Investment is an allocation of money with an expectation of return. We invest in assets to generate income. However, revenue generated from these investments is subject to taxes. Profit from the sale of investment is subject to capital gains tax. Furthermore, share trades are liable to transactions taxes. And so on. In other words, taxes apply to most transactions, directly or indirectly, and are a reality of life. The point here is not to deliberate why taxes, as we can do little to influence. What is essential, though, is to understand the importance of optimizing investments while saving taxes.
Taxes are a part of our daily life, as much food, clothes and shelter. After all, we pay taxes directly or indirectly in almost every transaction we conduct. Why so? Simply put, the government requires these funds to carry out its functions and duties. Direct taxes help manage income inequality. Etc.
Focus on the big picture, i.e. goal accomplishment
Let us start with a story. India launched ‘Mangalyan’ in 2013. It was the maiden and successful attempt by India to send a craft to Mars. The project cost was approximately Rs 450 crores (or ~$60 million at the current rate).
When India struggles with many internal issues like poverty, unemployment, low per capita income, etc., is it right for India to go after such glorious projects? Yet, despite all the odds, India still went ahead with the project focusing on the big picture.
As a result, India became the first Asian country and the fourth globally to reach Mars. The world community looked at India with awe and appreciation. Indian scientists proved indigenously it can achieve the incredible feat and at a much lower cost. Thus, India established its superiority in this domain. New knowledge and innovation in space programmes will benefit humankind at large.
What’s the key message here? There are always two sides to a coin. For every possible action, there will always be an equally compelling reason why not do so.
Let’s try to put this into perspective. From a financial planning perspective, an investor’s primary focus is to create wealth. Optimizing taxes is a process that exists in parallel. Often, there are compelling reasons to invest in tax-efficient investment options. However, if those do not earn the required risk-adjusted net return, you stand a chance to miss meeting the financial goal. Therefore, the focus should always be on a higher net of tax returns than choosing tax-saving options.
Change the way you think about taxes
Investors often think about tax as a monster and do not want to face it. Ok, let us be realistic. It is true that you hate paying taxes, but is there anything we can do there? No, then let us not be enemies, even if we cannot be friends.
Do not let reduction in tax burden be such a significant consideration that it affects investment decisions. But, of course, an investment decision cannot be reckless, and investment strategy must factor in the impact of taxes.
However, saving taxes is not the primary objective. Tax is an outcome. Above all, the idea is to optimize investments that allow you to minimize tax costs without compromising returns.
Avail of all the possible tax benefits
Investors must take the maximum possible advantage of the available tax deductions. Later in the article, we will discuss some of the most common tax exemptions/deductions available.
However, the list is not conclusive. Several other tax exemptions are available based on the nature of the transaction. For example, through specific investments, you can exempt or significantly reduce the burden of capital gain arising from the sale of a house.
Further, there are plenty of deductions under the sections of income from house property. For instance, section 24 allows the homeowners to claim a deduction of up to Rs 2Lacs as interest paid on their home loan. Moreover, total interest paid on loan is allowed as a deduction in letting out property. Furthermore, a reduction from income on account of payments made towards municipal taxes is possible. There is also a provision to reduce the standard deduction of the net annual value.
For now, we will focus on some crucial exemptions/deductions available under the Income Tax Act:
Section 80C and 80CCD – Investments, insurance and pension contributions
Section 80C allows tax benefits of up to Rs 1.5 Lakhs by investing in one or more eligible investments or specified expenses. This deduction is available only to individuals and HUFs.
For example, investments in life insurance, ELSS, provident fund or public provident funds, etc., are eligible for a tax deduction. On the other hand, expenditure on school tuition fees, stamp duty paid on a house purchase, principal housing loan repayment, etc., are eligible for deduction.
Additional tax benefit of up to Rs 50,000 is available under section 80 CCD (1b) by subscribing to National Pension Scheme (NPS). Contributions made to Atal Pension Yojana is also eligible for the deduction here.
Further, under section 80CCD (2), employers contribution is allowed as a deduction of up to 10% of the basic salary plus dearness allowance for salaried individuals.
Section 80D – Medical insurance
An individual (or HUF) can claim a deduction of up to Rs25,000 per annum paid as a premium for medical insurance. The insurance policy can be for self, spouse and dependent children.
An additional deduction of up to Rs25,000 is available if the premium is for parents less than 60 years of age. The deduction amount is Rs 50,000 for parents aged above 60years.
Above all, if the taxpayer and parents are above 60years of age, the deduction amount is capped to Rs 1,00,000.
The taxpayer can also claim a deduction of Rs5,000 for a preventive health checkup.
Section 80DD – Disabled dependent
The section allows expenditure incurred on the medical treatment, training and rehabilitation of disabled dependent relatives as a deduction. It includes any expense incurred on the nursing care as well.
Further, an amount paid or deposited under the Central Board of Direct Taxes (CBDT) approved scheme is also deductible.
If the disability is between 40-80%, the annual deduction is Rs75,000 fixed. In case the disability is severe (beyond 80%), the amount is Rs125,000 fixed.
Do not mix the deduction under this section with section 80U (physical disability), and these two are different. For instance, section 80U is available to a specially-abled person. And, in contrast, section 80DD allows the deduction to the person taking care of a disabled dependent.
Section 80DDB – Medical expenditure
An exemption of Rs40,000 is available to a resident individual regarding any expense incurred towards the treatment of specified medical disease or ailments. The cost can be towards self or dependents. A deduction is also available to a HUF to treat any of the HUF members.
