What is Tax Deduction?
The revenue stream to the Indian government that helps maintain various aspects of the country is through the taxes paid by the citizens. They can be a bit harsh on the pockets considering existing personal expenses, and now, there are taxes to be paid, too. Fortunately, within the Income Tax Act, the government offers tax deductions under various provisions.
While you may have heard about tax deductions from your chartered accountant or financial advisor, there is more to it than meets the eye. Let’s begin with understanding the significance and meaning of tax deductions.
About Tax Deduction?
A tax deduction, otherwise known as an income tax deduction is a benefit on the taxable amount that reduces the tax liability of a person or an organization. These deductions are otherwise expenses that the taxpayer incurs during the year that can be subtracted from your gross income to understand the amount of tax owed to the Government. In India, under income tax deductions, several provisions can be utilized to lower your taxable income. More often than not, such deductions are subject to specific conditions. Tax deductions also promote investments and savings by a taxpayer.
How is that different from tax exemptions or tax credits?
Tax deductions & exemptions are forms of tax relief that lower your taxable income. However, tax exemptions may also include complete relief from taxes on certain income, reduced tax rates & tax on only part of total income. For instance, income from agricultural activities is exempted. Erstwhile, a tax credit is utilized to reduce the amount of tax owed, independent of the amount of taxable income.
Tax on your income is calculated as follows:
Gross total income is calculated by adding income from all sources that are broadly categorized into 5 different heads.
Then all deductions & other tax-exempted allowances (HRA, LTA, etc.) that you can claim are subtracted from the gross total income. The net result is taxable income.
It is this resulting taxable income that is then taxed as per the income tax slab rates in effect for that particular year.
Any tax rebates or credits are deducted from the computed tax liability to come at a final tax payable figure.
For your ease of understanding, we have broadly illustrated the process flow of tax computation.
Gross Total Income
Net Taxable Income
Tax liability calculated as per Income Tax slab rates for the
Less: Tax Credit
Tax Payable ✅
There are several advantages to claiming tax deductions. It lowers the amount of your income subject to tax, subsequently reducing the money you need to pay as tax. Who doesn't love some good old beach hat?
What are the various types of income tax deductions that you can claim?
There are various investments and forms of expenditure that help you to avail deductions on your income. This list of investments include:
Life insurance premium u/s 80C: Any premium that you pay towards life insurance policies for your spouse, children, or self, to a limit of Rs. 150,000/- qualifies for a deduction. The maturity amount of the policy will also be free from tax subject to prescribed conditions. Life premium? More like a tax premium.
Public Provident Fund: One of the most popular long-term saving schemes which give an agreeable rate of interest and returns on investments. Hitting two birds with one stone.
Bank fixed deposits: Investments in fixed deposits with scheduled banks for a period of 5 or more years are eligible for a tax deduction. However, it is important to note that the interest which accrues on the fixed deposit will be taxable.
Standard Deduction for Salaried Individuals (Old Tax-regime): Rs. 50,000/-
National Savings Certificate(NSC): Investments in NSC are eligible for a tax deduction. However, the interest earned is taxable in this cumulative scheme.
Mutual Funds & Equity-linked Savings Schemes: One of the many long-term tax-saving investments that you can opt for.
Charitable Contributions: Any charitable amount made before 31st December of every year qualifies for tax deductions. However, the deduction is not allowed for donations that exceed Rs. 10,000.
Registration charges and stamp duty: Transferring immovable property does not qualify as taxable income up to a limit of Rs. 150,000/-.
House Rent: This deduction applies to salaried taxpayers who do not own residential accommodation at the place of employment and do not receive HRA. The extent of tax deduction is limited to the least of the following options:
- Rent paid minus 10% of the total adjusted salary
- Rs. 60,000/- pa
- 25% of the total adjusted income
*Adjusted Total Income means Total Income minus long-term capital gain, short-term capital gain under section 111A and Income under section 115A or 115D, and deductions 80C to 80U (except deduction under section 80GG).
Home Loan: First-time homebuyers can claim a deduction of Rs. 1,50,000/- on home loan interest payments under section 80 EEA. Additionally, the buyer should not have an existing house in his name.
Infrastructure Bonds: Investments in bonds issued by infrastructure companies after they have been approved by the government, qualify for a tax deduction for a maximum of Rs. 20,000/-. However for long-term secured bonds the limit is over and above 1 lakh.
Unit-Linked Invest Plans: Your money is invested in debt, equity, and money markets. Subject to certain conditions the premium paid is deducted from the taxable income up to the permissible limit under Section 80C.
Interest paid on education loan: Under Section 80E, you can claim a deduction of the interest paid on an education loan. This loan for higher education can be for your spouse, children, or a student to whom you are a legal guardian. This deduction can be availed for eight years starting from the year you start paying the loan. More incentive to be well educated.
Post Office Time Deposit: These deposits for 5 years, qualify for a tax deduction. The interest however is fully taxable.
(the above list is inclusive and not exhaustive)
While this is a comprehensive list of basic deductions, we, at IIFL have broken the entire process down for one deduction for better interpretation.
Example 1: House Rent Deduction
Yash earns 5 lakhs annually (after all deductions) and stays in a rented accommodation for which he is not getting any house rent allowance. The annual rent paid by Yash is Rs 150,000/-. In such a case the deduction would be least of the following:
Monthly rental limit of Rs 5000/- every month i.e. Rs. 60,000/- per annum
Rent paid i.e. 1.5 lakhs minus 50,000 (10 % of annual income) = Rs. 100,000/-
25% of the total annual income = Rs. 125,000/-
In the example above, Yash would be eligible for a deduction of Rs. 60,000/- per annum for his house rent expenditure.
There is absolutely no reason to restrict yourself from making financially prudent decisions. Make income tax deductions your best friend. A best friend who saves you money, for a change.