Starting December, mutual fund houses and insurance companies will begin to aggressively promote tax saving instruments. And as usual, taxpayers who have not completed the process of investing in tax-saving instruments will end up buying some of them out of desperation. But they need to remember a few things about taxation.
Since, for many, the investment and tax advisor are two different people, there isn't a proper plan in place. The tax payer collates information on all the income and investment transactions during a year, pays the relevant taxes on the same and files the return. However, investing is a year-round activity. More often than not, investors look out for tax-efficiency in every investment they do, whether it is in the form of tax deductions, tax-free income or tax-free maturity. Thus, investors keep evaluating and executing different investment options round-the-year and file returns only once in July / September. Also, very rarely, does it happen that an individual’s investment advisor/planner and tax professional are the same. Typically, a tax payer dumps his/her income and investment data with the tax professional, who in turn, files the returns.
In this process, many a times, investors lose out on claiming the different tax-advantages available with the investments in their returns. It is mainly because of lack of knowledge about the tax treatment of specific investment products by the tax professional or simply through oversight. Some common instances that a tax payer should keep in mind to optimise the available tax advantages are as follows:
Fixed Maturity Plans (FMPs)
FMPs score over bank fixed deposits mainly on account of their differential tax treatment. As per the income tax provisions, the gains made on a FMP, which matures after 12 months, is liable to tax as long-term capital gains. Further, the cost of investment can be indexed as per the cost inflation index applicable for the year. The resulting capital gains are then taxed at 20 per cent. The tax outgo on these indexed gains provides good tax-efficient gains for the investor.
In many cases, this favourable indexation benefit is ignored at the time of tax filings, thus, depriving the investor of tax-savings. This saving is more pronounced for FMP investments made in the month of March and maturing in April next year as it gives a double indexation benefit.
Debt mutual funds
Similar to FMPs, debt mutual funds are also subject to taxation in a manner that is different from equity mutual funds. Short term capital gains are taxed at the applicable slab rates and long term capital gains are taxed at 20 per cent after cost indexation. Not to omit that the long term gains on debt funds can be taxed at 10 per cent without cost indexation too. Most debt funds’ returns range between 8 and 9 per cent and as per the last declared cost inflation index for 2012-13 (852), the cost indexation between financial years 2001-12 and 2012-13 stands at 8.5 per cent. It may be noted that the indexation can, thus, help investors earn tax-free returns from debt funds for periods ranging beyond 1 year.
Private management funds
A lot of private institutions that offer investment opportunities to investors in the form of real estate funds or private equity funds are often guised as trusts. These trusts are responsible for managing the funds as per the objectives and distribution of the surpluses to investors.
Under the income tax provisions, trusts are further classified as discretionary trusts. A discretionary trust is a trust in which the individual shares in income or corpus of the beneficiaries are indeterminate or unknown. As a general rule, such trusts are taxed at the maximum marginal rate. The law further provides that where a trust is taxed at maximum marginal rates or at a higher rate, share of income from the trust is not to be included in the hands of the beneficiary for computing tax liability.
In other words, any dividend or any other form of income distributed by a discretionary trust to investors is tax-free in the hands of investors. In case this benefit is ignored, the investor will be paying double tax on the same income.
Bonus and dividend stripping
Many investors look to make a quick fortune in the markets by buying shares of companies or units of a mutual fund just before the due dates of a large dividend payout. Their idea is to sell these shares immediately after the share/ unit price gets adjusted for dividend and incur a capital loss.
The income tax act has separate provisions to avoid this undue benefit; wherein it is provided that if any shares are bought within a period of three months prior to the record date and sold within three months (in case of shares) or nine months (in case of mutual fund units), then the losses are not allowed to be claimed to the extent of dividend earned.
A similar provision exists for losses arising out of buying and selling mutual fund unit to take advantage of a bonus issue by a mutual fund. In such cases, the loss accounted for is then deemed to be the cost for the bonus units.
Tax payers must ensure that the advantages (of tax saving), which they evaluated while selecting an investment product, are actually utilised at the time of filing of returns.
The instances mentioned above are only illustrative. It is advisable to have the investment advisor run through the income tax computation to ensure that no tax benefits are unutilised.
The writer is a certified financial planner
