HAPPY CHRISTMAS AND A VERY HAPPY AND PROSPEROUS NEW YEAR 2008 TO YOU

HAPPY CHRISTMAS AND  A VERY HAPPY AND PROSPEROUS NEW YEAR 2008 TO YOU .

LET YOUR CHERISHED DREAMS AND GOALS BE ACHIEVED IN THIS YEAR WITH GRACE OF ALMIGHTY AND YOUR INTELLIGENT EFFORTS.

P K Kothari

 

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TAX STRUCTURE IN INDIA

1) Qus. : What are you doing?
Ans. : Business.
Tax : PAY PROFESSIONAL TAX!

2) Qus. : What are you doing in Business?
Ans. : Selling the Goods.
Tax : PAY SALES TAX!!

3) Qus. : From where are you getting Goods?
Ans. : From other State/Abroad
Tax : PAY CENTRAL SALES TAX, CUSTOM DUTY & OCTROI!

4) Qus. : What are you getting in Selling Goods?
Ans. : Profit.
Tax : PAY INCOME TAX!

5) Qus. : Where you Manufacturing the Goods?
Ans. : Factory.
Tax : PAY EXCISE DUTY!

6) Qus. : Do you have Office / Warehouse/ Factory?
Ans. : Yes
Tax : PAY MUNICIPAL & FIRE TAX!

7) Qus. : Do you have Staff?
Ans. : Yes
Tax : PAY STAFF PROFESSIONAL TAX!

8) Qus. : Doing business in Millions?
Ans. : Yes
Tax : PAY TURNOVER TAX!

9) Qus. : Are you taking out over 25,000 Cash from Bank?
Ans. : Yes, for Salary.
Tax : PAY CASH HANDLING TAX!

10) Qus.: Where are you taking your client for Lunch & Dinner?
Ans. : Hotel
Tax : PAY FOOD & ENTERTAINMENT TAX!

11) Qus.: Are you going Out of Station for Business?
Ans. : Yes
Tax : PAY FRINGE BENEFIT TAX!

12) Qus.: Have you taken or given any Service/s?
Ans. : Yes
Tax : PAY SERVICE TAX!

13) Qus.: How come you got such a Big Amount?
Ans. : Gift on birthday.
Tax : PAY GIFT TAX!

14) Qus.: Do you have any Wealth?
Ans. : Yes
Tax : PAY WEALTH TAX!

15) Qus.: To reduce Tension, for entertainment, where are you going?
Ans. : Cinema or Resort.
Tax : PAY ENTERTAINMENT TAX!

16) Qus.: Have you purchased House?
Ans. : Yes
Tax : PAY STAMP DUTY & REGISTRATION FEE !

17) Qus.: How you Travel?
Ans. : Bus
Tax : PAY SURCHARGE!

18) Qus.: Any Additional Tax?
Ans. : Yes
Tax : PAY EDUCATIONAL, ADDITIONAL EDUCATIONAL & SURCHARGE ON ALL THE
CENTRAL GOVT.'s TAX !!!

19) Qus.: Delayed any time Paying Any Tax?
Ans. : Yes
Tax : PAY INTEREST & PENALTY!


20) INDIAN :: can i die now??
Ans :: wait we are about to launch the funeral tax!!!

Tax-planning tips for 2007-08

Wondering how to plan your taxes in the new financial year? Do you want your tax-planning to generate returns as well?

Want to know about short-term investments that also offer you rebate on income tax?

While tax can be saved on investments like insurance, mutual fund, fixed deposit and various other debt schemes, are you confused about the ideal mix?

Are unit linked insurance plans bad investment options? Are their returns not as good as other insurance products?

Get Ahead tax expert Mahesh Padmanabhan answered tax and investment-related queries in a chat with Get Ahead readers on April 25.

For those of you who missed the chat, here is the transcript.



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Paul asked, I want to know if LTA is allowed to teachers also. How much value is it?

Mahesh Padmanabhan answers, LTA or leave travel assistance is merely a component of your salary structure and is general in nature. There is nothing restrictive in its use in a segment manner for a certain class of employees. Yes, the basic condition, however, is that there should be an employer-employee relationship.



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phanichaganti asked, Hi my age is 27. Right now division of my tax savings is (Rs 100,000= Rs 25,000 (FD 5yrs) + Rs 28,000 (EPF) + Rs 30,000 (NSC) + remaining (MF). Is my way of investing good/bad/moderate?

Mahesh Padmanabhan answers, From your investment mix, you seem to be a very risk averse person as the debt component is very high as compared to the equity component.

Investment in debt securities is not a bad option but you need to consider the tax implication of the interest, liquidity of such investment, pre and post tax yield (returns), etc before deciding whether this investment mix is suitable for the growth of your wealth. Historically, equities have always scored higher in the long run.



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Krishna asked, Hi Mahesh, I am working in one of the company in a European country through business VISA through their branch in delhi, and my gross salary is Rs 10 lakhs. Please suggest how much I could invest for tax saving? Already I have been paying Rs 25,000 per annum through LIC. Also take into consideration that from April �08 I may go permanently to Europe through work permit visa. Please give your suggestions on the same. Thank you very much.

Mahesh Padmanabhan answers, I guess you are looking at a short-term fix for your current tax problem. In this case you can invest in ELSS (equity linked saving scheme), which has a lock-in period of about three years. You can also put your money in a five year FD. In case of life insurance, you are seriously advised to consult a financial/ insurance advisor to determine your insurance needs and accordingly go about putting your money in such insurance without taking a look at the tax perspective.



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RAGHAVENDRA asked, HI RAGHU HERE, AM EARNING RS 35K PER MONTH IN HAND, AND REQUEST YOU TO SUGGEST ME A GOOD INVESTMENT PLAN.

Mahesh Padmanabhan answers, Raghu, there is no single best plan available on a common platform; it all boils down to individual financial perspectives. However, if you are averse to taking risks, then go for debt tax savings instruments such as NSC, PPF, eligible FD etc or else go for ELSS mutual funds, ULIP schemes, etc. Additionally, you would also need to consider your long-term planning for various other aspects such as home acquisition, etc.



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sandhya asked, Hi ,My take home salary is Rs 15 k per month. Please let me know the best investment opportunities. I have already invested in FDs, RDs (recurring deposit) and NSC.

Mahesh Padmanabhan answers, In case your salary structure is absolutely unfriendly and the entire Rs 1.8 lakhs salary is taxable, then you need to put aside at least Rs 35,000 in certain tax saving investments to bring your tax liability to zero. Generally, RDs are not tax saving instruments and you will need to ensure that the FD that you have created is stamped by the bank for being eligible for tax savings purpose. NSC is a tax saving instrument.



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dip asked, Sir, I have invested around Rs 54,000 in 2 ULIP funds , ICICI prudential (Rs 24,000) and AVIVA life bond 5 (Rs 30,000). I know that investing a huge chunk of money in ULIPs was not a good idea but do you think I should persist with these investments.

Mahesh Padmanabhan answers, If someone has told you that investing in ULIP is bad, then the person is absolutely wrong. Yes, if you have done so without proper consultation with an advisor, then probably you might get involved with the wrong insurance company or the wrong plan.

