ASSIGNMENT

ON

TAX PLANNING REGARDING SAVINGS AND INVESTMENMTS

Submitted in partial fulfillment for the degree ofMASTERS OF BUSINESS ADMINISTRATION

MBA(2009-2011)

SUBMITTED BY : RISHABH KEDIA

MBA-CMROLL NO. -901112037

INSTITUTE OF MANAGEMENT SCIENCE LUCKNOW

INTRODUCTION

Tax Planning is described as the practice of making adjustments so as to reduce one's tax liability to the least possible amount. For example, one may wait to sell a security until the next tax year so as not to realize capital gains.

Tax Planning India is an application to reduce tax liability through the finest use of all accessible allowances, exclusions, deductions, exemptions, etc, to trim down income and/or capital profits. 

Salaried individuals in India are not fully aware of the tax planning exercise which is why they rush at the end of the tax-planning season and make investments to reduce their tax liability. This has negative effect on tax payable by them and they eventually end up paying more taxes than they are required to. For this reason tax planning is of utmost importance.

OBJECTIVE

The objective of tax planning is Optimization of one’s wealth.

Tax-planning can reduce tax accountability of salaried people by following ways:-

1. Make full use of the entire Section 80C deduction –  

The maximum reduction available in Section 80C is Rs 100,000 and salaried citizens whose gross salary is Rs 250,000 or more are entitled to use the full Rs 100,000 limit. 

Individuals who make monetary infusions of over Rs 100,000 in Section 80C in selected areas fail to understand that the advantages are limited. In spite of investing Rs 70,000 and Rs 40,000 in Public Provident Fund and ELSS respectively, the amount entitled by the investor is only Rs 100,000. 

Following investments/contributions meet the criteria for Section 80C reduction:

Public Provident Fund Accrued interest on National Saving Certificate Life Insurance Premium National Saving Certificate Tuition fees paid for children's education (maximum 2

children) Principal component of home loan repayment 5-Year fixed deposits with banks and Post Office Equity Linked Savings Schemes (ELSS)

2. Reduction of tax liability beyond Section 80C deductions –

 If salary surpasses Rs 250,000 pa and the reductions under Section 80C are not enough to minimize the general tax liability consider the following:

Home loan: Interest payments of up to Rs 150,000 pa are entitled for reduction under Section 24.

Medical insurance: A deduction of up to Rs 15,000 pa under section 80D is applicable under this.

Donations: Tax advantages under Section 80G entitle the donations to particular funds/institutions.

3. Assert tax advantages on house rent paid –  

If HRA is not included in the salary structure then the salaried individuals can asset rent paid by them for residential lodging. This reduction is accessible under Section 80GG and is smallest amount of the following: 

25% of the total earnings or, Rs 2,000 every month or, Surplus of housing charge paid over 10% of total salary.

4. Reorganize the salary –  

Reorganizing the salary and incorporating certain apparatus can help in the long run in minimizing the tax liability. In order to assert tax benefits salary reform is a more competent measure. The following can be included in an individual's salary structure: 

Food coupons can release up to Rs 60,000 per year from tax. Medical expenses which are compensated by the employer

spare up to Rs 15,000 per year. House Rent Allowance (HRA) should be incorporated in the

salaries of individuals who stay in rented houses Transport allowance discharge up to Rs 800 per month.

5. Go for a combined home loan –  

The primary reimbursement on a home loan is entitled for a reduction of up to Rs 100,000 pa and the interest rewarded is entitled for a reduction of up to Rs 150,000 pa. When a home loan is for a considerable amount then the interest and chief reimbursement surpass the allotted limit. A salaried individual can go for a combined joint home loan with his parent, spouse or sibling, to guarantee the best utilization of tax advantages. 

In this way both the owners can assert tax reductions in the percentage of their stake holding in the loan.

