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Business News/ Money / Personal Finance/  Here’s a better and efficient way to save tax
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Here’s a better and efficient way to save tax

No! You cannot save more tax through deductions

Here’s a better and efficient way to save taxPremium
Here’s a better and efficient way to save tax

No! You cannot save more tax through deductions. With the tax planning season on, a common query on everybody’s mind is on how to save more tax. Most would be maximizing the current set of deductions available like section 80C, 80D, etc., of the Income Tax Act. Yet, the total tax that can be deducted with all these options is only around 5 lakh.

People often lament about tax burden and how it is affecting their wealth creation. But there is a bigger aspect that is hindering the growth of wealth, and that is tax inefficiency. There is so much focus on tax deductions that people miss out on paying attention to efficient tax-planning and so often ignore the growing pile paid as taxes.

With talk about the old tax regime being done away with, and the limited set of tax deductions allowed, individuals need to direct their attention to tax efficiency which is basically maximizing after-tax returns. The impact of taxes on long-term investment returns can be significant and that, coupled with non-inflation beating instruments, means not meeting financial goals.

Take the case of investing in National Savings Scheme versus Public Provident Fund (PPF). A sum of 1 lakh invested for a 15-year period in PPF will grow to 2.75 lakh as compared to the same growing to 2.07 lakh in the National Savings Certificate (NSC), i.e. 32% higher absolute amount. Clearly, one needs to consider the net post-tax return over gross returns while choosing investments.

Often, the amount saved as tax deductions is not reinvested but used up for expenses. While tax nudges can get people to save tax, this doesn’t necessarily translate into increased savings. Expenditure- based options in Sec 80C like principal repayment of home loan or school fees do not build wealth either.

Keeping loans alive for the purpose of saving tax is a common practice, which needs to be reconsidered. The interest paid is an additional cost and the overall benefit is limited to 30% only. Besides, the maximum limit is only 2 lakh per year. Given the cost of housing in India, the amount of tax saved versus the interest outgo is insubstantial. Not to mention the long-term financial burden and the constantly changing mortgage rates, which only compound the interest outgo more.

Tax efficiency is an important factor, not only for tax planning but also for investing otherwise. In order to boost returns, investors end up taking more investment risk in instruments and schemes such as non-convertible debentures (NCDs) or Alternate Investment Funds (AIFs). A debenture yielding 9% per annum, pre-tax, would only give 6% yearly after taxes. In a similar time period, there are target maturity funds which give better post tax returns, with lower risk and better diversification. Adding up the variable expenses in AIFs, post tax returns could be in the range of 10-12% which can be achieved via a simple index fund with much less paperwork and tax reporting. Tax efficiency is not only about getting better returns but ensuring fewer hassles.

Sometimes tax efficiency is assumed in products. For example, investment linked insurance plans qualify for Sec 10(10D) and hence returns are tax free. But not all insurance policy returns are tax free. Pension plan returns in the form of annuities or policies with premium more than 10% of the sum assured are taxable at slab rates. Keep away from such investments.

With most tax deductions already being availed of, it is time for investors to stop chasing tax deductions, tax harvesting strategies and high returns, and instead concentrate on tax efficient allocation of wealth and optimizing portfolio returns. While evaluating products for goals, first check the expected post expense, post-tax returns, and appraise the product further only if it beats inflation.

With limited number of EEE (exempt, exempt, exempt) instruments, restricted subscription amounts, and interest and dividend income being taxed at slab rates, the last E should form the basis of investing. That’s the mantra for 2023!

Mrin Agarwal is founder and director of Finsafe India

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Updated: 26 Dec 2022, 06:37 AM IST
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