Tax Planning – How to increase cash flow and beat taxes

Armed with an MBA in Financial Management and 12 years of work experience, Pradita Nambiar, a certified Equity Research Analyst, shares a valuable article on Tax Planning.

Those inevitable taxes can be reduced , atleast to the minimum required by law. That may not sound like too great an accomplishment, but each year more than a million individuals overpay income tax returns on the basis of information included in their returns. In addition, there are others who overpay simply because they do not take advantage of all the tax saving opportunities available to them under the law.

We have all heard of TDS or Tax deducted at Source(which the employer takes care of) and  the filing of Tax returns(your CA firm does this for you). But very few of us are aware of Tax Planning. Taxes can be harmful to your financial health. This does not mean that you evade tax as this is illegal. But it is an exercise to   proactively reduce your tax liability by using all allowances, exclusions, deductions, exemptions etc .

Here are some tips for effective tax planning for salaried employees.

1. What is Tax Planning?

This is primarily rearranging your finances which is income (from salary, house property, capital gains etc) to reduce taxes.

2. When should I ideally do Tax Planning?

Tax Planning needs to be done in the first 2 weeks of April every year after taking into account all pay hikes received or likely to receive. Many people do Tax planning when they file the IT returns for the prior year.

3. How do I do Tax Planning?

The tax payer needs to have a fair knowledge of the exemptions, allowances available under Law. Becoming familiar with tax rules does not mean that a person is expected to become an accountant overnight. That is neither possible nor necessary. However there are some important points which an average taxpayer needs to be aware to derive the benefit of reduction in taxes.

Some of the more commonly used tax planning exercises are listed here.

I. Reduction of Gross Taxable Income

Gross Taxable Income is a key element in determining your taxes. Gross Taxable Income determines the tax rates. As you can guess, the higher the taxable income the higher the tax rates. Therefore we begin the tax planning with the Gross Taxable Income. This is done by ensuring that all entitled exemptions have been deducted from the Taxable Income and intimated to the employer in the required format thus reducing the taxable income and thereby making an impact on the tax slabs that the individual will come under.

1. Individuals living in a rented accommodation should opt for HRA as part of their salary.
2. Leave Travel Allowance can be claimed twice in a block of 4years for domestic travel.
3. Transport Allowance is exempt up to Rs.800p.m.
4. A joint home loan with the spouse enables to have the tax benefit optimized as both the owners can avail the benefit in the proportion of the holding in the loan. The co-owner who falls in the higher tax bracket needs to have the higher proportion of the loan to maximize the benefits.

Eg. A salaried individual with taxable income of Rs.12lakhs receives HRA of Rs.10,000 pm. He is entitled to an HRA exemption of Rs.6000/- which he does not claim. He therefore pays an additional tax of Rs.21600/-(30% of 6000*12).

II.  Maximum Utilization of deductions under sec 80C

The maximum deduction available under this section is Rs.1,00,000. Salaried individuals should use the entire limit of Rs.1,00,000.

Eg. A person with a taxable income of Rs.9,50,000 who utilizes only half of this deduction will pay an additional tax of Rs.15,450/- as against the person with the same taxable income but who has utilized the entire limit.

III. Invests in parent’s name

One of the effective tax saving tool could be in your house in the form of your old parents or children. They can bring down your tax liability in various ways, provided they are in a lower tax bracket or already retired. Exploiting the loophole of Sec 56 of Income Tax Act, relating to tax on gifts, one can broad base its income by transferring money to them which can then be invested in their name. Also provision relating to clubbing of income would not be applicable here as family members (except spouse) who are major (above 18 years of age) can freely be given any amount of money as a gift without the donor coming into the clubbing net.

