Nothing is certain about life except death and taxes. However, planning your finances correctly can make taxes a relatively light burden. Indian tax law offers you a number of provisions to cut your tax bill in an entirely legal fashion.

Tax Slabs in India

India has the following tax slabs for individuals

Income Tax Rate
0 – 2.5 lakh Zero
2.5 lakh to 5 lakh 5%
5 lakh to 10 lakh 20%
10 lakh to 50 lakh 30%
50 lakh to 1 crore 30% + Surcharge of 10%
1 crore and above 30% + Surcharge of 15%

Income tax is levied on a proportionate basis. For example, if you have a gross annual income of Rs 12 lakh and you are not claiming any deductions, your tax bill will be calculated as follows:

  1. The first Rs 2.5 lakh will not be taxed
  2. The second Rs 2.5 lakh to Rs 5 lakh will be taxed at 5%. You pay Rs 12,500
  3. The next Rs 5 lakh will be taxed at 20%. You pay Rs 1 lakh.
  4. The next Rs 2 lakh will be taxed at 30%. You pay Rs 60,000.

Thus in total, your tax will amount to Rs 1,72,500 which is 14.37% of your total income. This rate will be even lower once you claim investment related and other deductions.

Thus even though you are in the highest tax bracket of 30%, your entire income is not taxed at the rate of 30%.

For simplicity, we have not taken surcharge and cess into account. These do increase your tax bill to some extent but this difference is not very large. A surcharge is a ‘tax on tax.’ For example, if you pay a tax of Rs 1 lakh, a surcharge of 10% means you now have to pay Rs 1,10,000. Cess is also payable in the same manner.

Your annual investment deductions

Section 80C (read our article) is the most commonly used section in every financial planner’s manual and it certainly must be one of the first to be looked at. It offers you an annual tax deduction (Rs 1.5 lakh for FY 18). They cannot be carried forward to subsequent years and hence you must either use it or lose it. It includes a number of tax saving options within its ambit, giving you plenty of choices:

i) ELSS

ELSS or Equity Linked Savings Scheme is one of the most high-reward options available under Section 80C. This is essentially a mutual fund (which is designated as ELSS) which invests in equities and has a lock-in of at least three years. The dividends on it and the amount available at maturity are also completely tax-free. Also, although the tax deduction for ELSS is limited by the total deduction under Section 80C (Rs 1.5 lakh for FY 18), there is no upper limit to how much you can contribute to it. You invest in ELSS in the same way as you invest in any mutual fund (through a mutual fund distributor or directly with a fund house).

Read our article on ELSS funds: Five ELSS Or Tax Saving Funds To Invest In 2018

ii) PPF

The PPF or Public Provident Fund was set up by Public Provident Fund Act, 1978. It pays out a fixed rate of interest which is reset every three months. The PPF rate for Q1 for FY 18 is 7.8%. This interest and the amount you receive on maturity are both exempt from tax. The PPF has a lock-in of 15 years which can further be extended for a period of five years at a time (with no limit). However, you can make partial withdrawals on specific grounds from the fifth year onwards. You have to keep contributing a minimum of Rs 500 per annum to the PPF. The maximum contribution limit is Rs 1.5 lakh. You can open a PPF account through a bank or post office.  

Read our articles:

Now You Can Open PPF Account Online Instantly

PPF And National Savings Certificates Rates Halved For Non-Resident Indians

iii) EPF

Employee’s Provident Fund or EPF (also commonly called just ‘PF’) is a mandatory tax deduction for certain categories of employees whose monthly salary does not exceed Rs 15,000. However several organisations voluntarily set up EPF accounts and make contributions on behalf of their employees. Typically both employer and employee contribute 12% of the employee’s salary to the EPF account.

The EPF interest rate is declared by the Employees’ Provident Fund Organization (EPFO) every year (8.65% for FY17). Your EPF interest rate and maturity amount are entirely tax-free.   

The EPF ‘matures’ at the age of 58. However, you can withdraw from it before this age if you lose your job. You can also make partial withdrawals for reasons such as the purchase or construction of a house, for medical treatment and marriage. If you fail to contribute for more than three years to the EPF account (for instance because you have lost your job), the account will become inactive and stop earning interest. In such a situation it may be best for you to withdraw your EPF amount completely. However, if you do find another job that is covered by the EPF, you can simply transfer your EPF account to your new employer.  

