Most of us seek to save on our income tax outflows but is it possible to save tax and also make smart investment choices? You can. Here are 7 fundamentals to make you a tax-smart investor.
Know the difference: If you are a salaried person, you may have claimed deduction on your home loan or children’s education or medical expenses. But remember a good part of these are expenses not investments. These are not going to help you build a kitty. Take maximum advantage of the investment options available for deduction under Section 80C of the Income Tax act.
Amplify returns: The tax benefit available on the capital you invest can significantly change the yield of investments that look unattractive at first notice. Take the case of the humble small savings scheme, National Savings Certificate (NSC). A five-year NSC with current interest rate of 8.6 per cent will generate a yield of 16.2 per cent if you are in the 30 per cent tax bracket. The cash outflow saved in the first year helps jack up overall returns.
Don’t delay: Most of us tend to invest towards the end f the financial year. If you can help it, complete your investments at the beginning of the year, to allow your capital to enjoy interest early on. This will also ensure too much tax is not deducted too early – as most employers start deducting tax in a phased manner from the initial part of the financial year.
If you cannot do this, try to invest as and when you have surplus. You can invest small sums in PPF or invest them in tax-saving funds.
Set goals: You seldom skip your insurance premium in any year. Similarly, ensure that you don’t skip your investments. Do this by setting goals against the NSC, ULIP, PPF or tax-saving fund. If you earmark this for your child’s education or marriage, chances are, you will be motivated to invest regularly.
Balance between regular and tax-saving investments: All the above said, saving tax need not be your only goal when it comes to investing. In the process of saving tax, do not miss out on investment options such as equities or bonds that may not offer deduction on your investments but deliver superior returns and are tax efficient.
What you keep matters: It’s not what you make but what you keep that matters. A bank deposit may offer 9 per cent returns but net of a tax (assuming 30 per cent), your returns are 6.3 per cent. That does not even beat inflation, which means you have negative returns. A diversified equity fund or a stock may not give you any upfront tax deduction but offers superior returns and nil capital gains tax in the long term.
Going long is tax efficient: Yes, holding long is tax efficient in case of most assets. In equities/debt funds, holding for over a year entails capital gains benefits. In most other assets too, longer holding (over three years) allows you to index the cost of your investment to current prices, thus reducing your tax burden. Unless there is a near-term requirement, hold gold, property or bonds for the long to generate high post tax returns.
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Due to ETE taxation, isn’t the annual interest accrued on NSC investment taxed (per tax bracket) ?
So can you explain the calculation used to conclude :
“A five-year NSC with current interest rate of 8.6 per cent will generate a yield of 16.2 per cent if you are in the 30 per cent tax bracket.”
Hi Amit, Interest on NSC (which is calculated on a half-yearly basis) is treated as reinvested every year under Section 80C. Hence, while it is on one hand a taxable income, since it enjoys Sec 80C deduction, it is not taxed in each of those years. But in the final year, as the interest is not reinvested it is taxed. In this case, the 5th year interest come of Rs 12303 is alone taxed. Taking in to account this tax deduction (at 30%), the net amount received in hand is Rs 1,48,659. Calculating IRR for this amount with year zero investment (it is taken as Rs 70,000 as the Rs 1 lakh would have reduced your cash outlow by 30% or 30,000). In other words, yield=(148659/70000)^1/5 which is 16.2%. Hope this clarifies. rgds. Vidya
Hi. Can you explain the logic behind 70000 figure.
Rohit, when you get enjoy tax deduction in the year of investment, you save cash outflow to the extent of the benefit in that year. Int this case, a person in 30% tax slab effectively reduces his cash outflow by 30% of investment of 1 lakh or 30,000. Hence, for all yield calculation purpose in tax-saving instruments, the net cash flow (net of tax saved) is used as the base year’s investment.
Vidya
how are foreign feeder mutual funds taxed, pl explain
Hello Reen,
Foreign feeder mutual funds are treated on par with debt mutual funds for taxation purposes. That short term gains are taxed at your marginal income tax level. Long term gains are taxed at 10% without indexation and 20% with indexation.
Hope this helps,
Srikanth
Hi,
Going long is tax efficient: Could you please explain this with some example. Its not completely clear.
Thanks in advance.
Regards,
Veeresh
Hi Veeresh, The longer you hold an asset the more tax efficient it gets. In equities holding more than one year exempts you from capital gains tax. In debt, holding more than one year would allow you to take indexation benefits. In other assets, whether immovable property or jewellery, you will get benefit of capital gain indexation if you hold the asset for more than 36 months before you sell. In the short term (less than 12 months for shares, Mfs and bonds and less than 36 months for other capital assets) the tax impact will be higher. This is what we meant by saying going long makes you tax efficient. – Vidya
Thank you very much for the information given Vidya.
I understood that If I hold any share of equity for more than 1 year I don’t have to pay any tax on the gain.
Could you please elaborate on what is indexation benefit.
Thank you again.
Regards,
Veeresh
Yes Veeresh, your understanding i right. Cost inflation index helps bring the cost of your investments to present value based on inflation. This way, it helps reduce your total gains, adjusting it for inflation. Read all about this index in this link: http://taxguru.in/income-tax/cost-inflation-index-meaning-and-index-for-all-the-years.html.
For equity funds since long term capital gains is exempt, there is no question of claiming indexation benefit. For debt funds held over one year, you can either choose to get indexation benefit and pay 20% capital gains tax or pay 10% capital gains tax without indexation benefit. – Vidya
Thanks for the information given.
Now I understood completely.
