TAX PLANNING

Tax planning is an essential part of your financial planning. Efficient tax planning enables you to reduce your tax liability to the minimum. This is done by legitimately taking advantage of all tax exemptions, deductions rebates and allowances while ensuring that your investments are in line with your long term goals.

What tax planning is not...

Tax Planning is NOT tax evasion. It involves sensible planning of your income sources and investments. It is not tax evasion which is illegal under Indian laws. Tax Planning is NOT just putting your money blindly into any 80C investments. Tax Planning is NOT difficult. Tax Planning is easy. It can be practiced by everyone and with a very little time commitment as long as one is organized with their finances. Planning taxes this year a. You will have certain needs and goals to meet. Understand what those are and then figure out how to maximize tax efficiency in your effort to meet them. Tax planning should be a part of the overall financial planning that you must do. For instance, you might be getting married and need to buy a house. In this situation you need to get insurance to protect you spouse if they are financially dependant upon you, as well as you need to get a home loan. What should you prioritize and what do you have the capacity to afford? If you blindly put money into an insurance policy, it might not even be sufficient to give you adequate insurance cover. However, if you choose to pay off the principal on your home loan, that could be a better option in this situation. b. Do not blindly invest money with the the first agent that you might come across. You might end up making mistakes. A lot of people end up buying insurance policies with minimal insurance coverage or putting money in instruments where they cannot access the money when they need it. c. Do not make last minute decisions just because your payroll department has reminded you that the internal deadline for submitting proofs is approaching. Tax planning involves planning in advance to avoid the last minute scramble.

Selecting tax saving investments

You should think about the following criteria, before selecting your tax saving investments for the year: Liquidity: How quickly will you need the money? Will you need to access the money within the next year or two years or over what duration? None of the above instruments let you withdraw your money quickly, in fact there is a minimum three year lock in for all tax saving investments. Risk and Return: How much risk do you want to take. There is a tradeoff between the two, some instruments are very low risk, but as a result they give low returns which are capped. Inflation protection: The instruments that give you a low return typically are the worst type of investments regarding inflation. This is important because many of the instruments give you a fixed rate of interest, and lock in your money for a long period. This is not a good protection against inflation. Tax Exemption: All tax saving investments under Section 80C are alike in one respect that they are tax exempt when they are invested. But they differ with respect to the tax on the income you earn from such an investment as well as the tax on the maturity of the investment

How can I save Taxes this year?

Some of the Sections of Income Tax Act, 1961 are detailed below which detail few exemptions and categories of exempt income that you can take advantage of: Section 80C: Investment in specified instruments and expenses

Section 80C gives every income tax payer up to a maximum of Rs. 1,00,000 tax free income in a year if they invest in or buy the following instruments. Please not that this is a combined total of Rs. 1,00,000 and not an individual figure for every instrument: 1. Premium for Life Insurance or ULIP 2. Provident Fund (PF) contribution 3. Public Provident Fund (PPF) - only up to Rs. 70,000 in a year 4. Repayment of home loan principal 5. Equity Linked Savings Schemes (ELSS) of Mutual Fund Companies

6. Infrastructure Bonds 7. National Savings Certificates (NSC) 8. Tax Saving Fixed Deposits with Banks 9. Tuition Fees of children

Comparison of 80C Investment Avenues

Type of 80C Instrument Lock Period Equity Linked Savings 3 years Scheme (Mutual Fund) Market Linked High In Returns Risk Taxation Returns No tax of

(58% Category Average for yr ending Dec

28,2007) Life Insurance Premium 2 years 6% Low No tax

ULIP Premium 1 PPF (fixed returns) Home Loan Repayment Infrastructure (fixed returns) NSC (fixed returns)

3 years 15 years 5 years

Market Linked 8% NA

High

No tax

Low 2 No tax NA Risk Free NA Interest taxed Interest taxed Interest taxed is is is

Bonds 3

years 6%

(min) 6 years 8.16%

Risk Free

Tax

Saving

Fixed 5 years

8%-8.75%

Risk Free

Deposits

(fixed returns)

Notes: 1: ULIP premium needs to be at least 1/5th of the sum assured to qualify under Section 80C 2: PPF returns are set by the Government of India and can be revised either upwards or downwards in any year. Section 80D: Health Insurance Premium

You can take advantage of an annual deduction of Rs. 15,000 from taxable income for payment of Health Insurance premium for self and dependants. For senior citizens, this deduction is Rs. 20,000. Section 80E: Interest paid on educational loans You can claim a deduction on the interest paid on loans taken for higher education for yourself, your spouse and children. There is no limit on the amount of deduction you can claim.

The only thing to keep in mind is that the program for which the loan is taken should be a graduate or post-graduate program in engineering, medicine or management or a post-graduate course in the pure or applied sciences. Section 80G: Donations to Charitable institutions You can claim a deduction for any donation that you might have made to a charitable fund or institution. However, please note that these donations should be made only to specified institutions. And a proper proof of payment must be provided for the same. Based on the classification of the charity , you can claim either 100% or 50% of the donated amount as deduction. The deduction might also be subject to a certain limit again based on the type of charity that you are donating money Section 24: Interest paid on housing loan Under Section 24, a maximum of Rs 1,50,000 can be deducted from your taxable income as interest repayment for a self occupied house. Please note that this deduction is not available if you the house is still under construction and you do not have occupation of the house. Provisions that you should take advantage of if you are a salaried employee: Section 10(13A) : House Rent Allowance

You can take advantage of the provisions under this section if you are renting an accommodation. These provisions will not be available to you if you stay in a rent-free accommodation or live with your family or in your own house.