Read our article:

Employee Provident Fund Interest Is Taxable After You Stop Working

Supreme Court Opens Doors To Bigger EPF Pensions

iv) Senior Citizens Savings Scheme (SCSS)

The SCSS is a savings instrument available to resident Indians above the age of 60. It has a duration of five years which can be extended by another 3 years.

Interest Rate and Tax

Contributions to the SCSS are available as deductions from income tax under Section 80C up to a limit of Rs 1.5 lakh. The interest rate on the SCSS is linked to the interest rates on government bonds and is reset every quarter (for new subscribers). Interest on it is paid out quarterly. You can find the latest rate here. The interest on the SCSS is fully taxable and TDS is deducted from it if the interest payable is more than Rs 10,000.

Investment Limit

You can invest a minimum of Rs 1000 and maximum of Rs 15 lakh in the SCSS.

How to invest

You can open an SCSS account with a bank or a post office. Breaking SCSS prematurely carries a penalty of 1.5% to 1% depending on how long it has been held.  

v) National Savings Certificate

National Savings Certificate (NSC) is a savings instrument eligible for tax deduction up to Rs 1.5 lakh under Section 80C. The interest on it is linked to the interest rate on government bonds and is reset every quarter. The interest on the NSC is compounded rather than being paid out to you (meaning that it is added back to the principal).

Tax

NSC is also eligible for deduction under Section 80C up to Rs 1.5 lakh. No TDS is deducted from NSC on maturity. NSC has a lock-in of 5 years. It is available for purchase at post offices throughout India.

vi) Sukanya Samriddhi Yojana

This is an investment scheme designed for the benefit of the girl child. It can be opened by the parent or legal guardian of a girl at any time after her birth until she reaches the age of 10. The account matures 21 years after opening or when the girl gets married after crossing the age of 18. It requires a minimum annual deposit of Rs 1,000 and can take a maximum deposit of Rs 1.5 lakh per annum. The account is operated by the parent or legal guardian of the girl child till she reaches the age of 10. Thereafter she can operate it herself. The parent and child must be resident Indians.

You have to keep contributing to the account for 15 years after opening it. The interest on it is compounded and added back to the principal. The account continues to earn interest after 15 years until it matures. The interest rate on the SSY is linked to the rate on government bonds and is reset every quarter.

Tax

Contributions to the SSY are available as tax deductions under Section 80C up to Rs 1.5 lakh. The interest earned on it and the total value paid out at maturity are also exempt from tax.

vii) Home Loan Repayment

The repayment of principal on your home loan is eligible for deduction under Section 80C up to Rs 1.5 lakh. However, you get this deduction only after construction is complete and a completion certificate has been awarded. The deduction will also be reversed if you sell or transfer the house within a period of five years of getting possession of the same.

viii) National Pension System

The  National Pension System (NPS) is special. There are three reasons for this:

  1. Contributions to it are eligible for tax deduction under Section 80C up to Rs 1.5 lakh. This is available to self-employed persons up to 20% of income. For employees, we will discuss this deduction in point no. 3.
  2. Contributions up to an additional Rs 50,000 are deductible under Section 80CCD (1B). This effectively takes the deduction to Rs 2 lakh.
  3. For employees, the deduction is available to:
    a) Their own NPS contributions up to 10% of their salary and within the limit of Rs 1.5 lakh. b) 
    Employer contributions to NPS up to 10% of salary with no upper limit. Eg: If your salary is 30 lakh, you can get a deduction on your employer contribution up to Rs 3 lakh. You can supplement this with an employee contribution of 1.5 lakh and an additional contribution of Rs 50,000. This will effectively take your tax deduction to 5 lakh.

ix) Life Insurance

Your life insurance contributions are tax deductible under Section 80C up to Rs 1.5 lakh per annum.

However, for policies with a tenure of 10 years or more, the life cover must be more than 10 times the annual premium that you pay for it. Eg: For a 10-year life insurance policy with an annual premium of Rs 50,000, the sum assured must be more than Rs 5 lakh

For policies with a tenure of fewer than 10 years, the life cover must be more than five times the annual premium that you pay for it. Eg: For an 8-year life insurance policy with an annual premium of Rs 50,000, the sum assured must be more than Rs 2.5 lakh.

