Sunday, March 4, 2012

Smart investing through better tax planning :

A penny saved is a penny earned. Nothing can be truer than this when it comes to smart investing through better tax planning. Many investors look at only the gross returns while evaluating the merit of a financial investment.

The tax efficiency of financial investments can vary widely, typically from no tax to 30% tax. So an instrument, let's say PPF, which pays 8.6% tax free, is better than a fixed deposit that pays 10% p.a. but with a tax rate of 30%.

Let us look at a simple example of smart investing. If a person needs, let's say, 50,000 after one year from his investment income, he has two choices. One, he can invest in a fixed deposit of 5 lakh that can yield a return of 50,000.

However, the interest earned would be taxed and the net in hand may be only 35,000. The other option is to invest only 45,000 in a fixed deposit that can grow to 50,000. In the second scenario the tax will reduce to just 1,500. So while the risk of both the investments was the same, one investment provides higher return than the other considering the tax paid.

We can look at tax planning at three different levels - Tax planning at the source; Choosing the right tax saving instruments; and overall investment planning.

The tax planning options at the source of income are fairly limited and more so for people in the higher income categories. The only significant tax saving option is those under Section 80C that includes investments like insurance, PF, PPF, ELSS etc.

Choosing the right tax saving instrument is important here. PPF provides tax-free income and is now tied to the 10-year government security returns and it will now vary with the market rate of interest. Equity-linked saving schemes can also be an excellent choice for moderate risk investors as they are the only instruments that have the potential to give higher returns.

When it comes to income from investments, tax planning can really make a difference in the overall returns generated.

The investment income is taxed primarily under three broad heads - interest income, dividend income and capital gains income. Interest income is taxable at the highest applicable tax rate, also called the marginal tax rate. Investors can make such investments efficient by investing in instruments that provide tax-free interest.

Dividend income is derived from investment in shares or mutual fund units and is tax free in the hands of investors. Even fixed income mutual funds have the benefit of tax-free dividend income after a dividend distribution tax of 12.5% for individuals. Therefore, fixed income funds provide an efficient way to plan investments and score over traditional fixed deposits because of the tax efficiency.

The third form of investment income is capital gains that are further segregated into short-term and long-term gains. Long-term gains have a concessional rate of tax and also provide the benefit of adjustment for inflation. In case of equity investments there is zero long-term capital gains tax.

There are many ways in which one can plan long-term gains tax. In case of house property, buying another property whose value is equivalent to the extent of capital gains can save complete tax. A similar benefit is available if the capital gains are invested in a capital gains account of a nationalised bank.
Source : ET

No comments:

Popular Posts