Tag: Tax

Last moment tax planing in 30 minutes

Posted on by Jagoinvestor

Just in case you have not done your tax planning for this year and you are in a rush of doing it for providing documents proof to your employer, I will tell you how you can quickly do your tax planning at the last moment. First of all it’s not advised that you wait for last minute for your tax planning investments but now if you are late, let’s see how you should plan for your investments at the last minute to save your taxes. We will also discuss in this short article what are the things you should not do in hurry.

Don’t get mad about tax saving: If you have short term Commitments and can’t afford to lock your money for long term it’s better you do not put money in Tax saving Instruments. You should never do Investments just for tax savings. I have personally not invested for much tax saving this year apart from my company PF and Insurance. I have short term commitments and I cannot afford to lock my money for another 3 yrs. So I better pay tax on the part which I could have invested. There is no point in locking my money and then again running around for personal loan or credit from Friends and Family when need arises.

Life Insurance: Make sure you have adequate life insurance cover. If not, take a term insurance for amount of the cover your are short of. Protection is the first step of successful Financial planning. Take a Term Plan from two Insurers. Look at how to calculate your Insurance requirement. The cheapest Term plan at this moment in market is iTerm from Aegon Religare.

Planning for Long Term Goals: Make a list of goals for long term like Retirement, Child Education, Child Marriage etc (Anything thing with a target date of 5+ yrs). For these goals you can invest in Tax saving Instruments. If the goal is extremely critical and you are not a risk taker then the best thing would be Tax saving Fixed Deposits. If you can take some amount of risk, you can invest your money in ELSS Mutual funds (here is a list of good Equity Mutual funds). For goals which are 10+ yrs away, you can also put partial money in PPF. Investors who have sound knowledge of Markets movement and can spend time and efforts on switching can go for Low cost ULIP’s (see Wealthsurance and Aegon religare). Short term ULIP investing is a BIG and BOLD No No!!

Health Cover: The next thing you should target is your Health Insurance. Better take a Family Floater Plan for your Family  and  the premium will be exempted under Sec 80D up to max of 15,000.

Short Term Goals: If you have any short term goals then do not put money in any tax saving instrument, rather put money in non-tax saving instruments like Plain FD (See, how to find best FD), Debt Oriented Mutual funds, Avoid Equity as far as possible if you are not a risk taker.

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So the hierarchy of your products should be like this

  • Life Insurance
  • Health Insurance
  • Long Term Investment products like ELSS and PPF
  • Medium term Investment Products like tax saving FD

What you should not Invest in?

Another Important Point is what no to do in Hurry? So here are some of the things you need to remember

  • Do not invest in ULIPS in hurry, the last 3 months of financial year is the time when Agents will give their best performance in luring away investors. Don’t listen to their stories of India Shining and other bakwaas, if you don’t understand the product and you do not have skills to manage ULIP’s. Same applies to ULPP’s or any other market linked products.
  • Do not invest in Endowment or Money back plans for tax savings. Your Father, your Grandfather or your Uncle might push for it but investing in those policies is a long term commitment and just for saving tax this year you cant invest in those policies.
  • Evaluate your risk appetite again and then take decision. Most of the people can take risk and their situation allows them but they don’t take risk. On the other hand there are people who’s situation does not allow taking risk, but still they take the risk. They confuse between Willingness to take risk Vs Ability to take risk.

Conclusion

Tax saving should be done at the start of year always so that we dont take wrong decisions in hurry. But if you are late you can take some logical decision and still do your tax planning.

Please share your ideas about what other instruments can be used for long term tax savings. Let other know how early tax saving decision has helped you.

Do not Invest just for Tax Saving

Posted on by Jagoinvestor

“Tax saving should be result of your Investment planning and not vice versa” . Understand this very well . For most of the people, saving tax is such a big thing , that they forget the primary rule of Financial Planning and concentrate all their energy into Tax Saving .

I see most of the people are trapped in idiotic products because of their obsession with Tax Saving . Most of the people today are invested in products which does not suit them, which they dont need, Which they do not understand .

All because of their idiotic decision of “Investing for Tax Saving !!”  .

tax saving joke

 

For some people the Products they buy for Tax savings are like This Pond , They are not sure what they will get from buying it , but they are happy about the fact that they are saving some money in Tax . Which is idiotic .

Typical Scenario

Most of the people dont do their Tax Planning in the start of the year . They just neglect The Tax Planning part. Somewhere at the end of the Year around Feb, They recieve a letter from their company that they need to submit their Documents for Tax savings so that they can avail the benefit of 80C and other Tax saving benefits like HRA , LTA ,  Medical Reimbursements , etc .

Even then they dont budge and most of the people wait till the deadline date to come very near .

