The annual tax-planning exercise for most investors tends to be divorced from their financial planning process. As a result factors like risk appetite, investment objective and tenure of investment are often overlooked when tax-planning investments are made.
While apathy or lack of awareness on the investors' part could be partly 'credited' for this, the restrictive nature of Section 88 of the Income Tax Act should also shoulder the blame.
Section 88
In the erstwhile tax-regime (prior to Finance Bill 2005), provisions for the purpose of tax sops fell under the gamut of Section 88. Investors were required to make investments in stipulated tax-saving instruments to claim tax rebates under the given section.
Tax rebates under Section 88
|
Annual Income |
Tax Rebate |
|
Up to Rs 150,000 |
20% |
|
Rs 150,000 to Rs 500,000 |
15% |
|
Over Rs 500,000 |
Nil |
As can be seen from the table above, the investor's income level was the key to determining the rebate he was entitled to; a higher income level translated into lower rebates. Investments eligible for the purpose of claiming tax benefits included Public Provident Fund (PPF), National Savings Certificate (NSC) and tax-saving funds among others.
The upper limit (in monetary terms) for the purpose of tax-saving investments was pegged at Rs 100,000.
However, the hitch was that 'sectoral caps' existed on the various investment avenues. For example, investments in tax-saving funds (also referred to as ELSS) of up to Rs 10,000 were eligible for claiming tax benefits.
Similarly investments in instruments like PPF, NSC, tax-saving funds and avenues like insurance premium, repayment of home loan (principal component of the EMI only) among others accounted only for a Rs 70,000 benefit. The balance Rs 30,000 (Rs 100,000 less Rs 70,000) was reserved for infrastructure bond investments.
Effectively, the investor had little choice in selecting the tax-saving investments. Instead, it was Section 88 which determined how each individual would make his investments.
An investor with a high-risk appetite had to choose the same investment avenues as a low risk investor because of Section 88's restrictive nature.
Enter Section 80C
Section 88 was scrapped in Finance Bill 2005. Instead, Section 80C was introduced. All avenues that were eligible for tax benefits under Section 88 were brought under the Section 80C fold.
However, instead of offering tax rebates, investments (up to Rs 100,000) under Section 80C qualified for deduction from gross total income. Hence a new system of claiming tax benefits was introduced; furthermore a new tax structure too was introduced.
The new tax structure
|
Net Taxable Income |
Tax Rate |
|
Up to Rs 100,000 |
Nil |
|
Rs 100,001 to Rs 150,000 |
10% |
|
Rs 150,001 to Rs 250,000 |
20% |
|
Above Rs 250,000 |
30% |
(A 10% surcharge is levied on assessees with a net taxable income above Rs 1,000,000)
The biggest advantage Section 80C offered was that sectoral caps on tax-saving instruments were removed. As a result investors were given the freedom to select investment avenues of their choice for tax-planning purpose.
Why Section 80C scores over Section 88
Investing in line with one's risk appetite is a tenet of financial planning and Section 80C promotes the same. Removal of sectoral caps on investments for tax-planning purposes means that investors can invest in line with their risk appetites and needs.
A risk-taking investor can invest his entire corpus of Rs 100,000 in a high-risk instrument like ELSS; conversely a risk-averse investor can select small savings schemes like PPF and NSC. As a result, every investor's tax-saving portfolio can now reflect his individual preferences.
Another advantage that Section 80C offers is for investors whose gross total income is greater that Rs 500,000. Under the earlier tax regime, these investors were not eligible for Section 88 tax rebates. However, Section 80C has done away with this disparity and investors across tax brackets can claim the Rs 100,000 deduction.
Tax-saving schemes at a glance
|
Particulars |
PPF |
NSC |
ELSS |
Infrastructure Bonds |
|
Tenure (years) |
15 |
6 |
3 |
3 |
|
Min. investment (Rs) |
500 |
100 |
500 |
5,000 |
|
Max. investment (Rs) |
70,000 |
100,000 |
100,000 |
100,000 |
|
Safety/Rating |
Highest |
Highest |
High Risk |
AA/AAA |
|
Return (CAGR) |
8.00 |
8.00 |
12.00 - 15.00 |
5.50 - 6.00 |
|
Interest frequency |
Compounded annually |
Compounded half yearly |
No assured dividends/returns |
Options available |
|
Taxation of interest |
Tax free |
Taxable |
Dividend & capital gains tax free |
Taxable |
Eligible avenues for Section 80C
What should investors do?
Clearly Section 80C has ensured that the onus of conducting the tax-planning exercise in line with one's risk profile has shifted to investors. Investors now need to utilise the opportunity by making the right investments. Investors would do well to remember that investments made for the purpose of tax-planning can have a significant impact on their finances over the long-term horizon, hence due importance should be accorded to it.
Our advice: engage the services of a qualified investment advisor, make an investment plan for your tax-planning investments and stick to it; finally don't deviate from your risk appetite.