Money Blog

In the third quarter of financial year, everyone is busy in tax planning. We all want to save as much tax as we can. A number of consultants and brokers are busy selling tax saving plans. And on the last dates we tend to sign any paper and somehow manage to save tax.

Generally we don’t expect too much from the tax saving plans. At the time of making investment we only look at the tax being saved through the transaction and not the return that the investment will yield in the long run. Generally we opt for post office savings, life insurance premium, Government bonds, etc for tax deductions, which give us 5 to 8 percent returns per annum.

Nowadays there is increased interest in Tax-saving mutual fund schemes and ULIPs which also qualify for the deductions under section 80C of the Income Tax Act, 1963. In the past some years the mutual funds, particularly equity based mutual funds have given tremendous returns. Average mutual fund schemes have yielded more than 20% returns annually which are much better than the Government securities. And with the switch options you can make your plan more debt oriented in the times of falling markets, thus hedging your gains against the down turn in the stocks.

Now let us analyze the treatment of investment in Mutual funds under the Income Tax Act 1963.

Deduction under section 80C
As per the provisions of section 80C of the Income Tax Act, 1963, an individual can claim deduction from his total income of the amount invested in the eligible securities subject to maximum Rs. 1,00,000. The eligible instruments include some post office saving certificates, subscription to provident fund, select Government bonds, eligible schemes of mutual funds, life insurance premium, etc.

As per the above provisions you can reduce your taxable income by Rs. 1,00,000 and if you fall in a 30% tax bracket you save around Rs. 30000 plus surcharge and education cess (if applicable) payable thereon.

For example if you are employed somewhere and Rs.3,00,000 is your total income. Rs.40,000 was deducted by your employer as your contribution to provident fund and you have paid a life insurance premium of Rs.20000. Now the total investments made by you come out to Rs.60,000. Now you can invest Rs.40,000 more in a tax saving mutual fund scheme or in any other eligible investment to exploit the maximum benefits provided under section 80C of the Income Tax Act, 1963. Here your taxable income will be only Rs.2,00,000.

Capital Gains

Long term capital gains
In case of listed securities and units of mutual funds, if an investment is sold after holding it for more than one year the profit emanating from it shall be treated as a long term capital gains.

Short term capital gains
Where the above mentioned security is sold within one year of its purchase, the profits there from shall be short term capital gains.

Tax treatment of capital gains
As per the provisions of Income Tax Act 1963, there is no tax on long term capital gains generated on sale of listed securities and units of mutual funds. Whereas short term capital gains are taxed at a flat rate of 10%.

Dividend declared by a mutual fund
Dividend received from a mutual fund is tax free, however the NAV of the scheme decreases immediately after the payout to offset the effect of reduction in assets. This is beneficial in the long run as your capital gains are reduced due to dividend payout.