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The strategy
All income on your investible funds can be made tax-free, legally! Surprised? Well, I shall be more explicit. Suppose you are in the 30% tax bracket. You have Rs. 50 lakhs investible funds. You earn a modest interest of 10% p.a., from a safe source. On this income of Rs. 5 lakhs (10% of Rs. 50 lakhs), you would pay a hefty
Rs. 1,30,200 tax, inclusive of the 5% surcharge.
I claim, you do not have to pay even one single rupee as tax, legally! How can this be achieved?

PODs
Pure-growth, Open-ended, Debt-based schemes (PODs) of UTI/MFs have emerged as a great avenue for investment. I like these because ---

1. Being Pure-growth, these attract the concessions of long-term capital gains after a holding period of just one year.
2. Being Open-ended, the investor can deposit money any time he has investible funds and can redeem partly or fully any time he needs funds. The repayment is effected within 5 working days at most. Many of them are operating at no load, or a nominal load, either at entry or exit. Thus, these have become virtually, savings bank accounts with much higher returns.
3. Being Debt-based, the returns are modest but normally higher than the normal market rate and are almost assured.

Tax on Long-term Gains
Starting with FY 81-82 as the base year, the central government notifies the 'Cost Inflation Index' (CII) every year. Long-term gains are computed by deducting from the full value of the consideration indexed cost of acquisition. Such gains are charged to tax at a flat rate of 20%. You cannot avail of any tax deduction under section (u/s) 80L, 80D etc., or the tax rebate u/s 88 in respect of such gains. However, tax rebate u/s 88B for senior citizens or u/s 88C for non-senior women is certainly applicable. The most beneficial part is --- where the liability to tax arises in the case of an individual or an HUF only because of the inclusion of long-term capital gains in the total income, tax will be levied at the capital gain tax rate on the excess over the minimum taxable limit i.e., Rs 50,000.
For example, if you have Rs. 20,000 normal income, after claiming the deductions u/s 80L, 80D, 80G etc., and have earned capital gains of Rs. 55,000, you will be required to pay tax only on Rs. 25,000 (20,000 + 55,000 - 50,000).

Pure-growth, Open-ended, Debt-based schemes (PODs) of UTI/MFs have emerged as a great avenue for investment.

Sec. 54EC & ED
Contributions to avenues u/s 54EC within 6 months of earning capital gains are exempt from tax on capital gains. Full exemption is available if the amount of contribution equals or is more than the capital gains. Lower contribution attracts proportional exemption. The lock-in is 3 years. Bonds of NABARD, NHAI and REC are covered by the section. The budget proposes to add Bonds of NHB and SIDBI to the list with a lock-in of 3 years are available. Contribution to IPOs give the same benefit u/s 54ED. Here the lock-in is of only 1 year.

The Strategy
An example will clarify the utility of these investment avenues and tax provisions. We assume that your normal income has taken you to 30% tax bracket. You have Rs. 50 lakhs investible funds and can earn a growth rate of 10% in an MF scheme and --- this is most important --- you require Rs. 5 lakhs every year, over and above your normal after-tax income, for your day-to-day expenses.
Please read on even if you do not have Rs. 50 lakhs. If you have Rs. 10 lakhs (and not 50), all that you have to do is to divide the figures by 5. I entreat you to understand the fundamental principle and be guided by it.

Short-term
Now, suppose the NAV of the POD at the point of your entry is Rs. 10 and it grows by 10% to Rs. 11 in one year. For some strange reason, you withdraw Rs. 5 lakhs from this fund on the 364th day, just one day prior to the completion of one year. This is short-term gain which is taxed at the normal rate. What is the quantum of this short-term gain? Have a look at Table-1.

The normal concept is that the short-term capital gains are taxed at the normal rates applicable to the assessee and therefore, there is no difference between earning income through capital gains and earning income as interest (or dividend). This is a misconception. The fact is that the total growth is Rs. 5 lakhs and the amount withdrawn is also Rs. 5 lakhs.
In other words, we are stripping growth. A large portion, Rs. 4,54,545 to be precise, of the amount withdrawn is capital in nature and therefore, not taxable. What is taxed is only Rs. 45,455. What is available for consumption is Rs. 5 lakhs. The tax works out at less than 3%, even if you are in the highest tax zone, thanks to your other income.
The rest of the growth remains invested and not taxed. By using this strategy, you are 'Investing Income and Consuming Capital'.

Long-term
What if you withdraw just after 366th day? In that case, you are eligible to the benefit of indexation of cost.
The cost inflation index for FY 01-02 is 426 and for the previous FY 00-01 was 406. We find that the indexed cost is Rs. 4,76,936 (= 454545 x 426 / 406). The long-term capital gains are Rs.23,064.The tax payable @20% will be Rs. 4,613. The capital gains without indexation is Rs. 45,455. This is taxed @10%. Therefore, the tax is Rs. 4,546. The tax payable will be Rs. 4,546 (being lower of the two. With surcharge, it is Rs. 4,773 (= 0.95%). Even this small tax can be saved by parking Rs. 23,064 in bonds of NABARD or NHAI.

Any-term
What if you have no other income? In that case, your total income is Rs. 45,455. This being lower than the tax threshold of Rs. 50,000 the tax liability on the Rs. 5 lakhs withdrawn is nil!
Since you have your capital of Rs. 50 lakhs intact at end of the year, you can adopt the cycle for next year and all the subsequent years! Unless, of course, the tax provisions are changed by a subsequent Act.
Note that the increase of the surcharge from 2% to 5% has no effect on this strategy. Finally, this analysis assumes indexation benefit for only one year. Higher the holding period, better is the effect of indexation. Moreover, and this is the most amazing part, there is no need to look at any tax-saving devices, including deduction u/s 80L and rebate u/s 88.

To Sum
PODs are currently giving a yield, much higher than dream yields (See Table-2). This is due to the mark-to-market method of computing the NAVs which temporarily climb up when the interest rates are cut and descend down when the interest rates are hiked up. The above calculations assumes a growth rate of 10%, in view of the interest rate sliding down.
Obviously, PODs are slated to be a major investment vehicle of tomorrow. Mr. Sinha is thankfully forcing you to start today. Finally, those of you who have some risk appetite, may use the same strategy with equity-based schemes of UTI/MFs. Indeed, India has become tax haven.