Generally all insurance companies generate reasonable returns on ULIPs but the cost varies between companies, making the returns relatively up or down in comparison to peer companies. What you need to ensure is that you learn about the scheme you have invested in and see if you can leverage by moving from debt oriented fund to equity oriented fund or vice versa as per your risk profile.

Also, if you are unhappy with the scheme available as such then look at the escape route to get out of the insurance plan with as minimum damage as possible.



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Ravindra asked, Hi mahesh, I want to know about the investments that are short in time and also provide income tax rebate?

Mahesh Padmanabhan answers, The lowest time frame that you can probably look at is three years of lock-in. ELSS schemes, infrastructure bonds, etc, carry such time frame. But my sincere advice is do not be shortsighted in investing; the deductions that are provided are to promote retirement funding or to provide long term financial security/ means to individuals. Do not liquidate these investments unless the funds are required badly.

Also, invest your money with a proper strategy in mind after consulting a financial planner.



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ARPAN asked, What is an ELSS scheme?

Mahesh Padmanabhan answers, ELSS schemes are mutual fund schemes specifically aimed at tax investing with a lock in time frame of 3 years. These are essentially same as the regular mutual fund investments but are more focused and generally yield consistent returns. However, these are also subject to the vagaries of the stock market.


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Make Losses, Save Tax

Negative income does not attract tax, but actually saves you money

Praful Poladia


Income tax is a tax on income earned by a taxpayer in a given year. However, each and every activity of a taxpayer may not result in positive income.

It may cause losses too. It would be unfair to tax a person on his income, while ignoring the loss. In recognition of this principle, there are elaborate provisions permitting adjustment of loss, including the provisions for carrying forward unadjusted (unabsorbed) loss to future years. Understandably, there are restrictions, which have been introduced to prevent misuse of artificial losses. Heads of income. Income of any assessee for the purpose of levy of income tax is computed under five heads—salary, house property, profits or gains of business or profession, capital gains and other sources. There are specific rules provided for computation of income under each of these heads of income. Considering the computation rules, no loss can occur under the head ‘salaries’.

Intra-head set off. Within each head of ‘income’, there could be more than one source of income. For example, a person may have two properties in different cities let out to different lessees. Each property is a source of income covered by the same head of income. The law requires adjustment of loss falling within the same head of income in priority of adjustment of loss against profits under any other head of income.

Some Basic Rules. Adjustment or carry forward of loss is not an inherent right. One requires specific provision in the Act permitting such right. But, once such a right is available, an assessee cannot, by choice, forego it in one year and choose to exercise it in the second year, when he expects a much higher income.

House property loss. Loss under the head ‘house property’ may occur when, say, in respect of a self-occupied house or a rented house, interest expenditure is incurred on the loan borrowed for acquisition of property. In case of a self-occupied house, income is computed as nil and interest expenditure results in loss. Any such loss can be set off against income from any other head, including salary income. If there is no sufficient income to absorb the loss, unabsorbed loss can be carried forward for eight years to be set off against house property income, if any, in the future year. It cannot be set off, in the future year, against any other income head like salary.

Business loss vs Salary income. Loss under the head ‘profits and gains from business or profession’ cannot be set off against salary income.

This restriction has been introduced very recently to plug the unhealthy practice of salaried employees claiming artificial business losses for the purpose of setting it off against salary income.

Business loss—Speculative vs normal. There is a distinction drawn between loss in speculative business and loss in any other business. Speculation loss can be set off only against speculation income. For example, loss from speculation in shares can be set off against income from speculation in commodities, but not against share brokerage income or salary income.

What is more, such speculation loss can be carried forward for a period of four years only. Even in those four years, it can be set off against income from speculation business only.

Business loss & unabsorbed depreciation. Business loss is divided into depreciation loss and operating business loss. Say, a person is engaged in the business of software development and training, which requires investment in computers eligible for depreciation at a higher rate of 60 per cent. He may become entitled to claim a large depreciation (Rs 10 lakh for example) while his profit before depreciation is low (Rs 2 lakh for instance).

Such loss (Rs 8 lakh) is known as depreciation loss.

The rules for carry forward of depreciation are different from rules for carry forward of unabsorbed business loss (see: Uneven Rules).

Loss under Capital Gains. Capital loss assessed under the head ‘capital gains’ cannot be set off against income under any other head. Capital loss can be set off against capital gains income only. Further, long-term capital loss cannot be set off against short-term capital gains. Unadjusted capital loss can be carried forward up to eight years. Long-term capital loss cannot be set off against short-term capital gains even during this period.

Loss under Other Sources. Loss under the head ‘other sources’ can be adjusted against income under any other head in the same year. But, there are no provisions for carry forward of unadjusted loss incurred under this head to subsequent years. Unabsorbed loss under this head will, therefore, lapse in the same year.

Set-off, as a tax-saving instrument, works only under certain conditions and is not always helpful

Submission of return within due date. One of the critical conditions for availing the benefit of carry forward of loss to future years is that the return of income for the year, in which loss has been incurred, should be furnished within the due date. This condition is applicable for carry forward of loss to next year and does not affect the right to adjust or set off loss in the same year. As a measure of relaxation, unadjusted depreciation can be carried forward even if there has been delay in furnishing the return.

Conclusion. Tax provisions about setting off losses are, indeed, a bit complex, but so is life. One needs to file income tax returns within the due date for availing the benefit of losses to reduce future tax liability.;

The author is a member of the Bombay Chartered Accountants’ Society

li’l club class travellers

Your minor child’s income would be lumped with yours. So try to create tax-free income streams for him

Sunil Dhawan


A child can start earning from the day he is born. Someone can open a fixed deposit account in his name. That can be followed up with insurance policies, mutual fund schemes, real estate investments, and what have you. Now if a child is capable of owning assets, argues the taxman, there is no reason why he should not be paying taxes too.

snapshot

The parent who earns more annually pays tax on behalf of a minor child—their incomes are clubbed

MF dividends and PPF interest are tax-free, so if your child earns these, your tax liability doesn’t rise

Inheritances are not taxed in the hands of the kid



Since assets and income are actually being created on behalf of the child, taxes, too, have to be paid on his behalf. And the onus of doing so, according to the Income Tax Act, is on the parent with the higher annual income—the income of a minor child will be clubbed with his. The implication is simple: if you are trying to create assets for your child, try to ensure that the income from them is tax-free. And, for whatever it is worth, the I-T Act allows a deduction of Rs 1,500 per child from such clubbed income of a parent.

According to Lovaii Navlakhi, managing director and chief financial planner, International Money Matters, while it does not matter from the tax point of view whether the money is invested in the name of the parent or the child, it is still a great idea to create assets in a child’s name. That’s because parents are loath to withdraw investments for short-term needs if they are in the name of their child.

When the child is a minor, the interest earned on investments made in his name is taxed on accrual basis even if it is not realised. In most cases, that would be annually. Take National Savings Certificates, for instance. While the only payout is when the certificate matures, interest accrues annually. So, every year, the interest amount will get added to your income. It is important to keep this interest payout in mind when investing for your child.

So, what are the investments you can make for your child that will provide tax-free income? Equity mutual fund units are a good option. Another is a Public Provident Fund account. Dividends in the first case and interest in the second are tax-free and, therefore, will not add to your tax liability (see Funding Your Child’s Needs, page 38).