Then finally comes the deadline date and now “Giving The proofs of Investment” is much more important than “Making Sensible Financial Decisions” . Its too late to Plan for things . ULIP agents , Insurance agents and Mutual funds agents are ready to take the charge and they will brain wash you with all their nice words , They themselves dont understand the product a lot of times .

You have no choice but to invest so that you save tax now . You cant even imagine a scenario where you dont invest your money and pay the tax . It feels like the most idiotic Decision ever . Which I feel can be a good decision sometimes .

Top Reasons for Investing

Below is a small diagram which tries to show how what are the biggest reasons people invest their money . Please Note that this is based on my understand and experience with so many investors over the years . And this is what I feel depicts the scenario closest to actual .
Investing Pattern for Tax Saving in India

Problems arising Due to This

  1. The worst Sufferers are those who invest in LIC and other companies Endowment Polices and Money Back Polices  for the primary reason of Tax Savings. These people do not think that even though they are saving tax for this particular year , they are actually getting into commitment for next 15-20 yrs (or Policy Tenure) and Have no Idea how its going to meet their Future Goals . Read a Review on LIC Jeevan Tarang Policy .
  2. Similar problem is with people who take ULIP’s . They Invest for a year to save tax and then next year they have no idea if they would be able to even afford it or not !! . This happens with mostly new joinees in Companies .They have no idea what to ask their ULIP agent at the time of Buying the product .
  3. Next is “Liquidity Problem” . Most of the people do not think about the lock in period and do not take into consideration their Liquidity Requirement for coming Years . They Invest in ELSS and then next year they need money . They Invest in Tax Saving FD’s and then cry for any Expenses which were very obvious to arise down the line .

What we must Learn

Tax Saving is just a benefit provided when you Invest your Money, dont make it as a Primary objective to Invest. What you have to concentrate on is your Investment Planning , and after you have to restructure your Investment planning in such a way so that you also get Tax Benefits from them.

Investment Planning First and Tax planning second .If you are not able to save tax , its fine , Pay taxes . Its always better to avoid getting into messy products which dont suit you and suck your blood out . Tax Planning is Important, But the more Important things is that you don’t get to obsessive about it and do it only if its needed.

Its not a big deal to save tax at the cost of your Finances future . See an article on Gfactor , a decision making tool for Financial Products

I can relate this with “Not using Protection during Sex” and then suffering for a long time because of that small mistake .  This is exactly True with all people who dont not need Crappy Insurance and then one single mistake, Investing in it for Tax saving and then every year , Suffer with it, Paying a huge premium for the Small Insurance not sufficient for you and for the Maturity Amount which is not at all exciting .

Make sure that you invest in some product only if matches these 4 criteria .

So are you one of them who tax Tax saving with High Priority ? Have you invested for Tax saving as primary reasons ? Share with us . We can talk about it and make sure that it does not happen again . Post your Views on this ..

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What are Income Clubbing Provisions and Tax Implications?

Posted on by Jagoinvestor

I have invested some money in Fixed Deposit in the name of my wife as she is not earning any income. Will she have to pay tax on this?

This is an innocent questions because of inadequate knowledge of Tax Provisions on Clubbing of Income and how it attracts tax liabilities. Let us see some Must know tax rules for Clubbing of Income.

Income Clubbing Provisions and Tax Implications

Top rules of Clubbing of Income

  • Income of a minor child is added to husband or Wife’s Income depending on whose total income is greater. So if Child earns Rs. 1 Lacs and Wife is earning 5 lacs and Husband is earning 4 lacs, then the income of Child will be added to Wife’s Income and it will be 6 lacs of income for Wife and it will be taxed accordingly. Do you think you can live with 90% of your Salary?
  • If you invest money in your Minor Child’s or Spouse’s name then all the income earned from that investment will be clubbed into your own income. The main thing to note here is whoever is the original owner of money will be taxed on the income.

Exception: Income of a minor child shall not be clubbed and is taxable if the child is suffering from a disability (under Section 80U) such as physical disability, complete blindness or if he earns the income through manual work or any activity involving application of his skills or talent or if both his parents are not alive.

  • The compounded income is not subject to clubbing. Which means that the income arising from the income which is clubbed is not clubbed. So, if Ajay invests 30 Lacs in an FD in his Wife’s Name, suppose the Interest on this FD comes earns Rs. 2.4 Lacs and the interest from this FD will be included in Ajay’s income, but any income which comes from this interest of 2.4 lacs will be considered as his Wife’s income and not Ajay’s income and hence will not be clubbed back to Ajay’s income. So if his Wife uses this Rs. 2.4 lacs and makes an income of 1 lacs from it, then this 1 Lac will not be considered in Ajay’s income. Do you know How to find the Best Fixed deposit?

