K N Sharma

Governments levy taxes to balance their budgets and to execute their statutory obligations which include defending country's borders, maintaining law and order, creating infrastructure and ensuring provision of basic amenities to citizens like education, health services etc. Citizens are expected to pay taxes in order to enable the Government to perform its duties. Governments are elected by citizens and are mandated by them to frame tax and other laws. However, whenever, energetic and innovative finance ministry officials announce some new variety or category of taxes (for eg. Service tax, banking transaction tax, fringe benefit tax and so on), citizens cry FOUL.
This tussle between citizens and governments is centuries old and is likely to last till eternity. Let's admit, no one likes to pay taxes smilingly. Taxmen are feared and taxes are dreaded.
Ironically, governments keep on inventing and discovering new taxes, new ways to collect taxes, new laws to ensure wider coverage and compliance and citizens,on the other hand, keep pace by finding new ways to save taxes and new means to stay out of Tax net.
Despite this inherent conflict between tax-payers and tax-collectors, tax collections have improved substantially in the current fiscal.
More and more numbers of law abiding citizens are coming forward, declaring their income from various sources, paying due taxes and breathing comfort, peace of mind and sense of pride. How did this turnaround in mental attitude and perception happen? The reasons are not difficult to find. These include sufficient simplification of tax-laws and procedures, introduction of several tax saving avenues and above all buoyancy in economy which has given rise to substantial increase in earning levels and disposable incomes of citizens in high and middle income strata of society.
Encouraged by buoyancy in tax collections FM Mr Chindarabam has hinted for further lowering of tax rates in the forthcoming budget in Feb 07. This is surely music to ears of millions of tax-payers.
Section 80 C is the most important section for saving tax or for reducing tax-liability. All tax-payers (individuals only) regardless of income levels, age, gender or profession can get a deduction of upto Rs 1,00,000 in their incomes by investing or spending this amount on a variety of instruments . How to spread this maximum deductible amount of rupees one lac becomes the crux of tax-planning and also provides opportunities to create long term wealth while tax in the current year.
The list of investment-cum-insurance and other options to which Rs.1 lac can be on is quite exhaustive. It includes contribution to Provident Fund, ELSS, Insurance Plans, Bank Deposits of 5 years and above, National Savings Certificates, repayment of principal amount of Housing Loan and Payment of Tuition Fees for up to 2 children, etc. The rationale for inclusion of Tuition Fees and Bank Deposit, etc is not easy to comprehend. It encourages people to avoid risk which is an essential element of the wealth creation process.
Continuous contribution to EPF/GPF/PPF (as the case may be) helps taxpayers to build up a sizable corpus which comes in handy at the time of retirement. Current yield ranges from 8% p.a. to 8.5% p.a. tax-free and is highly attractive when compared to other fixed income options such as bank deposits where interest income is fully taxable.
In PPF, maximum contribution in a financial year is capped at Rs.70,000/- . However, in case of EPF and GPF, there is no upper limit and complete deduction under section 80-C can be availed by contribution to Provident Fund alone.
Wealth cannot be created without taking risk. However, risk can be managed or minimized if one follows the principles of asset allocation. ELSS is one such option where taxpayers can regularly contribute out of their current income, in the process save tax U/s 80-C and also hope for creating long-term wealth for meeting their life goals, like children's education, children's marriage and retirement, etc.
ELSS as a product category has posted highest yield among all equity oriented Mutual Fund Schemes over the years. Equity Linked Saving Schemes (ELSS) are managed by leading Mutual Funds and the investors' contributions are mainly invested in shares of Companies with a potential of upside movement. The Fund Manager constructs a diversified portfolio and the scheme has a 3 years lock-in period. This lock-in period helps the Fund Manager to take long-term calls on certain shares which he feels will unlock their value in time to come, thereby giving rise to attractive returns. Here also, instead of lump sum investment, taxpayers should consider the option of contributing through Systematic Investment Plan (SIP), say Rs.5,000/- p.m. or Rs.8,000/- p.m.
Unit Linked Insurance Plans (ULIP) are another attractive options from Life Insurance Companies where annual premiums paid qualify for deduction from taxable income under Section 80-C. Regular contributions to ULIP ensures continuous protection for the family through the coverage of life (sum assured) and also taxpayers can hope to receive a sizable corpus at the maturity of the plan because many ULIP schemes invest more than 50% of the amounts mobilized in equity related products. However, please remember that one must buy a ULIP plan with a fairly long-term perspective, say 20 years or more as the expenses tend to be lower for a longer period policy and the returns tend to improve due to longer time horizon and the power of compounding.
For senior citizens, ideal break up of Section 80-C will be Rs.70,000/- in PPF and Rs.30,000/- in ELSS.
For taxpayers in the age group 40-60 years, the ideal break up will be Rs.30,000/- in PPF, Rs.40,000/- in ELSS and Rs.30,000/- in ULIP. For individuals below 40 years, the ideal break up will be Rs.60,000/- in ELSS and Rs.30,000/- in ULIP and Rs.10,000/- in PF.
The above should be followed as a thumb rule. One must consult a financial planner to understand one's risk taking capacity and then accordingly decide on the break up of Section 80-C deduction of Rs.1,00,000/-.

