Five Minutes to Understanding EET

What is EEE?Several savings and insurance instruments in India have had a long tax free run. Provident Fund PF, Public Provident Fund PPF...

What is EEE?
Several savings and insurance instruments in India have had a long tax free run. Provident Fund PF, Public Provident Fund PPF and certain life insurance products have been totally exempt from tax under the E E E or Exempt Exempt Exempt regime. One way to understand this alphabet soup is to look at the savings and investment flow as a three part process. At stage one, you make an investment say Rs 100. At stage two, this investment gathers a return say Rs 8 of interest that is not paid out but accumulated taking the value to Rs 108 at the end of one year. At stage three, you withdraw from the product say after 15 years you get back Rs 317 as the initial investment earns 8 per cent each year at a compound rate.

If this product was the PPF, then the investment was tax exempt at all three stages. The contribution to the PPF account gets you a tax benefit, it used to be a rebate from the tax to be paid till last year and from this financial year, it will be a deduction from taxable income. The interest earned by the PPF account as opposed to say the interest earned on a bank deposit that is taxable on your marginal income tax rate is tax free. Now at the end of 15 years you withdraw from the PPF account and the entire principal and interest that has compounded is tax free at this stage, unlike say a property sale that will attract a tax on the capital gain difference between sell price and buy price will be taxed when the property is sold.

When will EET be introduced?
The Kelkar Committee Report on Direct Taxation had recommended that this EEE status be changed to Exempt Exempt Taxed EET, where the tax is levied at the withdrawal stage and not during contribution or accumulation. In his Budget speech for 2005-06, the finance minister said that India has already introduced EET-based taxation in the defined contribution pension scheme applicable to newly recruited government servants, but administrative issues like what happens to earlier contributions and at what rate should the corpus be taxed need to be sorted out before the other savings schemes were migrated to such a system. For this a committee has been set up.

At what rate will I be taxed?
Still under discussion. The tax could be structured like a capital gains tax, in which the investor pays a certain amount of tax on the profit earned on the investment. If the buy price was Rs 10 and sell price is Rs 20, the tax is paid on Rs 10 simplified to ignore indexation and other costs that reduce the profits. Alternatively, the tax could be an income tax where the corpus is seen as the income of the person for that year and taxed at a certain rate. The details are still being worked out.

Should I stop investing in these schemes?
No. They remain good risk-free medium return instruments that can be used to accumulate long term capital at zero risk.