Six ways to help you save tax next time you pay it 

Everybody complains about high taxes, but in the lowerand mid-income groups, the effective tax rate is not very high. A person with a taxable income of Rs 40,000 a month will pay only 3.2% of his income in tax.

Someone earning Rs 80,000 a month will pay 9.5%. This assumes that these taxpayers will invest at least 15% of their income in tax-saving options under Section 80C. Yet, many taxpayers believe they are paying too much tax. They could be right. Faulty investment strategies, poor awareness about tax rules and tardiness could be exacting a high tax from some of the individuals.

One of the most common reasons for paying higher tax is the inability to avail of the full deduction under Section 80C. If you procrastinate tax planning and wake up at the end of February, there's a good chance that you won't be able to utilise the entire Rs 1.5 lakh tax-saving limit. "If you save regularly, you won't face any problem at the end of the financial year," advises Sudhir Kaushik, Cofounder and Chief Financial Officer of tax filing portal Taxspanner.com. Last year, Tax spanner noted that nearly 51% of the salaried taxpayers who used their portal to file tax returns had not fully exhausted the Rs 1 lakh saving limit under Section 80C. The figure might be higher next year because this year's budget has enhanced the saving limit to Rs 1.5 lakh. 

This week's cover story looks at some of the most common reasons that taxpayers end up paying more tax. We also offer suggestions on how to avoid this higher outgo of tax by realigning investments and optimising the tax deductions that are available. If you are also following a faulty investment strategy or are not aware of the various rules that can help save tax, the nuggets of information in the following pages can prove invaluable for you. 

Investing in tax-inefficient options

Fixed deposits are hot favourites of Indian investors. Nearly 56% of total household savings are parked in these deposits. But these are also very tax inefficient. The entire interest earned on the fixed deposit is taxed as income at the rate applicable to the investor. In the highest tax bracket, 30.9% tax pares the post-tax yield of these deposits significantly. Recurring deposits, infrastructure bonds and small saving schemes such as NSCs and the newly relaunched Kisan Vikas Patra get the same tax treatment. 

Patra get the same tax treatment. What's particularly galling is that you have to pay the tax on the interest that accrues every year, even though you might get the amount only on maturity. If you invested in a 10-year cumulative fixed deposit in April 2014, you will get the principal and the interest in 2024. But you will have to pay tax on the interest it earns every year. 

But there are other more tax efficient debt instruments on offer. Debt funds allow you to defer the tax till you withdraw the investment. If you hold them for three years, you also get the benefit of lower tax. The income from debt funds is treated as long-term capital gains after three years and taxed at 20% after indexation. 

Indexation takes into account the inflation during the holding period and accordingly adjusts the buying price to reduce the tax liability of the investor. An investor in the 30% tax bracket would have to pay Rs 9,670 in tax on a 3-year fixed deposit of Rs 1 lakh. But if he invests in a debt mutual fund or a 3-year FMP, he can get away by paying a tax of only Rs 175.

Many investors like Rajesh Varma (see picture) are not aware of debt funds and the benefits they offer. They are under the misconception that mutual funds only invest in stocks. It would save them a lot of tax if they replace the fixed deposits in their portfolios with debt schemes. 

Not utilising HRA benefit 

The house rent allowance (HRA) is usually a substantial chunk of the salary. Those living in rented accommodation can avail of deduction under Section 10(13A). If you live in your own house, you can't avail of this deduction. However, if you live in your parents' house, there is a way out. You can pay them rent and claim HRA exemption. This is possible only if the property is registered in the name of your parent. This is a useful strategy if you are in the higher tax bracket and your parent's income is lower.

Your parent will be taxed for the rental income after a 30% deduction. So, if you pay your father a rent of Rs 4.2 lakh a year (Rs 35,000 a month), he will be taxed for only Rs 2.94 lakh. If the parent is a senior citizen with no other taxable income, one can effectively pay Rs 35,700 a month without adding a rupee to his tax liability. Mumbai-based Gargi Jain uses this clause very effectively to reduce her tax liability. 

Even if the income exceeds the basic exemption limit of Rs 3 lakh for a senior citizen, the tax rate will be only 10% for income up to Rs 5 lakh. High income earners may find it cost-effective to pay rent to their parents and pay the applicable tax.

Even this can be cut by investing under Section 80C options, such as the Senior Citizens' Saving Scheme, five-year bank fixed deposits or tax-saving equity mutual funds. It gets better if the property is jointly owned by both parents. Then you can split the rent so that the tax liability gets divided between the two parents. However, make sure that the property is jointly owned before you do this. 