Under Section 10(13A), HRA is exempt to the least of the following: i) 50/40 per cent of basic salary= Dearness Allowance (if, applicable), ii) excess of rent paid over 10 per cent of basic salary; and iii) actual HRA Lets illustrate this calculation with an example: Assumptions HRA Basic Monthly per monthly rent month salary = = = Rs Rs Rs 15,000 30,000 14,000 received.

Rental accommodation is in Delhi. Exemption The HRA exemption would be the least of the following: 1. Actual amount of HRA: Rs 15,000

2. 50% of salary (basic component + dearness allowance) = 50% x (30,000 + 0) = Rs 15,000 3. Actual rent paid - 10% of salary (basic component + dearness allowance)= Rs 14,000 - [10% of (30,000 Rs The 11,000 + being the 0)] least HRA = of the of Rs 14,000 three amounts will 3,000 be the = Rs exemption be from 11,000 HRA. taxable.

balance

4,000 (15,000-11,000) would

Please note that HRA exemptions are only available on submission of rent receipts or the rent agreement. Paying Rent to parents or relatives

If you want to pay rent to your parents or any relatives (like uncle/cousin) whom you are staying with. You will need to treat them as landlords. And request the owner of the house (which will be one of your parents) to declare it in his/ her personal income tax return. This will prevent any litigation in the future. Section 10 (14) Rule 2BB(10) : Transport Allowance

Transport allowance granted for commuting between your residence and place of work is exempt up to Rs. 800 a month. You can take advantage of this provision to get a tax exemption of Rs 9600 annually by providing your employer with bills or a self declaration.

Section

17(2)

Medical

Reimbursement

You can claim exemption up to Rs 15,000 annually on actual expenditure incurred on your medical treatment or for treatment of any of your dependants. Moreover, there is no restriction of approved hospitals or clinic for the same. This is exempt only on provision of actual bills.

However, if the amount is paid out as an allowance not a reimbursement then it would be fully taxable.

Best Tax Saving Mutual Funds for 2010

Investment Yogi : Offers a comprehensive list of the Best Tax Saving Mutual Funds Online in 2010 in India. What is ELSS (Equity Linked Saving Scheme)? ELSS, popularly known as Tax Saving Mutual Fund, is a category of Mutual Fund where a major portion is invested in Equity & Equity related instruments. An investment up to 1 lakh is exempted from income under section 80C, but there is a lock in of 3 years before you can withdraw. However, there is no upper limit on investments and long term capital appreciations are tax free. Dividends received are also tax free in the hands of the investor. ELSS is a great instrument for tax planning which also ensures good returns. But investment should be carefully planned and you should devote sufficient time in selecting the right fund.

Types of ELSS

1. Growth: Investor does not get any income during the tenure of the investment. He will get a lump sum amount at the time of redemption or on maturity. 2. Dividend: Investor gets a dividend from the fund house. He has two options: He can cash on the dividends. He can opt for dividend re-investment option.

In most funds you have Growth as well as Dividend options which you can choose depending upon your priorities. Best Funds We present the top 7 funds based on last 5 years performance:

Figure 1. Source: Value Research

How to choose a fund for investing? A good track record is no guarantee for future performance. You should also look at some quantitative measures to evaluate which fund is good for you. Expense Ratio: Denotes the annual expenses of the funds, including the management fee, and administrative cost. Lower expense ratio is better. Sharpe Ratio: An indicator of whether an investment's return is due to smart investing decisions or a result of excess risk. Higher Sharpe Ratio is better. Alpha Ratio: Measures risk relative to the market or benchmark index. For investors, the more positive an alpha is, the better it is. R-squared: Measures the percentage of an investment's movement that are attributable to movements in its benchmark index. A mutual fund should have a balance in R-square and ideally it should not be more than 90 and less than 80.

Which fund is best for you? Choice depends upon your risk profile and priorities. You should make an investment decision based on overall financial planning. Large Cap Funds: These funds mostly invest in the large cap companies. While this may mean muted returns when the markets are rising, it also may mean a limited downside when the going gets tough. Franklin India Tax shield and SBI Magnum Tax gain are a few examples of this type of fund. Growth Funds: These Funds have about 30% exposure to mid-caps, 10% to small-caps & the rest in large caps in its portfolio. Hence, it may give a higher return in rising markets. Sundaram BNP Paribas Tax saver is a good option in this category. Mid-cap Funds: No pain, no gain. These funds have a sizeable exposure to mid-caps and small-caps. This aggressive investment style can pay rich rewards. Sahara Tax Gain and HDFC Taxsaver are good examples of a fund in this class. Small Cap Funds: Small-cap stocks can act like performance enhancing drugs. In the above discussed types, the maximum allocation to small-caps is 12%. However, Taurus Tax shield has invested almost 30% in this high-risk zone. This can be very rewarding when the going is good, but a dream run can easily become a nightmare. Taurus Tax shield has given 98.01% returns in last 1 year. Conclusion You should do sufficient analysis before taking investment decisions. It should be guided by your overall financial situation, goals and risk profile. A Financial Plan is recommended before making investment decisions. SIP (Systematic Investment Plan) for a long time horizon is the most recommended way to invest in equity funds. You should avoid lump sum investments especially when the market is on a high.