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Going beyond 80C to invest efficiently
Sunil Dhawan, Outlook Money
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August 23, 2007

With the market matrix fast changing, we need to change too. And also our mindset towards tax saving. While equity-linked saving schemes and unit-linked insurance policies are firmly entrenched in our minds, we now need to look at the tax impact of non-Section 80C investments to soak up rising savings.

Yesterday. The middle class obsession for tax planning can be traced to the 1970s. In 1973-74 the Rs 5,000 exemption limit came with a tax range of between 10 per cent to 85 per cent over 11 tax slabs. Throw in a 10 per cent surcharge on income below

Rs 15,000 and 15 per cent for income above Rs 15,000. The maximum effective marginal rate came to 97.75 per cent. No wonder the 70s taxpayer was tax obsessed.

But things improved in the subsequent years and by July 2000, the effective income tax rate came down substantially to 34.5 per cent (including 15 per cent surcharge) for the highest marginal tax rate. However, this was still relatively higher than other countries. But personal income tax laws remained complicated with an alphabet soup of exemptions (Sections 54B, 54D, 54EA and 54EB), rebates (Section 88) and deductions (Standard and Section 80CCC, 80L).

Today. But then came the Kelkar Committee Report on Direct Taxation that recommended a total clean-up of the laborious and confusing personal tax laws. Now, we have a three-slab progressive tax system with a basic threshold at Rs 110,000 and a highest income tax bracket of 33.99 per cent.

Investments under Section 80C get you Rs 1 lakh of a deduction on taxable income, mediclaim premium of up to Rs 15,000 deduction. Another Rs 150,000 is allowed as a deduction for interest on a home loan. This is the big broad tax planning that an under 65 male needs to do.

The overall message of tax laws is that the government accepts the growing affluence of a section of the population and is quick (as quick as a tax regime can be) to reflect this. Take the example of the rise in the basic exemption in income tax, which has grown beyond the inflation mandated rise. The Rs 5,000 exemption of 1973-74 would have been Rs 36,000 at an annual inflation rate of 6 per cent today, but this stands at Rs 110,000.

Take another example, understanding that equities allow a person to build wealth, purely market-oriented products like ELSS have been included in the basket of Section 80C products.

As the tax laws for the traditional salaried person have got simpler, a new tax has come in to bring the burgeoning service industry (this is 55 per cent of Indian GDP) under the tax net. In 1994, services were made taxable. Today, more than 100 services pay a service tax of 12.36 per cent. Expect more of this in the future.

Tomorrow. Those who already have annual savings of more than Rs 100,000 and those that will get there in the next few years, the tax planning needs to be looked at from outside the frame created by Section 80C investments. Even as we find most of the Section 80C investments getting soaked by the PF, PPF, tuition fees, previous commitments towards insurance premiums and home loan principal repayment contributions, the annual hunt for that magic tax saving instrument is no longer that important.

Freedom from tax. The effect of taxation can be one of the biggest threats to wealth. It is very important to create and manage portfolios that can swim past the shackles of tax or, at least, mitigate the impact of tax to the minimum. Many investors choose investments only to save taxes. While saving money on taxes is a serious consideration, an investment should not be selected solely on the basis of tax savings. Tax efficiency is more important. For those in high tax brackets, taxes can have a significant impact on the final return.

So, choose your investments carefully. Gains from investing in direct stocks of listed companies are not subject to tax if such gains are realised after 12 months. Even dividends received from such investments are exempted from taxation. A carefully selected stock with the objective of holding it long-term (that is where equities have returned well) is one ideal way of creating wealth the tax-efficient way.

If direct stocks are not your cup of tea, indirect exposure in them can be had through exchange-traded funds (ETF), or the more popular diversified equity mutual funds. Remember, the ETF or the managed funds that are predominantly invested in equities currently enjoy tax breaks. A relatively new product in this space is the unit-liked insurance plan (Ulip) that, too, has a tax-free status.

For all those who are looking at tax-efficient growth in the non-equity space, fixed maturity plans - that carry an 'indicative' return unlike bank fixed deposits - are the ones to look at. Dividends from FMP's are tax-free, though the mutual fund pays a dividend distribution tax of 14.16 per cent.

In contrast, interest on FDs is fully taxable. For income over Rs 10 lakh, for instance, the tax on interest on FDs is 33.99 per cent. FMPs with growth options and tenors of more than a year can get the benefits of long-term capital gains, where the tax rate is at 10 per cent (without indexation benefits) or 20 per cent (with indexation benefits).

Further, a couple with incomes from two separate jobs can take advantage of the tax laws by buying a residence through a home loan. A deduction for interest up to Rs 150,000 per year on a loan for acquiring a house is available individually to both the spouses. To be eligible for the deduction, both the spouses need to take the home loan jointly. Both should be equal owners. A joint home loan application also helps a couple acquire a larger loan.

Conclusion. Asset allocation is the key to creation of wealth. The kind of assets you choose will lead to financial freedom. So choose carefully. However, do note that income tax laws apply in the year in which you earn income and, hence, sometimes tax exemption may turn into tax-deferment. Needless to say tax is not imposed on retrospective basis. Therefore, go ahead and create a tax-free bounty for yourself.

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