Some Tips Use can use to save Tax

#1: For High Net Worth Individuals

If you are a High Net worth Individual and your Spouse does not Work, you can make the investment on his/her name. So that the income which comes from the income arisen from that investment is at least not taxed.

Example : If Robert invests 50 Lacs in Stocks and Earns 20 Lacs, It will be considered as His income and Taxed and now if he invests this 20 Lacs in FD, all the Interest he gets is also taxed.

But If he Invests this 50 lacs on his Wife name, the 20 Lacs income generated will be taxed as his income, but then when that 20 lacs is invested in FD, all the interest coming from that will be treated as Wife income and If Wife is not doing anything, Her Total income will just be this interest, around 1.6 Lacs considering 8% interest and hence It will not be taxable at all as its below the limits.

#2 Invest on your would-be-Wife or Son’s-Would-be-Wife name

Tax Clubbing rules do not apply when you invest money on some one’s name before Marriage (only your would-be and Son-would-be, not your-friends-would-be). So Any income earned from that investment will not be clubbed within your Income.

Example : If Manish is going to be married (thanks you guys) and He wants to invest 20 Lacs in an FD . He can do a simple tax trick, He can invest this money on his would-be-wife name.

Now by doing so, all the interest coming from this FD will be considered as his wife Income and if her total income comes under minimum limit, She will not pay any tax on this. Where as If he invest this 20 Lacs on his own name or in his wife name after marriage, The interest will be taxed.

#3 Make sure the Investment on your Child Matures after their 18th Birthday

Clubbing Rules applies only for Minor Child’s, It’s not applicable for Children above 18th. So make sure your Investments on Child Name mature after they are 18th so that any income which arise from it is not your income. Read why you should open a PPF account even if you don’t need it.

Example : So if you have a child aged 12 and you are planning to buy a Bond for 5 yr on this name, It will mature when child is 17 and hence will be taxed in your hand, better extend the Tenure by 1 yr and make it to 6 yr or 6.5 yr, so that The income arised from it is Child income and not taxed in your Hands.

#4 Give a Loan to your Spouse or Child, not a Gift

Clubbing Rules does not apply for genuine Loans Given to your Spouse or Child. So instead of just Gifting some money or Doing investment on their name, give Loan to them which they can use to invest them self. All the income from those investments will not be clubbed in your income.

Make sure that you have a documentary proof of Loan, A simple letter of Loan with Signatures of both the party will be enough as Documentary Proof, no need to run for Lawyers for these.

#5 Create a HUF for Family investments and Family Properties

If you have a Joint or Big enough Family, Its better to Create a HUF, so that then all the investment which are for whole family and all the assets which belong to whole Family are on HUF name, in that case HUF will enjoy all the Deductions and exemptions just like an Individual.

I don’t have much idea about HUF more than this .. so please control yourself before shooting detailed questions on HUF 🙂

Conclusion

Knowing Clubbing of Income rules can help you in saving your Tax in different ways and Without the knowledge you may also loose many times. So better use these Tax rules to make best use of your situation.

Note: There are many exceptions and details in Clubbing Rules which are not covered here. These are just high level rules and not detailed rules. So please handle with Care.

What is Direct Tax Code and How does it impact common person

Posted on by Jagoinvestor

There is going to be some really big changes in Taxation laws if “Direct Tax Code” comes into existence year 2011. There are some big changes proposed in the Draft which if implemented will be the biggest ever change in Tax laws and will impact people in a big way.

Let us see what are the changes Proposed and How they will affect you?

direct tax code

What is Direct Tax code ?

The Finance Ministry has released a new draft direct tax code, which is a document containing changes in Exemptions, Tax slab. This will be a big change to four-decades old Income Tax Act . As per the proposal, the new tax slab would be

  • 0% : Less than 1.6 lacs
  • 10% : 1.6 – 10 Lacs
  • 20% : 10 – 25 Lacs
  • 30% : 25+ Lacs

This sounds really amazing that almost 90% of Indian (tax payers) will then pay 10% tax because majority of the income earned will be below 10 lacs (that’s very obvious). We will a comparison at the end. Don’t Worry 🙂

If you are a Fan of Jagoinvestor or Manish , you might want to fill up the Fan book

Other Major Changes which can affect a Common person

1. Tax Exemptions upto 3 Lacs

At present we get exemptions upto 1 lac under section 80C . This may be raised to 3 lacs . This will encourage people to invest and help.

2. Proposes tax on Maturity amount from Insurance Policies, PPF, EPF and GPF

This is a big turnoff. So as per the new draft, the amount you get on maturity from your PPF, EPF or Insurance policies will be taxable, just like NPS right now. As per the proposal, the amount accrued till 2011 will be non-taxable, this will be applicable to all the proceedings after 2011. So some relief here.

