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Tax planning- meaning, objective, types

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Introduction

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Tax planning is the process of analysing a financial plan or a situation from a tax perspective. The objective of tax planning is to make sure there is tax efficiency. With the help of tax planning, one can ensure that all elements of a financial plan can function together with maximum tax-efficiency. Tax planning is a significant component of a financial plan. Reducing tax liability and increasing the ability to make contributions towards retirement plans are critical for success.

Tax planning comprises various considerations. Considerations such as size, the timing of income, timing of purchases, and planning are concerned with other kinds of expenditures. Also, the chosen investments and the various retirement plans should go hand-in-hand with the tax filing status as well as the deductions in order to create the best possible outcome.

 

Objectives of Tax Planning

 

·Minimal Litigation: There is always friction between the collector and the payer of tax. In such a situation, it is important that the compliance regarding tax payment is followed and used properly so that friction is minimum.

·Productivity: Among the most important objectives of tax planning is channelization of taxable income to various investment plans.

·Reduction of Tax Liability: As a tax payer, you can save the maximum amount from payable tax amount by using a proper arrangement of your enterprise working as per the required laws.

·Healthy Growth of Economy: The growth in an economy depends largely upon the growth of its citizens. Tax planning estimates generation of white money that is in free flow.

·Economic Stability: Stability is supplemented when the tax planning behind a business is proper.

 

Types of Tax Planning:

Tax planning is an integral part of every individual’s financial growth story. Since paying taxes is mandatory for every individual falling under the purview of the IT bracket, why not streamline your tax payments in ways that it offers substantial returns over a period of time with minimum risk? In addition, effective planning also reduces your tax liability drastically.

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The different mindset under which tax planning can be broadly classified are:

Purposive tax planning: Purposive tax planning means applying tax provisions in an intellectual manner so to avail the tax benefits based on national priorities. It includes tax planning with a purpose of getting the maximum benefit by making suitable program for replacement of assets, correct selection of investment, varying the residential status and diversifying business activities and income. Also, Under Income Tax Act, Section 60 to Section 65 is related to the income of other persons included in the income of assesses. Here, assesses can plan in a way that the provisions do not get attracted so as to increase the disposable resources. This is known as purposive tax planning.

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Permissive tax planning: Permissive tax planning refers to the plans which are permissible under various provisions of the law, for example planning of earning income covered by Section 10, Section 10(1), planning of taking advantage of various deductions, incentives for getting benefit of different tax concessions etc. In other words, it means planning made as per provision of the taxation laws.

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Long range and short range tax planning: Short-range planning means planning made annually to fulfil the limited or specific objectives. It is executed at the end of the year to reduce taxable income legally. Also, in short-range tax planning there is no permanent commitment. An individual may invest in NSCs (National savings certificate) or PPF (Public Provident Fund) within the prescribed limit when income is increased. It is not advisable to take LIC/ULIP/Pension Plan etc. Long range tax planning refers to the practices undertaken by the assesses. Long term planning is done at the beginning or the income year to be followed around the year.  Long term planning does not help immediately, for example transfer of assets without consideration to minor child. In this case, the income will be combined to transferor up to the child in minor but once the child turns 18, this will be the child’s income.

 

How to get started?

Anyone can start planning their taxes in a few simple steps:

1. Start by taking your total income into account. This is the starting point of the process and requires you to accurately assess your annual and monthly income.

2. Evaluate the taxable aspects of your income. Housing and rent allowances included in the salary on top of base pay are not taxable. However, profits made from investments could add to taxable income. Therefore, understanding one’s taxable income is a requisite to be able to plan taxes.

3. Make use of deductions to reduce the total taxable income. This can be done by structuring salary and proper planning of investments. For example, interest from a fixed deposit is taxed at the same rate as income tax, while a debt fund held over e years is taxed at 20%. So if you fall in the 30% tax bracket against the taxable income of 10 lakhs and above, debt funds are a more tax-friendly option.

4. Invest in tax-saving instruments. There exists a wide range of deductions available to eligible taxpayers in section 80C through 80U of the Income Tax Act, 1961. Other options such as deductions and tax credits are listed under the Income Tax Act, 1961. Investment options include Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) in mutual funds, National Saving Certificates (NSC) or 5-year bank deposits. Life insurance, health insurance premium and home loan payments can let you avail tax savings.