Other Deductions

a) House Rent

You can claim a tax deduction for house rent whether or not you get House Rent Allowance (HRA) from an employer. However, there are separate rules for these two situations:

b) If  you receive HRA

HRA or House rent allowance allows you to claim a deduction on the HRA that your employer pays you.

The HRA deduction is given to the least of the following three:

  1. Actual HRA received.
  2. 50% of gross salary for metros. 40% for non-metros.
  3. Actual rent minus 10% of salary.

Eg: If your salary is Rs 50,000 per month and you pay rent of Rs 10,000 per month. You receive HRA of Rs 10,000 per month. Your HRA deduction will be Rs 72,000 (Annual rent of Rs 120,000 – 10% gross salary of 480,000 which is 48,000).

c) If you don’t receive HRA

If you are self-employed or you do not receive HRA, you can still get the deduction for house rent. This will be the least of the following:

  1. Rs 5,000 per month
  2. 25% of adjusted total income (total income minus capital gain and specified deductions)
  3. Actual rent paid – 10% of adjusted total income  

Eg: If your total adjusted income is Rs 10 lakh and you pay an annual rent of 240,000 (Rs 20,000 per month), your total deduction under this provision will be restricted to Rs 60,000.

c) Home Loan Interest

The interest on your home loan is eligible for tax deduction under Section 24B up to Rs 2 lakh. However, if the house is let out rather than self-occupied, there is no upper limit on the tax deduction.

This deduction is also available for under construction properties. However, if the house is not constructed within five years of taking the home loan, the deduction is reduced from Rs 2 lakh to Rs 30,000 per annum.

d) Tuition Fees

Payment made towards school, college or university tuition fees for your children (maximum of two) is eligible for deduction under Section 80C up to Rs 1.5 lakh.

e) Interest on Education Loan

Interest on education loans for higher education (in India or abroad) is eligible for tax deduction without any ceiling under Section 80E. This deduction is limited to interest only and not principal repayment.

The maximum tenure for this deduction is 8 years (meaning if your repayment extends beyond 8 years, future instalments will not be eligible)

e) Health Insurance (Section 80D)

You can get a tax deduction on health insurance premiums up to Rs 25,000 per annum. Within this limit, you can spend up to Rs 5,000 on an annual health check-up.

Spouse and dependent children

You can get the benefit of this deduction even if this money is spent on the premiums or medical-check up of your spouse or dependent children. Eg: If you spend Rs 20,000 on a policy that covers your spouse and your two children, you will get a tax deduction for it. However, if you spend Rs 20,000 each on separate policies for each of them (taking this figure to Rs 80,000), your deduction is restricted to Rs 25,000.

Senior Citizens

The annual deduction is Rs 30,000 on health insurance for senior citizens. If you contribute up to Rs 30,000 for health insurance premiums (including medical check up) for your parents, this amount can also be claimed as tax deduction in addition to your own premiums. Eg: If you pay Rs 20,000 for your own health insurance premium and another Rs 27,000 for your parents’ premium (and they are senior citizens), you will get a deduction of Rs 47,000.

Charity (Section 80G)

Charitable contributions are eligible for tax deduction under Section 80G. Broadly these fall into 4 baskets:

  1. Institutions where 100% of the contribution is exempt with no upper limit
  2. Institutions where 50% of the contribution is exempt with no upper limit
  3. Institutions where 100% of the contribution is exempt up to 10% of adjusted total income (total income minus capital gains and specified deductions)
  4. Institutions where 50% of the contribution is exempt up to 10% of adjusted total income.

Please check which bucket your recipient falls under before making a contribution if you wish to claim a tax deduction for it. The vast majority of non-government institutions which are eligible for tax-deductible contributions will not fall into categories 1,2 and 3.

Gratuity

Gratuity is a lump sum that an employer pays you when your employment ends. Your employment may end due to various causes including retirement, termination and even death. The tax exemption for gratuity is available in all of these cases. In a recent move, the Government has hiked this exemption for a specific category of private sector employees (namely those covered by the Payment of Gratuity Act) from Rs 10 lakh to Rs 20 lakh.