The double benefits a tax payer can avail under the Indian personal income tax laws. The dual benefits are tax savings coupled with higher returns on investment. Also it does not require much of a financial expertise. An income tax payer with a little knowledge of his income computation and tax calculation can easily understand the tax saving legally.

Other Investments-

A tax payer after computation of his total income has to do some tax planning may be with the help of his chartered accountant (financial consultant).

Apart from the statutory deduction in the form of Provident Fund (PF) as an employee contribution to Provident Fund for salaried persons, a tax payer can benefit from a tax break if a contribution to Public Provident Fund (PPF) is made. This contribution is voluntary and there is a maximum limit of Rs 70,000 per year that can be invested along with other eligible investments/expenditures (u/s 80C of Income tax act) will be clubbed together for a tax deduction of not more than a sum of Rs 100,000.

The advantages of investing in PPF are:-

* The interest earned on PPF account is completely tax free.

* The tax free rate of interest at 8 per cent is comparatively higher than most other fixed income tax saving instruments.

Some constraints and benefits for the investor or tax payer are:-

* Once invested in PPF, the amount gets blocked for a period of 15 years.

* The investor can, however, withdraw some amount from his account after the completion of the sixth year, subject to prescribed conditions.

From the seventh financial year onwards, each year the investor can withdraw up to 50 per cent of the balance at the end of the fourth preceding year or the year immediately preceding the withdrawal whichever is lower. The tax payer or the investor is also allowed to take a loan against PPF balance, subject to limits.

* The minimum amount permissible for investment in PPF is Rs 500 and the maximum amount permissible is Rs 70,000, per person, per annum. The limit of Rs 70,000 is not prescribed in the Income Tax Act but it is prescribed in the Public Provident Fund Scheme.

One is entitled to get deduction from taxable income to the extent of Rs 70,000 per financial year, irrespective of whether the tax payer has made a contribution to PPF account or the PPF accounts of spouse or child irrespective of whether he or she is a minor / major, dependent / independent, married / unmarried.Since the overall ceiling of PPF contribution per person per annum is Rs 70,000, one can derive a further benefit from the PPF scheme by gifting surplus funds to spouse or major child so that they can contribute to their PPF accounts and claim a deduction of up to 70,000 per account per annum, in case they are filing their tax returns. In case they do not file their returns, it will merely build up their capital base for the future.

Equity Linked Savings Schemes (ELSS), also called tax saving schemes, are a highly popular investment avenue since they offer investors benefits that go beyond those available in other diversified mutual funds. They come with a tax benefit under section 80C, which enables to claim a deduction of up to Rs 100,000 per annum, to the extent of the investment, in keeping with the stipulations of this section. Beyond that, the three year lock in period, which characterizes this product, encourages savings. However, most retail investors still seem to be at a loss

when it comes to selecting between an existing ELSS plan and a New Fund Offer (NFO).

DEDUCTIONS UNDER SECTION-80(C)

Background for Section 80C of the Income Tax Act (India) / what are eligible investments for Section 80C:

Section 80C replaced the existing Section 88 with more or less the same investment mix available in Section 88.  The new section 80C has become effective w.e.f. 1st April, 2006.  Even the section 80CCC on pension scheme contributions was merged with the above 80C.  However, this new section has allowed a major change in the method of providing the tax benefit.  Section 80C of the Income Tax Act allows certain investments and expenditure to be tax-exempt.  One must plan investments well and spread it out across the various instruments specified under this section to avail maximum tax benefit. Unlike Section 88, there are no sub-limits and is irrespective of how much you earn and under which tax bracket you fall.

The total limit under this section is Rs 1 lakh. Included under this heading are many small savings schemes like NSC, PPF and other pension plans. Payment of life insurance premiums and investment in specified government infrastructure bonds are also eligible for deduction under Section 80C

Most of the Income Tax payee tries to save tax by saving under Section 80C of the Income Tax Act.  However, it is important to know the Section so that one can make best use of the options available for exemption under income tax Act.   One important point to note here is that one can not only save tax by undertaking the specified investments, but some expenditure which you normally incur can also give you the tax exemptions.

