Tax planning done right!

Our 'beloved' ICAI defines Tax Planning as 'an arrangement of one’s financial affairs in such a way that, without violating in any way the legal provisions, full advantage is taken of all tax exemptions, deductions, concessions, rebates, allowances and other reliefs or benefits permitted under the Act so that the burden of taxation on the assessee is reduced to the minimum.'

Supposedly, the last sentence does not really resonate with the Finance Ministry as they keep finding ways to increase taxes or bringing retrospective amendments anyway! (still cries Vodafone).

Given that, it’s a fact that an individual earning a reasonable livelihood does not shy away from paying taxes, provided they are given enough exemptions and incentives which do not make tax payments seem as a burden but a responsibility towards your country and its development.

Speaking of responsibility, every Chartered Accountant or a soon-to-be Chartered Accountant for that matter should find themselves as the ambassadors of exercising lawful tax planning and management, rather than devising schemes of tax evasion for their respective clients or even their family members, friends, among others.

There are various loopholes and exclusive exemptions and deductions omnipresent in our tax laws which can be understood and used within the ambit of law to save taxes and even contribute towards personal savings and growth of society too. This would ultimately make a person content and more secure about the future, after all every person who has fulfilled their basic needs, would now want to give it back to the society and its stakeholders in order to fulfil their humanitarian needs.

 There are a few important exemptions and deductions which are overseen or are not understood properly which are discussed further below. These can be resorted to for better tax planning as well as savings from a long term perspective in case one is planning a big trip to Las Vegas or Ibiza!

Some of them are illustrated as under:

1. Section 54EC: It stipulates that in case of any long term gains arising from sale of Land or Building (whether Residential or Non-Residential), the gains shall be exempt if invested in Rural Electrification Corporation of India (RECI) and National Highway Authority of India (NHAI) within 6 months of sale. The interest rate offered is approximately 5.25% p.a. which is almost risk free and the lock in period for the bonds is 5 years. The amount invested in these bonds contribute to the development of our country’s two major resources, Highways and Electricity.

2. Overriding title: The concept signifies diversion of income or a portion of income “at source” itself by an overriding title before it reaches the assessee in the event of which; it could be excluded from his assessable income. Such a diversion can take place either under a legal compulsion or under a contractual obligation. The true test is to probe into and decide whether the amount sought to be deducted, in substance, did not reach the assessee as his own income. In order to make sure that there is diversion of the income at source, the obligation is to attach to the source which yields income and not to the income only. In many cases, it would really be a matter of proper drafting of the document creating the obligation. This might help to utilise the non-exhausted exemption limit. So plan carefully!

3. Sources of Funds: It is an established fact that the return on share capital is a charge on the profits after tax whereas the return on loans to the lenders is a charge on the profits before tax. Thus, recourse to borrowings would offer a tax advantage which will be reflected in a higher rate of return on the owner’s capital. One must definitely pay heed to the concepts of Weighted Average Cost of Capital (WACC) and Capital Assets Pricing Model (CAPM) which fetches the right mix of equity and loans. The up side is that they cater to the needs of both new and existing business. These models may seem complex, but they are quite easy, ask any of your known CA or soon-to-be CA, they’ll show you how it’s a cakewalk!

4. Tax Saving Mutual funds/ Saving Schemes: Despite their annoying way of saying “Sahi hai” in those Mutual Funds advertisements, they really are worth exploring and investing because of their manifold benefits such as tax saving, no minimum lock in period, investment as low as INR 500 per month, low risks, negligible investment and operating costs and on the brighter side you get to own a little stake in a company you might have wanted to for long. These saving schemes help to take maximum advantage of the INR 1,50,000 deduction u/s 80C and register some real growth on your hard earned money in a reasonable time.

5. Section 80CCD (1B): Deduction for self-contribution to National Pension Scheme (NPS) for a deduction of up to Rs 50,000 in addition to the deductions u/s 80C for the amount deposited by a taxpayer to their NPS account or any contributions to Atal Pension Yojana.

So in conclusion, the intention is to bring about a shift of focus from the short term perspective to a long term perspective as the above mentioned incentives focus on real growth of you, your money and the society at large.