Four-letter words are accepted with greater equanimity by a section of the population than a certain threeletter word: tax. For years now, most of us have equated financial planning with tax planning. It’s almost a habit now to rush to find tax-saving instruments as March approaches. With new tax laws and investment options, this scramble has thankfully come down. Investors are now looking at various investment options, attracted by returns rather than by the tax-saving potential. Which is, of course, both good and necessary.
For a while, equities were the most attractive as they offered incredible returns. But with extreme volatility in the markets now a fact of investing, people are looking for more stable options. Fixed deposits and the like are getting increased visibility. Banks are cashing in by promising higher interest rates; there are advertisements offering up to 10.5% interest on fixed deposits, and investors are drawn to them like flies to honey. Why not, you might ask. After all, if the returns are good, why scorn fixed deposits?
This is where that hated three-letter word comes in again. The 10.5% interest rate on fixed deposits is pre-tax. The interest you earn on fixed deposits is added to your annual income and taxed at the applicable rate. In the highest tax bracket, this is 30% plus education cess (see table). Suddenly, 10.5% doesn’t look so appealing, does it? So, what options are you left with? Instruments such as fixed maturity plans (FMPs) of mutual funds are more tax-efficient and offer a higher post-tax yield if the period of investment exceeds a year. That’s because after a year, the income from FMPs is treated as a long-term capital gain and taxed at either a flat rate of 10% or 20% after indexation benefit. In these times of high inflation, double indexation can reduce the tax considerably. But most people who invest in fixed deposits, including those in the highest tax bracket, are not aware of FMPs and the concept of cost inflation indexation.
This mistake of not taking into account the post-tax yield of an investment is common to equity investors. Rakesh Goyal is a seasoned player who has been dabbling in the stock markets for the past two decades. Having been there, done that, the 48-year-old Delhi-based accounts manager in a nonbanking finance company does not get carried away by “irrational exuberance” and prefers to frequently book profits.
This strategy worked well during the bull run. Goyal churned his portfolio every now and then, making a neat packet in the bargain. And he paid only 10% short-term capital gain tax on the profits. The situation is very different now. Not only are most stocks in his portfolio in the red, but even the small profits he makes attracts a higher tax of 15%. “This means my post-tax profit will be lower than what I thought,” he says glumly.
Sudhir Kaushik, Director, Taxspanner.com
Chartered accountants always advise people to do everything well in time. It is not a good idea to compress your entire year’s tax planning into the last one or two months. And as tax planning also works as financial planning, any sub-optimal decision in the last days of March can be a costly mistake. For instance, a life insurance policy or an equity mutual fund bought without adequate research and thorough examination because you didn’t have time can be a losing proposition.
Despite my advice, I too fall into the category of taxpayers who leave things for the last minute. Call it complacency or overconfidence, but my tax planning usually starts around January or February. This year, I have decided to start early and get into the tax planning mode by Diwali. Or so I hope!
Procrastination is a common failing and late starters outnumber early birds by an overwhelming majority. It’s common to see people running around to find the money to invest in tax-saving schemes when they have to show proof of investments under Section 80C. If they are unable to borrow from friends and relatives, they take personal loans from banks. This is a zero-sum game. In these times of sky-high interest rates, the tax that they will manage to save will be gobbled up by the interest charge. So effectively, they will not save tax, only neutralise the tax effect.
There’s again a last-minute rush for filing tax returns. Here too, it is better to complete the formalities well in time to avoid the errors that creep in if you do it in a hurry.
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