• If MR X sells his house property worth Rs 50 lakhs. Of this, you gift Rs 24 lakh each to your senior citizen parents. Your money gifted to father and mother is tax-free in the hand of parents as per Sec 56 of Income Tax Act. Your gifted money that is Rs 24 lakhs, is invested by your parents into fixed deposit earning 10% interest per year. The parents being senior citizens, they will earn interest rate higher than earned by you from the fixed deposit. Each of your parents will earn interest income of Rs 2.4 lakh per year from fixed deposit investment of Rs 24 lakh. The earning for each parent is tax-free as this income amount is within the tax-free limit of Rs 2.4 lakh not-taxable income for senior citizen. Using the above strategy you have made interest income of Rs 4.8 lakh from fixed deposit of Rs 48 lakh tax-free. Otherwise you would have paid 30% tax on interest income of Rs 4.8 lakh. They don’t even need to file any return. However it is worth noting that it’s not the whole Rs 50 lakhs, but the returns (interest) on it that can be made tax-free.

IV. Set off long term loss against parents income

You can also minimize losses in share market and save capital gain tax through parents. If you have attracted long term capital losses, the same cannot be adjusted with your long term gains or short term gains for an individual. But elderly parents can help reduce your money as senior citizens are allowed to offset long term capital gain against other assets such as property, debt funds etc. Beside, enjoy the privilege to carry forward unadjusted loss for up to 8 successive financial years.

V. Avoiding TDS on certain income

Are you earning incomes on which Tax Deducted at Source (TDS) is deducted even though you are not eligible for paying taxes, e.g. tax on interest income from Fixed Deposits. Avoid those taxes before the financial year closes. Refer the example below:

Y, a 27-year-old woman, is employed and also has a Fixed Deposit in a bank. The following is her income and taxability situation:

• Salary income: Rs. 1.40 lakhs per annum
• FD interest Income: Rs. 30,000 per annum

As Y earns more than Rs. 10,000, she will be liable to a TDS deduction at source. However, she is not entitled to as Y’s total income (salary + interest income) is below the annual exemption of Rs. 1.90 lakhs available to women. Nevertheless, taxes will be deducted from her interest income at the bank where she holds her FD.

In such cases, Y will need to furnish a declaration before 31^st March, using the prescribed form to the bank or entity responsible for deducting tax. This declaration needs to state that no tax deduction is required because the income level does not fall into the taxable slab. The bank on the basis of details furnished will allow TDS to be rolled back within a stipulated time period.

What are these prescribed forms?

Form 15G: Applicable for a resident individual, other than a senior citizen

Form 15H: Applicable for a senior citizen

What if I don’t receive HRA, but pay rent?

1. Salaried people who pay rent and get a house rent allowance (HRA) can claim exemption of that amount in most cases. But what if you are not salaried? What if you are a businessman paying rent? Or, what if you are salaried but do not get any HRA? Then a relatively unknown Sec 80GG provides you a deduction up to the least of the following:
2. 1.Rent paid less 10% of total income
3. 2.Rs. 2000/- per month
4. 3.25% of total income

• Assesse or his spouse or minor child should not own residential accommodation at the place of employment.
• He should not be in receipt of house rent allowance.
• He should not have self-occupied residential premises in any other place

VI. Claim stamp duty, house registration under 80C

Income Tax permits you to claim Stamp duty and the registration fees of the documents for the house as deduction under section 80C in the year of purchase of the house. An important point to note here is that you should be in possession of the house if you want to claim these deductions. So in case of under-construction properties, you lose out on claiming this deduction.

VII. Don’t choose new house as self-occupied

If you have taken housing loan for a self-occupied property during the year and have more than one house, The Income Tax Law provides you the option of choosing one property as self-occupied (used for the purpose of own residents) while other will be deemed to be let out. Choose the house for which loan is taken as deemed to be let out. This is because as per Sec 24 of IT Act, if an individual uses the property for self-occupation, he can claim a deduction for the interest amount up to a maximum of Rs 1.5 lakh as deduction for self-occupied property, whereas if the property is rented the entire interest paid is allowed as a deduction, hence lower tax liabilities.

Thus X, a salaried employee, takes a home loan for a new property and pays an interest of Rs 2, 50,000 for 2010-11. X can claim a deduction of Rs 1, 50, 000 if he is occupying the new property for his own residence. However, if he had decided to let out that property, he will be eligible to claim the entire amount (Rs 2, 50,000) as deduction from the rental income.

Text by: Mrs. Pradita Nambiar