Here is how you pay tax on income not received in cash
March, 09th 2015
There are several occasions where an individual will be in a difficult situation tax wise and this will happen as they have to pay tax even though the income might not have been received in cash. This can put a lot of pressure on the financial condition of the individual and they need to have a plan in place that will help them to tackle this whole situation. This is significant as there could be a scramble at the end to try and get some cash to pay for the necessary amount but this can be avoided. Here are some of the conditions wherein such a situation would arise and how the individual can actually tackle it.
Mutual fund units
There are times when the individual shifts their units from one option or plan of a scheme to another option. This could mean something like changing the divided option to a growth option or vice versa. The same holds good for changing option from distributor option to direct option. In these cases there is no money that is actually coming in the hands of the investor as this is just a book entry and hence the changes are seen on paper only. However this result in a sale according to the income tax act and this could mean that there is some tax that has to be paid which would have to come from some other funds. This is also a condition wherein it might not be the decision of the individual to effect the change especially as seen in case of a merger but still they would end up bearing the tax impact.
There are several fixed income instruments where there is interest that is being accumulated. One of the most common examples here is that of the National Savings Certificates wherein the interest accumulates each year and this is paid out only at the time of the maturity of the instrument. Now the interest here is taxable which means it has to be included in the income of the individual and the tax paid on this. Similarly there could be a cumulative fixed deposit wherein the interest keeps on accumulating and this would be taxed but still the individual has not received the amount of the income.
Deep discount bonds
In case of many fixed income instruments there might be a slightly temporary mismatch if the duration of the instrument is less but in many of them like deep discount bonds there is a very long time period that is present. This could be a decade or more and in this case too there is income that is being earned each year. Once again this would be taxable and the individual would have to ensure that they are paying up the amount of the tax from their other sources of income if they are showing the accrued interest as income each year.
There is a way in which the whole situation can be tackled and this would involve knowing in advance the kind of income that these kinds of investments would actually generate. This is crucial because a wrong estimate can lead to a large amount remaining out of the plan and providing a shock at a later stage. There has to be separate cash that is set aside for this purpose and it would be better if this is done right at the time of the investment itself because in a majority of the cases the fact that this kind of situation would arise would be known beforehand. Planning for this would ensure that there is no cash pressure and that things go smoothly for the investment.