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Friday, June 06, 2014

What is the meaning of Taxation Regimes - EEE EET ETE TEE

There are different systems for tax exemption / deduction of investments, and for taxation of the income earned from it, like Exempt – Exempt – Exempt (EEE) or Exempt – Exempt -Taxed (EET).
What do these combinations mean? Which investment option follows which taxation regime? A fundamental understanding can help us select the right investment tool...Read on...

A. Stages for tax benefit and taxation
You investment has three stages when looked at from the tax man’s perspective.
(1) Investment Stage
This is the first stage. This is the time when you actually make an investment. Of course, there is no tax levied at the time of investment. However, there is a possibility of you getting some tax benefit / tax break for the investment that you make.
For example, if you invest something in the Public Provident Fund (PPF), you can claim deduction of that amount from your taxable income under section 80C.

(2) Earnings Stage
This is the second stage. This is the time when you earn from your investment. For example, you get interest on the amount invested. Here, the tax man has to decide whether this earning would be taxed or not.
For example, interest earned on investments made in National Savings Certificate (NSC) is taxed, whereas the interest earned on investments made in Provident Fund (PF) or Voluntary Provident Fund (VPF) is not taxed.

(3) Withdrawal Stage
This is the third and the last stage. This is the time when you withdraw the money along with the accumulated earnings. Again, the tax man needs to figure out if this would be taxed or not.
For example, the amount that you get at the maturity of your Public Provident Fund (PPF) account is not taxed.

B. What do the three letters signify?
Probably you would have guessed it by now – the three letters in any taxation regime name tell you what income tax benefit is available at each of the three stages. “E” means Exempt and “T” means Taxed.
So for an investment avenue, if there is income tax benefit available at the time of investment, the accumulated interest is not taxed, and even the withdrawal is tax-free, we say that an Exempt – Exempt – Exempt (EEE) regime is followed for that instrument.
Similarly, if for an investment avenue, there is income tax benefit available at the time of investment, the accumulated interest is not taxed, and the withdrawal is taxable, we say that an Exempt – Exempt – Taxed (EET) regime is followed for that instrument.

C. The taxation regimes
So what are the different taxation systems or regimes possible? Logically, it would be all possible combinations of the two letters “E” and “T” – EEE, EET, ETE, TEE, ETT, TET, TTE and TTT.
However, tax benefits are usually not available in the second and third stage if there is no tax benefit in the first stage. So, we need to consider only the regimes starting with E.
Thus, we have EEE, EET, ETE and ETT.
Also, either your earning would be taxed when you actually earn it OR when you withdraw it, and not at both times (as that would mean that the same income is taxed twice). So, the second and third stages can’t both have the “T” status.
Thus, practically speaking, there are three taxation styles:
  • Exempt – Exempt – Exempt or EEE
  • Exempt – Exempt – Taxed or EET
  • Exempt – Taxed – Exempt or ETE

D. Some examples
  • Investment: Tax-deductible
  • Accumulation: Tax-free
  • Withdrawal: Tax-free
That is, the Exempt – Exempt – Exempt or EEE regime is followed for PPF.
(2) National Savings Certificate (NSC)
  • Investment: Tax-deductible
  • Accumulation: Taxable
  • Withdrawal: Tax-free
That is, the Exempt – Taxed – Exempt or ETE regime is followed for NSC.
(3) Provident Fund (PF) and Voluntary Provident Fund (VPF)
  • Investment: Tax-deductible
  • Accumulation: Tax-free
  • Withdrawal: Tax-free
That is, the Exempt – Exempt – Exempt or EEE regime is followed for PF and VPF.
  • Investment: Tax-deductible
  • Accumulation: Tax-free
  • Withdrawal: Taxed (The monthly pension is taxable)
That is, the Exempt – Exempt – Taxed or EET regime is followed for NPS.

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