TAX LIABILITY
Filing of Income Tax Return

1. Filing of income tax return is compulsory for all individuals whose gross annual income exceeds the maximum amount which is not chargeable to income tax i.e. Rs. 1,35,000 for Resident Women, Rs. 1,85,000 for Senior Citizens and Rs. 1,00,000 for other individuals and HUFs.
2. The last date of filing income tax return is July 31, in case of individuals who are not covered in point 3 below.
3. If the income includes business or professional income requiring tax audit (turnover Rs. 40 lakhs), the last date for filing the return is October 31.
4. The penalty for non-filing of income tax return is Rs. 5000.

Tax Free Incomes
The following incomes are completely exempt from income tax without any upper limit.

1. Interest on PPF/GPF/EPF.
2. Interest on GOI tax free bonds.
3. Dividends on Shares and on Mutual Funds.
4. Any capital receipt from life insurance policies i.e., sums received either on death of the insured or on maturity of life insurance plans. However, in case of life insurance policies issued after March 31, 2004, exemption on maturity payment u/s 10(10D) is available only if the premium paid in any year does not exceed 20% of the sum assured.
5. Interest on savings bank account in a post office.
6. Long term capital gain on sale of shares and equity mutual funds if the security transaction tax is paid/imposed on such transactions.

Dividend Income
Dividend income from companies /equity-oriented Mutual Funds is completely exempt in the hands of investors. Dividend is also tax-free in the hands of investors in case of debt-oriented Mutual Fund schemes. However, the asset management company is liable to deduct 22.44% distribution tax in case of non-individuals /non-HUF investors and 14.025% in case of individuals or HUF investors.

Gift Tax: Gift tax was abolished with effect from October 1, 1998. The gifts are no longer taxable in the hands of donor or donee. However, with effect from September 1, 2004, any gift received by an individual or HUF will be included in taxable income, provided the amount of gift exceeds Rs25,000. However, gifts received from any of the following will continue to remain tax free:

1. Spouse
2. Brother or sister
3. Brother or sister of the spouse
4. Brother or sister of either of the parents of the individual
5. Any lineal ascendant or descendant of the individual
6. Any lineal ascendant or descendant of the spouse of the individual
7. Spouse of the person referred to in (2) or (6) Also, gifts received on the occasion of marriage or under a will by way of inheritance are also tax free

Capital Gains
Capital gain arises when certain assets like property (plot or a built up commercial residential unit) or shares/mutual fund units/bonds etc are sold for a profit. The treatment of capital gains is slightly different from other sources of income as listed above. It mainly depends upon whether the capital gain (profit on sale) is short term or long term.

Short Term Capital Gain
Capital gain is considered to be short term if immovable property is sold /transferred within three years of acquisition. Similarly, if shares or other financial securities such as mutual fund units are sold within
one year of purchase, the profit earned is treated
as short term capital gain.
Short term capital gain is included in the gross taxable income like other sources of income and
normal rates of tax apply, which depend on the gross taxable income from all sources including short
term capital gains.
With effect from October 1, 2004, the only exception is short term capital gains from sale of equity shares or units of equity oriented mutual fund schemes. In this case, short term capital gains are taxed at a flat rate of 10%, irrespective of the tax slab on other sources of income, provided securities transaction tax is paid on such sale.

Long Term Capital Gain
If immovable property is sold after three years of purchase, or financial securities such as shares, deep discount bonds, units of open - ended or close - ended schemes of mutual funds (including UTI) are disposed of (sold/redeemed/transferred) after holding the same for more than twelve months, then the gain is considered to be long term capital gain.
With effect from October 1, 2004, long term capital gain on transfer of listed shares/units of equity oriented mutual funds schemes has been exempted from tax, provided securities transaction tax has been paid on such sale.
For assets other than listed shares/units of equity oriented mutual fund schemes, tax is payable in respect of long term capital gains at a flat rate of 20% and the amount of gain has to be adjusted for inflation. This inflation adjustment is known as indexation benefit. Every year the Government of India announces inflation adjustment rate for the purpose of long term capital gain. A detailed chart is given below:
Long-Term Capital Gains arising from sale/ transfer of bonds and debt securities (including units of debt-oriented mutual fund schemes)
Long-Term Capital Gains tax in respect of bonds and debt securities is payable at a flat rate of 10% of the capital gains amount. But it should be noted that this lower rate of tax @ 10% will be applicable in respect of such bonds and debt securities, which are listed on any recognized stock exchange and also for units of debt-oriented mutual fund schemes. However, there is an option to avail the indexation benefits, but in that case tax will have to be paid at the normal Long-Term Capital Gain tax rate of 20%.
But how do you choose between the two options - pay capital gain tax @ 20% with indexation benefit or @ 10% without indexation benefit? We can make this choice clearer with the help of an example.

