What is Tax Planning?
Taxes in India consume a considerable portion of your earnings. Without proper tax planning, this compulsory contribution can eat a large bite of your hard-earned money. Fortunately, there are tools available to help you reduce tax liability. However, what does it include and how can you go about it? We’re here to explain tax planning.
About Tax Planning?
Tax planning refers to financial planning for tax efficiency. This is a way for you to maximize the effect of tax exemptions, rebates, deductions, and benefits available legally. Broadly, tax planning includes formulating financial and business decisions to minimize the income tax you owe the government in the best way.
In layman's terms, tax planning is simply a means to save money by investing in tax-saving instruments under different sections of the Income Tax Act, 1962. It requires one to plan their finances and taxes at the beginning of the fiscal year, instead of leaving it to the last month, week, day or hour. Tax planning for every individual is dependent on subjective factors that include age, income, financial goals & one's risk appetite.
What are the objectives of Tax planning:
Why should you plan your taxes when you can conveniently procrastinate until the end of the financial year? The objectives and meaning of tax planning go beyond saving a few meager bucks. Here’s how.
Reduction of your Tax Liability
Tax planning is essentially about reducing your tax liability. Every taxpayer wants to reduce the burden of paying the taxes and save their hard-earned money as future savings. Fortunately, the Government offers several different investment schemes through which tax liabilities can be reduced significantly. Therefore, it is important to plan your investments in tax-savings instruments and avail all the advantages to reduce the amount of tax owed to the government.
An important aspect of tax planning is to minimize legal litigations. This means resolving tax disputes with local, federal, or state tax authorities. There’s often a tussle between tax authorities and taxpayers since both have opposing objectives. One is trying to squeeze as much tax from the other and the other is trying to save as much tax as one could. Minimizing litigation saves you all the judicial harassment and court-kachehri trouble.
Leveraging Productivity & Financial Growth
Beyond reducing tax liability and litigation, tax planning also facilitates your economic growth. This includes routing your income from various sources, over specific timelines and investing in tax-saving & income-generating instruments that are right for you. This helps you create a nest of funds, thereby setting aside money for productive causes and thus contributing to your economic growth.
Stabilizing the Economic Health of the Country
The taxes paid to make up the revenue reserves of the Government. If taxpayers pay all the legitimate taxes which are legally due, they are directly and indirectly contributing towards creating a more productive economy. Thus tax planning is beneficial to you and the country you call home.
What are the Types of Tax planning?
As tax planning includes investing in the right instruments, at the right time, to achieve your short, medium, and long-term financial goals, there are broadly four methods of tax planning.
Short-range tax planning: Planning tax payments that are devised and executed at the end of the financial year. Investors resort to this type of tax planning on the heels of the end of the fiscal year, attempting to find ways to reduce their tax liabilities legally. Short-range tax planning does not involve long-term commitments, while it still promises substantial tax savings.
Long-range tax planning: Executed at the beginning of the financial year, which the taxpayer follows throughout the year. Such an arrangement may not necessarily provide immediate benefits as short-range tax planning. However, as the name suggests, it can prove to be valuable in the long run.
In simple language, short-range planning usually occurs towards the end of a fiscal year & long-range planning occurs in the beginning. Easy-peasy.
Permissive tax planning: This includes planning investments under various provisions of the Income Tax laws. There are many provisions of law, offering exemptions, deductions, incentives, and contributions. For example, the most popular, section 80C of the Income Tax Act of 1961, offers several different types of exemptions (on the amount invested, interest earned and the amount at maturity) as tax-savings investments.
Objective tax planning: Objective tax planning refers to the act of investing with a specific objective. It entails the precise selection of investment instruments, creating a suitable agenda to replace assets and/or diversify income and business assets based on your residential status, if necessary.
What are the various tax planning tools available?
Apart from merely investing in any of the available tax-saving instruments, you can also use these tax-saving tools for prudent tax planning. Here are some of the popular tax-saving tools:
Section 80C of the Income Tax Act: Deduction limit up to Rs. 150,000/-
Any Individual or a Hindu Undivided Family (HUF) can effectively invest in tax saving instruments, to optimally reduce their tax liability. This is considered one of the most sought-after sections when it comes to tax planning.
Here are some Tax-saving instruments that fall under section 80C:
Big risk-takers (Market-Linked Instruments)
Big risk-takers (Market-Linked Instruments)
Risk-averse (Fixed Return Instruments)
- Equity Linked Savings Scheme (ELSS)
- Pension Funds
- Unit-linked Insurance Plans (ULIPs)
- National Pension Scheme (NPS)
- Non-Unit linked Insurance Plans (Term life insurance, endowment plan, money-back plan)
- Public Provident Fund (PPF)
- National Savings Certificate (NSC)
- 5-Year Tax Saving Bank Fixed Deposit
- 5-Year Post Office Time Deposit
- Senior Citizens Savings Scheme (SCSS)
- Sukanya Samriddhi Account
Other helpful 80s
Contribution to Pension Fund of Life Insurance Corporation or any other insurer referred to in section 10(23AAB).
Contribution to the National Pension Scheme notified by the Central Government.
Rajiv Gandhi Equity Savings Scheme (RGESS)
Premium paid for medical insurance
Maintenance includes medical treatment of a handicapped dependent who is a person with a disability
Expenditure incurred in respect of medical treatment
Interest on loan taken for pursuing higher education
Donations to certain funds and charitable institutions
Rent paid in respect of property occupied for residential use
Certain donations for scientific research or rural development
The contribution made to any political parties or an electoral trust
Deduction in respect of interest earned on savings bank deposits
A person suffering from a specified disability(s)
Tax planning, if done precisely under the framework defined by the taxation authorities, is a legally smart decision. Based on your income tax slab, lifestyle choices, and social liabilities, you can pick a distinct tax saver investment instrument. We suggest taking up the services of a Chartered Accountant or a Lawyer. However, there are many resources available online and on IIFL to learn more about tax planning.