3. Interest you pay for housing loans cannot be exempted and your tax burden increases.

I know it can spill water on your plans to buy home, but that’s true. If new proposal becomes a law you will then be paying tax on that 1.5 lac which you could have saved. Business Pundit has a view that Removing the tax benefit on Home Loan Interest part is positive news and will impact positively . Read it

4. Recommends Long term capital gains tax to be reintroduced and Short Term Capital gain tax to be added in Income

Enough is Enough- is what you may be thinking. 🙂 But tax on long term capital gains may be introduced which means that you will have to pay some tax on that profit from Mutual funds or Shares which was tax-free after 1 yrs. Short term capital gains will be added in Income and taxed at applicable rate.

Also Short Term capital gains would be before 3 yrs and Long Term capital gain after 3 yrs. Long term Capital Gains will be less than regular tax slab, I think around 10% or 15%.

5. Suggested abolishing the Securities Transaction Tax (STT)

So the STT which was paid while buying shares will be abolished. Currently when you buy shares you pay a small tax called STT which is included in share cost by your Share broker, this will be no longer there 🙂

6. Perks now will be included as a part of the income for purpose of tax calculation, so tax burden may be sightly more.

All the perks you were getting from your employer like interest free loan, free lunch etc will get added to your income and be taxed.

7. Lowering Corporate tax to 25% from 30%

This will cheer up companies as their tax burden would reduce. I am not sure about its impact on common person.

Watch this video to know more about direct tax code:

Comparison of New Vs Old Tax Code

Lets see an Example
Name : Ajay Patel
Salary : 8 lacs per year
Investments : Investment of 30k in Mutual funds, 30k in EPF, 20k in PPF and 20k in Insurance Policy.
Home Loan : Taken a Home loan and pays 80k as Principle and 1.4 lacs as Interest.

Tax as per Current System

Amount Exempted = 1.4 lacs as home loan interest + 1 lac in 80C = 2.4 Lacs
Taxable Income = 5.6 lacs
Tax = 14k (10% from 1.6 to 3 lacs) + 40k (20% from 3 – 5 lacs) + 18k (30% on 5 – 5.6 lacs) = Rs.72,000

Tax as per New Tax Code

Amount Exempted = 1 lac from (mutual funds , PPF , EPF , Insurance) + 80k as Home loan principle = 1.8 lacs
Taxable Income = 6.2 lacs
Tax = Rs 44,000 (10% on 1.6 lacs – 6.2 lacs)

Note: Your Tax Liability will be totally different and can vary a lot depending on the your condition and financial commitments. Don’t take this one example personally as its just for demonstration purpose.

Is New Tax Code Good or Bad

This is an important and good question. I will classify this tax code as a good one the biggest thing to note in this is that the tax slab is just 10% for income from 1.6 lacs to 10 lacs. There are many changes in the new tax code which may look bad and hurting but at the end you will gain from it because the tax charged will be just 10%.

So your taxable salary will go up because of some changes but your tax liability will actually reduce. It will not reduce too much though but surely it will be a reason to cheer up.

The biggest doubt is that over long term if my Maturity amount from Mutual Funds, Insurance policies and PPF will become taxable?

Then YES! But now you will save more to invest. So, even if we assume 20% tax charged at the end, we need to invest 25% more than we usually do to gain that will happen I believe… Anyways, this is now a debate topic and can be argued upon.

Download the Full Direct Tax Code Bill 2009, Click Here

Conclusion

This was just an analysis of the proposed DTC and how the changes can impact if it is approved. But for now, its just a proposal so don’t panic. Lot of debates and discussion will happen on this and this can take totally new direction or may be it does not happen at all and we continue with current tax system.

Comments Please as I would like to hear your views on New Tax code and how can it impact you. Do you think its a right thing to do and what are the issues involved with it? Did you like it?

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Why it is mandatory file Income Tax Return even if your taxable income is below tax limit?

Posted on by Jagoinvestor

Filing Income Tax Return  is an important thing and as the date for filing ITR is approaching you should have a clear idea about how to file ITR. But is it mandatory to file Income Tax Return?

A lot of people are confused about this simple question of when to file your tax return, In this short article lets see what are the conditions under which you need to file your tax return.

Filing Income Tax Return is mandatory

Who should file Income Tax Return?

As per Indian Income Tax Act 139(1), it is mandatory to file Income Tax Return, for every individual who’s income exceeds the exemption level.

People say that if you don’t have to pay tax , you don’t have to file returns which is not true totally. Lets see the simple rules.

Rule : You have to file your tax returns if your Total Income for the year exceeds the exemptions limit. That’s it !! This is the only rule which applies.