Gifts, in general, should be avoided. If you or anyone else gives your child a gift, it will be taxable in your hands because of income clubbing. But there are exceptions. Inheritances are not taxed in the hands of the recipient.

Nor are gifts given by a “close relative” out of “natural love and affection”. Relatives include brothers and sisters, brothers- and sisters-in-law, maternal and paternal uncles and aunts, lineal ascendants and descendants and their spouses. Also, make sure that there is no consideration for the gifts received.

If a child’s income continues when he has ceased to be a minor, he would have to file tax returns, even if his only earning is income from sources other than business or salary. He should also get a PAN number.

Get the edge

Five ways with which you can effectively structure your loans and investments to reduce the tax burden

Kanu H. Doshi


“The way of taxpayers is hard and the legislature does not go out of its way to make it any easier.” Lord Curzon



Deduction on jointly-taken home loans is available individually to both the spouses

Lord Summer
Lord Summer’s aphorism about taxation remains true despite personal direct income tax rates having come down from the dizzy heights of 97.75 per cent in the 1970s to 30 per cent at present. The decrease in tax rates have also been accompanied by elimination of many routes for tax planning, most notably tax rebates, such as those under Section 88 and Section 80L. However, there still exist some provisions in the Income Tax Act, 1961 (Act) that contain some possibilities of reducing the personal tax burden. I suggest moves that may help you in the smart management of finances.


Smart Move
Apply jointly with your spouse for a home loan to claim larger tax deductions.
Section 24(b) grants deduction for interest up to Rs 1.5 lakh per year on a loan for acquiring a residential house. This deduction is available individually to both the spouses. To be eligible for the deduction, the home loan needs to be taken in joint names, property be owned and financed jointly in equal shares, with both spouses being joint owners. Needless to say, a joint loan application will also help a couple avail of a larger loan.


Smart Move
Get tax deduction for home loan interest repayments. Self-occupied residential properties can avail of another tax concession under Section 23(2) that provides that the notional income for the purpose of income tax for such properties will be deemed nil and yet the deduction for interest up to Rs 1.50 lakh will be available. In other words, there will be negative income (loss) from such property that will be available for set off against the tax payer’s any other income, including salary income. To put it differently, interest on borrowed money becomes tax deductible. If husband and wife both were to have an annual income of Rs 15 lakh each, they could claim an annual tax deduction of Rs 3 lakh (Rs 1.5 lakh for each) and save aggregate tax of Rs 1,01,970 (33.99 per cent of Rs 1.5 lakh multiplied by 2) between them. For convenience, they can file a declaration with their respective employers to deduct a specified amount of lesser tax at source from their salaries.

Smart Move
Claim tax deduction for principal repayment for home loan. Repayment of the principal amount of a housing loan is one of the tax concessions a taxpayer can enjoy under Section 80C. But unlike Section 24, this deduction is available only for repayment of the loan from an approved source like banks, HDFC, HUDCO or the employer company. The repayment of principal part of the loan qualifies for a deduction under Section 80C up to a maximum of Rs 1 lakh per year. In case of joint home loan application, this results in joint tax saving of Rs 67,980 (Rs 33,990 multiplied by two). But the biggest advantage in availing Section 80C deduction for repayment of housing loan is immunity from any adverse tax consequences of the proposed EET (Exempt, Exempt and Tax) system—where investments will get taxed on maturity, redemption, or sale. The simple reason for this is that by the very nature of the transaction (repayment of a loan), there is no question of “withdrawal’ of funds to attract tax, unlike in the case of National Savings Certificate (NSC), Public Provident Fund (PPF) or life insurance policies with cash values.



The growth option in MFs is a tax-efficient option for those trying to create wealth for kids

Smart Move
While investing for kids, opt for growth option in mutual funds (MFs). The growth option in MFs is a great tax-efficient option for higher net worth individuals trying to create wealth for their kids. With the clubbing up provisions of Section 64 in the Act, by which all incomes of minor children (under the age of 18 years) are to be added to the income of that parent (father or mother) whosoever’s income is higher, the scope of tax planning here is very limited. The growth option comes in handy in such cases. Here’s how.
The father could subscribe to a MF scheme with a large cheque of Rs 25 lakh and opt for growth option till the minor child attains majority. Under this option, the scheme does not declare any income distribution but merely accumulates it. Because the scheme does not declare any income, it does not pay income distribution tax (or dividend distribution tax) of 12.5 per cent, imposed by Section 115-R. The accumulated income of the scheme has the effect of enhancing from year to year the net asset value (NAV) of units held by the parents for the benefit of their minor children. When the child attains majority, the parents may transfer the units to the child and allow it to grow or encash the units (likely to be over Rs 1 crore) to fund future requirements such as higher education and marriage. This can be done without paying any gift tax (abolished from 1 October 1998) or any wealth tax (since units are exempt from wealth tax) or any income tax (since there is no income declaration).

Smart Move
Stocks: Buy cum-bonus, sell ex-bonus. Equity shares of listed companies that announce bonus shares present excellent opportunity to book short-term capital loss without effectively losing any money. Such loss is available for set off against any other capital gain, including long-term capital gain. The modus operandi goes like this. Let’s assume that a company’s shares are quoting

at Rs 2,000 per share on 20 June 2007. On 22 June, the company announces one bonus share for every one share held and declares 10 July 2007 as the record date for allotting bonus shares. A taxpayer buys 1,000 shares (cum bonus) on 25 June 2007 at Rs 2,000 per share and pays Rs 20 lakh for the same. On 11 July 2007, the price of the company’s share drops to Rs 1,000 per share and hence the taxpayer will sell 1,000 shares for Rs 1,000 per share and get Rs 10 lakh as sale proceeds. Since he was holding 1,000 shares on the record date (10 July 2007), the company will allot him 1,000 bonus shares. He bought 1,000 shares at Rs 2,000 per share cum-bonus and sold 1,000 shares at Rs 1,000 per share ex-bonus booking a short- term capital loss and yet in effect retaining his original holding of 1,000 shares. The loss, as indicated earlier, can be used for setting off against any other capital gain and can’t be contested by authorities since there is no legal bar on it.;

Taxing times ahead, are you on track?

If you haven’t planned on taxes already, do it before it gets too late. Only, while doing this, decide whether you just want to save taxes or make goal-based investments

Sunil Dhawan


Two types of people complain about taxes: men and women. Every year, taxpayers try to save and invest so that they minimise taxes and maximise disposable income. Tax planning, as part of your overall financial planning exercise, helps you figure out how to make full use of the breaks on offer.

The ideal time to plan your taxes is in April, at the beginning of the financial year. But for those who couldn’t and are doing so now with just about four months to go for the year to end, there are still enough investment options that would substantially lighten the burden while deploying funds profitably.

Investment-related tax breaks. Finance Bill 2006-07 offers a deduction from income of up to Rs 1 lakh on specified investments, expenses or payments like notified bank deposits with a minimum period of five years, life insurance premiums, Employees’ Provident Fund (EPF), public provident fund (PPF), repayment of principal amounts on housing loans, payment of tuition fees, national savings certificate (NSC) and equity-linked savings schemes.

