If you get up early, work late, and pay your taxes, you will get ahead - if you strike oil.
- J Paul Getty
This famous quote by J. Paul Getty, the American-British industrialist, drives home the point. However, the irony here is that Getty himself was a petrol tycoon, but most of us are not so lucky!
As dutiful citizens we are liable to pay tax on our incomes and ironically, this very act can eat away into our earnings, especially if we are salaried. The Government has provided various tax deduction methods to lower one’s income tax liability and smart tax planning implies that one does not unnecessarily end up paying more tax. Plus several tax-saving avenues are designed in such a way, that they encourage people to save and invest. Tax saving just for the sake of it, may not always be a wise thing, as long as it is not aligned to an individual’s financial goals. This is where tax planning assumes importance as opposed to mere tax savings.
Computing one’s tax liability is the very first step towards the tax planning process. Commenting on the importance of computing tax liability, Naveen Wadhwa, DGM, Taxmann, explained, “Income-tax is levied on the total income of a taxpayer. Hence, it is important to first compute the total income. Under the Income Tax Act, there are five heads of income—inter-alia, salary, house property, business or profession, capital gain and other sources. The aggregate income (after set-off of losses) from these five heads is termed as Gross Total Income (GTI) out of, which various deductions are allowed to a taxpayer on account of investments and savings made by him or her.”
It is thus important to factor in all sources of income when computing one’s tax liability.
“You can compute income from salary with the help of TDS certificate in Form 16. Income from property involves accounting for rental income you receive by letting your property out. Calculating capital gains and income from business and profession if any, can be quite cumbersome, depending upon the number and complexity of transactions,” said Ankur Choudhary, Co-Founder and CIO, Goalwise.com.
Chaudhury suggested, one can resort to an online income tax calculator or consult a professional Chartererd Accountant to help one calculate one’s tax liability in a correct manner. Remember, you cannot afford to be negligent in this regard as the Income Tax Department may ask you to substantiate your claims at a later stage.
Other sources of income also need to be considered. “An individual taxpayer is liable to pay tax not only on his own income but also on certain other incomes, which may be indirectly clubbed with his or her income. For example, deposits made in the name of spouse or minor children; earnings from the same will get added to your income,” said Kuldip Kumar, Partner and Leader, Personal Tax at PwC India.
Next comes in the various deductions under the Income Tax Laws, through, which one can arrive at a total earning. The idea is to bring down the total income to the least possible number by using eligible deductions under the Income Tax Law.
Kumar explained that apart from the deductions for investment and expenses admissible under Income Tax Act, 1961, which need to be subtracted from the GTI, there are also source-specific deductions, such as standard deduction for salary income, deduction of actual property taxes paid and 30 per cent of net rent from income from house property and deduction of Rs15,000 for family pension for income from other sources. Once, the net total income has arrived, prescribed rates of tax under the Act are applied on such income to determine the total tax liability.
There are different tax rates specified under the Act for certain streams of income. For example, long-term capital gains are either exempt or taxed at 20 or 10 per cent. From the total tax liability, one can deduct the taxes already paid by way of withholding TDS and advance tax and compute the final taxes owed or refund to be claimed. Further, where the tax liability (after deducting the TDS) is more than Rs10,000, interest is levied if taxes were not discharged by way of advance tax.
Now, coming to the most significant part of tax planning—deductions form an integral part and understanding them are essential. The Income Tax Act, 1961 (‘The Act’) has provided for several deductions for investments and expenses made during a financial year. These deductions are reduced from the GTI to arrive at the total income, which reduces the tax outgo.
The next step is to see how one can use these various eligible deductions to minimise one’s tax outgo. This depends entirely upon one’s situation and varies from one individual to another.
“First step before making any investment is to see what is actually getting saved mandatorily. For example, where one is employed, there is compulsory deduction for contribution towards Provident Fund. If one has school-going children, then tuition fees are eligible for deduction under section 80C of the Income Tax Act, 1961” said Kumar. He further mentioned that, similarly, where one has home loan EMIs to pay, the principal repayment is eligible for deduction under Section 80C. Once such items have been considered, then you need to determine the remaining amount you need to invest to save taxes. Next one needs to consider tax deductions that are a priority.
For example, if you do not have life insurance, then this should be the priority especially if you are the only earning member. Then in case you have parents to look after, buying insurance for them is necessary. Availing education loans to support children’s higher education can also help reduce tax liability substantially.
Even after you have considered all the above situations, you may still need to invest to save taxes. When it comes to investing in various financial products for tax saving purposes, Section 80C is undoubtedly the most crucial, so it warrants a closer look.