Exemption limit can be different for male (1.5 lacs), female (1.8 lacs) or senior citizen (2.25 lacs). So if your Total income for the year exceeds your exemption limit, you have to file tax.

Do you know how to calculate your tax?

Should I file Income Tax Return even if I don’t have to pay any tax?

Didn’t you read what is said above :-). The only rule is already mentioned above. You don’t have to pay tax. This can happen in two cases.

Case 1 : Income itself is below exemption limit

In this case you don’t pay tax and don’t file your Returns.

Case 2 : Your Income exceeds, but not taxable income

Though your Income exceeds, but After all the exemptions and deductions like 80C investments, HRA, Home loan interest exemption etc etc, your taxable income is below your exemption limit. In this case you don’t have to pay tax, BUT !! you have to file tax returns because your income (not taxable income) was above the exemption limit.

What are the other cases when I have to file the returns?

There are other cases also when its more than paying tax. lets see those cases

  • If you have some form of losses carried forward in subsequent years to write off against profits in future, in that case its obvious, that you will have to file a return so that you can give this information.
  • If Govt itself gives you notice to file tax return, it may happen that you are cheating this nation and making black money , then tax department can ask you for details and you will have to file tax return.
  • If you want a Tax refund because of TDS (Tax deducted at Source by your company). This happens with people who do part time jobs for some months or with Interns in the company who are there for 3 months or 6 months and TDS is cut. So in order to get back the amount you have to file a tax return.

Watch the video given below to know why it is necessary to file ITR:

Why is it necessary to file Income Tax Return?

There are some reasons why should file income tax return, which may look simple but they have a major impact on your financial life. Lets see what are those reasons:

  1. If you are planning to take loan in future, the lender may ask the proof of your ITR filing.
  2. The ITR filing proof is also essential to get VISA if you want to travel abroad.
  3. It is also important if you want to claim the adjustment against past losses.
  4. ITR report is provided by Income Tax departments, so if you file Income Tax  Return regularly on time, it will make your future transactions easier without any complications.
  5. In some states, you can not but an immovable property if you don’t have the Income Tax Return filing proof.

Besides all these reasons, filing Income Tax Return on time makes you a responsible citizen.

Tax Exemption limit may be raised to 1.7-2.0 lacs

Posted on by Jagoinvestor

Today in morning newspaper, I read that in this budget Tax exemption limit may be raised to 1.75-2.00 lacs . What will that mean to a common person like us .

It simply means that we will be left with some extra surplus every year .

A male who has taxable salary of 4 lacs per year and has 1.5 lacs as exemption limit , pays around 40,000 as tax . Now , after the exemption limit is raised to 2 lacs (assumption) , there can be 2 scenarios .

Read How to calculate Tax and tax slab for year 2008-2009

Scenario 1 : Exemption limit is raised but tax rates are not . Current tax rate is not

10% for 1.5 – 2.5 lacs
20% for 2.5 – 5 lacs
30% for 5+ lacs

In this case , he will have to pay 35,000 as tax (assuming tax rates for 2008-2009) . This means a saving of 5,000 on tax from previous year .

Scenario 2 : Exemption limit is raised and tax rates are also adjusted. A common sense guess would be

10% for 2-3 lacs
20% for 3-5 lacs
30% for 5+ lacs

It must be something like that , this is the minimum we will/should get

In this case , the tax would be 30,000 , and savings would be 10,000 per year.

What can this small amount do ?

So we can save in range of 5,000 or 10,000 or someother amount depending upon the changes. What can be the value of this for us as investment point of view.

this money can be invested in a mutual fund through SIP monthly for next 30 yrs ,

5000 can make
14 lacs at 12%
29 lacs at 15%

10,000 can make
29lacs at 12%
58 lacs at 15%

Assumption is that the money can be divided in 12 equal installment and can be invested per month .

What do you think about this ?

Did you check video post for Basic formula’s in Personal Finance and How to choose Mutual funds ?

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How different Products can yield different post tax Returns?

Posted on by Jagoinvestor

This post will teach you how to take advantage of different products tax rules keeping in mind your income tax bracket. Different products can yield different post-tax returns for people in different tax bracket. FD’s return can be 7.2% post tax for you, but may be its 5.6% for me 🙁

Lets take an example to understand this post.

How different Products can yield different post tax Returns?

Two of my friends Ajay and Robert asked me what should they invest in for 2 year. They have Rs.1,00,000 to invest.

I recommended following products to them :

Ajay : Fixed Deposits
Robert : FMP’s ( Read what is FMP’s )

You must be wondering why did I suggest different products to them? Both have same risk-apetite, Age etc.

The answer lies in there tax bracket. The post tax returns depends on your tax bracket too. Lets see how.

Ajay Case

Ajay does not earn much, His annual income is less and he falls in 10% bracket.