Example 1
Mr Singhal had invested Rs 2,00,000 in a Bond Fund (debt-oriented Mutual fund Scheme ) on March 20, 2003. He redeemed his investment on September 15, 2006 and received redemption proceeds of Rs 2,48,000.

Thus, Mr Singhal has earned a Long Term Capital Gain of Rs 48,000. He has an option to pay tax @ 10% of the capital gain amount i.e Rs 4,800. On the other hand, he can consider the second option of claiming indexation benefit. In that case, the current value of his investment with indexation benefit will be :

Rs 2,00,000 x = 2,32,215
In this case, the Long-Term Capital Gain amount is Rs (2,48,000-2,32,215) = Rs. 15,785 on which he is required to pay capital gains tax of Rs 3,157 only @ 20%.
Thus, through the above example, we can see that the second option is better for Mr. Singhal, as he needs to pay only Rs 3,157 as Long-Term capital gains Tax on Rs 48,000 of gain amount.

Section 54 EC
In order to save capital gain tax, the total amount of Long -Term Capital Gain (after availing indexation benefit) has to be invested in any of the following two schemes specified under section 54EC.
1. Bonds issued by Rural Electrification Board (REC)
2. Bonds Issued by NHAI (National Highways Authority of India)

NOTE: These bonds have a minimum lock-in period of three years. If 100% capital gain amount is invested in the above-mentioned bonds, 100% tax is saved. Similarly, if 60% of capital gain amount is invested, in that case only 60 % of capital gain tax will be saved and the balance 40% tax has to be paid.
(At the time of going to the press, none of the
above mentioned two government companies were accepting capital gains bonds subscriptions and as a result many citizens are in a quandary as to how to save Capital Gain tax.)

Point to Ponder:
In case of sale/ transfer of residential house, the same must have been held for at least three years. Only in that case, the gain (profit on sale) shall be considered as Long-Term Capital Gain. Tax on Long Term Capital Gain can also be saved by buying another house within a period of two years from the date of sale or by constructing a new residential house within three years of sale.

Deduction under section 80D.
Under this section, a deduction of up to Rs 10,000 (Rs 15,000 if at least one of the insured is a senior citizen) is allowed in respect of premium paid by cheque towards health insurance policy, like "Mediclaim". Such premium can be paid towards health insurance of spouse, dependent parents as well as dependent children.
Accordingly a person who is/ falls in the 30% tax bracket can save income tax up to Rs 3,060 (or Rs. 3366 if the annual income exceeds Rs 10,00,000) by paying Rs 10,000 as premium for "Mediclaim" policy in a year.

Deduction under section 24(b)
Under this section, interest on borrowed capital for the purpose of house purchase or construction is deductible from taxable income up to Rs. 1,50,000 with some conditions to be fulfilled.

An Example of Proper Tax Planning
Mr Abhay, 35, a manager in a software company, earns an annual salary income of Rs. 12,09,000. He has existing investments of Rs 2 lacs in 8% GOI Bonds and Rs 2 lacs in 6.5% Tax-Free Bonds. He has also taken housing loan. In the F.Y. 2006-07, he shall pay a total sum of Rs 1,20,000 towards the refund of Housing Loan and the break-up will be Rs 45,000 as principal and Rs 75,000 as Interest. He visits his investment advisor for tax planning. His investment advisor suggests the following:
The total tax liability of Mr. Abhay without Tax Planning investments under section 80C and 80D is Rs. 3,30,990 (tax-Rs 2,95,000, surcharge-Rs. 29,500, education cess Rs. 6,490) The tax liability after investments under section 80C and 80D is reduced to Rs. 2,93,964. Hence, Mr. Abhay has saved Rs 37,026 in taxes (Rs.3,30,990-Rs. 2,93,964) Similarly, a person who has retired should allocate his funds at his disposal among various assets classes (cash, debt , stocks etc) in consultation with an experienced financial advisor. The thumb rule is to park bulk of the funds in avenues and options offering assured return to ensure a regular cash flow and minimize his tax out go.
Every citizen has a fundamental right to avail all tax incentives provided by the government. Therefore, through prudent tax planning, not only is the income tax liability reduced, but also a better future is ensured due to compulsory savings in highly safe government schemes. We sincerely advise all our readers and clients to plan their investments in such a way that the post-tax yield is the highest possible keeping in view the basic parameters of safety and liquidity.