You could be paying more tax due to faulty investment strategies, poor knowledge of rules and lethargy. Here's how to avoid doing so;
Many people believe they are paying too much tax. They could be right.
Faulty investment strategies, poor awareness about rules and tardiness could be extracting a high tax from some investors.
The most common reason for paying higher tax is the inability to avail full deduction under Section 80C. If you procrastinate tax planning, there's a good chance you won't be able to utilise the '1.5 lakh tax-saving limit. "If you save regularly, you won't face any problem at the end of the financial year," advises Sudhir Kaushik, Cofounder and Chief Financial Officer of Taxspanner.com. If you are following a faulty investment strategy or are not aware of the rules that can help save tax, the information below can prove invaluable for you.
INVESTING IN TAX-INEFFICIENT OPTIONS Nearly 56% of total household savings are parked in fixed deposits in India. But these are very tax inefficient. The entire interest earned on the fixed deposit is taxed as income at the rate applicable to the investor. In the highest tax bracket, 30.9% tax pares the post-tax yield of these deposits significantly. Recurring deposits, infrastructure bonds, NSCs and Kisan Vikas Patra get the same tax treatment.
You have to pay tax on the interest that accrues every year, even though you might get the amount only on maturity. If you invested in a 10-year cumulative fixed deposit in April 2014, you will get the principal and the interest in 2024.But you will have to pay tax on the interest it earns every year.
But there are other more tax efficient debt instruments on offer. Debt funds allow you to defer the tax till you withdraw the investment. If you hold them for three years, you also get the benefit of lower tax. The income from debt funds is treated as long-term capital gains after three yea'and taxed at 20% after indexation. Indexation takes into account the inflation during the holding period and accordingly adjusts the buying price to reduce the tax liability of the investor. An investor in the 30% tax bracket would have to pay '9,670 in tax on a 3-year fixed deposit of '1 lakh. But if he invests in a debt mutual fund or a 3-year FMP, he can get away by paying a tax of only '175 (see table).
NOT UTILISING HRA BENEFIT
The house rent allowance (HRA) is usually a substantial chunk of the salary . Those living in rented accommodation can avail of deduction under Section 10(13A). If you live in your own house, you can't avail of this deduction. However, if you live in your parents' house, there is a way out. You can pay them rent and claim HRA exemption. This is possible only if the property is registered in the name of your parent. This is a useful strategy if you are in the higher tax bracket and your parent's income is lower.
Your parent will be taxed for the rental income after a 30% deduction. So, if you pay your father a rent of '4.2 lakh a year ('35,000 a month), he will be taxed for only '2.94 lakh. If the parent is a senior citizen with no other taxable income, one can effectively pay '35,700 a month without adding a rupee to his tax liability. Mumbai-based Gargi Jain (see picture) uses this clause very effectively to reduce her tax liability.
Even if the income exceeds the basic exemption limit of '3 lakh for a senior citizen, the tax rate will be only 10% for income up to '5 lakh.
FAILING TO BOOK LOSSES
It may sound bizarre, but you can gain from your losses. If you have made short-term losses on stocks this year, these can be adjusted against any short-term or long-term capital gains from the sale of property, gold or debt funds. Shortterm capital losses can be set off against both short-term capital gains as well as taxable long term capital gains. This can be especially useful for someone who has booked profits on debt funds this year. Suppose you sold the units in a debt fund and earned a long-term capital gain of '50,000 after indexation. At 20%, the tax payable on this long-term capital gain is '10,000.However, if you also lost some money in stocks during the year and made a short-term loss of '25,000, you can set this off against the gains from the debt fund. Then the gain from the debt fund will get reduced to only '25,000 and the tax payable will be '5,000. If your losses are higher and cannot be fully adjusted, you can carry them forward for up to eight financial years and adjust them against future capital gains.
However, there are some conditions to be fulfilled. One, you should file your tax return before the 31 July deadline to be eligible for carrying forward the losses. Also, one cannot set off shortterm gains from stocks against long-term capital losses from other assets.
OPTING FOR DIVIDEND IN NON-EQUITY FUNDS
The dividend distribution tax (DDT) is an invisible tax that many investors pay without even knowing. It is levied on dividends paid by mutual fund schemes other than equity funds and equity-oriented balanced schemes. For all other schemes, fund houses deduct a DDT of 28.33%.Many investors, especially senior citizens who have opted for the dividend option of monthly income plans or debt funds, don't even know that they are paying DDT. They may not be in the tax net but pay a 28.33% tax on the dividend income from their mutual fund investments.
Instead of dividends, one should go for the growth option in non-equity funds. If you are looking for a regular monthly or quarterly income, start a systematic withdrawal plan (SWP).A predetermined amount is redeemed on the day of the month fixed by you. If you are looking for a lump sum, just redeem the amount when the need arises.
The growth option is more tax-efficient because unlike in the dividend option, the entire sum is not taxed. Only the capital gain is taxable. So, if you bought the fund when the NAV was '12 and sold it when it was '15, the tax will only be on '3 per unit. In the first three years, this '3 will be added to your income and taxed at normal rates. After three years, the gain is eligible for indexation. In recent years, high inflation has reduced the capital gains tax to almost nil.
NOT AVAILING OF TAX DEDUCTIONS AVAILABLE
As mentioned earlier, many taxpayers are not aware of all the deductions available to them. For instance, not many know that if you rent out a house bought on a loan, the entire interest paid can be claimed as deduction. Of course, the rent you receive is taxable (after 30% standard deduction) as income.
There are many other little known clauses in the tax laws. For instance, even if you don't get HRA as part of your salary, you can still avail of deduction of up to '2,000 a month under Section 80GG. Then there is tax deduction of '50,000 available if you or your dependant suffers from a handicap. If the condition is severe, the deduction under Section 80DD is up to '1 lakh. Similarly, there is a deduction of '40,000-60,000 if a dependant is suffering from any of the specified diseases listed under Section 80DDB.
There is tax deduction on donations as well, but you must remember to retain the receipts of the donations you make to avail of the benefit under Section 80G.
DELAY IN AVOIDING TDS, AVAILING OF CREDIT
Lethargy can be a costly habit, especially when it comes to your finances. Tilak Raj Gaur (see picture) understands this only too well. The Delhi-based marketing executive incurred losses in stocks in 2013 but did not mention these in his tax return. He also missed the 31 July deadline, so he can't carry forward his losses or even revise his return now.
Some investments are subject to tax deduction at source (TDS). If the interest on your bank deposits in a branch exceeds '10,000 a year, there will be 10% TDS. If the investor's income is below the basic exemption limit, he can submit a declaration using Form 15G (15H for senior citizens) to avoid TDS. But this form must be submitted before the TDS is deducted. If you send it late and TDS has already been deducted, you can get the refund only by filing your return. For senior citizens and retirees who are out of the tax net, this can be quite cumbersome.
Some taxpayers end up paying more tax because they don't take the trouble of verifying their tax credits in the Form 26AS. The Form 26AS can be accessed online after a simple registration process. It has details of all the taxes paid on your behalf by your employer, bank, insurance company, bond issuer or even by yourself. Tax professionals say that one should periodically verify that all tax payments have been duly credited to one's PAN.