Tax planning is a legitimate process to reduce one's tax liability by availing all the permissible allowances, deductions, exemptions and rebates.
The best thing about making mistakes is that one learns something from them. However, that lesson can be costly and unrepairable if that is learnt from wrong investment decisions. A prudent person can’t avoid the taxes, but he can surely reduce them by learning from the mistakes of others.
Tax planning is a legitimate process to reduce one’s tax liability by availing all the permissible allowances, deductions, exemptions and rebates. Some of these benefits accrue after the fulfilment of certain conditions. In this article, we shall discuss about the investment-linked tax deductions and the common mistakes a taxpayer generally makes.
One should align one’s tax planning with long-term financial goals. Tax-saving is an important part of overall financial planning and should ideally be planned throughout the year. Three-fourth of the current fiscal year is over and taxpayers are now left with just 3 months to plan or re-arrange their tax affairs.
Taxpayers generally ignore the important factors, i.e., return on investment, liquidity, etc., while making the investment decisions and have an eye on the quantum of tax savings. One should always distinguish between the end goal and auxiliary benefits of an investment. The end goal should be return on investment and building corpus for the future, and auxiliary benefits should be tax savings. In a nut-shell, even if you have not made any tax-saving investment, don’t go for it in great haste. Make an informed decision by avoiding the following common tax-saving mistakes:
1. Overflow in one, while shortfall in others
Section 80C is a common provision for pool of investments with an overall deduction limit of up to Rs 1.5 lakh. We have witnessed that due to lack of awareness, taxpayers keep investing in all those options which are eligible only for deduction under Section 80C, i.e., insurance policies, FDs, ELSS, etc. Consequently, the limit prescribed under Section 80C is fully exhausted, while as other deductions remain unutilized. So, to get most of deductions, diversify your investment portfolio and spending. Any contribution to the NPS is eligible for Section 80CCD deductions and payment for health insurance premium and preventive health checkup expenses give you Section 80D deduction.
So, first make a list of all deductions that could be availed during the year and the investment that would be eligible for such deductions. Check your salary slips, bank statements and credit card statements to find out if there are any investments that are already eligible for deductions, i.e., housing loan EMI, contribution to PF, children’s school fees, etc. If some deficit remains, then plan for making further investments.
2. Investment without research
Taxpayers generally have the sole intention of tax saving while making any investment. They ignore the factors of return and risk factors. Tax saving can’t be an end result, it is an ancillary benefit we achieve when we choose an investment plan. Wisely choose the investment options by taking into account the options available, assured returns, previous years’ return, etc., so as to minimize the tax liability and to increase the returns.
For example, you have an option to invest in bank FDs, PPF or NSC. All of these investments are eligible for Section 80C deductions. The factors to choose the right investment plan should be the lock-in period, rate of return and risk factors. All of them are completely secure. FDs and NSCs have a lock-in period of 5 years, whereas the PPF has a lock-in period of 15 years. In terms of interest, NSCs and PPFs provide the same rate of interest (8% w.e.f. October 1, 2018), whereas SBI offers 6.85% on 5-year FDs. If the term of investment is not a deciding factor for an investor, PPF would be a better investment opportunity for him as the interest earned on PPF is tax free whereas interest earned on NSC is chargeable to tax. Thus, while making tax planning one should consider the financial goals along with tax saving.
3. Choosing wrong mode of investment
The government always pushes for digital payments as they can be traced back to check any false claim. Many sections allow deduction or exemption only when the investment is made by any mode other than cash. Before making payment for any investment, a taxpayer should always check if payment in cash would be eligible for deduction. Example, Section 80D allows deduction for medical insurance premium only if it is paid through banking channels. Similarly, Section 80G restricts deductions for any donation in excess of Rs 10,000 if it is made by way of cash payments.
4. Not planning investments in advance
The most common mistake a taxpayer commits is planning investments in the last quarter of the year. He ends up with investments in less-yielding schemes or schemes which are not eligible for deduction. Thus, to avoid bad investments, start your tax planning from the start of the year. Before making any investment, one should evaluate all the available avenues thoroughly. It is important for a taxpayer to invest in multiple schemes so as to diversify the investment portfolio. If you have not yet done tax planning for the year 2018-19, you should plan your investments according to your financial goals and reduce your tax liability instead of delaying it any more.
5. Ignoring tax exempt expenses
Most of the people don’t even know that the expenses they incur in their day-to-day lives can also help them save taxes. They often ignore the regular expenses made during the year which are eligible for deductions. So, you should first learn about all the expenses which qualify for deductions. Example, tuition fees, medical expenditure, stamp duty and registration fees paid on purchase of immovable property, donations, interest on housing loans, etc. So, keep a track of all eligible expenses made during the year along with their receipts so as to claim deductions in such respect at the end of the year. Just because of such ignorance we end up paying higher taxes, even though we could have saved them.
As it is almost the end of third quarter of fiscal, buckle up and start planning wisely for your taxes and investments. Plan wisely, evaluate rationally and execute brilliantly to maximize returns and minimize the tax burden. Remember that your best teacher is your last mistake and don’t repeat a mistake twice.
(By CA Naveen Wadhwa, GM–R&D, Taxmann.com and CA Ritu Gupta, Assistant Manager, Taxmann.com)