Besides these investments, the payments towards the principal amount of your home loan are also eligible for an income deduction. Education expense of children is increasing by the day. Under this section, there is provision that makes payments

towards the education fees for children eligible for an income deduction

Sec 80C of the Income Tax Act is the section that deals with these tax breaks. It states that qualifying investments, up to a maximum of Rs. 1 Lakh, are deductible from your income. This means that your income gets reduced by this investment amount (up to Rs. 1 Lakh), and you end up paying no tax on it at all!

This benefit is available to everyone, irrespective of their income levels. Thus, if you are in the highest tax bracket of 30%, and you invest the full Rs. 1 Lakh, you save tax of Rs. 30,000.

Qualifying InvestmentsProvident Fund (PF) & Voluntary Provident Fund (VPF)  

PF is automatically deducted from your salary. While employer’s contribution is exempt from tax, your contribution (i.e., employee’s contribution) is counted towards section 80C investments. You also have the option to contribute additional amounts through voluntary contributions (VPF). Current rate of interest is 8.5% per annum (p.a.) and is tax-free.

Public Provident Fund (PPF)

 Among all the assured returns small saving schemes, Public Provident Fund (PPF) is one of the best. Current rate of interest is 8% tax-free and the normal maturity period is 15 years. Minimum amount of contribution is Rs 500 and maximum is Rs 70,000. A point worth noting is that interest rate is assured but not fixed.

Life Insurance Premiums:

Any amount that you pay towards life insurance premium for yourself, your spouse or your children can also be included in Section 80C deduction. Please note that life insurance premium paid by you for your parents (father / mother / both) or your in-laws is not eligible for deduction under section 80C. If you are paying premium for more than one insurance policy, all the premiums can be included. It is not necessary to have the insurance policy from Life Insurance Corporation (LIC) – even insurance bought from private players can be considered here.

Equity Linked Savings Scheme (ELSS)

 There are some mutual fund (MF) schemes specially created for offering you tax savings, and these are called Equity Linked Savings Scheme, or ELSS. The investments that you make in ELSS are eligible for deduction under Sec 80C.

Home Loan Principal Repayment

The Equated Monthly Installment (EMI) that you pay every month to repay your home loan consists of two components – Principal and Interest. The principal component of the EMI qualifies for deduction under Sec 80C. Even the interest component can save you significant income tax – but that would be under Section 24 of the Income Tax Act. Please read “Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage”, which presents a full analysis of how you can save income tax through a home loan.

Stamp Duty and Registration Charges for a home

 The amount you pay as stamp duty when you buy a house and the amount you pay for the registration of the documents of the house can be claimed as deduction under section 80C in the year of purchase of the house.

National Savings Certificate (NSC)

National Savings Certificate (NSC) is a 6-Yr small savings instrument eligible for section 80C tax benefit. Rate of interest is eight per cent compounded half-yearly, i.e., the effective annual rate of interest is 8.16%. If you invest Rs 1,000, it becomes Rs 1601 after six years. The interest accrued every year is liable to tax (i.e., to be included in your taxable income) but the interest is also deemed to be reinvested and thus eligible for section 80C deduction.

Infrastructure Bonds

These are also popularly called Infra Bonds. These are issued by infrastructure companies, and not the government. The amount that you invest in these bonds can also be included in Sec 80C deductions.

Pension Funds – Section 80(CCC)

This section – Sec 80CCC – stipulates that an investment in pension funds is eligible for deduction from your income. Section 80CCC investment limit is clubbed with the limit of Section 80C – it means that the total deduction available for 80CCC and 80C is Rs. 1 Lakh. This also means that your investment in pension funds up to Rs. 1 Lakh can be claimed as deduction u/s 80CCC. However, as mentioned earlier, the total deduction u/s 80C and 80CCC cannot exceed Rs. 1 Lakh.

