 "taxes, tax, taxing, audit")
India's wealthy are a growing class, and with their rising fortunes comes a natural desire to optimize their tax burden. HNIs go beyond traditional tax deductions under Section 80C. Business Standard delves into options High Net-worth Individuals (HNIs) are employing to save taxes.
LLPs
LLPs
Wealthy Indians (High Net-worth Individuals or HNIs) often use Limited Liability Partnerships (LLPs) to reduce their tax burden. LLPs offer a lower tax rate (34.94%) compared to the highest individual tax bracket (42.74%). Unlike companies where profits are taxed twice (once at the company level and again as dividends to shareholders), LLPs are taxed only once on their total income. This is because profits distributed to LLP partners are exempt from tax.
Example: An HNI investing in a company through an LLP would pay a lower tax on dividends compared to directly owning shares. If an HNI invests directly in a company (X Ltd) and receives dividends, the dividend income is taxed at the highest individual tax rate (42.74%). If the HNI holds shares in X Ltd through an LLP, the effective tax rate on dividends received is lower (34.94%) because LLPs are taxed at a lower rate than individuals.
LLPs can be formed with family members, allowing HNIs to manage investments and share profits efficiently.
"LLPs offer pass-through taxation, where business income is not taxed at the company level but at the individual partner level. This can be beneficial for profit distribution and tax planning, especially for businesses with high profit margins. However, one will need to ensure that their business operations align with the LLP structure for optimal tax advantages," said Ritika Nayyar, Partner, Singhania and Co.
Point to note: An LLP set up in India will broadly be a tax resident of India, despite temporary change in residential status of any partner. Share of profits received from a LLP are fully tax exempt, despite the residential status of the partner.
Hindu Undivided Family (HUF):
By creating a Hindu Undivided Family, an individual can split their income among family members, reducing the total tax burden. Each member of the HUF, including the HUF itself, enjoys the benefit of separate tax slabs and deductions. " For example, Ashok splits Rs 10 lakh of family business income across four family members in the HUF, each earning Rs. 2.5 lakh. This lowers the tax rate for each portion, potentially reducing the overall tax rate from 30% to 5% or 10% for each member, saving a significant amount in taxes," said Amay Jain, Senior Associate, Victoriam Legalis - Advocates & Solicitors.
By creating a Hindu Undivided Family, an individual can split their income among family members, reducing the total tax burden. Each member of the HUF, including the HUF itself, enjoys the benefit of separate tax slabs and deductions. " For example, Ashok splits Rs 10 lakh of family business income across four family members in the HUF, each earning Rs. 2.5 lakh. This lowers the tax rate for each portion, potentially reducing the overall tax rate from 30% to 5% or 10% for each member, saving a significant amount in taxes," said Amay Jain, Senior Associate, Victoriam Legalis - Advocates & Solicitors.
Multiple PAN cards: An HUF can have a separate PAN card from its members, allowing income splitting and potentially lowering the overall tax burden.
Deductions: HUFs can claim deductions available to individuals under Section 80C (investments, PPF, etc.).
Tax-efficient asset transfer: Assets can be transferred to the HUF, and income generated might be taxed in the HUF's hands, potentially at a lower rate.
Angel Investing:
Investing in promising startups can yield significant returns, and the Income tax Act offers tax deductions for investments in startups under Section 54GB. This can be a great way to support innovative ventures while potentially lowering your tax burden. One should conduct thorough due diligence before investing, as startups are considered inherently risky. Nayyar explains this in detail:
Investing in promising startups can yield significant returns, and the Income tax Act offers tax deductions for investments in startups under Section 54GB. This can be a great way to support innovative ventures while potentially lowering your tax burden. One should conduct thorough due diligence before investing, as startups are considered inherently risky. Nayyar explains this in detail:
Example: Lets say Mr X after thorough due diligence invests Rs 1 crore (Rs. 10 million) in the startup. Under Section 54GB of the Income Tax Act, they may be eligible to deduct a portion of this investment from their taxable income, subject to certain conditions. Potential tax Benefit, assuming 50% of the investment (Rs. 50 lakh) qualifies for deduction under Section 54GB, Mr X could potentially save Rs. 50 lakh (deduction) x 30% (assumed tax bracket) = Rs. 15 lakh on their taxes.
