New finance act: The downside for investors on withdrawal of tax nudges

The revised new tax regime has become the default regime with effect from 1 April, and long-term capital gains and indexation benefit will not be applicable on debt, international and gold funds. These changes have left investors even more confused about which regime to choose and where to invest. Can I ask my firm not to deduct money for employee provident fund? Why are certain deductions like house rent allowance (HRA) not allowed? Should I stop contributing to the National Pension Scheme (NPS) as the deduction under Section 80CCD 1& 1B is not applicable under the new tax regime? These are some of common queries they ask about the new tax regime.

While the new tax regime will result in individuals having more disposable income, the extra income is more likely to be spent on lifestyle expenses rather than it being invested for long term goals, as is clear from the above queries. It is worrisome to see that investors are not thinking about retirement planning in the absence of tax benefits. At least, the ₹50,000 additional tax benefit over and above Section 80C was getting investors to consider investing in NPS. There has been hesitancy in subscribing to NPS and the uptake on NPS is less than 10% in most companies because employees are not sure how a market linked retirement product will perform in the long term. I doubt those opting for new tax regime will even consider NPS now.

With the withdrawal of long-term capital gains and indexation benefits on debt funds, investors will be prone to chasing yields at the cost of safety. Over the last couple of years with low yields, investors were enquiring about bonds, peer-to-peer (P2P) lending, invoice discounting, etc. Investors do not understand the risk associated with investing in low-rated bonds. What happens when an issuer gets downgraded and has to pay a higher coupon and also provide exit for investors. How will investors get their funds back? In case of debt funds, there are clear guidelines on quality of bonds that can be invested into and the issuers are monitored by professional fund managers. In P2P, how will investors chase borrowers in case of default. Investors do not realize these risks until there is a negative event. Even in case of the Reserve Bank of India’s direct retail bond scheme, investors do not know what to do in case of a drop in price of the bond.

Then there is the issue of getting into high-cost investments like investment-linked insurance plans whose returns do not beat inflation. The leeway of allowing policies with aggregate premium less than ₹5 lakh to be tax free means the bulk of India’s population is at the risk of being mis-sold products that do not grow their wealth.

International funds allowed investors to take exposure to overseas stocks at much lower costs and with much lesser tax compliance as compared to investing directly in these stocks. Most investors buying international stocks are unaware of the proces of filing tax returns for these holdings and have a high chance of receiving tax notices. The withdrawal of long-term capital gains (LTCG) on international funds will lead to high transaction costs and increased stress of dealing with tax notices and huge penalties running into lakhs of rupees that has to be paid on omission or inaccurate filing of foreign stocks. I would urge investors to be mindful of the above issues and focus on their financial goals. The extra savings due to the new tax regime should be channelized into investments. Choose low- cost and low-risk investments over chasing instruments with high fixed returns or considering investments like insurance plans just because they provide a tax deduction.

The lack of financial awareness is driving investors to take wrong decisions that will put pressure on their finances. Tax nudges are an effective way to encourage people to save in the right way. The removal of these tax nudges has far-reaching consequences on the long-term financial health of the citizens. Hence, the government should take a relook at introducing the tax benefit on NPS subscription under the new tax regime, and have tax parity on all market-linked debt instruments like debt funds and insurance plans. Certainly, an investor taking market risk should have some tax benefit over fixed deposits. At least, funds other than target maturity funds(where the yield is predictable) should have LTCG benefits.

Investor protection and happy citizens should get precedence over tax parity.

Mrin Agarwal is founder director, Finsafe India.