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Pay Less Tax with Your Investments

There are a wide range of investments that allow you to reduce your tax liability


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Pay Less Tax with Your Investments

Income Tax is a complex subject. Our goal here is to familiarise you with the taxation aspects only of that income (or losses) that you may have from your investments and the ways and means available to use your investments to reduce the amount of tax you have to pay. This chapter only seeks to familiarise you with concepts. It is recommended that you consult your tax advisor for details and classification on tax laws that might be needed to actually file returns.

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Paying Taxes On Investments
Of the various types of investments discussed here, mutual funds and stocks are capital assets and gains from the purchase and sale of these is called capital gains. If you lose money on them, then those are capital losses. Capital gains or losses occur only when you actually sell an investment and get the money.

Dividends paid by funds or shares is dividend income, while interest earned from bank, post office or other such deposits is called interest income.

Here's an overview of the taxation situation of each of these:

Capital gains tax on mutual funds
Non-equity funds are treated as long term capital asset if held for more than three years. The long-term capital gains tax is payable at 20 per cent with indexation benefit on the gains realised. Gains on investment of non-equity funds held for up to three years are added to income and taxed as per the applicable slab.

Equity funds are treated as long term capital aset if held for more than 1 year. The long-term gains are taxed at 10 per cent without indexation. Short term capital gains from equity funds are taxed at 15 per cent.

Capital Gains from Mutual Funds and Shares

Type of Investment Short-term Holdings Long-term holdings
Shares, Indian Equity Funds and Equity-oriented Hybrid Funds Up to 1 year; taxed at 15 per cent Gains exceeding Rs 1 lakh are taxed at 10 per cent
All other funds (fixed income, gold and international funds) Up to 3 years; Added to income Treated as long-term capital gains, adjusted for inflation

Dividend Income from Mutual Funds and Equity

Type of Investment Dividend Distribution Tax
Shares, Equity Funds and Equity-oriented Hybrid Funds 10%
All Other Funds 29.12%
Source: Income Tax Act, 1961

As an example, say you have made an investment in 2002-03 for R1 lakh and sold it for Rs 5 lakh in 2017-18. Your capital gains tax will be adjusted for the inflation adjustment factor i.e. 272 divided by 105, which is 2.59. By this method, your cost of the investment will be deemed to be higher by 2.59 times than what it actually was, that is, it will be Rs 2.59 lakh. Thus, your profit will be Rs 2.41 lakh and the tax payable will be Rs 48,200.

Interest Income: Interest income is simply added to your income and taxed according to whatever tax bracket you are in.

Cost Inflation Index for Calculating Capital Gains

Financial YearIndex
2001-02100
2002-03105
2003-04109
2004-05113
2005-06117
2006-07122
2007-08129
2008-09137
2009-10148
2010-11167
2011-12184
2012-13200
2013-14220
2014-15240
2015-16254
2016-17264
2017-18272
Source: http://www.incometaxindia.gov.in/charts%20%20tables/cost-inflation-index.htm

Saving Taxes through Section 80C
Section 80C offers a window of investment opportunities for up to Rs 1.5 lakh investment in each financial year. This benefit is available to everyone, irrespective of their income levels. For instance, if you are in the highest tax bracket of 30 per cent, the investment of Rs 1.5 lakh under this section will save you Rs 46,800 each year. The various financial products that qualify for Section 80C benefits are as follows:

  • Life Insurance premium payment
  • Home loan principal, wherein the principal portion of the home loan EMI qualifies for deduction under Section 80C
  • Your contribution to Employees Provident Fund (EPF) (employers' contribution is not deductible).
  • Tuition fees for two children can be claimed upto R1.5 lakh. However, any payment towards any development fees or donation to institutions is excluded. Also, aggregate deduction under 80C should not exceed the overall R1.5 lakh limit.
  • Contributions to the PPF
  • Investments in the senior citizens savings scheme
  • Savings in notified term deposits in scheduled banks with a minimum period of five years under the bank term deposit scheme, 2006.
  • Savings in post office time deposits with 5-year lock-in
  • National Savings Certificate, five-year government-backed security available at post offices
  • Investments in tax planning mutual funds, (ELSS)
  • Investments in pension plans
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