Tax Planning in 2007

An analysis of the tax-saving options available under S ection 80C

By Babar Ziadi        Print Edition: January 25, 2007

An analysis of the tax-saving options available under S ection 80C:


Public Provident Fund

Invest in this old favourite before the tax laws change.

Tax exemption on the amount invested, tax free interest and even withdrawals. For those who don’t believe in living on the edge, tax planning doesn’t get better than this. The happy times may not last long though. With the proposed phasing out of EEE (exemptexempt-exempt, where investments, income and withdrawals are not taxed) regime, interest earned on PPF deposits may be taxed at the time of withdrawal.

But this is likely to be with prospective effect, leaving existing investments out of the tax net (see guest column: EETing Into Your Returns). PPF also scores on the tax front. Section 80L, under which up to Rs 12,000 of interest income (from bank deposits and other specified securities, including NSCs) in a year was tax free, has been removed.

In the 30% tax bracket (income above Rs 2.5 lakh a year), investments in these instruments will yield a post-tax return of 5.6%. Bharat Bhushan, CEO of Noidabased financial planning firm Money Options, says there has been a surge in PPF deposits after the removal of Section 80L. Investors are scrambling for the tax benefits. But you can invest only Rs 70,000 in PPF in a financial year (see story on page 52). Join the party before the taxman realises he is giving too much away.

NSCs and Bank FDs

If the income they earn is taxed, what makes NSCs still hot? Safety, liquidity and 8% assured returns. But as your income levels rise, they become increasingly tepid. For instance, if you fall in the highest tax bracket, NSC investment notwithstanding, you will be paying 30% tax on the income plus surcharge. Even in the 20% bracket (annual taxable income between Rs 1.5 lakh and Rs 2.5 lakh), the post-tax yield is less than 6.5%.

 FIVE-YEAR FD RATES (%)

 Kotak Bank 8.25
 UCO Bank 8.25
 Tamil Mercantile Bank 8.50 
 Saraswat Bank 8.50
 Cosmos Co-op Bank 8.50
 Shamrao Vithal Co-op Bank 9.00

From 2006 onwards, five-year bank fixed deposits are also eligible for deduction under Section 80C. With a five-year lock-in, they are slightly more liquid than the sixyear NSCs and even offer a higher rate of interest.

Keep in mind though that NSCs are government bonds, and therefore offer the highest safety. It is here that fixed deposits lose out. Of course, it is fairly safe to invest in a nationalised bank or even a good private bank. But steer clear of the attractive rates being offered by little known banks. What’s a devil if he is not tempting?

Insurance policies

When you ask your money to run a race for big returns, don’t expect it to scramble back when you feel a sudden need. Then your money gets confused and can do neither well. So keep investment and insurance separate.

 

 Unsuitably insured

 Option                    Returns (%)
 Money-back policies 4-5
 Endowment policies  5-6
 NSC and FDs           8-9
 PPF/EPF                  8-8.50
 ELSS                      15-20
Returns from the investments in endowment plans and money back insurance policies are very low. Such policies offer only 5-6% returns on the premium paid. And that, when income from insurance policies is exempt from tax. When the EET regime is introduced, even income from insurance policies may become taxable. The post-tax returns from a moneyback policy may then get pared to about 3.5% in the highest tax bracket, dangerously close to the yield earned from a savings back account.

 Your insurance agent may argue that you need to factor in the life cover offered by an endowment policy when evaluating its value. But the cover too is abysmally low. For instance, a 40-year-old man will pay around Rs 41,000 every year for 15 years to get a cover of Rs 5 lakh.
If you have made the mistake, is there a way out? Yes, you can convert your existing endowment policy into a paid-up policy. As far as insurance is concerned,buy a term plan that gives you life cover without charging a huge premium. If the 40-year-old did not buy an endowment plan and instead took a term plan, a Rs 5 lakh cover for 15 years would cost him less than Rs 3,000. That leaves him with a surplus of Rs 38,000 which could be investedin other avenues for higher returns. Why, even PPF will give him higher returns than his endowment policy.

 Of course, you must keep one thing in mind: term plans are pure insurance products and the policyholder does not get anything back at the end of the policy term. The premium paid goes into buying the life cover, much like in the case of your medical or car insurance. 

 

WHY YOU ARE A TAX EVADER

Are you a tax evader? You probably are. The removal of Section 80L, under which Rs 12,000 of interest income (from bank deposits and specified government securities) in a year was tax free, has turned thousands of honest taxpayers like you and me into tax evaders. If you have some money in a bank account—savings, recurring, sweep-in or current—you must have earned some interest on that in the past year. And if you have not included that interest in your income for the year, you are evading taxes.

This is not a hypothetical scenario. It is not uncommon for people to have savings bank accounts they haven’t operated for years. In some cases, the account holders don’t even know that these bank accounts exist. Many of these bank accounts were opened when the account holders were minors. When they took up jobs they opened new accounts but didn’t close the old ones. Interest income from the small balances in these dormant accounts must be included in the income for the year and is liable to tax at normal rates.

Relocation to another city is another reason why people have multiple bank accounts. It is easy to open a fresh account than get an existing one transferred to the new city. Perhaps the finance minister should revisit the decision to abolish Section 80L so that thousands of innocent tax evaders can become honest once again.

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