Last Updated on July 23, 2023 at 12:53 pm
Everyone desires to save tax, and Indian investors are particularly motivated by tax savings. Salaried individuals can reduce their tax liability by utilizing Section 80C, Section 80D, and Section 24 (for tax savings on home loan interest). Investing 50,000 annually in the NPS (National Pension Scheme) can also provide further tax benefits. These are the conventional methods of reducing tax liability.
With the introduction of the new tax regime, it is crucial to explore new ways of achieving tax efficiency rather than relying solely on tax savings. A few unusual yet legal ways to save tax in India continue to be effective under the new tax regime. Are you aware of these strategies?
About the author: Ajay Pruthi is a fee-only *SEBI registered investment advisor. He can be contacted via his website plnr.in.
Let’s discuss these unusual methods of tax savings in India one by one
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1 Investing in the Name of a Non-Working Spouse
Usually, the interest generated through investments made in a non-working spouse’s name is clubbed into the individual’s income, attracting tax liability. However, there is a legal way to avoid this. Let me give you an example:
Invest in instruments where the accrued interest is not taxable. For instance, invest 1.5 lakhs annually in your spouse’s Public Provident Fund (PPF) account. Since the interest generated is not taxable, it will not be added to your income, and there will be no clubbing of income.
Another way to achieve this is by indirect transfer. Suppose a husband wants to transfer five lakhs to his wife’s account. If he directly transfers the funds, the earnings from this amount will be clubbed into the husband’s income and taxed accordingly. However, instead of a direct transfer, the husband can transfer the five lakhs in the name of his father-in-law. At the same time, his mother-in-law can transfer the same amount to his daughter’s account. In both cases, the transfer is considered a gift, and the tax liability will be in the hands of the receiver. There will be no clubbing of income in this scenario.
2 Making investments in the name of a major child
When investing in the name of a minor child, the interest generated is clubbed into the parent’s income and does not provide tax benefits. However, this strategy can be highly advantageous once the child becomes a major. Let’s understand this with an example:
Suppose you have accumulated 20 lakhs for your child’s education, with an annual educational fee of 5 lakhs. If you invest the same amount in fixed deposits (FDs) in your own name, the interest income of 1.4 lakhs (assuming a 7% interest rate) will be subject to tax at your applicable tax bracket, resulting in additional tax liability. However, if you make the same investment in your major child’s name, there will be no tax liability.
This strategy can also be beneficial for financing your child’s marriage expenses.
3 Making investments in the name of a minor child
The interest generated through investments made in the minor child’s name is clubbed into the parent’s income. However, there is a legal way to avoid tax liability. Consider the following example:
Suppose you want to accumulate ten lakhs for your child’s higher education over the next five years, requiring an investment of 15,000 per month.
Debt mutual funds can be helpful in this scenario. In the case of debt mutual funds, you do not need to pay tax unless you withdraw the amount. Start investing in debt mutual funds in the name of your minor child. Once the child reaches the age of majority, this amount can be withdrawn for their higher education. The tax liability will be in your child’s hands, as they are now considered a major. There would not be any clubbing of income here.
4 Making Investments in the Parent’s Name
Fixed deposits are popular debt investment options, but they are not tax-efficient. However, it is possible to make FDs tax-efficient by investing in the parent’s name. Consider the following example:
Ajay, who falls under the 30% tax slab, wants to invest 10 lakhs in FDs. Assuming a 7% return, the interest income will be 70,000 annually. Ajay would have to pay 21,000 in taxes on this amount (without considering cess). Ajay can transfer the ten lakhs to his father’s accounts to make the investment more tax-efficient. This transfer would be considered a gift, and no taxes would be imposed if given to blood relatives. Moreover, since senior citizens receive higher interest rates on FDs, Ajay’s father will earn around 8% interest instead of 7%, resulting in an additional interest income of approximately 10,000. Overall, this strategy saves around 31,000 in taxes and additional interest.
This strategy is also useful for non-resident Indians (NRIs) residing in foreign nations such as the US and Canada, as it helps them save tax on the income generated through these FDs.
5 Paying Rent to Your Parents (Applicable to old tax regime only)
Living with your parents not only provides emotional satisfaction but also offers an opportunity to save taxes. If you live with your parents, you can pay them rent and claim House Rent Allowance (HRA). The rent needs to be paid to the owner of the property, which could be your mother or father. Your parents must declare this rental income while filing their income tax return.
Let’s consider an example:
Ajay, who falls under the 20% tax slab, stays with his parents. He can claim an HRA of 8,000 per month based on his basic pay norms, but he currently does not. As a result, he ends up paying an additional tax of 19,200 (20% of 96,000). Ajay can start paying his father a monthly rent of 8,000 to save this amount. Since his father’s annual income is less than seven lakhs, including his pension, he will not have to pay any taxes on his total income.