 

A simple example is, if an individual’s income is 6.5 lakhs per annum and they invest 1.5 lakhs in the notified schemes, they can bring down their taxable income to 5 lakhs- consequently reducing tax liability to NIL as a person having taxable income upto Rs 5 L available for rebate of Rs 12,500 u/s 87A. The savings can then be put to productive use. With a simple assessment of your income and some basic tax rules; planning your taxes can ensure your overall financial security.

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Corporate Tax Planning

This is a way of lowering the liabilities on a registered company. One of the most used methods is by including the deductions on business transport, health insurance of employees, etc. With tax deductions and exemptions provided under the Income Tax Act, 1961, your enterprise can largely reduce its tax burden in a legal way.

Rising profits of an enterprise means higher liabilities of tax. In such a situation, it is important that they dedicate enough time on tax planning that reduces liabilities. With a tax plan, both direct tax and indirect tax is lessened at the time of inflation. Not just this.

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Tax planning means a proper planning of:

  • Expenses.

  • Capital budget.

  • Sales and Marketing costs.

 

How to save income tax

There are different ways through which you can save tax. Some of them are:

1. By buying life insurance:

The premiums paid on life insurance policies are eligible for deduction from taxable income under section 80C resulting in tax saving. Some of the other tax-savings options which fall under this section are Public Provident Fund (PPF), National Savings Certificates (NSC), Sukanya Samriddhi, National Pension System (NPS) and your child’s tuition fees. However, the maximum amount which can be claimed as deduction from taxable income under this section is `1.5 lakhs.

 

2. By insuring your and yours loved one’s health:

Under Section 80D, premiums paid in any mode other than cash towards insuring the health of self, spouse, and dependent children are eligible for a deduction for up to `25,000 from your taxable income. Paying the premium on health policies of senior citizen parents makes you eligible for an additional deduction of `30,000 from your taxable income, thereby helping you save more tax. This limit includes the expenses of up to `5000 incurred on preventive health check-ups.

 

3. By submitting rent receipts:

If you are staying in a rented accommodation and receive  from your employer, you can House rent allowance claim deduction under Section 10(13A). The least of the following three will be allowed as exemption from taxable income before calculating tax on total income.

  • Actual HRA received from the employer

  • The actual rent paid is more than of 10% of salary*

  • 50% of the salary if you stay in a metro city and 40% of the salary if you stay in a non-metro city

* Salary= Basic Salary+ Dearness Allowance as per employment terms

However, under Section 80GG, if you do not receive HRA from your employer or do not own a residential house, you can get adeduction of house rent expenses from your taxable income. The least of the following three will be allowed as adeduction from taxable income:

  • `60,000 per annum(`5000 per month)

  • Rent paid minus 10% of thetotal income

  • 25% of total income for the year

 

4. By making a charitable donation:

A donation made towards certain relief funds and charitable organisations is eligible for deductions under Section 80G. However, any donation made in items such as food material, medicines, etc., are not eligible for deduction.

 

5. By financing higher education:

Under section 80E, the interest paid on loan taken for higher education qualifies for a deduction from taxable income. The deduction is offered for a maximum of 8 years or till the time the interest is paid, whichever is earlier.

 

6. By buying a house:

Under Section 24, you can get deduction from taxable house property income, of the interest paid on home loan up to `2 lakhs. Also, first time home buyers can claim an additional deduction from taxable income of  50,000 on home loan interest under section 80EE, provided the following criteria are met:

  • The housing loan should be sanctioned in the FY 2016-17

  • The loan should not be more than `35 lakhs

  • The residential house value should be less than `50 lakhs

  • The home buyer should not have any other residential property registered in his name

 

 

 

DISCLAIMER- These materials are public information and have been prepared solely for educational purposes. These materials reflect only the personal views of the author and are not individual legal advice.

It is understood that each case is fact specific and that the appropriate solution in any case will vary. Finally, the owner will not be accountable for any loses injuries or damages from the exposures or usage of this information.

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