Tax Planning an Effective Tool..........

Ratan Deep Saxena (Asstt Manager (Accounts & Finance))   (2993 Points)

21 October 2009  

The term Tax Planning refers to the use of the saving instruments (deductions & exemptions) given by the government so as to decrease the tax liability, but sometimes the word tax planning is misunderstood and the people choose the ways of tax evasion and tax avoidance. The tax planning is completely legal and is done keeping in mind all the rules and regulations. 

For example; If Mr. X as an individual has an income of 5, 50,000 for the assessment year then the tax that he needs to pay is 70,000. Solution: according to the tax rates of assessment year 2009-2010 the calculation is as follows;
                               =50,000 x 30% = 15000 (Above 500000 30% Tax)
                               =200000 x 20% = 40000 (Between 300000-500000 20% Tax)
                               =140000 x 10% = 14000 (Between 1, 60,000 – 300000 10 %)
                     =3% education Cess on 69,000 (15000+40000+14000) = Rs 2070
             Tax Payable = 15000 + 40000 + 14000 + 2070 = 71,070
If Mr. X decides to deposit Rs 70,000 to the Public Provident fund then the tax liability will change because his taxable income comes down to 4,80,000 and his tax liability will come down to 51, 500 this is called the Tax planning.
Tax avoidance is within the legal constrains and is done using the loopholes of the system. For example a company is thinking of starting a manufacturing unit and it has lot of land in the present city where its head office is located but it sets up the manufacturing unit in some of the northern states or backward states as there is 100% deduction.
Tax evasion is completely illegal. Here the person tries to show false figures or cook up the books so as to completely reduce the tax liability. For example the person may have purchased a car for personal use and while giving the details he puts it as used for renting and when he does it the depreciation amount that he will get increases and hence the total income decreases or in another case a company may just set up a dummy manufacturing unit in a backward state and prepare those parts in some of its own manufacturing units. The company gets tax deduction but it is illegal and if found guilty then it may be punished. 

Tax planning Vs Tax Management

There is always some confusion created by these words and most often the person who is doing a tax planning thinks that he is managing the tax and vice versa in some cases. We will have a look at some of the points which clearly indicate that these are two different words all together.
The tax planning is a wide term and the tax management comes under it. Tax planning is done in order to reduce the tax liability whereas the tax management is paying the taxes in compliance with the set rules. The tax planning is done for the future whereas the tax management relates to the past, present and future.    
Tax planning is not at all a complex process provided the assessee knows the tax code. The complete knowledge is not necessary all he needs to know is the correct tax slabs and the various deductions allowed. Today as we are living in a very busy world we tend to overlook at the tax planning and hurry things when the due date is fast approaching where as if there is a proper tax plan then we will be reducing the tax liability. Having said this now let us have a look at some of the deductions.
(Note: we will be mainly focusing on the deductions that are allowed for the individuals)
Deductions Under Income tax
Below given are the major deductions avaulable under the income tax act.
Section 80C
It gives deduction upto Rs 1, 00,000 for the investment done by an assessee in Public Provident Fund, National Saving Certificate, Accrued interest on National Saving Certificate, Life Insurance Premium, Equity Linked Savings Schemes (ELSS), 5-Year fixed deposits with banks and Post Office etc.
Section 80D
Section 80D gives the assessee 100% tax deduction for the medical insurance premium paid by him for his or spouse’s or the children’s medical insurance. An additional tax deduction of 15000 is given if he has paid the medical insurance of his parents and it will be increased to 20,000 if they are senior citizens. Point to be noted here is that the payment should be made by any means except by cash.
If the payment is made to the scientific research association or to a university or to a college for scientific research or for the statistical research then under the section 80GGA then 100% of the amount is taken as deduction.
The donations given to some of the approved funds or institutions are given an exemption of 50% and 100% in certain cases under 80G.
Under the section 80E the interest on the loan that is taken for the higher education is eligible for deduction.
Under the section 80GG the house rent in excess of 10% of taxable income, paid by a salaried or self employed person who is not getting the HRA( House Rent Allowance) then 25% of the total income or Rs 2,000 per month (whichever is less) is given as deduction. 
Everyone has a fair knowledge about the insurance policies available, medical insurances, post office savings account, house rent allowance, donations for research so we will discuss about some of the deductions in the 80C.