Total deductions available under Section 80C is Rs1.5 lakh. As mentioned earlier, one needs to look at the deductions one is already using up under this section before going for further eligible tax saving investments. For example, one should estimate the insurance premium he will pay in the current year on insurance policies taken earlier and total contribution he is likely to make in provident fund, by way of employee’s contribution. “In such a situation, the decision to make further investment should be made only if estimated investments in insurance policies and employee’s contribution to PF is less than Rs1.50 lakh,” said Wadhwa.
If one still has some amount left after paying off premium and contributing to PF, then its necessary to consider other 80C investment options.
“Before making an investment, a person needs to check the following three factors,” said Wadhwa. These include, risk, i.e., how likely is it that you are going to get the return you expect; return, i.e., how much do you expect to earn off your investment and liquidity, i.e., how easy is it for you to get money from that investment. “It is very rare that any investment option satisfies all the three parameters. So, before making any investment decision, one should consider his financial goal,” he added.
Which investment option you choose, will depend on the factors mentioned above and also on your stage of life.
Public Provident Fund or PPF is perhaps one of the most popular 80C options as it is fully EEE (exempt-exempt-exempt) under the tax regime, offers good returns and is also a long-term retirement product. Tax saving mutual funds or ELSS are also great. “Historically PPF is a very popular choice to avail 80C deductions, and this forms a substantial portion of one’s portfolio in debt,” said Archit Gupta, Founder and CEO, ClearTax. He further stated that, investing in ELSS is also a good way to start building one’s equity and meet certain goals and the best way to do so is to start an SIP, as one can spread one’s investment across the year. Fixed Deposits(FDs) suit those who are looking for guaranteed returns over a period of five years. Jigar Bhatt, 23, a SAP OTC Consultant, invests a small amount in 80C to completely utilise 80C benefit, but primarily invests in ELSS SIPs for higher returns.
“In case of super senior citizens, they would prefer to invest in secured instrument with high returns, such as Senior Citizen Saving Schemes. Since income up to Rs5 lakh is exempt in case of super senior citizens, investing in such schemes would be ideal if overall income is up to Rs5 lakh,” confirmed Ashok Shah of NA Shah Associates. “Taxpayers can also invest in Sukanya Samriddhi Yojana, which has highest tax-free return, fully secured as backed by sovereign guarantee and comes with the EEE status. This instrument is specifically designed to financially secure a girl child’s future,” added Shah.
NPS is yet another tool that can be considered for the purpose of creating a corpus for retirement, especially if your employer is contributing to it. “Every individual between 18–60 years can voluntarily invest in NPS with the purpose of creating a corpus for retirement,” confirmed Manish Kumar, CBO, Financial Hospital. He clearly explained the deductions available
(1) Sec 80 CCD (1) - Self contribution of 10 per cent of gross salary to an extent of Rs1.5 lakh as deduction under Sec 80C.
(2) Sec 80 CCD (2) - NPS contribution by employer; It will not form part of 80C. The maximum amount eligible for deduction is lower of the below - (i) Actual NPS contribution by the employer, or (ii) 10 per cent of basic salary + DA, or (iii) Gross Total income.
(3) Additional self contribution of `50000 under section 80 CCD(1B) as NPS for claiming tax benefit.
Apart from Section 80C, one should keep in mind other less-popular avenues of tax deductions as well.
When we are discussing tax planning, needless to say that Budget 2019 also needs a mention. Keeping in mind the budget, Shah said, that Budget 2019 raised the standard deduction for salaried taxpayers from Rs40,000 to Rs50,000 and also announced an increase in rebate from Rs2,500 to Rs12,500 for individual taxpayer with an annual income of Rs5,00,000.
Once you have used up all the deductions and still need to save taxes, you need to look at investments, which are tax free or attract less tax. It goes without saying that such investments make for great options.
“In that situation, you need to evaluate various investment options to save taxes or invest in instruments which are tax free,” confirmed Kumar. For example, if you do not need money in near future, but want to save for your retirement, contributing voluntarily to the Employee’s Provident Fund could be a good option. The money is safe and will earn tax free interest. Similarly, you may think of investing in a smaller house or in mutual funds to help improve your return on investments while balance the tax considerations. “Consulting a financial adviser may be the right thing as it will help to rationalise your investments vis-a-vis risk and other considerations,” he added.
Designing a tax plan requires multiple factors of consideration. A tax saving scheme may give you temporary relief from tax payment, but may also have bad consequences in other aspects of personal finances.
If you require assistance in understanding how to plan for your taxes, ask your personal financial adviser today.
anaghpal@outlookindia.com
(With inputs from Himali Patel)