4 Golden Rules to Tax Planning
“Right to tax planning is a legitimate right of the taxpayers provided it is within the framework of law”
If tax is considered as cost then it variable as well as controllable to some extent within legal framework. Tax impact varies with person, time, place, nature of income and two persons with same income can have different tax liability. Tax planning is a powerful tool to manage the impact of tax. There are numerous tax planning tools which varies from person to persons and need individual approach. However, here are 4 golden rules that can help al individual tax payers in general in managing tax impact:
Concept of ‘Divide & Rule’:
One person in a family with income of Rs. 10 Lakh is required to pay more tax as compared to two person in the family with income of Rs. 5 Lakh each. i.e., in case the entire income of a family belongs to just one member, the tax impact is much higher vis a vis income amongst different family members. “Divide & Rule” is one of the most powerful tools of tax planning. It simply means that each family member must have its independent source of income so as to be qualified as an independent tax payer.
(a) It is not possible to arbitrarily divide income amongst different family members. It can be done through proper planning like gift, starting of new business by the family member with lower income, family settlement etc.
(b) Tax planning has of income has to be done at source itself as diversion of income without diversion of source is not a valid tax planning tool.
(c) Taxpayer should understand the clubbing provision before using gift as a tax planning tool for diverting income.
Planning for the ‘Right Business Vehicle’ for carrying out the business.
Choosing the right vehicle (Proprietary firm, partnership firm, LLP, Company etc) for carrying out the business is important tax planning tool. The right choice of business entity is dependent on various factors like number of promoters, vision for business, anticipated turnover & profitability, nature of business, investment, etc. Very often, tax burden increases because of poor planning on this front. Like, husband & wife carrying out the business by forming a partnership firm even if individual income of partner is not in highest tax slab. Proprietary firm is one of the simplest forms for taxation. However, with the introduction of 25% tax slab for company with turnover not exceeding 250 Cr, High Net worth Individuals (HNI) can explore it as a powerful alternative. Similarly, for a smaller size business, partnership firm/LLP could be better than a private limited company.
Earning ‘Exempt Income’:
Taxpayer should invest in such a way that the tax impact on the income is minimal. There are various incomes under the Income Tax Law which are not taxable at all. Such incomes are known as ‘Exempt Income’. While investing, interest rate should not be the sole criteria for investment but post tax returns should be compared before taking any investment decisions. For example, interest on PPF is totally tax free whereas interests on Bank FDR, Debentures etc are liable to be taxed. Proper planning of investments in a way so as to generate tax exempt incomes is one of the golden rules of tax planning. Likewise, dividends received from companies, Tax free Bonds, etc are also tax exempted.
Enjoying all the ‘Permissible Deductions’:
Various deductions are permissible while computing taxable income of the taxpayer. An attempt should be to avail the optimum benefit of these deductions by each and every member of the family. For example, Individual tax payers are eligible for a deduction u/s 80C towards specified investments/expenditure to the tune of Rs. 1.50 Lakh. If there is only one person in the family who is paying insurance premium of all the family members, tuition fees of the children, investing in ELSS etc and amount exceeds Rs. 1.50 Lakh p.a then the benefit would be restricted to Rs. 1.50 Lakh p.a. per person only. By distributing the amount amongst family members in such a way that everyone enjoys the deduction of Rs. 1.50 Lakh would be a good tax planning tool. Dividing the amount of investment amongst various family members would result in optimum benefit of exemptions & deductions. Taxpayer should note that
a] Benefit of deduction u/s 80C is available if the insurance premium is paid towards the policy taken for self or spouse or children of the individuals. So, if mother/ father (who may or may not be senior citizen). Can claim deduction u/s 80C if they pay the premium of even their major son/ daughter.
b] Even HUF can claim deduction u/s 80C towards the premium paid on the policy of any of the members.
The best strategy is to prepare a check-list of various investments done in the family and permissible deduction. By routing investment from the proper source, it is legally possible to save considerable income tax.
Saving tax is the right of the taxpayer. And it can be done legally on the basis of acceptable tax principles. The dividing line between tax planning & tax evasion is very thin and care should always be taken that tax planning doesn’t result in tax evasion. Simple, easy, Peaceful and indisputable claim should be the approach of the taxpayer while doing the tax planning.