SynopsisEarning higher returns is not in the hands of investors. However, they can take steps to minimise their tax outgo. In this cover story, ET Wealth identifies five investment strategies that can help you save tax without violating the law and improve your returns.
If you invest in stocks and equity funds, you must have earned healthy returns in the past few years. But while the going has been good on the investment front, there is bad news flowing from the tax department. In the past few years, the tax monster has spread its tentacles and started moving into what were considered safe havens till now. In 2018, the tax exemption for long-term capital gains from stocks and equity-oriented funds was removed. Last year, dividends from stocks and mutual funds were made taxable as income.
Even fixed income options have not been spared. The interest earned by contributions to the Provident Fund above Rs 2.5 lakh a year will now be taxed at the marginal rate applicable to the individual. And Ulips with premiums of more than Rs 2.5 lakh per annum will now get taxed as mutual funds.
The spread of the tax net coincides with a sharp fall in incomes and savings in the past two years. Almost 74% of the respondents to an online survey conducted this month said their income either stayed stagnant or decreased due to the pandemic last year. Though some people say that the worst is behind us, this optimism is yet to show up in salary slips and appointment letters.
Earning higher returns is not in the hands of investors. However, they can take steps to minimise their tax outgo. There are enough opportunities in the tax laws that smart investors can utilise to bring down their tax liability. We reached out to tax professionals and investment advisers to know how taxpayers can legitimately utilise the tax rules to their advantage.
Mind you, we are not suggesting tax evasion, only tax avoidance by intelligent use of the provisions in the tax laws. We have identified five such strategies that can help you save tax without violating the law. Some of these, such as distribution of income and investing through family members, are already known. But some, like the advice to invest in the NPS, are based on recent developments. We hope you will find these suggestions useful.Keep in mind that not all these strategies will be relevant for all investors. There’s no point investing through your spouse if she is also in the same tax bracket as you. It would be a mistake to gift money to a financially irresponsible child. And investing in the name of a parent or grandparent could trigger a legal battle among heirs and siblings. Even if the nomination has been done properly, a legal heir can stake claim on an investment. An airtight will is required to ensure that the rightful owners get the assets left behind by an individual.
1. Invest in NPS, but not in annuity
If the corpus is below Rs 5 lakh, the entire amount can be withdrawn on maturity.
One of the biggest stumbling blocks of the NPS is the compulsory annuitisation of 40% of the corpus. Not only are annuity rates in India very low, but the thought of putting away their retirement money forever is unacceptable to many investors. But an amendment in the withdrawal rules of the NPS has changed this to a certain extent, making the pension scheme especially attractive for those in their 50s.
The new rule says that if the corpus at the time of maturity is up to Rs 5 lakh, the subscriber can withdraw the entire amount without buying an annuity. This reopens a tax-saving avenue for investors who have stayed away from NPS due to the compulsory annuity rule. One can save tax in three different ways through NPS. First, NPS investments are eligible for deduction under Section 80C. If one has already exhausted the Rs 1.5 lakh ceiling under Section 80C, one can claim an additional deduction of up to Rs 50,000 under Section 80CCD(1b). Lastly, up to 10% of the basic salary put in the NPS can be claimed as deduction under Section 80CCD(2).
An investor in his 50s can safely put away Rs 50,000 in the NPS every year to claim the tax deduction under Section 80CCD(1b). By the time he retires at 60, his total NPS corpus would not have grown to more than Rs 5 lakh and the entire amount can be withdrawn.
Those very close to retirement can claim more tax benefits if their company offers the NPS benefit. Under Section 80CCD(2), up to 10% of the basic salary put in the NPS by the company on behalf of the employee is tax free. Individuals who have enough liquidity can squirrel away up to 10% of their basic salary in the NPS in the last 2-3 years of their employment. “This particularly suits high income earners who can escape tax in the last few years of their working life,” says Raj Khosla, Managing Director of MyMoneyMantra.com.
However, keep in mind that the entire amount withdrawn will not be tax free. Though there is no reference to this in the tax laws, it is reasonable to assume that 60% of the withdrawn amount will be tax free while the balance 40% will be taxed at the normal rate.
It is here that another change in the NPS rules comes to the rescue of the investor. “A subscriber can now continue in the NPS even after retirement till the age of 70 years, so the withdrawal of the corpus can be managed to reduce the tax outgo,” points out Khosla.
2. Rent to parents makes HRA tax-free
Claim tax exemption for house rent allowance if you live in your parents’ house.
The house rent allowance (HRA) is a significant amount and normally accounts for 25% of the salary. This amount is tax free if the person is living in a rented accommodation, but fully taxable if she does not pay rent. Many young taxpayers who live with their parents do not claim exemption for HRA. “Missing the HRA exemption is a big loss, which can be avoided in many cases,” says Sudhir Kaushik, Cofounder of tax filing portal Taxspanner.
Kaushik says a person living in her parents’ house can pay them rent and claim exemption for the HRA. This is possible only if the parent is the owner of the property. Of course, the rent received by the parent will be subject to tax. Keep in mind that if the rent exceeds Rs 1 lakh a year, one has to furnish the PAN number of the landlord while claiming exemption for HRA. If the landlord does not have a PAN, he must submit a declaration to this effect.
