Don't Evade, Avoid Taxes

Every year, taxpayers try to save and invest so that they minimise their income tax liability and maximise their disposable incomes. Tax planning, as part of the overall financial planning exercise, helps figure out how to make full use of the breaks on offer.

Only, while doing this, one needs to decide whether he just wants to save taxes or instead wants a goal-based investment portfolio.

Investment related tax breaks:
In India, 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 Saving 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, comes with a dual advantage. In addition to giving an assured and fixed return, it comes as a tax break.

It is a one time investment with no commitment to pay in future. However, the entire interest income from such deposit is taxable.

• Public Provident Fund (PPF): It is a self directed investment option with a compulsive 15 year investment tenure. It currently earns a tax free return of 8 percent.

• Employees’ Provident Fund (EPF): This is a forced contribution that happens in the life of an employee. Twelve percent of the basic pay is deducted from the monthly salary and invested into a kitty maintained either by the government or the company’s trust.

The contribution currently earns a tax free return of 8.5 percent and is fixed by the government every year in March-April.

• Home loan repayment: The interest payable on home loans taken on or after April 1, 1999 is tax deductible up to Rs. 1.5 lakh a year. A principal repayment of up to Rs 1 lakh a year also qualifies for this rebate.

• Children’s fees: Under Section 80 C, parents can claim a deduction for tuition fees – up to Rs 12,000 per child - for a maximum of two children.

However, any payment towards any developmental fees or donation to the institution are excluded.

• National Savings Certificate: This government backed security is specially designed for the risk averse category. Available at post offices, it comes with an interest rate of 8 percent, compounded half yearly. The interest is entirely taxable and has a lock in period of 6 years.

• Equity linked savings schemes (ELSS): Under this scheme, those with a penchant for risk stand to gain from the benefits of the equity market returns.

However, these plans have a lock in period of 3 years and ELSS does not allow moving out of the investment in case of market volatility.

• Life insurance: The premium that is paid towards a life insurance policy is eligible for tax deduction up to Rs 1 lakh under Section 80C.

However, if the premium paid in any year during the term of the policy is more than 20 percent of the sum assured, then deduction only for premiums up to 20 percent of the sum assured is allowed.

• Health insurance: Under Section 80 D, medical insurance premium of up to Rs 10, 000 is tax deductible. While for senior citizens (65 or above) this limit extends to Rs 15, 000 a year.

• Pension plans: Premiums of more than Rs 10, 000 on pension plans are eligible for tax deduction under Section 80CCC.

Risk and return share a close relationship with each other. With sectoral caps removed from this year on, investors can make investments based on their risk appetite and need.

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 instruments and, hence, short term and long term objectives should be clear before locking in the funds.

The value derived through liquidity, returns and security over the years should be an integral part of the investment decision.