Ways to prune your tax burden

Here is a compendium of the financial avenues and instruments that can help reduce the amount of tax you pay.

Pritam P. Hans/Namrata Dadwal        Print Edition: February 2011

Two millennia ago, Aesop penned a fable about an ant and a grasshopper. The ant toils through the whole year storing food for the winter while the grasshopper sings and dances during the summer months.

As the grey clouds of winter cover the sky, the ant remains comfortable and cosy, while the grasshopper is hard-pressed and starved during the cold months. Aesop's moral about hard work and preparation is apt even today, more so at the end of the fiscal year.

Like the ant, some investors have been systematically investing to save tax . However, most investors find themselves in a situation similar to the grasshopper's-scrambling during the last quarter to invest in tax-saving avenues.

Fortunately, you still have time, and a multitude of options to choose from. Also, unknown to many investors, some of their expenses, such as house rent, have already contributed to their tax-saving plan. We take a look at how the money you have already spent can help you save tax, the financial instruments you can invest in and the various sections of the Income Tax Act that can benefit you.

The Cover Advantage
Insurance is essential for every individual. Though it should never be bought as a tax-saving avenue alone, it can help to reduce your tax burden.

The premium paid for a life insurance policy that covers you, your spouse and dependent children is eligible for deduction of up to Rs 1 lakh under Section 80C. However, this should not prompt you to buy a money-back or endowment policy where you have to pay high premiums. A better alternative is to opt for pure term plans, which are cheaper than traditional policies, and invest the balance money in other tax-saving avenues that deliver higher returns.

Buying a medical insurance policy will provide you peace of mind and tax savings. You can claim a deduction of up to Rs 15,000 under Section 80D for the premium paid for a health cover. You can also buy health insurance for your parents for an additional deduction of up to Rs 15,000. The limit is increased to Rs 20,000 in case of senior citizens.

A Tax Haven
Here's how expenses on your house can also help you save tax.

The rent you pay is often a big chunk of the household expenses. Most employers structure their salaries to include a house rent allowance (HRA), which is exempt from taxes if receipts are furnished. The lowest of these three will be considered as exemption on HRA:

a) The HRA received
b) 40% of the basic pay (50% in case of metro cities)
c) The rent paid minus 10% of basic pay

If your salary does not include HRA, you can still claim a deduction under Section 80GG. However, to claim this, you or your family (spouse and minor children) should not have a residential property in the place of accommodation. You should also not have a self-occupied house in any other place. The least of the following can be claimed as a deduction: rent paid less 10% of the total income, 25% of the total income or Rs 2,000 per month.

If you're a landlord who receives rent, you can claim a standard deduction of 30% on the annual value under Section 24. You can also deduct municipal taxes from the amount of rent received.

If you have taken a loan, the EMIs you are paying will help you out of the tax quagmire. The cumulative principal amount of the EMIs paid is eligible for deduction of up to Rs 1 lakh under Section 80C. However, the deducted amount will become taxable if the property is transferred within five years of the claim. The bigger advantage is the deduction you can avail of for the interest component of the EMI. You can claim up to Rs 1.5 lakh under Section 24(B). The benefits double if you have taken a joint loan as both co-borrowers can avail of the tax deduction separately.

Savings and Investments
Putting your money in the following financial avenues can help relieve your tax burden.

Every month, it may pinch a little to watch a part of your salary go into the Employees Provident Fund (EPF), but this contribution can be a saving grace now. The money that has been contributed to the EPF is eligible for tax deduction of up to Rs 1 lakh under Section 80C. This benefit is available to all recognised provident funds, including the Public Provident Fund (PPF), a favoured avenue for investors as it carries no risk and gives a return of 8%.

In case of the PPF, the maximum deduction allowed is Rs 70,000. Also, the 15 year lock-in period ensures that you reap the benefits of the power of compounding. However, if you need to, you can withdraw up to 50% of the money in your account from the seventh year onwards.

The EPF usually gives a return of 8.5%, though this year it has proposed to increased it to 9.5%. Negotiations are also on to use a portion of the EPF corpus to invest in the stock market. If, and when, this does happen, you could hope to earn even higher returns. Also, you cannot withdraw the money till you retire or opt out of the job market, which means that you're also steadily building your nest egg. You can withdraw the money if you desperately need it for specific purposes.