5-Yr bank fixed deposits (FDs)

Tax-saving fixed deposits (FDs) of scheduled banks with tenure of 5 years are also entitled for section 80C deduction.

Senior Citizen Savings Scheme 2004 (SCSS)

A recent addition to section 80C list, Senior Citizen Savings Scheme (SCSS) is the most lucrative scheme among all the small savings schemes but is meant only for senior citizens. Current rate of interest is 9% per annum payable quarterly. Please note that the interest is payable quarterly instead of compounded quarterly. Thus, unclaimed interest on these deposits won’t earn any further interest. Interest income is chargeable to tax.

5-Year post office time deposit (POTD) scheme

POTDs are similar to bank fixed deposits. Although available for varying time duration like one year, two year, three year and five year, only 5-Yr post-office time deposit (POTD) – which currently offers 7.5 per cent rate of interest –qualifies for tax saving under section 80C. Effective rate works out to be 7.71% per annum (p.a.) as the rate of interest is compounded quarterly but paid annually. The Interest is entirely taxable.

NABARD rural bonds

There are two types of Bonds issued by NABARD (National Bank for Agriculture and Rural Development): NABARD Rural Bonds and Bhavishya Nirman Bonds (BNB). Out of these two, only NABARD Rural Bonds qualify under section 80C.

Unit linked Insurance Plan

ULIP stands for Unit linked Saving Schemes. ULIPs cover Life insurance with benefits of equity investments. They have attracted the attention of investors and tax-savers not only because they help us save tax but they also perform well to give decent returns in the long-term.

WHAT TO INVEST?

Like most other things in personal finance, the answer varies from person to person. But the following can be the broad principles:

Provident Fund

This is deducted compulsorily, and there is no running away from it! So, this has to be the first. Also, apart from saving tax now, it builds a long term, tax-free retirement corpus for you.

Home Loan Principal

If you are paying the EMI for a home loan, this one is automatic too! So, it comes as a close second.

Life Insurance Premiums

Every earning person having dependents should have adequate life insurance coverage. Therefore, life insurance premium payments are the next.

Voluntary Provident Fund (VPF) / Public Provident Fund (PPF)

If you think that the PF being deducted from your salary is not enough, you should invest some more in VPF, or in PPF.

Equity Linked Savings Scheme (ELSS)

After the above, if you have not reached the limit of Rs. 1, 00,000, then you should invest the remaining amount in Equity Linked Savings Scheme (ELSS).

Equities provide the best, inflation-beating return in the long term, and should be a part of everyone’s portfolio.

WHEN TO INVEST?

Many people start looking for investment avenues only in

February or March, just before the Financial Year is getting over. This is a big mistake! One, you would end up investing their money without putting proper thought to it. And secondly, people would end up losing the interest / appreciation for the whole year. Instead, decide where they want to make the investments, and start investing right from the beginning of the financial year – from April. This way, people would not only make informed decisions, but would also earn the interest for the full year from April to March.

OPTION IN DEBT INSTRUMENTS

Debt based instruments usually have the nature to guarantee the principal amount of the investor and hence come with lower investment risk in comparison to equity based instruments. Few

years ago small investors used to invest most of their money in debt based instruments due to limited availability of other options, for example Deposit schemes (Bank Fixed deposits, Post office deposits, company deposits), debt mutual funds, saving schemes (PPF, NSC) and liquid funds etc. However, there has been a major shift in the personal finance sector during the last few years. Many innovative and hybrid investment instruments have been introduced in the market in personal finance space which has made this space more interesting and confusing.

Debt instruments should be part of every investor’s investment portfolio. Inclusion of debt based investment instruments provides stability to the portfolio and reduces the overall portfolio risk. However, the percentage allocation towards the equity versus the debt based instruments should depend upon the risk profile of the investor and the study of prevailing market conditions. Although debt instruments are considered a relatively safe investment option, there is a hierarchy of risk even among these. In fact the pure debt based instrument does not provide the returns even to cover the ongoing inflation rate which means a negative return on a net basis. An investor has to look for the trade-offs between risk, return and liquidity while making an investment decision.