Bank deposits. The term deposits in a scheduled bank with a minimum period of five years under the Bank Term Deposit Scheme, 2006, in addition to giving you a fixed and assured return (around eight per cent) comes with a tax advantage. There is a one-time investment and there is no commitment to pay in future. Since the benefit of Section

80L (interest income up to Rs 12,000 from bank deposits and NSC were exempted) has been removed, the entire interest income from any such deposits would be taxable. State Bank of India (SBI) and HDFC currently offer 7.25 per cent interest over five years, while ICICI Bank offers 7.5 per cent.

EPF. This is a forced saving that happens in the life of an employee and helps him save for retirement. Twelve per cent of your salary is deducted every month and put into a kitty maintained either by the government or your company’s trust. The contribution currently earns a tax-free return of 8.5 per cent and is fixed by the government every year in March-April.

PPF. This is a self-directed investment option. It is essentially a 15-year investment that carries a tax-free interest rate of eight per cent as of now. The rate is subject to change. Investments of Rs 500-70,000 qualify for a tax rebate under Section 80C.

Home in on home loans. The interest payable on home loans taken on or after 1 April 1999 is tax-deductible up to Rs 1.5 lakh a year. If you factor in the tax advantages, the effective interest rate works out to 6.3 per cent for an eight per cent loan—against which you get to build a long-term asset. Those eligible for Section 80C benefits stand to gain even more. The total amount eligible for deduction under this section is Rs 1 lakh a year. and principal repayment of home loans up to that amount also qualifies.

Children’s fees. Under Section 80C, parents can also claim a deduction for tuition fees—up to Rs 12,000 per child—for a maximum of two children. This means that parents with two children can claim a deduction of Rs 24,000. However, any payment towards any development fees or donation to the institution are excluded.

National Savings Certificates. For those who are less averse to risk, there’s the National Savings Certificate. This government-backed security is available at post offices and comes with an interest rate of eight per cent, compounded half-yearly as of now. The interest is entirely taxable and is right for those in lower tax slabs with an investment horizon of around six years.

Equity-linked savings schemes (ELSS). It is eligible for a deduction under Section 80C. By investing in these schemes, those with a penchant for risk stand to gain from the benefits of equity market returns. Do note that like all tax savings options, these plans have a lock-in period of three years. ELSS does not allow moving out of the investment in case of market volatility, unit-linked insurance policies (Ulips) allow this, through their switching facility.

Life insurance. The premium that you pay towards a life insurance policy is eligible for a tax deduction up to Rs 1 lakh under Section 80C. If the premium paid in any of the years during the term of the policy is more than 20 per cent of the sum assured, then deduction will be allowed only for premiums up to 20 per cent of the sum assured. This applies to all term, endowment or unit-linked plans bought from any of the 14 private life insurance companies as well as from LIC.

Health insurance. Under Section 80D, medical insurance premium of up to Rs 10,000 is tax-deductible, with an additional deduction of up to Rs 5,000, where the premium is paid by a senior citizen (65 years or older).

Pension plans. If you have a pension plan with a premium of more than Rs 10,000, you can now claim that under Section 80CCC. If any investment has been made under this section, then the qualifying amount under Section 80C will stand reduced to that extent.

What to do: Risk and return have a close relationship with each other and is an important pillar in building wealth over a long time. An investment under Section 80C is a step towards that. Removal of sectoral caps this year on investments for tax-planning purposes means that investors can invest in line with their risk appetites and needs.

However, investments in tax instruments should never be done merely to save taxes. The choice of an instrument is as important as the amount of tax saved. Liquidity is a crucial factor in all the instruments and, hence, short- and long-term objectives should be clear before you lock your funds in them. the value derived through liquidity, returns and security over the next few years should be an integral part of your investment decision.

If your immediate need is only to save taxes and your investment horizon is not very distant, then ELSS would be suitable. Remember, the risk involved is high too. If you can commit to pay regularly for a longer duration, Ulip would be a better option. A risk-averse investor can select small savings schemes like PPF or the bank deposit with assured return on investment.

Finally, having made your investments and claimed the tax breaks, don’t forget to keep the records and documents of your investments and tax deduction certificates, since you will have to attach them with your returns.

30 Minute TAX GUIDE

Calculate your income, find the deductions, and work out your tax. In a matter of minutes

Swami Saran Sharma and Udayan Ray


The hardest thing to understand in the world is income tax.
Albert Einstein

For most of us, Albert Einstein needs no introduction. And when the man who changed the course of mankind with his scientific thinking expresses his exasperation about a subject, you are bound to take it seriously. You are entitled to ask that if taxation confounded an intellectual colossus like Einstein, what hope would ordinary folks have. But the irony of taxation is that it is an integral part of our lives. Probably that’s why another genius, Benjamin Franklin, opined: “In this world nothing is certain but death and taxes.”

Such gloomy views on the subject obviously didn’t develop overnight for the story of taxes and the civilised man go back a long way. Taxes were levied when Pharaohs ruled Egypt 5,000 years ago. In India, a treatise on taxation existed 2,300 years ago in the form of Chanakya’s Arthashastra. It emphasised on fairness and equity, recommending that the affluent pay higher taxes as compared to the not so fortunate.

The modern system of Indian taxation started taking shape from the year 1922. After Independence, the Income Tax Act in its present form was passed in 1961. For the purpose of taxation, the total income of an individual’s income has been divided under five heads: salaries, house property, profession, capital gains and other sources. A number of deductions are allowed from the gross total income computed on the basis of individual income accruing under the five heads. The deductions allowed are usually in line with the fiscal policy of the government. For example, when the government wanted to promote investment in the housing sector, annual exemption up to Rs 1.5 lakh was allowed on interest repayment for home loans.

It is probably fair to say that the increase in the importance of taxation coincided with the enlarged role of the government, a phenomenon that came to the fore in the twentieth century, especially after the Great Depression of the 1930s. Governments across the globe had to enormously increase their spending to create employment and catalyse economic activities that would help out their citizens suffering in depressed economies. Governments were now much more than the police states of the preceding centuries, where their primary focus was on defence and maintenance of internal law and order. So, governments were setting up banks, industries, schools, universities, hospitals and, in many cases, handing out old age and unemployment doles. In the decades since then, governments may not have been as active in all the areas but they continue to spend large amounts of money raised primarily as taxes from individuals and companies. This, then, begs an important question. If taxes are for our collective good, why do most of us hate them so much? Two reasons immediately come to the mind.

First, at a subconscious level, we probably see it as diminution of our freedom—the freedom to do what we please with our hard-earned money. Second, the language of taxation is understood mostly by experts and intimidates laypersons, who see it as a complicated subject. It is this second aspect that we hope to address in this special issue on taxation. We have designed a package that will help you understand, calculate and pay your taxes with unprecedented ease—all in just 30 minutes.

We break the whole tax paying process into three parts: calculating your total income, figuring out the deductions to arrive at the taxable income and, finally, paying your taxes. Our primers and interactive worksheets will help you in comprehending the basics of taxes. We are aware that tax saving investment options are of great interest to our readers. This is more so with the deluge of equity-linked savings schemes (ELSS) from mutual funds and pension plans from life insurance companies in the recent past. We help you pick the best ELSS schemes and life insurance pension plans. We also give you insights into the two pension schemes provided by mutual funds. The tax on the earnings made by our investments can make a crucial difference in the long term, especially in retirement. We provide you a guide map to help you make your investments more tax efficient so that they provide better returns.

