Income-Tax Planning

Franklin D Roosevelt said, “Taxes, after all, are dues that we pay for the privileges of membership in an organised society.” Tax is a compulsory payment made to the government for the services it provides us, though people may not be completely satisfied or convinced with these services.

Income tax is an instrument used by the government to achieve its social and economic objectives. Simply put, it is a tax that income-earning individuals pay to the government in exchange of benefits such as law and order, healthcare, education and a lot more. With proper planning, your tax liability can be reduced and optimised effectively, leaving you with a greater share of income in your hands than being paid out as tax. The income earned during the 12 months between April 1 and March 31 (the financial year) is taken into account when calculating income tax. Under the Income Tax Act, this period is called the ‘previous year’. A related term is assessment year. It is the twelve-month period, from April 1 to March 31, immediately following the previous year. In the assessment year, a person files his return for the income earned in the previous year. For example, for FY2015–16, the AY is 2016–17. You are required to pay tax if your income in a particular year is above the minimum threshold in the category you fall in. There are, however, certain other criteria which decide the need to pay income tax, including your residential status. The three different kinds of residential status are:
• Resident Indian
• Non-resident Indian (NRI)
• Not ordinarily resident (NOR)

Gross Total Income

The gross total income is the sum of income from all sources that an individual has or the total income he earns in a financial year. It can fall into one of the five following heads.

Income from Salary

Income can be charged under this head only if there is an employer–employee relationship between the payer and payee. Salary includes basic salary or wages, any annuity component, gratuity, advance of salary, leave encashment, commission, perquisites in lieu of or in addition to salary and retirement benefits. The aggregate of the above incomes after exemptions is known as gross salary.
An allowance is a fixed monetary amount paid by the employer to the employee for expenses related to office work.

Basic salary along with commissions and bonuses is fully taxable.

Allowances are generally included in the salary and taxed unless there are exemptions available. Some allowances are fully taxable such as dearness allowance, city compensatory allowance, overtime allowance, servant allowance and lunch allowance. Specific exemptions are available for some allowances such as
• Conveyance allowance Up to `1,600 per month is exempt from income tax.
• House-rent allowance (HRA) This allowance is given by the employer to take care of your rental or accommodation expenses. The employer can choose to offer you HRA in the salary package, irrespective of whether you live in a rented accommodation or in your own house. It is important to understand how the income-tax department treats HRA to use it efficiently. To arrive at HRA, ‘salary’ is defined as the sum total of basic, dearness allowance and a percentage of commissions of turnover achieved by the employee.
• Leave travel allowance (LTA) LTA accounts for expenses for travel when you and your family go on leave. While this is paid to you, it is tax-free twice in a block of four years and the travel to avail LTA is restricted to India.
• Medical allowance: Medical expenses up to `15,000 a year are tax-free. These expenses can be incurred by the employee or his family members.
• Perquisites: Perquisites (or personal advantage) are benefits in addition to the normal salary. Examples of these are rent-free accommodation or car loan. Perquisites could both be taxable and tax-free.

Income from House Property

Any residential or commercial property that you own is subject to tax. Even if your piece of real estate is not let out, it will be considered earning rental income and you will need to pay tax on it. Income-tax authorities tax you on the capacity of the real estate (not let out) to earn income and not the actual rent. This is called the property’s gross annual value and is the higher of the fair rental value, rent received or municipal rent. From the gross annual value, a deduction of 30 per cent of the annual value is permitted to arrive at the taxable income. Also, one can deduct the property tax and any interest paid for outstanding loans taken against the property.

Income from Profits and Gains of Business or Profession

- The income earned through your profession or business is taxed. The income chargeable to tax is the difference between the credits received on running the business and the expenses incurred. The deductions allowed are depreciation of assets used for business, rent for premises, insurance and repairs for machinery and furniture, advertisements, travelling, etc.

Rent receipts need to be produced as proof to your employer to claim HRA.

If you own a house and have a house loan on it, you can still avail of HRA benefits, along with home-loan tax benefits. It does not matter where your house is located as both home-loan tax benefits and house-rent-allowance benefits can be availed simultaneously.

Income from Capital Gains

Any profit or gains arising from the transfer of capital assets held as investments are chargeable to tax. The gain could be short term or long term. A capital gain arises only when a capital asset is transferred. This means that if the asset transferred is not a capital asset, it will not be covered under capital gains. Profits or gains arising in the previous year in which the transfer took place are considered as income of the previous year and are chargeable to income tax. The concept of indexation may also apply.

Income from Other Sources

- Any income that does not fall under any of the four heads of income above is taxed as income from other sources. An example is interest income from bank deposits, lottery, any sum of money exceeding `50,000 received from a person (the person shouldn’t be a relative; money received in marriage or as inheritance is also not considered under this head).

More about Capital Gains

A capital asset is any property held by the income-tax assessee, excluding the following
•  Jewellery, drawings and paintings.
•  Any item held for a person’s business or profession (stock, ready goods, raw material)
•  Agricultural land, i.e., any piece of land from which agricultural income is derived.