In cases where the house owner is not in the high income bracket, the rental income will not push up his tax outgo significantly. But even in the highest 30% bracket, the arrangement will be beneficial because there is a 30% standard deduction on rental income. So, if the parent gets a monthly rent of Rs 50,000 (Rs 6 lakh per year), he will be taxed only for Rs 35,000 (Rs 4.2 lakh per year).
Tax savings if HRA is exempt
If the individual’s basic salary is Rs 9.6 lakh and gets Rs 4.8 lakh as HRA, the tax payable on this would be Rs 1.49 lakhThis arrangement can also be done with any other relative or even a sibling. But you cannot pay rent to your spouse or minor child and claim HRA exemption.
The taxpayer must have proof of the transaction. Ideally, he should transfer the rent to the owner’s bank account every month or pay through a cheque so that there is evidence of the payment. Incidentally, a taxpayer can claim exemption for the rent paid even if he does not receive HRA in his salary. One can claim exemption for monthly rent of up to Rs 5,000 under Section 80GG.
3. Invest in homemaker wife’s name
The income will be clubbed with yours but there are ways to escape tax.
The tax department doesn’t care if you gift money to your wife. But it will be very interested if that money is invested and earns an income. The taxman will club the earnings from the investment with your income and tax you accordingly. This clubbing provision under Section 60 is meant to check tax evasion.
But financial planners say that money given to the homemaker wife for her personal expenses do not come under the purview of the clubbing provision. “There is no fixed amount or percentage prescribed under the tax law, but it can be safely assumed that someone with an income of Rs 1 lakh a month will give Rs 10,000-15,000 to his wife for her personal expenses,” says Chhaya Kothari, founder of the Mumbai-based CK Financial Advisory.
If the wife invests out of this personal money, the income will not get clubbed with the income of the husband. However, some tax professionals are not convinced. “The money for personal expenses remains a grey area and should not be stretched to unreasonable limits,” says Gunjan Kapoor, a Delhi-based chartered accountant.
Kapoor says there are better ways to get around the clubbing provision. The clubbing happens only at the first level of income. If the earnings are reinvested, the income from that reinvested money will be treated as that of the wife and not clubbed with the income of the husband.
Let’s see what happens if the wife invests the gifted money in tax-advantaged options such as stocks and equity funds. The husband will not be taxed for long-term capital gains of up to Rs 1 lakh in a year. That amount will then be treated as the income of the wife and can be reinvested without fear of clubbing. “The income from the reinvested income does not attract the clubbing provision,” points out Kaushik.
4. Utilise exemption for senior citizens
Up to Rs 50,000 interest earned by senior citizens is tax free.
If income clubbing is a problem, you can take help from your parents, and even your grandparents. Unlike the investments in the name of a spouse or a minor child, there is no clubbing of income in the case of parents and grandparents. If any parent is a senior citizen and does not already have investments, you can invest in that individual’s name to earn tax-free interest. Every adult above 60 already enjoys a basic exemption of Rs 3 lakh. In case of very senior citizens above 80, the basic exemption limit is even higher at Rs 5 lakh. Two years ago, the government extended an exemption of Rs 50,000 to interest income of senior citizens. If you assume an interest of 7% on bank deposits, up to Rs 50 lakh invested by a senior citizen will not attract any tax.
The best options are the Senior Citizens’ Saving Scheme which is currently offering 7.4% interest. The Pradhan Mantri Vaya Vandana Yojana is another safe and secure bet. Banks also offer higher rates on fixed deposits to senior citizens.
Besides these fixed income options, one can also get senior citizens to invest in stocks and mutual funds. That way, every person can individually benefit from the Rs 1 lakh exemption per year for long-term capital gains. If the total income is below the basic exemption limit, even the short-term capital gains from stocks and mutual funds will not attract any tax.
But these options should be exercised with due care. Make yourself the sole nominee of the investments in your parents’ name. This will ensure that there are no disputes with siblings. You need to take extra precautions when it comes to investing through your grandparents because there might be more legal heirs in the family.
5. Invest in name of adult child
Income earned by the adult child not subject to clubbing.
Just like parents, your children can also help you save tax. Investments made in the name of minor children below 18 will not help because the income gets clubbed with that of the parent. But after a person turns 18, he is treated as a separate individual for tax purposes. He enjoys the same basic exemption and other tax deductions like any other adult and the income from investments is no longer clubbed with his parents’ income.
Being a legal adult, an 18-year-old can also invest in stocks and mutual funds on his own. Open a demat account and stocks trading account in her name and let the Warren Buffett in her come alive. Up to Rs 1 lakh of long-term capital gains will be tax free in a year and short-term capital gains will be tax-free till the basic exemption of Rs 2.5 lakh a year.
There are other advantages too. In case of minors, the annual contributions to the Public Provident Fund are clubbed with that of the parent and the total cannot exceed the annual limit of Rs 1.5 lakh. But once a child turns 18, she can have her own PPF account, which increases your investment limit in the tax-free option. You can separately invest up to Rs 1.5 lakh a year in her PPF account.
Gifting money to an adult child and investing in his name is tax-efficient but be very careful when you do this. If the child is financially irresponsible, you can say goodbye to your money. Unlike a will, which can be changed whenever you wish to, a gift is irrevocable, and once given, there is no looking back. In your attempt to save 20-30% tax, you could lose 100% of the principal.
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