In sum, this special edition of Outlook Money will empower you to be better informed about taxes. You might still need expert and customised advice from a chartered accountant, but you will be aware of what he is doing for you and your tax planning would be a more participative process. Hopefully, you would have gone a long way in cracking a problem that even Einstein couldn’t.

Calculate your income

It takes 10 minutes to find out your Gross Total Income

Sunil Dhawan and Swami Saran Sharma


“I’m spending a year dead for tax reasons.”

This is what the tax noose made English writer Douglas Adams say. Many, like Adams, would do anything to escape the pain of taxes. While knowing the tax process does not take the pain away, it does give a better grip on the tax cuts that we get. For incomes to be taxed, they first need to be classified under various categories to allow us to count them better. Incomes like those from agricultural activity and dividends (from mutual funds and stocks) are not part of income that is counted for taxation. Incomes are classified under five heads in India. Here’s a quick guide to doing what you believed was too tough for you. This is not an exhaustive list of what you can include under each head, but you would be 90 per cent there. For the rest, call the friendly neighbourhood CA.


Salary income

First, you have to find out the “income chargeable under the head salaries”. For this, you need to know your gross salary, which normally includes basic salary, commissions earned, taxable allowances, taxable perquisites and retirement benefits. Subtract certain deductions like conveyance allowance (upto Rs 800 per month) from this. The balance is charged under the head salary income.

Total taxable income. Your ‘basic salary’ is fully taxable. Further, any amount of dearness allowance, commissions and bonuses, city compensatory allowances, overtime allowance and even lunch allowance that you get is fully taxable.

House rent allowance (HRA): HRA is exempted up to a certain limit provided you are actually paying house rent. The lowest of three amounts, actual HRA received or rent paid in excess of 10 per cent of basic salary or 50 per cent of your basic salary (40 per cent of your basic salary if you reside in a city other than Mumbai, Kolkata, Delhi and Chennai), would determine how much is to be exempted. The balance is taxable.



Conveyance allowance. Up to Rs 800 per month is exempt from tax.

Leave travel allowance (LTA). This is a reimbursement for travel expenses that you and your family members incur within India while you are on leave. While LTA can be paid to you every year, it is treated as tax-free only for two journeys in a block of four years. Both these journeys can be made in any one of the four years or spread out over the four years.

Medical allowance. Reimbursement of medical expenditure incurred by you and your family is tax-free to the extent of Rs 15,000 per annum. Remember, all reimbursements need to be supported by bills or other documents.

Perquisites. Perquisites are benefits that your employer gives you in addition to your regular salary. These are usually in the form of accommodation or car or concessional loans. The total of all perquisite values is added to the salary and tax is calculated on the usual slabs. Premium paid by your employer under group insurance or medical insurance premium paid by your employer escapes the tax net. However, you need not worry about calculating all this. Your employer will give you Form 12 BB which will show you the value of perk as part of your salary.

You will also get Form 16, which shows the ‘income chargeable under the head salaries’ and TDS, taking into account all the allowances and deductions. If there is no deduction of tax at source for you, your employer will give you a certificate of salary earned during the financial year instead of Form 16. American journalist Bill Vaughan had remarked, “The tax collector must love poor people, he’s creating so many of them.” You might want to agree after seeing what taxes have done to your income.

Income from house property

Rental income from a residential or commercial property that you own is liable to be taxed. Even if the property is not rented out (see Let Your Second House Pay For Itself, page 64), it will be treated as rented out and the rental income will be liable to be taxed. What is taxed under this head is not the actual rent but the inherent capacity of the property to earn income. This is known as the property’s “annual value”. The gross annual value is the highest of these: the municipal value, the actual rent, or the fair rental value. To calculate your gains, see the worksheet. Preferential treatment is given to one self-occupied house which has not been let out at any time. In this case, the annual value is taken as ‘nil’. The interest payable on home loans taken on or after 1 April 1999 is tax-deductible up to Rs 1.5 lakh a year.

Capital gains

If you hold a house, commercial property, gold or silver for more than 36 months, they are termed as long-term assets. If you hold them for 36 months or less, they are short-term assets. However, shares and units of equity mutual funds are short-term assets if you hold them for a year or less and long-term assets if you hold them for more than a year. To calculate your gains, see the worksheet. Short-term capital gains are included in your gross total income and, after deductions, are taxed as per your tax slab. Other than for listed securities, long-term gains are taxed at 20 per cent with indexation. Gains from equity shares or units of equity mutual funds are tax-free in the long term and taxed at 10 per cent in the short term.

Gains from business and profession

Income earned from your profession, or through business, is taxed under the head ‘profits and gains from business and profession’. The income chargeable to tax is the difference between gross receipts and the expenses incurred to earn that income. A person carrying a profession of law, medicine, engineering, architecture or technical consultancy, whose total gross receipts from that profession exceed Rs 1.5 lakh per annum, is required to maintain books of accounts.

Other incomes

Any income that does not fall under the four heads of income mentioned above is taxed under the head ‘Income from other sources’. An example of such income is interest from bank deposits or national savings certificates.;

Calculate your Deductions

You can reduce your taxable income by investing in specified instruments. You can work that out in 15 minutes

Sunil Dhawan and Swami Saran Sharma


“If you beat us in a game of cricket, we will forgive your tax for three years. If you lose, you’ll have to pay triple the taxes.”

This was the condition the British administrator put before Bhuvan (Aamir Khan) in the film Lagaan. The Lagaan episode holds true even for you! Some of your tax is waived if you invest in specified areas. This is the crux of allowing deductions from your gross total income. The smaller the income on which tax is levied, the lesser is the tax. Under Section 80C of the Income Tax Act, you can reduce your total income by up to Rs 1 lakh by making specified investments. There are other sections of the Act as well wherein you can reduce your total income. These investments are mentioned below.

section 80C products

Bank deposits. Term deposits in a scheduled bank with a minimum period of five years notified under the Bank Term Deposit Scheme, 2006, not only give you a fixed and assured return (around eight per cent), but also a tax advantage. Term deposits are a one-time investment and there is no commitment to pay in the future. But remember that the entire interest income from such deposits is taxable. State Bank of India (SBI) and HDFC currently offer 8 and 7.75 per cent interest, respectively, over five years, while ICICI Bank offers 8.25 per cent.

Employee Provident Fund (EPF). This is a forced saving for employees and helps them save for retirement. Every month, 12 per cent of your basic salary is deducted and put into a kitty maintained either by the government or your company’s trust. The contribution currently earns a tax-free return of 8.5 per cent. The rate of return is fixed by the government every year in March-April. Your employer also pitches in with 12 per cent of your salary every month. Of this, 8.33 per cent is diverted to your pension fund, the remaining amount is put in the provident fund.


Public Provident Fund (PPF). This is a self-directed investment option. It is essentially a 15-year investment that gives a tax-free return of eight per cent as of now. The rate is subject to change. Investments of Rs 500-70,000 qualify for a tax deduction under Section 80C.

Home loans. The total amount eligible for deduction is up to Rs 1 lakh a year for the principal amount.

Children’s fees. Parents can claim a deduction for tuition fees for a maximum of two children within the overall limit of Rs 1 lakh. However, payment towards development fees or donations to the institution are excluded.

