MONEY MATTER

Tax planning for New Year

A N Shanbhag

Most taxpayers tend to defer their tax saving investments till March and then rush into putting their money into something with the sole objective of saving tax for the current year. The result of this is, at the end of the day, you end up tax saving but not tax planning.

Take for example Sec. 80C which is anyway the only meaningful deduction left. Under this section, as most of you would know, any investment up to Rs. 1.50 lakh made in certain specified instruments can be reduced from your taxable income.

There is a long list of eligible investments including an employee’s provident fund contribution, tuition fees paid for children, principal portion of housing loan installments, investments made in Public Provident Fund (PPF), Equity Linked Saving Scheme (ELSS), National Savings Certificates (NSC), Senior Citizen Savings Scheme, Post Office Term Deposits, Life Insurance Premiums paid etc.

Using 80C optimally

So how should an investor choose from amongst the various choices available? Here’s what you should do.

First take into account mandatory payments like employees provident fund, housing loan EMIs and tuition fees if applicable.

Reduce the total amount spent from the Rs. 1.50 lakh limit. Distribute the balance in a combination of ELSS and PPF. If you are relatively young and just starting out, put 70% into ELSS and 30% into PPF. As you advance, lower the ELSS and increase the PPF eventually reaching a 30% ELSS and 70% PPF combination.

Why PPF? Well, PPF is the best fixed income investment that you can make. An annual contribution of Rs. 1,50,000 will get you around Rs. 69 lakh in 20 years. Of course, this number is not precise but more of a ball park. The rate of interest is market linked now and not static as it was all these years. Also, the annual limit of Rs. 1.50 lakh can undergo changes over an extended period of time. Be that as it may, basically the idea is to give you an idea about how compounding works.

Also note that though PPF is essentially a 15 year scheme, we have used 20 years in the example. This is to showcase a small but important tip. Basically, after the first 15 years, the PPF account can be extended indefinitely – for a period of five years at a time. So in effect, after the first fifteen years, it becomes a recurring five year deposit.

An ELSS is nothing but an equity mutual fund that offers a tax deduction. On account of the tax deduction, there is a lock-in of three years on the investment.

The proportion of ELSS in your total tax saving investment should come down as age advances and the risk taking ability declines.

Old investments

Take the case of one of our friends, Amit, who is into web design. Amit’s lament was that he had over Rs. 5 lakh in receivables but customers in general were holding out for higher credit periods. Since our income tax law taxes income on accrual and not on receipt, this means he has to pay the tax on the Rs. 5 lakh not yet received. He was finding difficulty in arranging funds required to pay his employees for the month, so to keep anything aside for tax saving was a long shot.

In such cases, one can use another tax planning tool. We call it recycling. Amit can simply withdraw an earlier investment (say from ELSS or PPF) and redeposit the money, even in the very same instrument. He will get the tax deduction for no additional outlay – in other words, his savings remain the same, but without investing a rupee, he can avail himself of the 30% tax saving.

Last but not the least

Next year, instead of waiting till the fag end, start by investing in tax-saving avenues in the very beginning of the financial year, even on the 1st of April. Doing so has a two fold advantage. Firstly, these investments would earn a return from the beginning of the financial year (Apr-Mar). Secondly, often, many end up simply not having the lump sum required at one go for 100% tax saving. Realise that there is no compulsion that tax saving investments need be done towards the end of the year. A more efficient strategy is to invest throughout the year in a staggered manner so that by the time the year comes to an end; full advantage of the tax saving opportunity is taken. And don’t worry about how much or little you save each month. As Benjamin Franklin has so succinctly put it, “A penny saved is a dollar earned!”

(The authors may be contacted at wonderlandconsultants@yahoo.com)