Tax treatment of FD’s interest : Returns are added to your income and then its taxed as per your tax slab rate.

Now it means that tax on FD’s for him would be just 10%. Considering 8% interest.

Interest Received = 16,000
Total Tax paid = 10% of 16,000 = 1,600
Total Return = Rs 14,600

Robert Case

Robert earns well and falls in 30% tax bracket, hence FD will not be best for him, He will have to pay 30% tax on the Interest for FD.

Tax treatment for FMP’s : For Long term capital gains (more than a year), the returns from FMP’s are either taxed at 20% after Indexation or 10% without Indexation

Assumption : Lets day FMP’s provide indicative returns of 9% and lets also assume that they actually provide that return. then

Investment = Rs.1,00,000
Interest = 18,000
Interest = 10% of 18,000 = 1,800
Returns = 16,200

Note : I have not considered tax after indexation, please do it yourself. read this, Anyways it will be more than what he is paying without indexation.

Read What is Indexation Benefit ?

Why FMP’s were not better for Ajay ?

you might think that Ajay could have gone for FMP’s too. The returns are almost same and tax is also same, But you have to realise that FMP’s returns are not guaranteed ,they are just indicative.

Also FMP’s carry Default risk , then why to take extra risk, The only advantage he would have got is .5 or 1% extra returns but at the cost of the risk, which is not worth.

Why FD’s were not better for Robert?

Now this you know , obviously the tax to be paid on it would have been 30% as Robert tax bracket is 30% and hence he might have paid 30% tax on the returns from FD’s

Conclusion

So now you understand that a product can yield different post-tax returns for two people in different tax bracket

So when you do your investment planning, you must take these small details about tax, If you choose your investments considering your post-tax returns, you can make much better decisions, how ever this should come after an investment passes the 4 most important aspects of investments and GFactor basis .

I have started active blogging on my Technical analysis and options blog, I have suggested to go long in Satyam, Please read it.

– Go long in Satyam
– Detailed Analysis on Satyam

I came across a very good article called “What the IPL taught me about Investing”

 

How to Calculate Capital Gains and What is Indexation ?

Posted on by Jagoinvestor

In this post we will learn How to calculate Capital Gains or Losses. A lot of people make mistake in this . If you buy a house in 1995 at Rs.10 lacs and sell it at Rs.20 lacs in 2009. On how much profit will you pay the tax?

If your answer is Rs.10 lacs , you have no idea how to calculate capital gains. Read ahead to understand .

capital gain

What is Capital Asset ?

Capital Assets are the properties which can be held by a person . Some examples are Real Estate , Shares , Mutual Funds , Gold and Debt Funds. FD’s and other fixed returns Instruments are not part of it.

Taxation

For taxation of Capital Assets , read this : How to use your looses to Reduce Tax

How to Calculate Capital Gains ?

Most of the people think that

Capital Gain = Sell Price – Purchase Price

But , Actually the real formula is

Capital Gain = Sell Price – Indexed Purchase Price

What is Indexation ?

Indexation is a technique to adjust income payments by means of a price Index , in order to maintain the purchasing power of the public after inflation.

We must understand that prices in general also rises, so the actual prices should not be used while computing the profits , rather It should be Indexed as per Inflation in the country, so that people can get the real value from sale of there assets.

Indexation is used in Tax treatment for Debt , Gold and other asset classes

What is Cost Inflation Index (CII) ?

Year CPI
1981-82 100
1982-83 109
1983-84 116
1984-85 125
1985-86 133
1986-87 140
1987-88 150
1988-89 161
1989-90 172
1990-91 182
1991-92 199
1992-93 223
1993-94 244
1994-95 259
1995-96 281
1996-97 305
1997-98 331
1998-99 351
1999-00 389
2000-01 406
2001-02 426
2002-03 447
2003-04 463
2004-05 480
2005-06 497
2006-07 519
2007-08 551
2008-09 582
2009-10 632
2010-11 711
2011-12 785
2012-13 852

How to Calculate Indexed Purchase Price ?

Indexed Purchase Price = Purchase Price * (CPI for current year / CPI for year of purchase)

Once you have Indexed Purchase Price , you can subtract it from Sale Price and get your capital gains .

In some products Long term Capital gains is around 20% with Indexation and 10% without Indexation. In Equities Long term Capital Gains is exempt from Tax .

