SEPTEMBER 15, 2015

By TIOL Edit Team

TIME has come to revise rationally all tax incentives on all financial products to create a desired, if not leveled, playing in the investment domain. This issue has been dealt by two official panels lately and others in the past.

The limitation of most committees is that they have covered one or few segments of financial products market and not taken a holistic view of all segments right from risky & speculative equity to zero-risk post office account.

The Finance Ministry should thus study whether the instrument of tax incentives is being optimally utilized to promote savings, economic growth and secure future (insurance & pension) of citizens.

The Ministry should also ensure that tax incentives don't result in distorted flow of investments into different streams. Moreover, financial products should also not be designed in a way that they ultimately cause fiscal strain on the national exchequer as is the case with national small savings (NSS).

The Ministry-appointed committee to recommend measures for curbing mis-selling and rationalising distribution incentives in financial products (C-MFE), for instance, has limited its advice to what it calls push products – the ones which don't offer assured returns and/or have blurred cost structures. It has thus focused on insurance, mutual fund and pension products.

The Committee excluded from its discourse bank deposits, public provident fund, post office small savings. It considers these instruments as pull products. These offer relatively predictable returns. And they don't have opaque cost structures.

Notwithstanding its focus on push products, C-MFE has drawn broad contours of how tax incentives should be arranged.

It has thus aptly called for provision of tax incentives on function of the product and not the form of the product. It has identified three broad functions that are performed by products - protection, investment and annuity.

Taking the case of insurance products, the panel explains: "Since the government wants to encourage insurance penetration, tax breaks should be given on pure risk mortality and the treatment of the investment part should be harmonised across the different forms of the product across regulators."

It adds: "Despite tax breaks for insurance, pure insurance products are not promoted. While online sales have helped informed customers purchase these products, insurance for purely protection purpose needs to be mass scaled. This would require greater effort in rural areas and for this all possible tools including financial literacy and awareness campaigns and special distribution incentives should be considered."

Referring to tax treatment of investment products, the report notes: "The Income Tax Act, 1962 allows for certain tax deductions at the point of entry, during holding, and at exit (which differ based exit at maturity or premature withdrawal). These tax deductions are not applied consistently across all types of products and, as a result, similar products have to compete under very different tax regimes."

Post office-routed financial products not covered by the C-MFE that require scrutiny NSS and Kisan Vikas Patra (KVP) The latter was re-introduced by Modi Government in December 2014.

It is here pertinent to refer to a study commissioned by The Fourteenth Finance Commission that documented the adverse impact of NSS Fund (NSSF) on the fiscal health of the Government in September 2014.

The study captioned ‘Fiscal Transparency and Sustainability of Small Savings Schemes' pointed out that "Contrary to original intent of the scheme, there has been steady accumulation of operational deficits in NSSF accounts (Rs.69103 crore by 31st March 2013, which is projected to rise to Rs.91275 crore by 31 March 2014 and Rs.112728 crore by 31st March 2015.)"

This underscores the need for transparency in identification of tax incentives, costs and their impact in the entire chain of financial products the provider, the intermediaries, the customer and the national exchequer.

C-MFE has also rightly pitched for "a similar structure with regard to Service Tax, Stamp Duty and rural and social sector norms" for similar financial products.

The recommendation relating stamp duty has found echo in the report of the Standing Council on international competitiveness of the Indian financial sector (SC-ICIFS) whose report was released by the Ministry on 7 th September.

In its report on International Competitiveness of Currency, Equity and Commodity derivatives markets, SC-ICIFS has called for rationalization of stamp duty through the India Stamp (Amendment) Bill, 2014.

A crucial recommendation by SC-ICIFS that deserves consideration is the call for shift from source-based direct taxation to residence-based taxation regime over the longer term in currency, equity and commodity derivatives markets.

After collating recommendations of different panels, the Government should draw a big and complete picture of A to Z financial products as a prelude to taking a call on preparing a new road-map for financial products reforms.