Investment and Tax Planning

What is Tax Planning?

Tax planning is the process of analyzing and managing your finances from an income tax perspective. More specifically, it is done to reduce the tax liability through a combination of investments and by claiming deductions and exemptions available under various provisions of the Income Tax Act. In other words, tax planning is the optimal utilization of exemptions, benefits, and rebates with suitable investments.

Importance and benefits of early tax planning

  • Avoid paying extra tax - For salaried individuals, employers are considered responsible for deducting applicable tax based on an employee’s salary and their investment declarations. This is done in the form of Tax Deducted at Source (TDS) from the salary and paid on behalf of the employee. If sufficient tax-saving declarations are not made, employers may deduct a higher tax towards the end of the year and while you may get a refund later, your money will remain blocked for that duration.
  • Well researched and planned financial goals - Starting tax planning early gives you time to research and visualize measurable financial goals. Understanding the various provisions and deductions available under the Income Tax Act can help make smart investment choices. It may also induce change in spending patterns and getting accustomed to new financial habits.
  • No last-minute hassle - Planning early and recording financial transactions throughout the year helps avoid last-minute rush and hassles. Knowing potential tax liability in advance also facilitates better cash flow and allows you to tap all available deductions and exemptions in an organized manner. Keeping the documentation of all financial transactions handy also minimizes errors, omissions and glitches while filing income tax returns.
  • Liquidity for tax-saving investments - More often than not, people wait till the end of the year to make a lumpsum investment in tax-saving instruments. However, this can be difficult in uncertain economic conditions. Any volatility in the market can add unnecessary strain or financial burden and may even cause you to miss the investment targets. Thus, spreading the amount and allocating funds throughout the year allows you to manage liquidity.

Difference between tax planning, tax avoidance and tax evasion

The terms tax planning, tax avoidance and tax evasion are often confused and used inter changeably. From a legal perspective, the three are very distinct and the implications of not understanding them can be quite damaging. The table below will help to analyze these three terms better -

 

Tax Planning

Tax Avoidance

Tax Evasion

Meaning

To save on taxes by using provisions of the law.

To avoid payment of taxes by using loopholes in the law.

To evade paying tax through fraudulent means.

Attributes

Done with bonafide intentions and is legal.

Done with malafide intentions, may be legal, but immoral.

Done with malafide intentions, illegal and immoral.

Outcomes

Helps an individual reduce tax liability and enhances financial planning.

Can be questioned by the authorities and could lead to litigation.

Could lead to financial penalties, imprisonment.

 In a nutshell, tax planning is legal and done within the provisions of the law. On the other hand, tax evasion is a punishable crime.

Do’s and Don’ts of tax planning

Do’s

Don’ts

Start early, think long term: Like wealth creation, it is advisable to start early and think long term from a tax perspective too.

Don’t think tax planning is an independent activity: It is rather part of your overall financial plan and is done to reduce your taxable income and tax liability.

Prioritize health and life: Ensure adequate cover in the form of health and life insurance.

Don’t evade tax: Understanding what is tax planning and what is evasion or avoidance, can be very helpful.

Look beyond basic deductions: Besides the most popular section 80C, the IT Act offers several other avenues for reducing tax liability.

Don’t forget to opt for the right tax regime: Ensure to check the suitability of the tax regime every year based on your income and financial plan.

Plan cash flow for investments: Plan for and make your tax-saving investments through the year to avoid a cash crunch at the end of the year.

Don’t go for block investments: Like all investments, tax-saving instruments also vary in returns, it is advisable to evaluate options to spread the risk.

Stay organized: Keep records and receipts for all financial transactions as well as old tax returns and documents in an organized manner.

Don’t wait till the last day: Racing against the deadline to make tax-saving investments and to file your ITR may cause errors and omissions.

Deductions and investment avenues for tax planning

The Income Tax Act offers deductions on certain investments and payments. These deductions are applied before computing your income tax liability. Some of the popular tax-saving instruments are:

  • Equity Linked Savings Scheme (ELSS): Also known as tax saving mutual fund, ELSS is an equity-based mutual fund offered by registered Asset Management Companies or mutual fund houses. Linked to the equity market, it has the potential to earn smart returns and is recommended for people with a slightly higher appetite for risk. Investments up to ₹1,50,000 for a minimum duration of 3 years are eligible for deduction. Investors can use their existing Demat account to make investments in ELSS funds.
  • Unit Linked Insurance Plan (ULIP): A combination of insurance and investment, ULIPs are offered by insurance companies. A portion of the money paid is allocated to provide life insurance and the balance is invested in equity or debt instruments. Investment up to ₹1,50,000 qualifies for deduction under Section 80C and gains upon maturity are exempt from tax, provided the annual premium paid is less than ₹ 2.5 lakhs.
  • Sukanya Samriddhi Yojana (SSY): This is a tax-saving deposit scheme launched by the Government for the all-round development of the girl child. Sukanya Samriddhi Account can be opened at the Post Office or any authorized bank by the parent or guardian of a girl child before she turns 10 years old. An annual deposit of up to ₹1,50,000 is tax deductible. The Interest on the deposit is compounded annually and is fully exempt. All withdrawals and receipts upon maturity are also exempt from tax.
  • Public Provident Fund (PPF): It is one of the most popular tax-saving investment schemes offered by banks and post offices. It is a long-term investment with a lock-in period of 15 years with provision for partial withdrawal every year after 7 years. Individuals can contribute a minimum of ₹500 and a maximum of ₹1,50,000 in multiples of ₹50 in an account in a financial year. The best feature of PPF is the triple tax exemption it offers - on the amount of contribution, the interest earned and the proceeds upon maturity.
  • National Pension System (NPS): It is a retirement-focused, long-term investment option open to all Indian citizens between the age of 18 and 70 years. The basic idea behind NPS is simple but very powerful. Invest while you are earning and get regular income in the form of an annuity when you retire. Restriction on withdrawal before retirement provides a long time to allow the money to grow. There are many prudent restrictions about the avenues where money contributed by NPS subscribers can be invested by pension fund managers. This helps in generating a decent rate of return on the corpus at comparatively less risk and relatively lower cost.
  • Some other popular investment options / deductions:

Section

Description

Annual Deduction Limits (in ₹)

80C

Investment in stipulated instruments, Payment of insurance premium, contribution to PPF, repayment of housing loan etc.

 

₹ 1,50,000

80CCC

Contribution towards pension products offered by LIC or other insurers – up to ₹1,50,000

80CCD

Employees Contribution towards pension scheme – up to 10% of Salary

80D

 - Premium paid for medical insurance for self, spouse and children

 - Senior Citizen

₹ 25,000

₹ 50,000

 - Premium paid for medical insurance for parents – Others

 - For Senior Citizen

₹ 25,000

₹ 50,000

80DD

 - Expenditure on maintenance and medical treatment for dependents with a disability

 - For Severe Disability

₹ 75,000

 

₹ 1,25,000

80DDB

 - Expenditure on medical treatment of specified serious diseases and ailments for self and dependents

 - For senior Citizen

₹ 40,000

 

₹ 1,00,000

80U

 - Deduction for persons with disability

 - For Severe Disability

₹ 75,000

₹ 1,25,000

80E

Interest Paid on Education Loan (for up to eight years)

Full amount

80G

Donation to approved funds and charitable institutions

100% or 50%

80GGC

Donations to registered political parties and electoral trust

100%

Understanding capital gain and capital loss on investment

  • Capital gain in the case of investments like shares and mutual funds is the profit made on sale or redemption. If the selling price is more than the purchase price, it is called capital gain. And if the selling price is lower, the difference is known as capital loss.
  • The terms long-term capital gain (LTCG) and short-term capital gain (STCG) refer to the duration for which a financial asset or investment was held. If equity share or equity-oriented mutual funds are sold before 12 months, the profit earned is considered STCG. If the holding period is more than 12 months, then it is considered LTCG.
  • The Income Tax Act has no provisions to allow setting off of losses against any income or other heads except against capital gains. Long-term capital loss can only be set off against Long term capital gain and Short Term Capital Losses can be set off against both LTCG and STCG. Both Short Term and Long Term Capital Losses can be carried forward for eight years after the year the loss is incurred. So, if you booked a loss of ₹25,000 on a stock after holding it for over a year, you can set it off against any long-term capital gain and any remaining loss can be carried forward for eight years.

Tax on Equity and Debt Mutual Funds

Type of gain

Equity Fund

Debt Fund

LTCG

Exempted till ₹1,00,000. Then tax @ 10% without indexation.

20% with indexation

STCG

15%

As per income tax slab

How to calculate STCG and LTCG while filing returns?

Calculating STCG and LTCG while filing IT returns requires 4 elements: 

1. The purchase price

2. The selling price

3. Date of purchase 

4. Date of sale

For example: Let us consider an individual who has purchased 1,000 shares of a company at ₹1000 each for a total cost of ₹10,00,000. If he sells the shares within 1 year for a price of ₹1,250 per share, he will make a STCG of ₹2,50,000 and if he sells it at ₹1,500 per share after 1 year, he will book a LTCG of ₹5,00,000.

Thanks for reading the Article


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