BankBazaar.com CEO Adhil Shetty explains how debt instruments can help you save tax and earn reasonable returns too

The market has been volatile for a couple of quarters now and many investors have lost money. In such a scenario, investors are looking towards debt instruments like fixed deposits where the returns are less volatile, and fixed in some cases. Also, this is the season for income-tax filing and many would be curious to know the options available to save taxes. Tax has always been a complex subject for investors and salaried employees. Here, we will discuss some of the options for saving taxes.

Infra bonds

Infra bonds help you save taxes on the investments of up to R20,000 in a year. The tax savings in the bracket of 30.9% will be about R6,100 (see table).

Investors will receive this payment every year for five years and the principal in the fifth year (assuming buyback option). For the cash flow in the lock-in period, i.e., for five years, see table.

The effective interest rate here (18.1%) assumes that the interest will be reinvested in the bond at the same rate of returns. However, the interest is taxable as per the income tax slab of the individual. Factoring the tax rate at 30.9%, the returns will be about 15%. This is again a very handy return.

Tax-saver bank term deposit

The government has allowed taxpayers to save taxes on term deposit of five years in different banks. This deposit will come within the R1 lakh limit of Section 80C.

Tax-saver fixed deposits work on the same concept as infra bonds. The calculation for five-year term deposit will be similar and the effective rate of return will be the same. The difference is that the maximum limit under 80C is R1 lakh and the maximum can be used to save taxes by investing in a fixed deposit.

Post office monthly income scheme

Popularly known as MIS, post office monthly income scheme can be availed for tax benefits under Section 80C. It pays 8% interest every year and 5% bonus at the end of the tenure, effectively taking the rate at 8.9%. Since the interest is paid monthly, if a person invests the monthly income back into the scheme and withdraws it at the end of the maturity, the effective interest becomes 10.5%

Company fixed deposit

Companies, from time to time, float fixed deposit schemes where the rates are better than banks and other fixed deposit instruments. The income from company fixed deposits is taxable. For the effective rate of return from company deposit schemes, see table.

Company fixed deposit is very different from bank deposit. Bank deposits are guaranteed by deposit insurance and credit Guarantee Corporation for up to R1 lakh if the bank defaults on the payment. In case of company fixed deposit, there is no guarantee if the company goes bankrupt or defaults.

Regular bank deposit

Banks also offer fixed deposit or recurring deposit to investors. However, the interest earned is taxable as per the tax slab of the individual. The effective rate of return, post-tax, is shown in the table.

Debt funds

Debt-oriented mutual funds that invest more than 50% in debt pay dividends to the investors. The investor doesn?t need to pay taxes on the dividend income, but the company has to pay dividend distribution tax on the dividend paid to individuals.

Let?s take an example. Suppose a debt fund?s NAV is R10 and it pays investors 10% dividend, i.e. R1. This dividend will be taxable for the mutual fund.

The mutual fund will give dividend distribution tax of 13.84%. This means that the individual will get R0.8616. This is 8.6% returns post tax. This is much better than the fixed deposit returns given by banks on non-tax savers plan.

There are other debt funds which do not pay dividend, but the dividend accumulates and adds to NAV of the bond. Once the investor liquidates the fund, he or she has to pay taxes.

The short-term tax is paid as per the individual tax bracket. For long-term gain, if investors calculate capital gain with indexation, the tax rate will be 22.66% while it will be 11.33% without indexation. Indexation increases the initial value of the investment by taking inflation and other factors which depreciate the value of money. Debt funds are riskier than other investment options mentioned above because debt funds do keep some part of fund in equities which are market related.

There are many ways to save tax using fixed income schemes. The key is that many fixed income schemes may not provide the exact amount as mentioned because of uncertainty attached to it (as in debt mutual funds).

Moreover, the risks associated with different schemes are different. For example, the risk in infra bonds is more than risk associated with tax-saving term deposit.