) the payment of tax, depending on the lock-in period of your tax saving investment. Some time or the other, though, the investment will mature. And tax will be levied then.

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When?

Newspaper reports say the ministry of finance has constituted a five-member expert team whose mandate would be to work out a roadmap for moving towards the EET method of taxation of savings.

All savings instruments, including mutual funds, small savings schemes and fixed deposits too will be considered. The term 'savings instruments' could even mean savings in bank accounts.

However, nothing has been fixed till date.

Once the roadmap for EET-based taxation has been decided and the investments to fall under it determined, it will have to be passed in Parliament.

As of now, let's wait and watch. And, yes, keep our fingers crossed.