While it is perfectly legal to pay rent to parents, you cannot pay rent to a spouse and claim the HRA benefit. The tax authorities may disallow the deduction if the owner of the property is your own spouse. 

Failing to book losses

It may sound bizarre, but you can gain from your losses. If you have made shortterm losses on stocks this year, these can be adjusted against any short-term or long-term capital gains from the sale of property, gold or debt funds. Short-term capital losses can be set off against both short-term capital gains as well as taxable long-term capital gains. This can be especially useful for someone who has booked profits on debt funds this year. Suppose you sold the units in a debt fund and earned a long-term capital gain of Rs 50,000 after indexation. At 20%, the tax payable on this long-term capital gain is Rs 10,000. 

However, if you also lost some money in stocks during the year and made a short term loss of Rs 25,000, you can set this off against the gains from the debt fund. Then the gain from the debt fund will get reduced to only Rs 25,000 and the tax payable will be Rs 5,000. If your losses are higher and cannot be fully adjusted, you can carry them forward for up to eight financial years and adjust them against future capital gains.
However, there are some conditions to be fulfilled. One, you should file your tax return before the 31 July deadline to be eligible for carrying forward the losses. Also, one cannot set off short-term gains from stocks against long term capital losses from other assets.

Opting for dividend in non-equity funds 

The dividend distribution tax (DDT) is an invisible tax that many investors pay without even knowing. It is levied on dividends paid by mutual fund schemes other than equity funds and equity-oriented balanced schemes. For all other schemes, fund houses deduct a DDT of 28.33%. Many investors, especially senior citizens who have opted for the dividend option of monthly income plans or debt funds, don't even know that they are paying DDT. They may not be in the tax net but pay a 28.33% tax on the dividend income from their mutual fund investments.

Instead of dividends, one should go for the growth option in non-equity funds. If you are looking for a regular monthly or quarterly income, start a systematic withdrawal plan (SWP). A predetermined amount is redeemed on the day of the month fixed by you. If you are looking for a lump sum, just redeem the amount when the need arises. 

The growth option is more tax-efficient because unlike in the dividend option, the entire sum is not taxed. Only the capital gain is taxable. So, if you bought the fund when the NAV was Rs 12 and sold it when it was Rs 15, the tax will only be on Rs 3 per unit. In the first three years, this Rs 3 will be added to your income and taxed at normal rates. As we explained earlier, after three years, the gain is eligible for indexation. In recent years, high inflation has reduced the capital gains tax to almost nil. 

Not availing of the tax deductions available

As mentioned earlier, many taxpayers are not aware of all the deductions available to them. For instance, not many know that if you rent out a house bought on a loan, the entire interest paid can be claimed as deduction. Hyderabad-based IT professional Ramesh Chandra uses this clause to bring down his tax liability by almost Rs 38,500. Of course, the rent he receives is taxable (after 30% standard deduction) as income.

There are many other little known clauses in the tax laws. For instance, even if you don't get HRA as part of your salary, you can still avail of deduction of up to Rs 2,000 a month under Section 80GG. Then there is tax deduction of Rs 50,000 available if you or your dependant suffer from a handicap. If the condition is severe, the deduction under Section 80DD is up to Rs 1 lakh. Similarly, there is a deduction of Rs 40,000-60,000 if a dependant is suffering from any of the specified diseases listed under Section 80DDB.

There is tax deduction on donations as well, but you must remember to retain the receipts of the donations you make to avail of the benefit under Section 80G.

Not acting in time to avoid tax, avail credit 

Lethargy can be a costly habit, especially when it comes to your finances. Tilak Raj Gaur understands this only too well. The Delhi based marketing executive incurred losses in stocks in 2013 but did not mention these in his tax return. He also missed the 31 July deadline, so he can't carry forward his losses or even revise his return now.

Some investments are subject to tax deduction at source (TDS). If the interest on your bank deposits in a branch exceeds Rs 10,000 a year, there will be 10% TDS. If the investor's income is below the basic exemption limit, he can submit a declaration using Form 15G (15H for senior citizens) to avoid TDS. But this form must be submitted before the TDS is deducted. If you send it late and TDS has already been deducted, you can get the refund only by filing your return. For senior citizens and ret retirees who are out of the tax net, this can be quite cumbersome.

Some taxpayers end up paying more tax because they don't take the trouble of verifying their tax credits in the Form 26AS. The Form 26AS can be accessed online after a simple registration process. It has details of all the taxes paid on your behalf by your employer, bank, insurance company, bond issuer or even by yourself. Tax professionals say that one should periodically verify that all tax payments have been duly credited to one’s PAN.

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