These are various types of debt based investment instruments available in the market:

Small savings schemes

These are government schemes or bank deposits and therefore one of the safest investment instruments available in the market, for example bank deposits, public provident funds, National Savings Certificate etc. The returns net of tax are attractive under

most of these schemes as they offer tax benefits. However, most of these schemes are not very attractive in terms of liquidity (usually these schemes come with a long term lock-in period).

Liquid funds

These instruments are very good options for the short term investment needs. They provide maximum liquidity, however much lesser returns than other debt based savings schemes. Liquid or liquid plus funds come with a lock in period of a maximum of three days. The funds in liquid funds are as liquid as savings deposit. The returns in liquid plus funds is slightly higher as they come with higher lock-in period as well. Therefore, if an investor is parking a big amount of money for short term, he can look for investing it in liquid /liquid plus funds.

Company deposits

For company deposits, again investors should check the investment ratings by rating agencies. The returns offer on company deposits floated by blue-chip companies are similar to regular bank deposits. On the other hand, from a risk perspective, NCDs are less risky than company deposits as they are secured against some assets.

Hybrid products

There are a lot of hybrid types of products that offer a balance with respect to risk versus returns. Some of these instruments offer a fixed percentage of investment allocation towards debt and remaining into the equity with the option to investor to change the allocation based on his needs. Also there are some innovative products in the hybrid categories which promises to guarantee the principal amount but the returns are linked to some equity based milestones. There has been a major revolution in the personal finance space during the last few years. There are a lot of investment options available in the market but the key for success lies in the patience, portfolio balancing and maintaining a regular touch with your portfolio investments and the developments around them. 

THE BEST TAX SAVING INVESTMENTS AND OPTIONS FOR THE CURRENT ASSESSMENT YEAR (AY 2010-11)

During the last few months of a financial year you see people making last moment impulse decisions to invest in tax saving instruments and in the process they may end up buying products which are not right for them. Tax planning should be done a few months in advance as it gives you ample time to understand and evaluate different options that are specific to your financial situation. Start your tax planning now for Assessment Year 2010-11.Here are some simple tips for planning your taxes this financial year:

I .Utilize Income Tax exemptions

Section 80(C )

This is the most popular exemption as you can claim up to Rs. 1 lakh in deductions. The options include Employee Provident Fund (EPF), Public Provident Fund (PPF)- up to Rs.70,000 per annum, National Savings Certificate (NSC), 5-year bank fixed deposits, Life insurance policies, Equity-Linked Savings Schemes (ELSS), Unit Linked Insurance Plans (ULIPs), school fees, and home loan principal repayment. For making investments in this section you will have to decide on the ideal debt vs. equity mix that is right for you based on your age, risk-return profile and goals.  Section 80(D)

If you have taken a medical insurance plan for yourself, your spouse, dependant parents or children, you can claim deductions up to Rs 15,000 (and additional Rs.15,000 for your parents’ medical insurance) under Section 80D for the premiums paid. The

limit now has been enhanced to Rs 20,000 for senior citizens on the condition that the premium is paid via cheque.   Section 80(DD)

Expenses on the medical treatment of a dependent with a disability qualify for tax benefits under Section 80DD. In this case, deductions up to Rs. 50,000 or 75.000 can be claimed based on the severity.      

II. Interest on your home loan

The interest component of your home loan is allowed as a deduction under the head ‘income from house property’ under Section 24(b) up to a limit of Rs 1.5 lakhs a year in case of a self-occupied house. The claim can be made even on loans taken for repair, renewal or reconstruction of an existing property.  