Let take an Example

Purchase Price 1000000
Year of Purchase 1995
Sale Price 2500000
Year of Sale 2008
No of Years 13
Purchase CII 281
Sale CII 582
Indexed Purchase Price 2071174
Capital Gain 428826
Tax with Indexation 85765
Tax without Indexation 150000

I hope the above example is clear . Below is the calculator I have created for you to calculate Capital Gain tax for your self. Just play with different numbers . Just enter the year of Purchase and Sale and It will figure out the CII (incase it does not, please put CII yourself)

Capital Gains Calculator
I have made a Calculator for you : https://public.sheet.zoho.com/publish/manish.pucsd/temp

Capital Gains Tax with Indexation and Without Indexation

There are some asset classes where you have the choice of using Indexation or not . This is true for debt funds and FMP’s. So the current rate is either 20% with Indexation or 10% without Indexation for Long term Capital Gains .

For Tax without Indexation, you simply find out normal profit (sale price – cost price) and then calculate the tax.

So you can calculate tax using both ways and then choose the one which is lower 🙂 .

How to save your Capital Gains Tax?

For people who are miser and do not like to pay lot of taxes , govt has provided some relief to them. Govt says that If you don’t want to pay tax on your capital gains, you can do following things to save your taxes.

Invest your Capital Gains in Real Estate: If you invest your Capital Gains in Real estate within 2 yrs, you will get the the exemption.

Invest in Capital Gain Bonds : There are some specific bonds issued under sec 54EC, some of them are NHAI or REC bonds. You have to invest in these bonds within 6 months. Generally the lock in period is around 3+ yrs. interest on NHAI or REC bonds is around 5-5.5% .

Tax on Capital Gains can be different for different People

Please note that Capital Gains tax can vary from one person to other person depending on which tax bracket he/she belongs to. It will also depends whether Tax with Indexation or without Indexation works out to be cheaper for him or not.

Note : For calculation purpose the Financial years are business year from April – Mar, Not Jan – Dec. If you buy in June 2009 and sell in Jan 2010, you are in the same year not 2 different years.

Conclusion

So, In this post we learned how you can calculate capital gains and also take advantage of tax benefits for saving your taxes on capital gains, Your aim should be to understand the process and learn about it, so that you can take informed decisions in your financial life .

No one should take advantage of your ignorance and also to take quick decisions and make rough calculations when there is a need. If you know these rules, you can take better decisions

Questions for you

Suppose you are age 30.
– In June, 2000, You buy 20 lacs Home
– In Aug, 2007, You buy stocks worth 10 Lacs
– In April, 2008, your sell your house at Rs 30 lacs
– In June 2008, your stocks have gone down in value are worth Rs.3 lacs now.

What should you do to avoid paying any tax on capital gains made from House?

In previous post I have discussed “What is NPS , New Pension Scheme” by Govt of India . Read it

Why you should Plan your Taxes at the start of the Year?

Posted on by Jagoinvestor

Most of the people take care of there 80C at the end of the year around Jan-Mar . Ideally it should be at the start of the year . Let us see why its should be done at the start of the year itself to plan your taxes.

Plan your Taxes

Following are the 4 most important reasons for Planning your Taxes in start of the year .

Easy on Pocket :

If you plan your taxes at the start of the year , you can then put small amount of money each month . Otherwise you will have to cough up all the money at the end of the year , which can be little difficult on the pocket .

For example :

If you want to invest 60k for this year … you have two choices , either plan your taxes in advance and invest 5k per month, or invest 60k at the end.

No Headache last moment: Another important point to consider is the tension and headache you go at the last moment because of the rush , there is sudden confusion at the end on what to take , where to go , where all the money will come from and all those things .

planning the taxes in the start of the year ensures that you do in correctly and without and headache for the last moment .

Correct products :

If you plan your taxes in the start of the year , you can do your research well and plan for products which you actually need and then go for it . I have seen most of the people taking all kind of wrong products which they don’t need, because there is just no time to think about your requirement , you just have to “invest to save tax” .

Conforms with principle of “Investing Early” : Also when you plan our taxes early you are putting your investments early, that way you are ahead of most of the other people .

Conclusion

An important aspect of Financial planning is to plan your taxes early . Why procrastinate when you know you have to do it anyways … Best of luck .

I have written a series of 4 articles which talks about “Buying Stocks Smartly”

You can read them here : Part 1, Part 2, Part 3 , Part 4

How to use losses to reduce income tax?

Posted on by Jagoinvestor

Are losses good? Do they have any benefit?

When you make a loss, do you feel it has nothing to provide or not at all beneficial. The answer is NO! Losses are bad, but our tax laws gives us a way to utilize them in such a way that we can reduce our income tax liabilities.

reduce tax

Let’s see how 🙂 , don’t worry, we will start from scratch and will explain in detail so that everyone can understand .

Let us talk about capital gains in detail today and let us understand how should we utilize it to minimize our tax liability. Things we will discuss would be stocks, mutual funds, Gold , Debt funds, Real Estate etc.

Understanding Terms and Rules

Capital Gains and Loss : Any profit or loss arises from the sale of capital assets is capital gain or loss. Capital Assets Include Shares, Mutual funds, Real Estate, GOLD etc.