National Savings Certificates (NSC). These are for those who are less averse to risk. This government-backed security is available at post offices and gives an interest rate of eight per cent, compounded half-yearly as of now. The interest is entirely taxable. NSCs are good for those in lower tax slabs with an investment horizon of six years.

Equity-linked savings schemes (ELSS). These are mutual fund products and carry market risk. Like all tax saving options, these plans have a lock-in period of three years. Therefore, it makes sense to go in for funds with good track records rather than the new fund offers, especially in this category. Choose the ‘growth’ option for an optimal investment (see Get Tax Sops, Reap Returns, page 38).

Life insurance. Your life cover premium is eligible for a tax deduction up to Rs 1 lakh under Section 80C. If the premium paid in any of the years is more than 20 per cent of the sum assured, then deduction will be allowed only up to 20 per cent of the sum assured. This applies to all term, endowment and unit-linked plans.

Pension plans. If any investment is made under this section, then the qualifying amount under Section 80C stands reduced to that extent. Investment in insurance and mutual fund pension plans also comes under this section with an overall limit of Rs 1 lakh.

other deductions

Health insurance. Under Section 80D, medical cover premium is tax-deductible up to Rs 10,000, with an additional deduction of up to Rs 5,000 if the policy is in the name of a senior citizen (65 years or older) and the premium is paid by him. If someone below 65 buys a plan for his dependents, he can avail benefit upto Rs 15,000.


Educational loan. The interest on loans taken for higher education are also eligible for deduction from your total income under Section 80E. There is no monetary ceiling on the interest you can claim as a deduction. The loan must have been taken from a financial institution or an approved educational institution. Remember, repayment of loan or interest on loans taken by parents for higher education of their child is not eligible for deductions.

Charity. To avail tax benefits under Section 80G, donations must be made only to specified trusts. The tax breaks vary according to the trust to which you have donated.

Medical treatment. Any expenditure for the medical treatment (including nursing) of a handicapped person, training and rehabilitation of a person suffering from a permanent physical disability (including blindness) or from mental retardation, qualifies for a deduction under Section 80DD upto Rs 50,000. A life insurance policy bought for the benefit of such a handicapped person is also eligible for this benefit up to Rs 50,000. In case the disability is severe, the claim can go up to Rs 75,000.

What to do. US radio comedian Fred A. Allen once said, “An income tax form is like a laundry list—either way you lose your shirt.” The law, indeed, takes its own course, and cares little whether you are left with your shirt on or not. But the law just became better this year, by removing caps on investments in the avenues mentioned above, except for PPF, where deductions are available only up to Rs 70,000. Thus, investors can invest in line with their risk appetites and needs.

Investments in tax instruments should never be done merely to save taxes. The value derived through liquidity, returns and security over the next few years should guide your investment decision.

The Income Tax Act does not treat all kinds of savings uniformly—the taxability of contributions, accumulations and withdrawals differs from one instrument to another. In a PPF scheme, for instance, you can avail deductions, and the interest and the money you get on maturity is not taxed. This is the ‘exempt-exempt-exempt’ (EEE) method of taxation, since all three stages—contribution, accumulation and withdrawal—are exempt from tax.

On the other hand, while contributions to, and accumulations in pension plans are not taxable, lump sums withdrawn or periodical pension are taxed in the year of receipt. This is the ‘exempt-exempt-tax’ (EET) method of taxation.

Don’t forget to keep the records of your investments and tax deduction certificates, since you will have to attach them with your returns.

If you think the tax rates are skewed, American explorer Jeff Rich will give you company. He said: “We are all are equal, but some pay higher tax rates than others.” And you thought tax was invented to make life fair for everybody.

Calculate your Tax

It is now just a five-minute sprint to calculating your tax liability

Sunil Dhawan and Swami Saran sharma


“When there is an income tax, the just man will pay more and the unjust less on the same amount of income.”

Greek philosopher Plato left this world about 350 years before Christ, but in this quote, he said something that would apply at all times, in all lands. When you add the incomes under all the five heads and account for the deductions to get your total taxable income, the amount on which you have to pay tax, Plato’s quote might find an echo in your mind too. There’s some relief for those with an annual income of Rs 1 lakh or less—they don’t have to pay tax. The limit is Rs 1.35 lakh and Rs 1.85 lakh for women and those above 65 years of age respectively. The tax payable at different income levels is shown in the table. Remember, filing of return is compulsory if your taxable income exceeds the basic limit indicated above, even if the tax payable is nil. You need to file returns even if you have incurred losses as a businessman or professional.



A surcharge and an education cess is levied on the amount of tax payable. The surcharge is 10 per cent of the tax amount and has to be paid if your annual income exceeds Rs 10 lakh. The education cess of 2 per cent has to be paid if your annual income is above Rs 1 lakh. These charges push the tax rate of 10 per cent to 10.2 per cent, 20 per cent to 20.4 per cent and the highest tax slab to 30.6. For those with income exceeding Rs 10 lakh, the rate becomes 33.6 per cent, including surcharge and education cess.

If the tax already deducted by your employer (TDS) is more than the tax payable, you are eligible to get a refund of the excess amount. Mention the details of your bank account in the tax form so that the refund gets credited to it.

The fundamental rule of income tax is that tax becomes due as soon as income is earned. In the case of salaried employees, tax is deducted every month after estimating the total income for the year and accounting for deductions. As far as business income is concerned, it is difficult to estimate income from day-to-day transactions. Therefore, tax is charged on estimation of income basis. As a thumb rule, if your income from a business or profession comes to Rs 100 at the end of a financial year, the income tax department assumes that Rs 30 (30 per cent) of it accrued up to September, Rs 60 (60 per cent) accrued up to December and the total income, that is, Rs 100, accrued till March. You are supposed to match this income pattern while depositing self-assessment tax. You will have to pay a penalty in the form of interest on the due amount if you don’t pay, pay less, or defer paying the advance tax. Don’t worry if you have paid all the taxes, but not filed your return by the due date, as the IT Act permits you to file the return till the end of assessment year. However, if you don’t meet this deadline too, you are liable to pay a penalty of Rs 5,000.

American Novelist Herman Wouk said, “The only imaginative fiction being written today is income tax returns.” Our advice: do your bit as a responsible citizen of the country, pay taxes on time, stay away from fiction, and relax.

Look beyond the tax breaks

Consider flexibility, performance and prospects before buying a pension plan

Sunil Dhawan

It is a happy combination. Pension plans from life insurance companies not only help you save for retirement, but also help create regular retirement income from the accumulated sum . Tax deductions make them a potent investment tool—investments up to Rs 1 lakh qualify for deductions under Section 80C.

Evaluate the investment proposition. For long, pension plans have been sold primarily as a tax-saving tool that provided life insurance. The practice still continues. Since you can get a cost-effective cover from term plans, opt only for pure pension plans. With retirement life in India, on an average, stretching to more than two decades, pension investing is becoming crucial. Also, with a large choice of pension plans, all offering tax deductions, it is important that investment prospects of pension plans are compared.

