Come March and all the salaried and business people are worried alike. Reason being – tax declaration. It’s that time of the year when all you can think of is how to save maximum tax by employing all the legit means. Of course, to cater to these demands there are various saving and investment schemes available. Saving tax is important. However, the tax mechanism of our country is so complex, there are so many sections, subsections and income tax slabs that most people, instead of trying to wrap their brains around it prefer to file their income tax return as it is and be done with it. But that’s not the right approach. Though it’s little difficult to understand, saving tax is a critical part of wealth creation. Even if you don’t understand the entire thing, it’s essential that you have a thorough understanding of the taxes that directly hamper your income. And it is in the best interest of your financial goals that you know how to save maximum tax.
Let’s explore this unusual beast called Tax and in the course of this article, we will also shed light on the most effective tax saving tools and how to sync it with your investment portfolio.
First Things First – How To Save Tax?
The good news is that there are various windows in income tax framework which offer various incentives and allowances for the taxpayers. The most popular amongst the salaried class is section 80C. However, apart from 80C, there are plenty of other tax saving brackets which a smart investor should chance upon. Let’s take a holistic look at all of them.
1. Section 80C – The Most Popular – If you invest money in the instruments specified by the government, in return, the government offers you certain tax concessions. It is in the interest of the authorities to promote the culture of saving amongst the general populace. Section 80C, 80CCC and 80CCD are some of the sections which have a lot to offer. However, there is a catch. The maximum combined deduction in all the above-mentioned section is Rs.1,50,000. That, too, if you have done a disciplined investment all through the year in the prescribed instruments.
Following are the investment instruments which are specified under section 80C, 80CCC and 80CCD
2. Life Insurance Premium (LIC)
3. National Savings Certificate (NSC)
4. Equity Linked Savings Scheme (ELSS)
5. 5 years fixed deposits with banks and post office
6. Tuition fees paid for children’s education, up to a maximum of 2 children
As our objective is not just tax saving but to get good returns, we will have to choose the investment instrument which will give the best returns. We will discuss the best investment instruments amongst the above mentioned later in the article.
2. Section 80D, 80DD and 80DDB – Another route to save tax is section 80D. The Income tax act allows taxpayers to save tax if they are buying health insurance. If you are spending for the health insurance for yourself and your parents and relatives then you can claim the deduction. The amount allowed for deduction varies in all these sections.
3. Section 80C (Home Loan) – If the you have taken a home loan, then you are eligible to claim a deduction on the principal amount of the loan. Furthermore, you can also claim a deduction on the interest that you have paid on the home loan under section 24. The maximum deduction allowed under this section is Rs.2,00,000, however, in some cases, there is no limit for claiming a deduction for the payment of interest on the home loan. One should always utilise the home loan for a tax deduction as for home loans tax deduction can be claimed in 3 different sections which give a huge tax relief to the taxpayer.
4. Save Tax Through Education Loan – If you have taken an education loan for yourself, your spouse or your children or even for a student for whom you are a legal guardian then you can claim tax deduction under section 80E, however, this tax relief is only available on the interest on the loan and not on the principal amount. Also, only individual taxpayer can claim deduction under this section.
5. Long-Term Capital Gains – If you have gained from the long-term capital asset, you can claim tax exemption under Capital Gains tax provided you invest the amount gained in the specified instruments. An asset is considered as a long-term capital asset if it is held for more than 3 years by the taxpayer.
6. Long-Term Capital Gains From Equity Shares – To encourage people to invest more in equity (stock market) and mutual funds, the IT act allows a complete tax exemption on the gains you get from selling the equity shares provided you have held the shares for more than 1 year. If you have sold the shares before completing 1 year, you are liable to pay tax on the gains. 15 percent tax, to be precise.
After studying all the tax provisions it becomes clear that the government and the income tax act offers various deductions and tax exemptions. In order to encourage saving and investment, the government has prescribed various investment mediums, investing in which can give you considerable tax relief. However, the glitch is that not all the mediums that government suggests are good for investment. For example, investing in LIC will give you tax relief but wouldn’t be a good investment as the returns are not good enough. To find a golden middle, investors have to find the best and the most tax efficient investment instruments at the same time they shouldn’t lose focus on their financial goals.
Let’s find out investment instruments which save tax and also give good returns.