A higher deduction of Rs1,00,000 if the cost is on behalf of a senior citizen.
Section 80E – Interest on an educational loan for higher studies
A deduction is available to an individual who has taken a loan to pursue higher studies. The loan could be for the taxpayer, spouse, children, or a student for whom the taxpayer is the guardian.
There is no qualifier on the amount of exemption under this section. However, the taxpayer can claim the deduction for a minimum of 8years or till the total interest gets repaid. The period starts from the year of the first interest payment.
Section 80G – Donations
This section covers deductions for donations done towards a social cause. The quantum of the deduction is either 50% or 100% of the amount, based on the nature of the contribution.
- 100% deduction applies without any qualifying limit for donations to funds like National Defence Fund, Prime Ministers Relief Fund, National Foundation for Communal Harmony, National Sports Fund, National Cultural Fund, etc.
- 50% deduction is applicable for donations made to Jawaharlal Nehru memorial Trust, Prime Ministers Drought Relief Fund, India Gandhi Memorial Trust, The Rajiv Gandhi Foundation.
- There are certain avenues where the 100% and 50% deduction is available but with a cap, i.e. subject to 10% of the adjusted gross total income
Section 80GG – House rent paid deduction when no HRA
Individuals/HUFs can claim a deduction of rent paid if housing rent allowance (HRA) is not received.
- The taxpayer, spouse, or the minor child should not own any house of their own at the place of employment
- There cannot be a self-occupied residential property in any other place
- The taxpayer must be living on rent and paying the rent
- If the above conditions get fulfilled, then the deduction is available to the extent of lowest of:
- Rent paid less the 10% of adjusted total income as defined in the section
- Rs 5,000/- per month
- 25% of the adjusted total income
Section 80GGC – Contribution to political parties
A deduction of an amount paid to a political party or electoral fund is eligible for deduction. However, an individual cannot claim this deduction of amounts paid in cash.
Section 80RRB – Royalty of a Patent
This section got introduced to reward someone who has done exceptional work. Above all, the exemption encourages individuals to produce good quality output. An individual can claim a deduction of the income received as royalty for a patent as a deduction. However, the maximum deduction cannot exceed Rs3Lakhs in a year.
Section 80TTA – Interest income on savings account
An individual or a HUF can claim an annual deduction of a maximum of Rs. 10,000 against interest income from the savings account. This savings account can be with a bank, cooperative society or post office. The limit is extended to Rs50,000 for senior citizens under section 80TTB.
Any other interest income, like interest on fixed deposits or bonds, is not eligible for deduction under this section.
Section 10(13A) – House Rent Allowance (HRA)
This section allows the salary component received towards the rent payment as a deduction from the taxable salary. Therefore, salaried employees who receive HRA as a part of their salary and pay rent can claim the HRA exemption.
The HRA exemption is the minimum of the below three:
- Actual HRA received by the employee
- 40% for a non-metro city or 50% of the salary for a metro city
- Actual rent paid less 10% of salary
The salary for the above calculations is as defined in the section.
Connecting the dots
We have covered aspects of how achieving the financial goal is the most critical factor in financial planning. In other words, the big picture, i.e. wealth creation, is the guiding star.
Therefore, while we believe the tax is an outcome, one cannot be reckless around the subject. And, that is why it is essential to optimize investments while saving taxes.
Below are some examples to help your thought process:
- In case you are planning to sell a house property, plan to minimize the capital gain taxes
- For homeowners, take advantage of interest deduction sections. Try splitting the loan if possible
- Take advantage of the HRA exemption in case you are paying rent and are eligible for the deduction
- Claim deduction for social contributions that you make
- We all spend on preventive health checkups, claim the deduction
- Do claim medical expenses incurred for your family
- Make an NPS contribution if you have an investible surplus
The bottom line – focus on goal accomplishment, keep the tax in mind
Taxes are one of life’s certainties and are inevitable. No one likes to give up on hard-earned money. However, it is practically impossible to avoid it altogether. Therefore, investors should embrace and plan for it.
Despite all the taxes, it is still possible to carve out an efficient way to optimize investments and take tax benefits. All this within the legal boundaries set for us. Proper financial and investment planning helps reasonably diminish or reduce the tax burden.
Above all, there is no financial instrument that helps you save tax, deliver high returns and is safe. One or more elements will be missing in any investment option. Avoid that trap.
In other words, the final choice of an investment should be on an array of factors. Amongst them, the most prominent is the risk-adjusted return of the asset and how well it supports your financial ambitions.
Dealing with income tax and efficiently planning tax costs can be cumbersome for many investors. If you are unsure of your circumstance and way ahead, connect with your financial advisor for help. Tax is a matter of expertise, and you do not want to land on the wrong side on these issues.
Happy tax planning!!
About the author
The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. Through his writing, the author wants to share his knowledge and understanding of the subject.
The author has used his knowledge, experience, and understanding of the subject and has exercised extreme caution to avoid possible mistakes. However, the author does not take any responsibility for any error that exists.
Any views, opinions, and thoughts mentioned in the article belong solely to the author and not necessarily to the author’s employer (past or current), organization, committee, or other group or individual.
Under any circumstances, the author shall not be liable for any views or analysis expressed in this note. Further, the opinions expressed are not binding on any authority or Court. We advise readers to consult their financial advisor for assistance in their specific case.