Participatory policies: security’s flip side. Till a few years back, most pension plans were with-profit or bonus-based. In such plans, the insurers bear the investment risk. Your investment is not at risk, and your returns vary with the profits and surplus, depending on the investment performance of the insurer. But the flip side is that these policies don’t disclose the investment performance and the costs incurred on fund management or administration. So, you make do with what is offered. Also, since such plans don’t invest in equities, which typically provide high returns in the long term, their returns are in the range of eight per cent. Participatory policies might work for extremely risk-averse people with low income. It may even work for those who want to use it to create a base retirement income, supplemented by income from other sources. But, most of us need the equity exposure that unit-linked pension plans (ULPP) provide.

The unit-linked advantage. In the past three to four years, life insurers, especially private players, have been launching unit-linked plans. They are becoming popular due to their features that provide flexibility. In a ULPP, you have to manage the investment risk yourself. Therefore, if retirement is quite some distance away, it makes sense to take higher risk options in such plans, especially exposure to equities. Of course, in this backdrop, you won’t be able to put a finger on what you will end up with. Therefore, it becomes important to carefully evaluate the plans based on various parameters.

ULPPs. The amount of money that a person invested in a ULPP, and will end up with during retirement depends on three factors—costs such as those for management and administration, fund management performance and the market growth over the years. Costs are important as they eat into your premium contribution before the remainder can be invested. Thus, the lower the costs, the better the chances of higher accumulation. Various companies structure or spread the costs differently during the tenure of their plan. The structuring may even differ with plans from the same company. Out of the three factors, while fund management and market growth are prospective in nature and beyond your control, you can research on the cost structure of various ULPPs—information that the insurance advisor can give you—before you invest. Given the cost structure, you can project the retirement corpus you will need at the get at the end of the tenure. Since most of the ULPPs right now have a very short track record, it makes sense to supplement it with the fund performance to find out whether the company can really deliver on its projections. An important point to remember here is to factor in the equity exposure since it makes a difference to the returns. For instance, while Aviva has a maximum equity exposure of 60 per cent; it is 100 per cent for HDFC Standard Life.

Considering plans with the highest equity exposure from six top life insurers (in terms of their market share), we find that among plans with 100 per cent equity exposure, HDFC Standard Life’s plan comes right on top with the best projected value. It has shown consistency in returns and has the maximum exposure to equities. Of the two other companies providing plans with lower equity exposure, the choice is not a clear one.

By now, it will be clear to you that in the future, you will have to do much more than just take the easy route of investing in a pension plan to save taxes. You will have to take an informed decision on the prospects. With the right amount of homework, you can ensure that you get a lot of happiness out of the happy combination pension plans provide.

Combo on offer

Take a look at funds that offer a combination of tax savings and pension after retirement

Kayezad E. Adajania


If you thought equity-linked savings schemes (ELSS) were the only mutual fund (MF) products you could invest in to save tax under Section 80C, here’s a surprise. Mutual fund pension plans, targeted towards your retirement corpus, can also help you in your tax planning. These are debt-oriented balanced funds that take equity exposure of up to 40 per cent (as opposed to 65 per cent equities in regular balanced funds), while keeping the remaining in ‘safer’ debt instruments.

Currently, there are two MF pension plans on offer—Templeton India Pension Plan (TIPP) and UTI-Retirement Benefit Pension Fund (UTI RBPF). Both these schemes offer section 80 C tax benefits.

For instance, if your taxable income is Rs 3 lakh, and if you invest Rs 1 lakh in TIPP or UTI RBPF, your taxable income comes down to Rs 2 lakh. As these schemes target your retirement, they mandate that you stay invested till the age of 58. Early withdrawals attract a high exit load. Of the two, we suggest you take a look at TIPP.

Consistent performance

TIPP has shown consistency over a long period of time. Over the past three and five years, TIPP returned 16.1 and 20.1 per cent, respectively, as against 15 and 17 per cent for corresponding periods by UTI RBPF. We took the standard deviation (SD) of all balanced funds for the past three years and checked out the extent of fluctuation of the scheme’s returns from that of its average return for the same period. TIPP has the lowest SD and stands third on the risk-adjusted returns (RAR) charts.

On the other hand, UTI RBPF, in the past year, has managed to return only 7.7 per cent despite investing 15-20 per cent in equities. Even a one-year bank FD earns eight per cent. Besides, the fact that the fund, which can invest up to 40 per cent in equities, is benchmarked against the Crisil MIP Blended Index (that has 15 per cent allocation to equities) doesn’t work in its favour.

Regular dividends

Once you turn 58, you can either withdraw the full amount (without exit load) or choose to receive a pension in the form of dividends. If you choose dividends, you are entitled to receive dividends in the form of pension. TIPP has consistently given an average of 12 per cent dividend per annum for six years now. Even if you choose the dividend option at the time of investment, you will start receiving dividends only once you turn 58.

Portfolio

TIPP has consistently maximised its equity investments. As per its December 2006 portfolio, its top three sectors are banks, information technology and auto companies. It also invests in debt scrips of high credit quality.



How the Funds Have Fared
Returns (%)
Scheme NAV (Rs) 1 Year 3 Years 5 Years
TIPP 44.2 19.5 16.1 20.1
UTI RBPF 19.7 7.7 15 17
As on January 16, 2007

Get tax sops, reap returns

That’s what ELSS investments have to offer, coupled with other benefits

Sunita Abraham


Taxing times are here again. For most of us, this would mean parking more money in PPF or NSC to earn tepid returns, just to claim the tax break. This year, if you are looking to save tax and earn relatively higher returns, we suggest you take a look at Equity Linked Saving Schemes (ELSS). Coupled with other benefits such as shorter lock-in periods and tax-free dividends, the ELSS is definitely worth a slice of your Section 80C investments.

WHY ELSS?

ELSS is like any other diversified equity fund but investors can avail tax benefits, provided the investment is locked-in for a period of three years. How do these schemes stack up against other instruments permitted for tax planning?

The best performing ELSS scheme gave a three-year return of 64.5 per cent, while the worst performer in the period gave a return of 19.88 per cent. The eight per cent return from PPF and NSC hardly compare. ELSS scores on the liquidity front too, with a lower lock-in of three years compared to the PPF’s 15 years and six years of the NSC.

Unlike assured return schemes, ELSS does not guarantee returns, but if you are comfortable with taking a moderate risk for higher returns, ELSS is just the product for you.

WHICH ELSS?

Outlook Money offers you a shortlist for selecting the ELSS that is ideal for you. While the category as a whole has given impressive returns, we have selected five schemes that are definite candidates in any selection process. To remove period bias from the return, rolling returns were considered to shortlist these schemes. Other factors such as portfolio composition and risk-adjusted return (RAR) were considered to ensure that the risk is lower.

Franklin India Taxshield. This scheme, which has given steady returns since its inception, makes the grade on consistency. It is suitable for investors who are not looking for fireworks in their returns and are uncomfortable with volatility. It has a comparatively lower exposure to mid-caps and that explains the lower returns of 34.49 per cent that the fund has generated in the three-year period as compared to its peers. There is a high degree of concentration in the portfolio with the top five holdings constituting a huge 29.76 per cent and the top three sectors constituting almost 50 per cent of the portfolio. This exposes the scheme to the risk of under-performance by these companies/sectors.

HDFC Taxsaver. This is a star performer from the HDFC stable. In the one-year and three-year periods, its returns were 33.92 per cent and 51.70 per cent, respectively.