Provident Fund
The provident fund is defined as a retirement benefit in which the employee and employer both part with certain amount of salary which is invested with the provident fund authorities or in the self maintained provident fund. The interest earned is credited to the provident account of the employee on a regular basis. There are four types of provident funds
  • Statutory Provident Fund
  • Recognized Provident Fund
  • Un-Recognized Provident Fund
  • Public Provident Fund 
Of the above the in first three types both the employer and employee needs to pay part of their salary whereas in the fourth one only employee pays and maintains the provident fund and this one is completely exempted. The maximum amount a person can deposit annually in the Public Provident Fund is 70,000 and the whole amount is taken as exemption. The rate of interest is 8% and is not liable for any tax. The important point to be noted here is that the provident fund is a long term investment i.e for 15 years. The PPF account can be opened by a salaried person in state bank of India or other associated banks such as state bank of mysore, state bank of rajasthan etc. The minimum amount that one needs to deposit to his PPF account is 500 and maximum limit is 70,000. The advantages of PPF may be that it is completely tax exempted, one of the safest investment, the investment can be taken as an exemption etc. the dis-advantages may be like the capital is held for a long time, the interest rates are lower compared to the FD rates etc.
Equity Linked Saving Scheme (ELSS)
ELSS is one of the investment options. The maximum amount that is exempted is 1, 00,000. The difference between ELSS, National Saving Certificate (NSC) & PPF is that the lock in periods is 3, 6 & 15 years respectively. The best way to invest in the ELSS is by Systematic Investment Plan (SIP). According to SIP every month the investor invests a fixed amount of money in the market. It is done to take advantage of the market fluctuations for example in one month if the rate of a unit is 40 rupees and the investor is investing 2000 rupees then in that particular month he will be buying 50 units and in the next month if the unit price is 20 rupees then he will end up by buying 100 units. The advantages of ELSS are that the money is locked in for short period of time; the dividend can opt for payment etc. The dis-advantage is that returns are directly depending on the variations of the markets.
Tuition fees
The tuition fees are rising and reaching the sky every year thus there is a deduction of 1, 00,000 in under section 80C upto two children. If both the parents are working then only one of them can claim the deduction. This deduction is applicable for recognized educational institutions and only the tuition fee is exempted. Transportation fees, admission fees do not come under this.  
The deductions for insurance, PPF, tuition fees, ELSS is given totally as 1,00,000
The assessee must know utilize the deductions so as to reduce the tax liability but must take care that he doesn’t invest his money in only one avenue. The safest would be to invest in many avenues taking into account constant returns, safety and tax exemption.
Let us have a look at an example under 80C   


In the above example a person has invested in PPF and ELSS and different combinations are given. The maximum limit for PPF exemption is 70,000 that’s why even though the PPF has risen to 90,000 and 1, 10,000 and ELSS=20,000 (in both cases) the total amount exempted is 90,000. It is the same in case of total exemption for example PPF=70,000 & ELSS=40,000 the total would be 1,10,000 but the exemption given will be 1,00,000 because that’s the maximum limit.
Importance of tax planning is
Mr. X is earning 4,00,000 per annum he has not done any investment and his children tuition fees is 50,000 but they are learning in unrecognized education institutions so it is not exempted.  Mr. Y earns the same amount per annum and out of his earnings he has deposited 10000 to his PPF account, paid insurance premium of 4000, ELSS=15000, and paid children tuition fees which amounts to 50,000. Mr. Z is also earning 4,00,000 and out of that he has deposited 20,000 in his PPF account, paid insurance premium of 10000, ELSS=50,000

Mr. X
Mr. Y
Mr. Z
Total income
(-) Deductions
Children tuition fees
Total deduction
Taxable income
3% education Cess
Total Tax liability



I M sure this article will surely benefit to all our members.