6 Tax Loss Harvesting
Tax loss harvesting is a strategy to reduce the net tax liability by selling stocks or assets with an unrealized loss, thereby offsetting the gains and reducing the taxable income. Let me give you an example.
If an individual earns 50,000 in Short-Term Capital Gains (STCG) within a year, they would be required to pay 7,500 in taxes, which is 15% of 50,000. However, if the individual possesses other stocks that have an unrealized loss of 40,000, they can choose to sell these stocks and incur a loss of 40,000. By doing so, their net tax liability would be reduced. They would only need to pay taxes on the remaining 10,000. In this case, the net tax liability would be 1,500, 15% of 10,000. This strategy is commonly known as tax-loss harvesting.
If the individual intends to hold onto the stocks worth 40,000, a simple solution would be to sell them today and repurchase them tomorrow.
The following points should be kept in mind while implementing tax loss harvesting:
- Long-term capital losses can be set off against long-term capital gains.
- Short-term capital losses can be offset against short-term and long-term capital gains.
By utilizing this strategy, individuals can reduce their tax liability and optimize their investment portfolio.
7 Tax Gain Harvesting
Tax gain harvesting involves strategically realizing long-term capital gains up to a certain limit to take advantage of the tax exemption. In India, long-term capital gains above 1 lakh in equity mutual funds are taxable at a rate of 10%. However, no tax liability arises if the gains remain below this threshold. Individuals can minimise tax liability by withdrawing the gains just below the limit and reinvesting the amount.
Let me give you an example.
Suppose you invest 5 Lakhs in equity mutual funds today. After one year, the value of your investment increases to 5.90 Lakhs, and after two years, it reaches 6.50 Lakhs. If you decide to withdraw the entire amount after two years, you would be liable to pay tax on the capital gains, which amount to Rs. 50,000. The tax rate for long-term capital gains is 10%, so your tax liability would be Rs. 5,000.
Net gains = Final value – Initial investment Net gains = 6.50 Lakhs – 5 Lakhs Net gains = 1.50 Lakhs
Long-term Capital Gain Tax (up to 1 Lakh) = Rs. 0
Long-term capital gains on 50,000 = 10% * 50,000 = Rs. 5,000
Now, let’s explore how tax gain harvesting works:
Suppose you invest 5 Lakhs in equity mutual funds today. After one year, the value of your investment grows to 5.90 Lakhs. At this point, you decide to withdraw the entire amount and reinvest it after a week. After two years and one week, the value of your reinvested amount becomes 6.50 Lakhs.
In this case, since the long-term capital gain has not exceeded the 1 Lakh limit in this particular year, you would not be required to pay any tax on the entire amount when you withdraw it.
Therefore, by timing your withdrawals strategically, you can minimize tax liabilities if your long-term capital gains remain within the specified limit.
8 Creating a Hindu Undivided Family (HUF)
Creating a HUF can be complex but can provide tax benefits in certain cases.
Suppose you have received an ancestral property with an annual rental income of 4 lakhs. Normally, this rental income would be included in your individual income and taxed based on your slab. However, if you create a HUF and transfer the property to its name, the rental income will be taxed separately under the HUF entity.
As a result, the tax liability can be significantly reduced or even eliminated if the HUF falls below the taxable limit.
Disadvantages and Considerations:
While these strategies offer potential tax savings, there are some disadvantages and considerations to keep in mind:
- If you have no siblings, it is generally understood that you would inherit all of your parents’ assets. However, if you have siblings, they will have a claim on your parents’ assets if you choose to invest in your parents’ name. While having a nomination and a will in place can be helpful in such situations, it’s important to note that both can potentially be contested or challenged.
- Secondly, it is important to ensure that your child does not misuse the money once you transfer it to their account. However, if you have any doubts or uncertainties, it would be wise to refrain from investing in your child’s name.
- While tax gain and loss harvesting can help you save on taxes, it’s important to consider that there is a possibility of incurring losses if the markets experience significant growth between selling and reinvesting securities.
- Creating a HUF can have long-term implications, and it may be difficult to break or dissolve it in the future.
Within the legal framework, these unusual ways of saving tax in India provide individuals with additional options for tax efficiency. However, please consult a tax professional to understand these strategies’ specific implications and suitability based on individual circumstances. Happy Tax Savings!
Disclaimer– Nothing in the article is a solicitation, recommendation, endorsement, or offer by the author or the editor. If you have any doubts as to the merits of the article, you should seek advice from an independent financial advisor. *Registration granted by SEBI, BASL membership, and NISM certification does not guarantee the intermediary’s performance or provide any assurance of returns to investors. Investment in the securities market is subject to market risks. Read all the related documents carefully before investing
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