Capital assets are of two Types -

•Short-term capital assetThis is an asset that is held for not more than 36 months immediately preceding the date of its transfer. However, some assets qualify as short-term capital assets if held for 12 months. These assets are:
• Equity or preference shares held in a company.
• Any other security listed on a recognized Indian stock exchange.
• Units of equity mutual funds
•Zero-coupon bonds
•Long-term capital asset This is an asset that is held for more than 36 months or 12 months, as the case may be. If real estate is held for three years, it qualifies for long-term capital gains; otherwise, short-term capital gains.
Transfer is defined as the sale of an asset, giving up of rights on the asset, forceful takeover by law or maturity of the asset. Many transactions are not considered as transfer, for example, transfer of a capital asset under a will.
Capital gains mean any profits or gains arising from the transfer of a capital asset. Examples of assets are an apartment, land, shares, mutual funds, gold, etc. There are two types of capital gains:
•Short-term capital gains Capital gains arising from the transfer of a short-term capital asset.
• Long-term capital gains Capital gains arising from the transfer of a long-term capital asset.
Capital gains can be taxed subject to the following conditions:
The assessee must have transferred the capital asset in the previous year.
There must have been profit or gains as a result of such a transfer.
•Computing Capital Gains
As per Section 10(38) of the Income Tax Act, 1961, on long-term capital gains from shares or securities or mutual funds on which securities transaction tax (STT) has been deducted and paid, no tax is payable. Higher capital-gains taxes apply only on those transactions where STT has not been paid.
•Concept of Indexation
The value of a rupee today is not the same as what it will be tomorrow because of inflation. Likewise, to be fair while paying the capital-gains tax, the effect of inflation on the purchase is included. Incorporating the effect of inflation in tax calculations is called indexation. The concept of indexation allows you to show a higher purchase cost, which lowers the overall profit and reduces the tax you pay on the gains. Using the inflation index, one can adjust the purchase price of an asset to in the year of sale.
The inflation index used in India for computing tax on long-term gains is called the cost-inflation index (CII). In order to use the CII, the CII for the year in which an asset is transferred or sold is divided by the CII for the year in which the asset was acquired or bought. Let’s say the year in which an asset (worth `20 lakh) is transferred or sold is 2011 and the CII for 2011 is 711. The year in which the asset is acquired or bought is 2002 and the CII for 2002 is 426. So the CII to be used is 711/426 = 1.67. This CII is then multiplied with the purchase price to arrive at the indexed cost of acquisition, which is the actual or true cost to be used at the time of tax computation or calculation. The indexed cost of acquisition is `20 lakh × 1.67 = `33.4 lakh. If the asset is sold at `35 lakh, then the long-term capital gain is `35 lakh - `33.4 lakh = `1.6 lakh.
In case of long-term capital gains, the tax liability is the lower of the amount arrived at between the following:
20 per cent tax liability arrived at by the indexation method.
10 per cent tax liability arrived at without using the indexation method.
In the example above, using indexation, the tax liability comes to (20/100) × 1,60,000 = `32,000.
If you do not use indexation, then capital gains = sale price of asset - cost of acquisition = `35 lakh - `20 lakh = `15 lakh. Capital gains tax on this at 10 per cent = `1.5 lakh. This clearly shows the advantage of using indexation.

Tax Deductions

Deduction is the reduction that one can claim under different heads to reduce the tax liability, thereby reducing the income tax that one pays.
Section 80C
Section 80C offers a window of investment opportunities for claiming tax exemption up to `1.5 lakh. For instance, if you are in the highest tax bracket of 30 per cent, the investment of `1.5 lakh under this section will save you `45,000 each year. Further an exemption for `50,000 can be claimed under Section 80CCD in each financial year for investment in the National Pension System (NPS). This benefit is available to everyone, irrespective of their income levels. The various financial products that qualify for Section 80C benefits are as follows:
Life-insurance-premium payment.
Home-loan principal
Employees’ Provident Fund (EPF), wherein 12 per cent of your salary is deducted every month and an equal amount is contributed by your employer. Only your contribution towards the fund is eligible for deduction under 80C.
Tuition fees for up to two children can be claimed. However, any payment towards development fees or donation to institutions is excluded.
Contributions to the Public Provident Fund
Investments in the Senior Citizens Savings Scheme
Term deposits in scheduled banks with a minimum period of five years; savings in post-office time deposits with a five-year lock-in
National Savings Certificate, six-year government-backed securities available at post offices
Investments in equity-linked savings scheme (ELSS)
Investments in pension plans
Investments in the National Pension System

Other Deductions

•Section 80D Premium payments towards medical insurance for self, spouse, children and parents qualify for deduction. The limit is `25,000 for self, spouse and dependent children. Additional deduction of up to `25,000 for parents is allowed (`30,000 if the parents are 60 years or above). Preventive health check-ups of up to `5,000 also qualify for tax deductions.
Section 24 Interest on home loan, with a maximum deduction of `2 lakh as interest payment for a self-occupied property; there is no limit for a property that is let out. Anyone taking a loan for the first home up to `35 lakh can also claim an additional deduction up to `50,000.
Section 80E Interest on an educational loan for full-time studies by self, spouse or children in any graduate or post-graduate course qualifies for deduction. However, there is no benefit on principal repayments.
Section 80G Donations to funds and charities are deductible from 50 to 100 per cent of the donated amount. But donations shouldn’t exceed 10 per cent of your gross total income. z
Section 80DD Deduction of up to `50,000 or `1 lakh on the medical treatment of a dependent with a disability. Certification by a medical authority required.
Section 80DDB Deduction of up to `40,000 for assessees under 60 years, `60,000 for senior citizens and `80,000 for super senior citizens on costs incurred for treatment of specified illnesses such as malignant cancer, chronic renal failure and other listed diseases.

When to Pay Income Tax

• An individual having salary income and no business income must file his return not later than June 30 of the assessment year.
•The due date of filing returns by an individual who has business income and whose accounts are not required to be audited is August 31.
• The return should be in the prescribed form.
•It is necessary to file a return to claim a refund of any excess tax paid.