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BW Businessworld

The Flip Side

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Not many people would know, but formal income tax was first introduced in India in 1860, to make good the losses suffered by the British on account of the Sepoy Mutiny of 1857. The levy was a kind of slap on the wrist for revolting against the British.

Over the years, income tax in India has become more accommodative in nature. The basic idea of income tax, apart from pooling government revenue, is to inculcate the habit of forced savings among citizens. So, what are the options out there for people to save on taxes? Salaried individuals have two broad options which can be classified thus: non-investment and investment.

Non-Investment Mode
Non-investment options, in general, cover expenditure incurred to meet your basic growth and personal development needs. Some of the most popular non-investment options comprise:

Home Loan Payments: If you have a home loan, you are eligible to claim relief on both the interest and principal component of your EMI. Interest (upto Rs 1.5 lakh) can be claimed as deduction under Section 24 of the Income Tax Act while a deduction on principal can be claimed up to Rs 1 lakh under Section 80C. You need to give a copy of your EMI break-up to your employer to avail this.

Children’s Tuition Fees: Individuals may submit education fee receipts of two children to avail tax benefits. This deduction — under Section 80C — is available for full-time education — right from play school to university-level courses.

Interest On Education Loans: Tax deduction can also be claimed on interest paid on education loans under Section 80E of the I-T Act. But this facility is only available for eight years, starting from the first instalment.
 
“At 8.8 per cent, PPF is a good option given that the amount invested is eligible for an 80C benefit and the interest is tax-free — the only caveat being the 15-year lock-in from commencement. That said, PPF is by far one of the best options, especially for individuals at the early stage of their career. Apart from that, there is a strong incentive for individuals to sign up for medical insurance — premium to the tune of Rs 15,000 is eligible for deduction. For HNIs, the tax laws governing income from house property can result in substantial tax savings — they should not miss out on the opportunity to consider ‘negative income’ arising out of the mismatch in home loan interest payments and rental yields. They can set off this ‘negative income’ against income, thus reducing taxable income. Investors could also consider investing in ELSS (albeit clubbed under 80C), which will add a possible upward return kicker and also an equities flavour to the portfolio — amounts invested are tax deductible and gains arising out of this post the three-year lock-in are also tax-free, in line with the exemption on long-term capital gains for equity — of course, this could also result in loss of capital since performance in these schemes is market-dependent”
— Sriram Iyer
 Chief business officer, Religare Private Wealth

House Rent Allowance: Rent receipts can be produced to reduce tax payouts. Individuals paying over Rs 2 lakh per annum need to furnish the PAN details of the landlord.

Leave Travel Allowance: LTA can be considered a tax-deductible twice in a four-year block. Tax exemption under LTA can only be availed for self and eligible family members. No tax benefit is available on foreign trips.

Charities, donations: Money given as charity comes under Section 80G of the I-T Act. Donations to registered charities can reduce your tax burden marginally.

Disability: Physically challenged persons can claim a tax deduction of Rs 1 lakh under section 80U.

Insurance (medical & term cover): Under Section 80D, medical insurance premium upto Rs 15,000 for self, spouse and children and Rs 20,000 for parents above 65 years of age qualify for exemption. Under Section 80C, term cover premium can also qualify for exemption. Under Section 10 of the I-T Act, the the next of kin can also seek a deduction on claims (death of the insured).

Investment Mode
Under this, individuals invest in select instruments and financial products to save on tax payouts. Most savings products fall under Section 80C and 80TTA (interest accrued on savings account). Options can be equity, non-equity or hybrid in nature.

Equity Tax-Savers
Equity tax-savers invest in the equities market. Equity-linked savings schemes (ELSS), unit-linked insurance plans (ULIP) and the Rajiv Gandhi Equity Savings Scheme (RGESS) are amongst the most popular.

ELSS: Under Section 80C, ELSS gives a deduction of up to Rs 1 lakh. The catch: Three-year lock-in.

ULIPs: Under Section 80C, premium paid on ULIPs is eligible for deduction, provided the cover is at least five times the annual premium. Income earned from investment is also tax exempt under Section 10. The catch: Five-year lock-in; expensive product.
 