Short Term Capital Loss and Profit : STCL for Equity (shares and mutual funds) is when you sell them at loss before 1 yr, for Real estate, GOLD its 3 yrs.

Long Term Capital Loss and Profit : LTCG for Equity is when you sell it after 1 year, for Real estate, GOLD its 3 years.

Following is the chart showing the tax treatment and time frame for short term for each asset class. Click on the chart to enlarge it.


General and Carry forward Rules :

  • Short-term capital loss can be set off against any capital gain (Long-term or Short-term)
  • Long-term capital loss can be set off only against long-term capital gain.
  • A long-term capital loss will have no value in a case where the long-term capital gain is exempt from tax. For example, In case of shares or mutual funds after 1 year, LTCG is exempt from tax, so If you hold a share for more than 1 year and then take a loss, That LTCL will have no benefit. This loss cannot be set off against any other income.
  • A capital loss can be carried forward for next 8 years.

How can you utilize the losses ?

As we know that capital losses can be offset with capital gains, we can utilize this advantage to reduce the tax liability.

The main idea is to create losses to offset any profits. There may be the cases where there is an investment on which you are losing, but still you have not booked the loss, but you can book it and use this loss to offset a profit on which you may have to pay the tax.

Let us see some examples

Example 1 :

Ajay had invested Rs.5 lac in GOLD in 2005 and currently in 2009 he sold it for Rs 10 Lacs, Now he made a profit of 5 lacs and it will be considered as a LTCG, as its after 3 yrs. and it will be taxed at 20% indexed (If you don’t know what is indexed, just forget it, don’t worry ). The tax would be around Rs 1 lacs.

Now Ajay also had invested Rs.10 Lacs in Unitech Shares in Apr 2008. His investment has come down to Rs.4 lacs now. But he thinks that it will go up and he wants to keep it and not sell.

Good !! I appreciate his belief that it will go up again. But what is stopping him from selling it today and then again buying it next day.

Watch this video to know 7 ways to save your tax:

What will happen if he does that ?

If he sells his shares and takes a loss of Rs.6 lacs, He now has made a STCL of Rs.6 lacs and law says that he is allowed to offset it with any STCG or STCL. So now he can offset his 5 lacs profit with this 6 lacs loss and hence, he can save his tax of that 1 lac which he had to pay, also he can carry forward a loss of remaining 1 lac which was not offset.

He can again buy his favorite Unitech share the next day. The only loss he will make is the brokerage charges and any fluctuations which may occur in prices, which will not be much, may be it has gone down and he can buy them later at better prices.

So the point is to generate the loss by selling a losing investment and again buying it back in some days. This will help you cook up the loses which then you can offset with existing profits and hence reduce your tax liabilities.

Example 2

Robert had invested 5 lacs in mutual funds in early 2008 or end of 2007 and currently has a good loss of 2.5 lacs (1 yr is still not complete). This is currently every one state, most of the people have burnt their fingers and made huge losses.

Now he is sad that he made losses, He also had bought some shares before some months and made a profit of 50k. Let us also assume that next year his mutual fund will rise to 4 lacs from current 2.5 lacs, which he sells next year.

Now he has 2 choices to make, let us see 2 cases.

Case 1 : He does not book the loss and holds it .

In this case, he will have to pay profit of 15% STCG on his profit of 50k, and next year he will have his current investment at 4 lacs. When he sells it, it will be a loss of lac which will be LTGL (because he had held it for more than 1 yr).

Case 2 : He books the loss of 2.5 lacs and then again buys it back the same day or next day .

In this case, he has made a STCL of 2.5 lacs (bought at 5 and sold at 2.5), Now he can offset his 50k profit with this loss. Then he would not have to pay the tax and he can then carry his loss of 2 lacs carry forward.

Next year, he sells his mutual funds for 4 lacs and makes a STCG of 1.5 lacs (because he has re-bought this mutual fund and 1 yr is still not complete) .. But he can offset this profit of 1.5 lacs with the carried forward loss of 2 lacs, and still carry another 50k worth of loss forward.

So what’s the advantage of case 2 ?

The advantage is that you can save tax on the existing profit and also generate STCL which you can take forward and save tax on future profits.

There are many people who make losses and don’t bother to show it in their returns, if they don’t show it in returns then they will not be able to use it for offsetting purpose in future. Note, The way I have shown the examples have their own benefit and problems, Its you who have to decide what you want and how to utilize the tax rules to your advantage.

Its smart use of knowledge, not cheating 🙂

I wish you have got some knowledge out of this article, please put your comments/corrections/suggestions so that we can do more discussion.

Also, don’t forget to put your vote on the poll at the top of this page.