Qualifying for the full deduction under Section 54GB might have requirements such as holding the investment for a specific period and the startup meeting certain criteria
Venture Capital Funds (VCFs):
Participation in VCFs that invest in a basket of startups may offer tax benefits under specific schemes. This allows you to diversify your portfolio across multiple high-growth potential ventures while potentially enjoying tax advantages. Partner with a reputable wealth management firm to navigate the complexities of VCF investments.
Participation in VCFs that invest in a basket of startups may offer tax benefits under specific schemes. This allows you to diversify your portfolio across multiple high-growth potential ventures while potentially enjoying tax advantages. Partner with a reputable wealth management firm to navigate the complexities of VCF investments.
Example: When one sells the shares in the fund after 12 months, can take benefit of lower rate of tax @20% as applicable to long term capital gains and if such proceeds are re-invested as per sec 54F, you do not end up paying taxes even on this sale of shares, subject to specified conditions.
Relocating family office to GIFT City or low-taxed countries
Some wealthy individuals in India relocating their family offices to special economic zones like GIFT City or even low-tax countries abroad.
Key Points:
GIFT City: A special economic zone in India offering tax benefits for businesses, including Family Investment Funds (FPIs).
Tax Benefits in GIFT City:
10-year tax exemption: FPIs established in GIFT City enjoy a 10-year exemption from paying taxes on their income.
Relaxed regulations: Easier rules for raising funds and making international investments compared to regulations outside GIFT City.
Low-tax Jurisdictions: Some countries near India have very low or even zero personal income tax rates.
HNI Strategy:
HNIs might strategically move their family offices, which manage their investments, to GIFT City or a low-tax jurisdiction.
This allows them to potentially:
Reduce overall tax liability by taking advantage of tax exemptions or lower tax rates.
Gain more flexibility in raising funds and making international investments.
In 2022, 7,500 HNWIs left India, and according to the Henley Private Wealth Migration Report, another 6,500 were estimated to leave India in 2023 (the final migration numbers are still not out). Dubai and Singapore are the most popular closest destinations.
Philanthropic Trusts: Setting up charitable trusts allows you to support causes you care about while potentially receiving tax benefits on the contributions. The rick often explore different types of trusts available and how they can be structured to align with their philanthropic goals and maximize tax advantages. Nayyar explains this with the following example:
Mr A, a philanthropist, makes annual donations of Rs. 1 lakh to various charities. These donations are eligible for a 100% tax deduction under Section 80G, but the impact might be fragmented across different causes.
Mr A establishes a charitable trust focused on environmental conservation, his area of passion and donates Rs. 5 lakh as seed capital to the trust. The trust can then make strategic donations throughout the year, potentially maximizing the impact and allowing Mr A to claim a deduction on the entire Rs. 5 lakh and any future contributions. Here's the potential tax benefit:
Traditional Approach (Donations to various charities): Tax benefit = Rs. 1 lakh (annual donation) x 100% deduction = Rs. 1 lakh (tax benefit every year)
Optimized Approach (Charitable Trust): Tax benefit = Rs. 5 lakh (initial donation) x Individual tax bracket (assuming 30%) = Rs. 1.5 lakh (one-time tax benefit) + Tax benefit on any future donations to the trust
Infrastructure Bonds: These bonds often offer attractive interest rates and tax benefits on the interest income. This can be a good option for generating stable returns with some tax shield, especially for those nearing retirement and seeking regular income streams.
Example: Mr. X, HNI, has steady income with tax benefits. He currently uses FDs with taxable interest.
