We will discuss two tools, which, if used optimally, can save you heavy taxes. When used simultaneously, they create an amazing synergy in tax savings.
Read how Mr Mehta benefited by investing money in his parents’ and children’s names
In this article, we will discuss two tools, which, if used optimally, can save you heavy taxes. When used simultaneously, they create an amazing synergy in tax savings.
The first tool is your basic tax threshold. Readers would know that the first Rs 1,10,000 of income is exempt from tax.
For non-senior women, the limit is Rs 1,45,000. For senior citizens (65 plus), the limit is Rs 1,95,000. So far, so good.
The second tool that works hand-in-hand with the first is known as Section 56 of the Income-Tax (I-T) Act.
It basically exempts cash gifts between relatives. Though there is a long list specified in the section, for our purposes, suffice it to know that as per the Act, you, your parents, your brothers and sisters and your children are all relatives of each other.
Now, in order to understand how these two tools can be used for some smart tax planning, let’s take the example of one
Mr Mehta, who is 49 years old. He happens to be in a senior management job, which puts him in the highest tax bracket.
His retired parents live with him. His wife is a home maker. And he and his wife are proud parents of an 18-year-old daughter and a 20-year- old son, both of whom are studying in college.
Read Mr. Mehta’s profile once more, if you must, because it is important in our scheme of things. Also remember that some of the numbers that are going to be thrown up are astonishingly large. Don’t get thrown off because of that.
This is just the power of these tools at work. You can use them at any income level to suit your particular situation. What’s important is understanding the concept, individual numbers can always be plugged in.
Now, Mr. Mehta, like most of us, finds that all tax-saving investments in the world can help him save a maximum of only Rs 33,900. That’s not enough. His tax outgo is much more.
Moreover, every rupee of post-tax income that he invests, in say, RBI bonds, Bank FDs and Post Office MIS and the like is subject to the highest tax rate.
If he doesn’t want to pay tax, he is forced to take market risks by investing in equity shares or mutual funds.
However, he finds the stock market too whimsical for his liking —- while it gives a reasonably good return for a period of time, it is risky and volatile.
Already suffering from hypertension, no beta blocker in the world could prevent his pressure from outswinging the market.
It was at this delicate juncture that Mr Mehta was introduced to our tax planning tools by an old chartered accountant friend. This is what Mr. Mehta did after his brief, but illuminating, chat with his friend.
He gifted Rs 19.50 lakh to his father and a similar amount to his mother. This gifted money was invested by his parents in a bank FD, yielding 10% per annum.
This basically meant that both Mr Mehta’s father and mother earned Rs 1,95,000 as interest from the FD (10% of Rs 19.50 lakh). However, not a penny of this is taxable as it is not beyond the initial tax slab available to senior citizens.
In one stroke, Mr Mehta effectively made an income from Rs 39 lakh of capital tax-free in the family’s hands.
Hade he invested the funds himself, he would have paid full tax on it. However, since the gift was tax-free and the tax slab was available, this strategy could be put to work.
Now, Mr. Mehta finds that his children have some time to go before they start earning. His daughter can earn up to Rs 1,45,000 without having to pay tax and his son can earn Rs. 1,10,000.
But they aren’t earning as of now, are they? They are studying and will continue to do so for the next 5-7 years. So what does he do? He gifts them around Rs 14.50 lakh and Rs 11 lakh, respectively.
This money, in turn, is invested in a similar bank FD by the kids, thereby earning Rs 1.45 lakh and Rs 1.10 lakh, respectively. Of course, as explained earlier, no tax would be payable.
In effect, by using two simple tools that the I-T Act offers, Mr. Mehta had managed to make Rs 6.45 lakh of income tax-free for the family. Putting it differently, over Rs 64 lakh of capital was deployed.
However, the income therefrom was totally tax-free. Note that it is not Rs 64 lakh of income that is rendered tax-free, it is the income on a capital of Rs 64 lakh (around Rs 6.45 lakh) that is sought to be made tax-free.
Now admittedly, Mr. Mehta is an extremely rich man. He had Rs 64 lakh to spare in the first place before trying to make it tax-free. Not everyone will have this kind of money. However, the example given is an optimal one.
You can use a similar strategy with the funds at your disposal and the benefit you derive will be proportional. In other words, it’s not an all or none strategy…….use it to the best of your ability.
Also note that Mr. Mehta’s profile was an ideal one. Also, not every taxpayer will have his profile. You father may be having taxable income but your mom may not be working.
Or your children may be earning already. However, the idea is to use that particular element in the equation which applies in your case directly.
Beyond a point (barring ideas such as discussed above) tax saving is not possible. The worst mistake any investor could make is to invest with the primary objective of saving tax.
The question to ask is would you have made the investment if it didn’t offer tax saving? If the answer is no, don’t touch the investment.
It’s better to try and optimise, post tax income instead of making a sub-optimal investment just to save on tax. Or like Donald Trump says, some of your best investments are the ones that you don’t make.
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