It was as far back as 1726, that the inevitability of taxes was pointed out by the author Daniel Defoe, when he wrote,
Things as certain as Death and Taxes, can be more firmly believ’d.
More than half-a-century later, Benjamin Franklin, one of the founding fathers of the United States of America, and among the authors of its constitution, wrote in a letter to a friend,
Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.
So it does become amply clear that taxes have been given the same sort of inevitability as death, and I could name a few people who have found them to be a rather more unpleasant thing than death as well!
Now without advocating such levels of exaggerated ill-will towards the taxman, it still goes without saying that none of us are particularly eager to pay more than our fair share of taxes. So how does one go about trying to minimise the incidence of tax on our income? The answer, as always, is to invest wisely.
There are two aspects of tax-related investing, though they sometimes overlap:
- Tax-free investments – these are investments on which the returns do not attract any tax
- Tax-saving investments – these are investments which get you a tax benefit by virtue of investing in them. Sometimes, a tax-saving investment is also a tax-free one, but not always.
Today, we will cover some tax-free investments by which you can lay out your money in such a way that the returns from it will not be taxed in your hands:
Public Provident Fund (PPF)
This is probably the single most important investment you should have as a part of your investment portfolio. PPF is offered by most Banks as well as your local post office, and offers an interest that is determined by the government. Currently, this is 8.70% per annum, which is still slightly more than what most banks offer on a long-term FD. More importantly, unlike Bank FD interest, the interst on PPF is completely tax-free and this is the safest investment you can have, since it is directly with the Central Government. The maximum investment allowed during a financial year (April – March) is limited to Rs 1,50,000/-
The only negative aspect of the PPF is that is has a long lock-in period of 15 years, though that can also be looked at as a positive thing since it ensures a compulsory long-term saving plan.
*PPF is one of those investments that is also a tax-saving investment, i.e. the amount invested is eligible for deduction from your taxable income under Section 80C of the Income Tax Act, 1961
Equity Mutual Funds
Investments in equity-oriented Mutual Funds have been mentioned in some of our earlier articles as well, as being an essential part of any young investor’s portfolio. While these do carry a risk – as any equity investment does – if you won’t take on a risk when you are young, when will you? Which to say, choose carefully, invest intelligently, but be aware that returns are not guaranteed.
That said, over the long-term, mutual funds do tend to perform well in a growing economy like India’s, and those who have invested consistently over time have found their returns to be higher than any other option. And the icing on the cake is, that whether you opt to receive the dividends on your investments as a payout, or prefer to let the gains accumulate in your portfolio, there is no tax on the payout in your hands. (For capital gains, the tax-free status only applies if the fund is held for a minimum period of 1 year from date of investment).
ELSS stands for an ‘Equity Linked Saving Scheme’ which might sound rather complicated, but really only means that it is a normal mutual fund with certain additional features. ELSS funds provide the benefits of Mutual funds, as mentioned in Point 2 above, with the additional benefit of being a tax-saving investment, just like PPF. While there is no limit on how much you can invest in an ELSS during a year, the tax benefit is restricted to the overall ceiling of Rs 1,50,000/- Also keep in mind that unlike regular MF’s that can be sold at any time depending on your requirements, an ELSS has a lock-in period of 3 years. However, it is a good idea to hold your Mutual Fund for an even longer period if possible. Equity gives it’s best returns over a period of more than 5 years.
Voluntary Provident Fund
Those of you who are salaried employees are already familiar with the Provident Fund, or EPF (E stands for Employee). It is a compulsory deduction of 12% of your basic salary that goes, with a matching contribution from the employer, into a fund in your name with a government-mandated return (presently 8.7%, on part with PPF). A VPF is simply an additional contribution that you choose to make (by informing your employer) over and above the compulsory contribution
So why am I recommending an additional contribution of this nature? It is because this additional contribution earns the exact same benefit as your PF contributions – tax saving as well as tax free returns. Like the regular PF, this contribution too cannot be withdrawn as long as you are in employment, though once 5 years are completed, you do become eligible for loans against it and so on.
*Once again, this is a tax-saving investment where the amount you invest is eligible for deduction from calculation of your taxable income under Section 80 C of the IT Act.
The Government of India issues tax-free bonds from time to time, as does the RBI and other PSU’s. These are similar to regular Corporate Bonds but the interest payable is exempt from tax. These typically offer lower returns than Bank FD’s on an absolute basis, but depending on your tax slab may give better returns. However, there is no tax-saving benefit for investing in these.
Direct investment in Equity
And last but not least, is the riskiest option of all – direct investment in shares. Dividends, as I have mentioned before, are always tax-free in the hands of the recipient, and for shares held for more than a year, there is no tax on any profits you might make on the sale as well. But be warned – this is the riskiest way to invest your money! Only put such money into direct equity as you can afford to lose, and even so, research well before investing.
So there you go – these are the primary ways you can lay out your money without bothering the taxman. Happy investing!
Disclaimer : The information provided above is based on the writer’s understanding of Income Tax law in India at the time of writing. Taxation laws are subject to change and all investors are expected to do their research before investing their money. Professional advice from a qualified tax consultant is recommended for planning your tax matters.
The author of the article, as well as indianyouth.net do not take any responsibility for funds invested basis the advice above. Don’t forget to take suggestions from your financial Adviser.