Gratuity paid to Central and State Government employees is fully tax exempt. For private sector employees, the tax exemption differs slightly depending on whether or not your employer is covered by the Payment of Gratuity Act. For workers covered by this Act, the tax-free gratuity limit has been doubled from Rs 10 lakh to Rs 20 lakh. For other employees, the limit of Rs 10 lakh stays.

The Payment of Gratuity Act applies to establishments in specific industries which employ more than 10 people. To be eligible for gratuity under this Act, you also need to have completed at least five years with your employer.

If you are not covered by this Act, the tax exemption for gratuity is given for the least of the following:

  1. Actual gratuity received
  2. Rs 20 lakh (this was earlier 10  lakh)
  3. Half month’s salary (taking the average of the last 10 months) multiplied by the number of years of service.

Eg: If your average salary in the last 10 months of service is Rs 60,000 and you have worked for 20 years, the tax-free gratuity limit would be Rs 12 lakh.

For workers who are covered by the Payment of Gratuity Act, the conditions are the same. However for such workers:

  1. The final salary rather than the 10 months’ average is considered.
  2. Employment for 6 months or more in a year is considered as a full year as against the requirement for full years to be completed for other workers.

Other types of taxation

  1. Capital Gains

When you buy an asset (eg: some land) and sell it later for a higher price, you make a ‘capital gain.’ This is treated differently from other types of income such as your salary or interest from your FD for tax purposes. The tax you pay on it is called ‘capital gains tax.’ This tax applies to gains on any type of asset including land, houses, stocks, mutual funds, gold etc.

Long Term v Short Term

Capital gains can be ‘long-term’ or ‘short-term’ depending on how long you have held the asset before selling it. This period also changes from asset to asset. The table below gives you some more information about this:

Asset Holding Period
Land, House 2 years
Stocks, Equity Mutual Fund 1 year
Debt Mutual Funds, International Funds 3 years
Other assets 3 years

The long-term capital gains tax is 20% (except for stock and mutual funds where it is zero). Long-term capital gains also come with the benefit of indexation.

For short-term capital gains, the gain is added to your other income and taxed as per your existing slab. Eg: If your total income comes to Rs 10 lakh after adding short-term capital gains of Rs 2 lakh, this gain will be taxed at 30%. However, for stocks as well as equity mutual funds, short-term capital gains tax is applied at 15%.

Indexation

This concept of taxation takes into account the effect of inflation while computing your taxable gains and can greatly lower your actual tax burden. The benefit of indexation is only available to long-term capital gains.

Eg: If the capital gain on your house is 50% and the Cost Inflation Index (CII) published by the Income Tax Department has risen by 20% over the same period then only 30% of your gain will become taxable. You can find the cost inflation index here. For assets bought before 2001, you can take the ‘fair market value’ of the asset on 2001 as your purchase price and then apply the CII to get the benefit of indexation.

Carry forward and set off

You may also sometimes sell your mutual funds or house for less than the price you paid for it. In other words, you have made a loss. You can adjust this loss against any gains you have made from selling other assets in the same year. This is called ‘set off.’ There are certain rules applicable to set off that you must take note of:

  1. Long term capital loss can be set off against long-term capital gain
  2. Short-term capital loss can be set off against short-term capital gain and long-term capital gain
  3. Long term capital loss cannot be set off against short-term capital gain.

Also, you cannot usually set off capital losses against other types of income such as salary or interest income.

You can also adjust your capital loss against the gains you might make in the next 8 years. This is called ‘carry forward.’

2. Dividends

When companies distribute a portion of their profits to you as a shareholder, you get ‘dividends’.

Equity Dividends

Equity dividends (dividends on shares) below Rs 10 lakh are exempt in the hands of the shareholder. This is because the company has already paid tax on it at the rate of 15% (20% after surcharge and cess) called ‘Dividend Distribution Tax.’ If you receive dividend income of more than Rs 10 lakh per year, you will be liable to pay tax on it at a rate of 10%.

Mutual Fund Dividends

You can also receive dividends on equity mutual funds and these are exempt from tax without any limit.

Dividends on debt mutual funds are also tax-free in your hands but the mutual fund pays dividend distribution tax on them at 25% (28.84% after surcharge and cess). 

Author
Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at neil@rupeeiq.com.