The scheme has a large-cap focus with the flexibility to move to other segments. This has helped the scheme generate good returns in most scenarios. It has a new fund manager and it remains to be seen if the fund will continue its past excellence.

Principal Tax Savings Fund. Principal tax saving scheme has rewarded investors with returns of 43.87 per cent, 41.99 per cent and 48.59 per cent, over one, three and five years, respectively.

The fund has consistently outperformed the category average by a wide margin since the portfolio was recast in 2004-05 to have greater exposure to mid- and small-cap stocks. Holding in individual companies do not exceed five per cent and top five companies constitute only 22 per cent of the now diversified portfolio. The smaller size of the fund, at around Rs 176, crore makes for easier implementation of fund management strategies.

Prudential ICICI Taxplan. This is the scheme for you if you are comfortable with higher risk for higher returns. With a portfolio that has more than 90 per cent in small- and mid-cap stocks, the fund gave excellent returns in 2004 and 2005 when these sectors outperformed the broader markets.

The fund returned 44.95 per cent in the last three years and 51.90 per cent in the last five years. With a one-year return of 25.92 per cent, the scheme has under-performed due to the poor run that the mid- and small-caps have had in the last six months.

The corpus of Rs 574 crore makes it one of the larger schemes. Finding avenues in the mid- and small-cap segment to deploy funds may become an issue.

SBI Magnum Tax Gain Scheme 93. This scheme finds a place in the best tax savings schemes on the strength of its outstanding performance in the last two years. The scheme turned the corner in 2003, with a shift in focus to mid-cap stocks, and has since outperformed the benchmark as well as peers by a wide margin. It has given returns of 44.55 per cent, and 64.51 per cent in one- and three-year periods.

The fund has now reduced mid-caps and increased large-cap stocks in the portfolio though mid-caps continue to have a dominant share. The scheme is suitable for investors comfortable with some volatility in returns.

The growth in the corpus, which stood at Rs 1,163 crore in December 2006, makes the fund less nimble, especially when investing in mid- and small-cap stocks, and the change in the management team since last year are triggers that the investor must watch out for.

WHEN TO BUY ELSS?

Timing entry into these schemes to take advantage of dividend declarations or lower NAVs when markets fall is not a sustainable strategy. Ideally, use systematic investment plans (SIPs) as they work to your advantage in a volatile market and a small investment made periodically is less heavy on the pocket than a lump sum one-time investment. Most SIPs can be started with an initial investment of Rs 5,000 and periodic investment of Rs 500.

ELSS provides the booster in returns to your tax planning. The ELSS, with its three-year lock-in, imposes a long-term investing discipline. However, the lock-in also has a flip side. If you make a wrong selection, you do not have an exit option for three years. This is where an existing scheme scores over a new fund offer as it gives you an idea of the efficiency of the fund management in good and bad markets.

The road ahead for your tax investments is clear. Evaluate and select a scheme, start an SIP, and have a well-balanced tax-planning portfolio.

Tax Axe on Investments?

Being an investor, and not a trader, makes a whole lot of difference to the tax liability of a person. We look at the tax implications that different investments have

Anil J. Sathe


Investors can choose from a variety of instruments and assets. While making the choice, they should also consider the tax axe that will fall on their investment. We take up the tax implications of investments here.

Types of Income. There are two types of income. One is earned from an asset while the investor holds it, say, interest, or dividend. The other is the gains or losses arising due to the transfer or relinquishment of the investment or asset.

Determinants of tax liability. To ascertain your tax liability, you need to ask yourself four questions:

Is the income from the asset exempt or entitled to deduction? For what period of time have you held the investment?

Under what head is the income taxable: capital gains, business income, or income from other sources?

What is the rate of tax applicable to the income?

It is the third question that creates the largest number of controversies. If a person treats his asset like a trader treats his stock, he will be assessed under the head business. If not, he will be assessed under the head capital gains or income from other sources. In this article, it has been presumed that the reader is an investor and not a trader. With this in mind, we analyse some popular categories of investments/assets. Education cess and surcharge, wherever applicable, are charged over and above the rates of tax. If a special rate does not apply, the income will be included in the income of the person and taxed according to the slab applicable. This has been mentioned as the normal rate.

Equity shares. You earn dividends while you hold an equity share. Dividends distributed by all domestic companies are exempt from tax. The tax on the income from sale or transfer of shares depends on whether they are a capital asset or stock (business asset). Some points that may be considered while deciding whether a person is an investor or trader.

Intention of the person;

The frequency of transactions during the year;

Whether the acquisition is being made with own funds or borrowed funds.

There are no definite guidelines in this regard. If the transactions are numerous and the individual has borrowed, there is a possibility of his being treated as a trader. In this case, the income will be taxed under the head business income and the period of holding will be immaterial. However, if the person is treated as an investor, the asset will be taxed under capital gains and the period of holding will determine his tax liability. If the share is held for one year or more, it will become a long-term capital asset. In such a case, if the share is listed and sold through a stock exchange, the transaction will attract the security transaction tax (STT). Apart from STT, the income from the transaction will be exempt. Other shares, like those of an unlisted private limited company, will attract 20 per cent tax. In case the equity share is listed and held for less than 12 months, it will attract 10 per cent tax, or the normal rate of tax depending on whether STT has been charged on the sale or not.

Mutual funds (MFs). Income distribution of MFs is exempt from tax. In most cases, an MF unit will be treated as a capital asset and not as stock-in-trade. If the fund is equity-oriented, then a gain on the transfer of a unit held long-term will be exempt. If it is held for short term, the gain will be subject to 10 per cent tax. In case of debt funds, the gains will be taxed at 20 per cent if the unit is held for long term, and at normal slabs if it is held for short term.

Derivatives. A derivative is a contract which confers the right to purchase or sell an underlying asset at a predetermined price at a future date. The asset can be the index (BSE Sensex or NSE Nifty), an equity share or a commodity. Such a derivative is called a “future”. A derivative in India is required to be settled by receipt/payment of difference.

The settlement of differences in respect of derivatives isn’t treated as speculation, and the income is taxed as either business income or income from other sources/capital gain. Derivative contracts need to be settled in less than 12 months and are, therefore, short-term assets. If there is a gain, the head under which the income is taxed is immaterial as no concessional rate of tax will apply and the income will be taxed at the normal rate. A loss, however, can be carried forward to the next year if treated as a loss under the head business or capital gain. Taxability will depend on whether the taxpayer is treated as an investor or a trader.

Gold/silver/precious metals. Gold is treated as a capital asset and the gain/loss from its transfer is taxed under the head capital gain. The gain/loss is computed under the head business only in case of jewellers or people who trade in precious metals. Investors will be also liable to wealth tax during the period that they hold gold/silver, subject to the overall exemption limit of Rs 15 lakh.

Paintings. If a painting is purchased for personal enjoyment, the gain from its sale is exempt from tax. However, if paintings are accumulated systematically with the intention of selling them at a later date, the gain from their sale will become chargeable as a capital asset. If the volume of acquisition or the frequency of sale is substantial, the gains may be treated as business income.

Real estate. Except in rare cases, gains from real estate are taxed under the head capital gains, with the rate depending on whether the period of holding is short-term or long-term. In rare cases, however, the real estate transactions may be treated as a business activity with the consequent gain/loss being regarded as business income.;

The author is a member of the Bombay Chartered Accountants’