Decoding the right approach to tax planning
“I love paying taxes,” said no taxpayer ever. But, you can definitely save on the amount of taxes you pay every year by investing in tax saving instruments. Most of us tend to relegate tax planning until the Income Tax Department starts sending us reminders that it is time for us to fulfill our duties as citizens. Consequently, many people end up making erroneous investment decisions just so they can reduce their tax burden. The right approach to tax planning can save reduce your tax liabilities significantly and erosion of your total income generated. Investments in tax-saving mutual funds can help you fulfill not just your wealth creation goals but they can also help you save taxes.
Parvati Iyer, chief investment officer at Femwealth.com, says “Garnering taxation efficiencies is an important part of financial planning. Section 80C is a common section for tax savings since there are a multitude of investments and schemes that are covered under this section. Historically most taxpayers gravitated towards Fixed Income or Debt Products especially PPF, EPF under this section. ELSS mutual funds however represent a superior product since they offer the best of both worlds - tax savings as well as equity investment. Also prominent in the section 80C umbrella is market-linked NPS.”
‘The three parts’
Deepak Chhabria, CEO of Axiom Financial Services Pvt Ltd explains there are three distinct parts to tax planning and availing tax benefits with mutual funds. He says, “Investors can avail tax benefits under Section 80C of the Income Tax Act by investing in equity-linked savings scheme (ELSS), which are equity-oriented funds. Investments of upto ₹1.5 lakh are eligible for tax deductions under Section 80C. It provides the dual advantage of wealth creation in the long run and saving on taxes.”
What makes mutual fund investments better than fixed deposits is the fact the appreciation in mutual funds is taxed only when the fund is sold and there is no tax on notional gains, unlike FDs where you pay tax on accrued interest, states Chhabria.
“In case of the equity funds, if holding period is more than 1 year the tax rate is only 10%, (if total long term capital gains amount from equity oriented mutual funds/ equity shares are higher than ₹1,00,000 in a year). Compared to bank fixed deposit debt mutual funds are ideal for investors in high tax bracket. The long-term capital gain tax if the investment is held for 3 years and more is 20% with indexation benefit. Thus, offering tremendous advantage as your investment is allowed to compound taking indexation [inflation] in consideration,” he says.
ELSS investments are eligible for annual tax deductions and have a lock-in period of three years. “They offer better post-tax returns than standard fixed deposits, because the long term capital gains (LTCG) of up to ₹1 lakh a year from ELSS mutual funds are exempt from income tax. The best way for investment in ELSS remains by the way of SIP. Holding equity mutual funds for the longer term is also tax advantageous. Gains made after 12 months are considered as LTCG and these are taxed at 10%( plus surcharge and cess). In general equity mutual funds can be considered to be the most efficient avenue for high returns after taking taxation into account,” Iyer says.
Chhabria highlights that compared to traditional tax-savers mutual funds can be a better bet for your portfolio in the long run. “Mutual funds are ideal investment for investors to create long term wealth not only due to its tax efficiency and convenience of investing - one can start with amounts as low as ₹500. If correctly aligned with long term goals, the investor can create substantial wealth. But attention
should be paid to proper fund selection and investor risk profile, before investing. Often investors panic during market corrections and take ill-timed decision to exit with losses as they may not have understood and accepted the risk involved.”
• Speak to your financial advisor to get a clear picture of the amount you are paying in taxes and the best investment avenues that align with your investment objectives and help you save taxes.
• Keep yourself updated about changes in the taxation policies.
• The taxes levied on regular mutual fund investments will depend on the kind of funds you have invested in and the duration of your investments. Consider these factors before picking a fund for investment.
(This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.)