For investors in lower tax bracket, choose your investment options so as to lower your tax burden.
By Joydeep Sen
There are certain attractive investment avenues which are taxable, and for most investors it is taxable at the slab rate of 30% plus surcharge as applicable plus cess. However, if you are in a lower tax bracket of 20%, these become effectively even more attractive for you as the net-of-tax take-home is that much higher.
Government savings schemes
There is 7.75% Government of India Savings Bonds issued by the RBI, and there are Post Office schemes such as National Savings Certificate (NSC) at 7.9%, Post Office Monthly Income Scheme (MIS) and Kisan Vikas Patra at 7.6%, Post Office 5-year Time Deposit (TD) at 7.7%, etc. Normally, your take-home from these are the interest rates mentioned minus tax at 30% plus surcharge plus cess.
If you are in a lower bracket of 20%, your net-of-tax is that much better. Bank fixed deposits also follow the same logic. However, interest rates offered by PSU banks or leading private sector banks are lower than the interest rate on the schemes mentioned above. Interest rates offered by ‘lesser’ banks may be higher, but the risk of keeping money with co-operative banks is too evident in the current situation.
Debt mutual funds
In debt-oriented mutual fund schemes, in the dividend option there is a dividend distribution tax (DDT) at a defined rate, which is 29.12% for individual investors. If you are in a lower tax bracket, it is advisable to go for the growth option rather than the dividend option.
Reason is, in the dividend option, the DDT is deducted irrespective of your tax bracket, though the net dividend is tax-free in your hands. On the other hand, growth option is taxable in your hands. If you are in a lower tax bracket of say 20%, then you will pay tax at 20% rather than 30%, in the growth option.
In the growth option of debt-oriented mutual fund schemes, if you cross three years of holding, you are eligible for long term capital gains (LTCG) taxation. LTCG is taxed at a defined rate of 20% but after the benefit of indexation, which reduces the effective rate of taxation significantly.
Investment in bond, issued by various private and public sector companies, becomes more efficient for people in lower tax bracket. Most of the returns from bonds come from the coupon, i.e., interest. Interest is taxable at your slab rate plus surcharge plus cess. If you are in a lower tax bracket, the coupon is taxable at, say, 20%, and your net return is that much higher. If you sell your bond holding before maturity, there may be capital gains. If your holding period is more than one year for a bond listed at the Exchange, LTCG is taxable at 10%. However, if you sell before one year, the short term capital gain is taxable at your slab rate i.e., 30% or 20%.
Buying bonds may be a challenge for people in the retail segment as the market is wholesale, i.e., trades take place in large lot sizes. Retail lots do trade at the exchanges, but liquidity is an issue. However, primary issues of bonds are available at lot sizes to suit your pocket.
An investment may be taxable at a defined rate; e.g., equity-oriented mutual funds where there is a DDT rate of 11.65% or LTCG at 10% plus surcharge and cess, irrespective of your tax bracket. On the other hand, there are certain investments, discussed above, that are taxable at your slab rate. For these investments, an investor can generate tax efficiency if she is in a lower tax bracket than the highest one of 30%.
The writer is founder, Wiseinvestor.in