A pension plan is an important tool that can help you build a retirement corpus. You also earn tax benefits as contributions up to Rs 1 lakh are deductible under Section 80C. You can choose from three types of pension plans-unit-linked pension plan, plans from mutual funds and the National Pension System. Unit-linked pension plans are cheaper than unit-linked insurance plans (Ulips) because they do not offer life insurance. However, on maturity, only 33% of the corpus that you get will be exempt from tax. If you do not get gratuity, up to 50% of the pension corpus can be commuted.

Investments in National Savings Certificates (NSCs) are as secure as those in the PPF. However, the returns earned from them are taxable, so these are less profitable. What appeals to most investors is the shorter lock-in period of six years. Another less risky instrument with a short tenure is five-year fixed deposits (FDs) with banks or the postal department. The interest rates for FDs vary each year, though they usually fall in the range of 7-8%.

These bonds acan help to further lessen your tax burden as investments in infra bonds can be claimed as an additional deduction up to Rs 20,000 under Section 80C, beyond the Rs 1-lakh limit. However, these may not be suitable for all investors (see May Not Always Bond, pg 50).

The overhauling of unit-linked insurance plans (Ulips) by the Insurance Regulatory Development Authority (Irda) has made these plans more attractive to investors. Most people prefer to invest in Ulips as these offer a unique combination of life cover, equity exposure and tax savings. Investment in Ulips can be claimed as deductible under Section 80C up to Rs 1 lakh. Though you may only need to pay the premium for 3-5 years, to get the maximum benefit from your investment, it is advisable to remain invested for at least 10 years.

This scheme offers a return of 9%, higher than those offered by most other safe instruments. However, the income is taxable though it should not affect you much as the tax exemption limit for senior citizens is Rs 2.4 lakh per year. Investment in this scheme is again eligible for deduction under Section 80C.

ELSS have an edge over other taxsaving instruments as these have the largest equity exposure compared with others. This also ensures higher returns in the long run. Over the past year, tax-saving plans have delivered an average return of 14.5%. The top ELSS over five years, Canara Robeco Equity Tax Saver, has delivered 22.26% returns (see pg 48). However, ELSS may not be everyone's cup of tea as they are also considered more risky.

The Learning Curve
You may grumble about how expensive it is to educate your children. But this can provide a respite when you have to save tax.

Under Section 80C, you can claim deduction of up to Rs 1 lakh for the tuition fees paid for two children. This can be availed of by both the parents, though not for the same two children. Only the tuition fees paid for full-time courses of institutions based in India are eligible. Other expenses such as transport fee, development fee, hostel charges, etc, do not qualify and neither do fees paid for coaching classes or to institutions abroad.

If you have availed of a loan for your education or that of your spouse or children, the interest paid on the amount is eligible for deduction from your income under Section 80E. This is in addition to the Rs 1 lakh deduction allowed under Section 80C. However, you cannot claim the benefit for repayment of the principal amount.

Other Ways to Save Tax

PROFIT FROM LOSSES: You win some, you lose some, and sometimes you win by losing. It isn't as convoluted as it sounds. You can set off your short-term capital losses from equities and equity-based mutual funds against other short-term capital gains, which includes gains from debt funds, gold and property. Such losses can also be set off against long-term gains from property and gold and can be carried forward up to eight years.

DONATIONS: Here's a reward for your kindness. You can avail of tax deductions of 50-100% under Section 80G for donations to charitable causes. This is subject to a ceiling of 10% of your gross total income. Donations to other specified organisations are also deductible. If you have given money to an institution involved in scientific research or rural development, you can avail of exemption under Section 80GGA, while full deduction for the amount given to a recognised political party can be claimed under Section 80GGC.

DISEASES: The expense on the treatment for certain diseases is eligible for up to Rs 40,000 as deduction under Section 80DDB. In case of those above the age of 65 years, the maximum exemption is Rs 60,000. You can claim the deduction for yourself or for a dependent suffering from specified diseases, such as neurological diseases (including dementia, Parkinson's disease), malignant cancers, AIDS, kidney failure and haematological disorders (haemophilia and thalassaemia). However, no deduction is available if the amount spent is reimbursed by the employer or an insurance company.

DISABILITY: Under Section 80U, if you suffer from a disability, such as blindness, leprosy, hearing impairment, loco-motor disability and mental illness, you can claim deduction of up to Rs 75,000. If you have a dependent who suffers from a disability, you can claim up to Rs 50,000. The deduction will depend on the degree of impairment, which should be at least 40%.

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