Traditionally, his income and tax on FDs shall be as under:
Investment: Rs. 50 lakh
Annual Interest: Rs. 3 lakh
Annual Tax: Rs. 90,000 (30% bracket)
We can see two scenarios in this case:
•When he invests in partially exempt bonds: These bonds offer a competitive interest rate (let's assume 8% for illustration). However, only a portion of the interest income, say 50%, might be exempt from taxes. In this scenario:
Annual Interest Income: Rs. 4 lakh (Rs. 50 lakh x 8%)
Taxable Interest: Rs. 2 lakh (50% of Rs. 4 lakh)
Tax Liability: Rs. 60,000 (Rs. 2 lakh x 30%)
Tax Savings Compared to FDs: Rs. 30,000 (Rs. 90,000 - Rs. 60,000)
•When he invests in fully exempt bonds: These bonds might offer a slightly lower interest rate (say 7.5%) but with the entire interest income exempt from taxes. Here's the potential benefit:
Annual Interest Income: Rs. 3.75 lakh (Rs. 50 lakh x 7.5%)
Taxable Interest: Rs. 0 (Fully Exempt)
Tax Savings Compared to FDs: Rs. 90,000 (Rs. 90,000 - Rs. 0)
Even with a slightly lower interest rate, tax-exempt infrastructure bonds can significantly improve the net return for HNIs like Mr. X.
"-When long-term capital gains from assets like land are reinvested in Capital Gain Bonds (such as those issued by NHAI or REC), taxes can be saved. This investment must be made within six months of selling the asset to claim this benefit. Example; Raj’s Rs. 10 lakh investment in NHAI bonds under Section 54EC helps him avoid the capital gains tax that would have been approximately Rs. 2 lakh (20% including cess), representing significant savings," said Jain.
Sovereign Gold Bonds - These bonds not only provide regular interest income that is exempt from tax but also exempt the capital gains at the time of redemption, making them an attractive investment for those looking to diversify their investment portfolio. Example; Lata earns Rs. 5,000 annually as tax-free interest from the Sovereign Gold Bonds. If this interest income were taxed at her income tax rate of 30%, she would have to pay Rs. 1,500 as tax. Additionally, the exemption on capital gains upon redemption further enhances her tax savings.
Long term capital gains:
By investing in assets like stocks or real estate and holding them for the long term, wealthy individuals benefit from lower tax rates on long-term capital gains. "For example, long-term capital gains on stocks are taxed at 10% beyond Rs. 1 lakh annually, which is significantly lower than the tax rate on short-term gains. Example; Anjali's long-term capital gain from shares is Rs. 300,000, with Rs. 200,000 being taxable at 10%. This results in a tax liability of Rs. 20,000, whereas if these were short-term gains taxed at her income tax slab, say 30%, her tax would have been Rs. 90,000, thereby saving her Rs. 70,000," explained Jain.
Points to note: Finance Act, 2023 took away a number of other avenues that were hitherto available to HNIs
Finance Act 2023: This recent legislation limited some tax benefits previously enjoyed by HNIs. Here are some specific changes:
Capped investment in residential property: There's now a limit (Rs 10 crore) on capital gains that can be exempted by investing in a residential property.
Taxed high-premium insurance policies: Life insurance policies with premiums exceeding Rs 5 lakh per year no longer offer tax-exempt benefits.
Taxed market-linked debentures: Gains from these financial instruments are now taxed at individual slab rates, eliminating previous exemptions.
Impact on HNIs:
These changes make it more challenging for HNIs to completely avoid taxes on capital gains. While Section 54EC bonds remain an option, they come with a lock-in period that may not be suitable for everyone.
Rental of Agricultural Land - Income from agricultural land is exempt from tax, which makes it an attractive investment for those looking to save on taxes. This income includes profits from the cultivation of crops or rent from the agricultural land. "Example; Sunita's Rs. 5 lakh annual agricultural income would have incurred a tax of Rs. 1.5 lakh if taxed at a 30% rate. By utilizing the tax exemption on agricultural income, she avoids this tax completely," said Jain.