“It is best to look for a combination of tax-saving options. Individuals can consider ELSS, which is quite flexible and also allows equity participation. This strategy may be fused with some investments in non-equity tax-saving options such as PPF and five-year bank FDs. People falling in the high tax bracket should consider PPF while those in lower tax slabs should invest in bank FDs. If you fall in the 10 per cent tax bracket, your tax payout will be lower on bank FD returns. At 9 per cent, you will still manage a post-tax return of 8 per cent.”
— Anil Rego, CEO, Right Horizons Wealth Management

RGESS: Investors with a gross income of up to Rs 12 lakh can invest in RGESS. Investors in RGESS-compliant funds get a 50 per cent deduction in the amount invested for three successive years. The limit is Rs 50,000 every year as per Section 80CCG. The catch: RGESS is a complicated product.

Non-Equity Tax-Savers
Non-equity tax-savers are instruments that invest (mostly) in rate bonds and government papers. These are lower risk-bearing than equity tax-savers.

Five-year bank deposits: Bank fixed deposits (FD) with a tenure of five years reduce taxable income significantly. Under Section 80C, the maximum amount to be invested in this scheme is Rs 1 lakh to derive tax exemption benefits. Bank FDs yield upward of 8.5 per cent currently.

The Catch: Bank FD is not a liquid option. Also, interest income is taxed.

Public Provident Fund: PPF schemes fall under the ‘Exempt, Exempt, Exempt (EEE)’ category, wherein the scheme is out of the tax net at all phases of its cycle — investment, earnings and withdrawal. A minimum of Rs 500 and a maximum of Rs 1,00,000 can be put in a PPF account in a financial year. The tenure of a PPF scheme is 15 years and the current rate of interest is 8.7 per cent per annum. The catch: Long tenure. Premature withdrawal not possible.
 
“The Indian tax system is structured in a way that if one focuses on financial goals, he automatically gets aligned to tax requirements and derives tax benefits. Most savings products in India meet different financial goals of people. So, if you want to have a retirement corpus, you can park your money in PPF, EPF or ELSS and also derive tax benefits; for regular income and tax benefits, one can invest in senior citizens’ savings schemes. People with near-term goals can opt for tax-efficient five-year bank FDs and national savings certificates”
Gaurav Mashruwala, Mumbai-based financial planner

“People should look at equity products this year for saving on taxes. We expect stocks to do well over the next three-four years. Therefore, investors can consider ELSS and RGESS options. There’s a need for a non-equity component, for which, individuals could look at PPF. People who are not covered under employee provident fund should compulsorily invest in PPF”
Raghvendra Nath, Managing director, Ladderup Wealth Management

Voluntary PF: Voluntary provident fund goes beyond the mandatory 12 per cent deduction of the employees’ provident fund from your monthly salary (that is, up to 100 per cent of basic and DA). Interest earned on VPF investments is tax free.  Currently, VPF yields around 8.5 per cent. The catch: Fluctuating interest rates. Rates of interest earned vary from year to year.

National Savings Certificate: Investments upto Rs 1 lakh for five years are eligible for tax deduction under Section 80C. NSC, run by India Post, currently yields 8.6 per cent. The interest earned every year is added to the principal amount and the same can be claimed as deduction. The catch: Five-year lock in period; post office hassles.

Hybrid Tax Saving Option
There are not many hybrid tax-saving schemes, but the most popular among the few is the National Pension System (NPS). ULIPs can also be categorised under hybrid schemes as they invest the pension corpus in both equity and debt assets.

NPS: It has three investment options — equity portfolio, corporate bond portfolio and government securities portfolio. Portfolio yields may vary on the basis of performance of underlying assets. NPS contributions are deductible from the total income under Section 80CCD of the I-T Act. Contributions through the employer (upto 10 per cent of basic and DA) are also eligible for deduction. The maximum investment limit is Rs 1 lakh. The catch: NPS follows the ‘exempt, exempt, taxed’ model.

Other Ways To Reduce Tax Burden
  • Food coupons are better than lunch/entertainment allowances. Food vouchers of upto Rs 60,000 a year are exempt from income tax
  • Using the company car. You can route the driver’s salary through the company
  • Break up total compensation into various perks (medical, telephone and travel expenses)
  • Produce bills of expenses to reduce tax outgo
Albert Einstein once said the hardest thing to understand in the world is income tax. But that’s not a good enough reason to not save on taxes. Use every provision in the law to reduce taxes. Happy saving!  

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(This story was published in BW | Businessworld Issue Dated 10-02-2014)