Public Provident Fund (PPF) – Is the most reliable and trustworthy investment scheme as it is operated by the government. However, PPF investment comes with certain stern conditions like 7 years lock-in period plus certain limitations on the quantum of investment like you can invest minimum Rs.500 or maximum Rs.1,50,000 in a year. It is one of the favourite Tax saving instruments of the investors as it gives compound returns. Under section 80C you can claim up to Rs.1,50,000 deduction by investing in PPF. To get the tax benefits, it’s advisable that some portion of your income should be allocated to PPF, however, it provides fixed returns and the interest rates get reviewed (read slashed) periodically. Hence, it should only be looked at a tax savings scheme and not a wealth creator.
Mutual Funds – Is one of the smartest and the most dynamic tools of equity investment. Mutual funds are available in equity, debt and liquid forms. All these types of mutual funds have their own set of pros and cons which depend on the Asset Management Company (AMC) managing the fund. Equity is a dynamic investment domine while debt offers risk-free growth. On the other hand, liquid funds offer, as the name suggests, extreme liquidity without any exit load. But does mutual fund offer tax benefits? The answer is no. The mutual fund is not a government specified instrument for tax saving. However, in case of equity funds, the returns you get are tax-free provided you hold the fund for more than one year. This is called long-term capital gain benefit.
Does Government Allow Deduction On Equity Investment?
Under section 80CCG, the provision which is also known as Rajiv Gandhi Equity Saving Scheme (RGESS). Under this section any taxpayer with the annual income less than 12 lakh p.a. is allowed to claim the deduction if he/she is investing in shares of the companies specified by the government. However, this benefit can only be availed by the first time investors. Those who have earlier invested in stocks/mutual funds are not eligible to claim deduction under this scheme.
However, stock investment is a good alternative if you have a long-term view.
Direct Equity investment – Many people try to avoid direct exposure to stock investment due to fear and ignorance. But there are means like stock advisory firms to help you reduce risk in stock investment. Over the years, stock investment has given uncapped growth to the investors. Every smart investor should have a stake in equity. As we discussed above, equity has the ability not only to keep the value of your money on the equal footing with inflation but also a step or two ahead. In the context of tax, equity investment offers tax-free income if the shares are held for more than 1 year. This is the advantage of the long-term capital gain which taxpayers can avail.
ELSS – The Best Tax Saver
Equity Linked Saving Schemes (ELSS) is one of the types of Mutual Fund. It works the same way as MF. Just like in a mutual fund, in ELSS, your asset management company will pool your’s and the other investors’ money and invest it across sectors. A bigger pool of money will attract greater returns while the losses can be spread out. The point where ELSS becomes different than mutual fund comes with a lock-in period of 3 years. In ELSS, you cannot liquidate your funds before 3 years. On the other hand, in mutual funds, there is no lock-in period. For the tax saving purposes, the investment in ELSS becomes very attractive. You become eligible for tax sops under Section 80C of the Income Tax Act as you can claim tax deductions. Other Mutual Funds do not offer this benefit. There are many ELSS Reliance Tax Saver available.
Things To Remember While Investing In ELSS
ELSS is essentially a tax saving mutual fund. All the ELSS schemes come with the lock-in period of 3 years. The good thing about ELSS is that it gives better returns than all the tax-saving investment instruments that are specified by the Income Tax Act i.e. PPF, NPS, ULIP, etc. However, under section 80C you are only allowed a deduction up to Rs.1,50,000 for investment in ELSS. Thus it is prudent only to invest that much amount in ELSS and if you have any surplus amount you should invest it in an open-ended mutual fund which offers more growth and high liquidity.
Too Complicated, Isn’t It? Let’s Simplify
The tax relief one can claim under Section 80C is Rs.1,50,000. It simply means, whether you invest in ELSS or PPF, the deductible amount remains the same. For example, in a financial year, if you have invested Rs.50,000 in PPF, Rs.50,000 in ELSS and Rs.80,000 in LIC, the total invested amount is Rs.1,80,000. However, you can only deduct Rs.1,50,000, which means the extra Rs.30,000 will be taxable.
We can look at it this way – the amount of Rs.30,000 that exceeds the prescribed deductible amount, which is now taxable, could have brought better returns had it been invested in a better place. While planning your tax you should always ensure that you put the exact amount of money in IT act specified mediums and the rest should stay firmly invested for purpose of wealth creation.
In a financial year, if you make any donations to charity you can claim tax deduction under section 80G of Income Tax. There are some pre-specified organisations like National Relief Fund to which taxpayer can donate. In this scenario, the only condition is that the donation has to make either by cash or cheque. In some case, 100% of the donation amount is allowed to be deducted while in some case only 50% amount can be deducted.