Hi all
Its d first year i am going to pay tax ao i hv very little knowledge abt these. Any hw I hv a small basic questions i wl b tnkful if sm1 cud guide
1. Say if my annual income is 2.4 lac hw much i need to invest in 80c tools. Will it b 2.4 – 1.8 = 60K
If your total income after all expenses (such as rent) and after Section 80C deduction is less than Rs 2 lakh, then you need not pay tax. In this case if you invest up to Rs 40,000 (or if you have expenses such as rent that you have not claimed) then you can bring your income to the Rs 0 – 2 lakh slab, for which the tax is nil.
FundsIndia should have a blog post or rather a section in the website telling about various tax rates for various investments like equity long term, equity short term, debt long term, Gold funds etc.
This information should be updated as and when law changes.
Such a place will help us plan our investement better and we will not have to go hunting other websites for updated info.
Thanks for your suggestion Mohit. We will work towards this.
An extension to Mohit’s request: Whenever we sell any fund units, we get an email for the sale transaction (specifying date, nav, units etc). Please consider adding 2 more columns to it – “Short Term Capital Gain”& “Long Term Capital Gain” This will make our life a lot easier to tax calculation.
Amit, the e-mail is a transaction note. You may pl. download the capital gains statement in our downloads section to view this.
Hi all
Its d first year i am going to pay tax ao i hv very little knowledge abt these. Any hw I hv a small basic questions i wl b tnkful if sm1 cud guide
1. Say if my annual income is 2.4 lac hw much i need to invest in 80c tools. Will it b 2.4 – 1.8 = 60K
If your total income after all expenses (such as rent) and after Section 80C deduction is less than Rs 2 lakh, then you need not pay tax. In this case if you invest up to Rs 40,000 (or if you have expenses such as rent that you have not claimed) then you can bring your income to the Rs 0 – 2 lakh slab, for which the tax is nil.
how are foreign feeder mutual funds taxed, pl explain
Hello Reen,
Foreign feeder mutual funds are treated on par with debt mutual funds for taxation purposes. That short term gains are taxed at your marginal income tax level. Long term gains are taxed at 10% without indexation and 20% with indexation.
Hope this helps,
Srikanth
Hi,
Going long is tax efficient: Could you please explain this with some example. Its not completely clear.
Thanks in advance.
Regards,
Veeresh
Hi Veeresh, The longer you hold an asset the more tax efficient it gets. In equities holding more than one year exempts you from capital gains tax. In debt, holding more than one year would allow you to take indexation benefits. In other assets, whether immovable property or jewellery, you will get benefit of capital gain indexation if you hold the asset for more than 36 months before you sell. In the short term (less than 12 months for shares, Mfs and bonds and less than 36 months for other capital assets) the tax impact will be higher. This is what we meant by saying going long makes you tax efficient. – Vidya
Thank you very much for the information given Vidya.
I understood that If I hold any share of equity for more than 1 year I don’t have to pay any tax on the gain.
Could you please elaborate on what is indexation benefit.
Thank you again.
Regards,
Veeresh
Yes Veeresh, your understanding i right. Cost inflation index helps bring the cost of your investments to present value based on inflation. This way, it helps reduce your total gains, adjusting it for inflation. Read all about this index in this link: http://taxguru.in/income-tax/cost-inflation-index-meaning-and-index-for-all-the-years.html.
For equity funds since long term capital gains is exempt, there is no question of claiming indexation benefit. For debt funds held over one year, you can either choose to get indexation benefit and pay 20% capital gains tax or pay 10% capital gains tax without indexation benefit. – Vidya
Thanks for the information given.
Now I understood completely.
FundsIndia should have a blog post or rather a section in the website telling about various tax rates for various investments like equity long term, equity short term, debt long term, Gold funds etc.
This information should be updated as and when law changes.
Such a place will help us plan our investement better and we will not have to go hunting other websites for updated info.
Thanks for your suggestion Mohit. We will work towards this.
An extension to Mohit’s request: Whenever we sell any fund units, we get an email for the sale transaction (specifying date, nav, units etc). Please consider adding 2 more columns to it – “Short Term Capital Gain”& “Long Term Capital Gain” This will make our life a lot easier to tax calculation.
Amit, the e-mail is a transaction note. You may pl. download the capital gains statement in our downloads section to view this.
Due to ETE taxation, isn’t the annual interest accrued on NSC investment taxed (per tax bracket) ?
So can you explain the calculation used to conclude :
“A five-year NSC with current interest rate of 8.6 per cent will generate a yield of 16.2 per cent if you are in the 30 per cent tax bracket.”
Hi Amit, Interest on NSC (which is calculated on a half-yearly basis) is treated as reinvested every year under Section 80C. Hence, while it is on one hand a taxable income, since it enjoys Sec 80C deduction, it is not taxed in each of those years. But in the final year, as the interest is not reinvested it is taxed. In this case, the 5th year interest come of Rs 12303 is alone taxed. Taking in to account this tax deduction (at 30%), the net amount received in hand is Rs 1,48,659. Calculating IRR for this amount with year zero investment (it is taken as Rs 70,000 as the Rs 1 lakh would have reduced your cash outlow by 30% or 30,000). In other words, yield=(148659/70000)^1/5 which is 16.2%. Hope this clarifies. rgds. Vidya
Hi. Can you explain the logic behind 70000 figure.
Rohit, when you get enjoy tax deduction in the year of investment, you save cash outflow to the extent of the benefit in that year. Int this case, a person in 30% tax slab effectively reduces his cash outflow by 30% of investment of 1 lakh or 30,000. Hence, for all yield calculation purpose in tax-saving instruments, the net cash flow (net of tax saved) is used as the base year’s investment.
Vidya