III. Shuffle and switch strategy

Shuffling is a popular strategy used by ELSS investors which have a mandatory lock-in of 3 years. If you have been investing Rs 50,000 for the past few years and don’t have cash to invest this year, you can easily redeem investments made 3 years ago and re-invest that amount this year to claim the benefits. You will not have to pay any long term capital gains since you will be redeeming after more than a year. Thus you can enjoy tax benefits without making any fresh investments. Only risk is that the NAV can go up or down in the shuffle process and you may end up making a small profit or loss. Some fund houses allow switch option for tax benefits. Let’s say an investor with previous ELSS investments doesn’t have money to make further investment in the current financial year 2008. He could consider switching it to a liquid fund and back into the ELSS

fund within a short span of time like 10-15 days to enjoy the tax benefits.   

IV. Charitable donations are tax smart

While donations should not be made simply for tax purposes but for philanthropic reasons, you can always make a couple more at the end of the year to lower your tax. You get a tax relief if you donate to institutions approved under Section 80G of the Income Tax Act. The rate of deduction is either 50 or 100 per cent, depending on the choice of the charity fund. There is no restriction on the amount given to charity. However, donations must be made only to specified trusts and also only donations of up to 10 per cent of your total income qualify for such a deduction. Remember to get receipts whenever you make any charitable donation. Please remember that tax exemption is only an added advantage of charity and it should not be the primary reason for doing so.   

V. Divide your income

Normally, if you invest in your wife’s or child’s name, the income generated from such investments will be clubbed with your income and taxed accordingly. However, if you transfer money through a deed to a child who is over 18 years of age and invest in his name, then the income generated from such investment will not be clubbed with your income. Instead, that will be clubbed with the income of your child/wife and taxed accordingly.Cash gifts received from specified relatives are exempt from income tax and there is no upper limit. Similarly, cash gifts of any amount and from anyone received during your child birth, marriage or any other specified event are totally tax-free. However, any cash received from a non-relative where the value

is in excess of Rs 50,000 in a particular year will be considered as income in the hands of the recipient.You should make sure that you have a record & valid receipts for all tax savings investments made in your name. You do not want to be running around at the last minute collecting all the documents required for tax filing.        In a nutshell remember the following-

Combine your Tax Planning with your Financial Plan so that the products you invest in match your risk profile and your future goals

A home loan is not necessarily a bad debt. Consider getting a loan while buying a home.

Charity is good- not only for the receiver, but the giver as well; Check on the validity and receipts before you claim that deduction u/s 80G

Take advantage of the tax breaks that the IT sections 80C, 80D and 80DD offer.

Insuring oneself makes sense- as the premium is exempt u/s 80C (upto 1 lakh) and the maturity amount is tax free

By taking medical insurance, you not only insure your family against medical expenses, you also get a tax deduction u/s 80D- so take that cover today!

File your taxes on time!

MINIMIZE   CAPITAL GAIN

Capital Gain   from Transfer of a Residential House-

Exemption   of   Capital Gains   u/s 54

Any long-term capital gains arising on the transfer of a residential house (including self-occupied house) will be exempt from tax if,

Conditions

1) If the assessee has within a period of one year before or two years after the date of such transfer purchased, or within a period of three years constructed, a residential house.

2) The assessee must not transfer the new house, within a period of three years from the date of its purchase or construction, as the case may be. Otherwise the exemption allowed under this section shall be reduced from the cost of the new house, in computing the capital gains arising there from.

3) If the whole or any part of the capital gain cannot be so utilized for acquisition a residential house before filling the return, the same should be deposited in Capital Gains Accounts Scheme, 1988 in order to claim exemption, before the due date for furnishing the return.

How much amount will be exempt?

The amount of exemption available is equal to the amount so utilized or the amount of capital gain, whichever is less.If the amount of capital gain is appropriated towards purchase of a plot and also towards construction of a residential house thereon, the aggregate cost should be considered for determining the quantum of deduction, provided that the acquisition of plot and also the construction thereon, are completed within the specified period as aforesaid.

In simple words, capital gains shall be exempt to the extent it is invested in the purchase and/or construction of another house.