Don't sell your car after 3 years for tax benefits

The last few years have seen a spurt in consumerism in India. The access to more funds has meant aggressive buying from people. The dream of owning a car is no longer a dream.

And the newfound alliance between the car maker, the dealer and the financier and their ability to juggle the margins between themselves has added to this rosy scenario.

Therefore, the potential buyer is able to get a better deal because of cross-subsidisation between the three.

However, there is an interesting trend emerging: cars are also being replaced quickly. There is a growing feeling that if you purchase a car through monthly instalments for three years and then, replace it with a new car, you can get tax benefits for businessmen and self-employed professionals. Let's look at it through this example.

Say Alok Jain, a lawyer with his own practice, purchases a Skoda Octavia Regular Series 1 at a value of Rs 12 lakh (Rs 1.2 million) for which the down payment is of Rs 248,000 (inclusive of insurance and other costs).

The remaining Rs 10.25 lakh (Rs 1 million) has been taken from a car finance company for an equated monthly instalment of Rs 33,075 -- payable for a period of three years. Once his EMI payments are over, Jain will sell this car and buy another one so that he can continue to get tax benefits. But what he forgets is the annual cash flow for the same deal.

Looking at the table we can see that depreciation claimed for a period of first three years is Rs 463,000 and interest claimed for the period Rs 166,000 and short-term capital loss on sale of assets Rs 112,000 resulting in total expenses claimed in profit and loss account is Rs 740,000. This has resulted in a tax benefit of Rs 249,000 on a cash outflow is Rs 397,000 per annum.

This loan has resulted in a net negative cash flow after considering tax benefit of Rs 316,000. Now when Jain sells his car after three years for Rs 625,000 when the written down value is Rs 737,000, he is making a short-term capital loss of Rs 112,000. As a result, Jain is enjoying a loss of Rs 316,000 which is 25 per cent of the value of the car!

However, the benefits for keeping the car after the loan has been repaid are more than selling it only on the fear of maintenance. While the tax benefits may no longer be there (he will only be able to set off depreciation, which will be declining as the car gets older), it is still a great deal.

It will still be better to pay the tax on the savings made by not buying a new car. This way, Jain will increase his net worth, which automatically increases the ability to garner bigger loans in the future.

Remember, loan approvals are directly proportional to your net worth. And even better, he can always invest the surplus and achieve other objectives in life.