I’ve seen a lot of comments in the last month or so that are from people who will be paying taxes for the first time this year.

There’s a fair bit of confusion on what to do and what option to choose, so I’m writing this post with some ideas with how someone who is going to pay taxes for the first time could approach tax saving schemes.

First of all – you will have to pay tax if you earn above the taxable limit – there’s just no way around it, so stop wasting your energy in trying to devise a method which gets you to avoid this.

There are some ways in which you can reduce how much tax you’re liable for and that’s where investments come in.

There is a section in the Income Tax Act which lists down certain expenses and investments that will enable a person to reduce their taxable income and as a result of that pay less tax.

This section is called Section 80C and the graphic on this page tells you what instruments you can invest in, what is their lock in period and what returns you can expect.

If you have some education loans or housing loans then you can use that to save tax, but if you don’t have that then you can invest in either mutual funds, fixed deposits, post office schemes or insurance products to save tax.

Since this is the first time you’re doing this and it’s rather late in the day to understand the nuances of these schemes properly there are two things you can keep in mind to help you make a quick decision.

First is that ELSS mutual funds have the lowest lock in period of just 3 years among these schemes and also happen to be the only equity product in this list. This means they are mutual funds that invest in shares and there is absolutely no guarantee with them.

Your investment could halve after 3 years, or it could double – it depends on the market, and there are absolutely no guarantees.

The second thing to keep in mind is that if you’re not comfortable taking this risk then you can opt for a fixed income product where the returns are defined at the beginning of the term and you can expect the principal plus interest to be paid out to you regularly. Among these options – a tax saving bank fixed deposit is probably the easiest for you to set up and the yields are as high (if not higher) than the other options.

The limit under 80C is Rs.1 lakh and if you exhaust this limit then you can invest an additional Rs. 20,000 in tax saving infrastructure bonds and reduce some more of your taxable salary.

Finally, if you are under the 10% tax slab and expect some big expenses in the near future then it may not even make sense to block your money in these products. Just pay the tax and keep your money in the bank to meet the expenses.

Keep these things in mind while deciding where to invest to save tax, and leave a comment if you have any questions.

SBI Mutual Fund has come up with a new fund offer for SBI Tax Advantage Fund Series II which is a 10 year closed ended ELSS (Equity Linked Savings Scheme) fund.

It’s an equity mutual fund which means that it will invest primarily in shares listed on the stock exchange. It’s an ELSS which means that it will give you tax benefits under section 80C. So, the money you invest in this fund will be reduced from your taxable income thereby reducing your tax liability.

The NFO has opened for subscription on December 22nd 2011, and will close on March 21st 2012. The minimum application is Rs. 500, and you can invest in multiples of Rs. 500 after that. Since this is a closed ended fund – you will be able to buy it only during the NFO period, and once the NFO closes units won’t be available for purchase.

The fund has a dividend and growth option, and since it is an ELSS fund – your fund will be locked in for 3 years in which period you won’t be able to redeem it.

The information document says that redemption or repurchase facility will be available after the 3 year lock in period. I have no experience buying into closed ended funds, so I don’t know how the redemption of these work – if anyone has any practical experience or insights on this then please do share that in comments.

SBI Tax Advantage Series II

This fund doesn’t offer any differentiation from the plenty of other ELSS funds that exist today, and I was hoping that they offer a lower expense ratio to lure in customers but that’s not the case.

The recurring expenses are going to be 2.50% for the first 100 crores of assets, 2.25% for the next 300 crores, 2.00% for the next 300 crores, and then 1.75% for the balance. I see that the series I of this fund has an asset under management of Rs. 550 crores so that could be a potential pointer on how much Series II could amass, and based on that it looks like the expenses will be relatively high. Expenses of the fund eat into the returns so you want them to be as little as possible.

I think ELSS funds are a great way to utilize the 80C limit because they are equity instruments and have the shortest lock in period among the 80C options, but for this particular fund – I don’t see any reason to invest in it at all.

There are plenty of other ELSS funds that have a fairly long track record, have lower expenses and buying one of those makes more sense to me than getting into this one.

This post is from the Suggest a Topic page.

Direct Tax Code (DTC) is supposed to be implemented from the next financial year, but there hasn’t been much news on it lately, and people are beginning to doubt if it will be implemented next year or be delayed even more.

I don’t think it’s a bad thing if it does get delayed because the main premise behind the DTC was that it will simplify the current tax code, and while the first draft was superb, the subsequent revisions have made it somewhat complex.

I think this is best epitomized by the way capital gains on shares is calculated where they will reduce the value by a specified percentage first and then add that to your income. Who comes up with these percentages and why tax people on capital gains on shares now when you haven’t done it earlier?

The first draft of the DTC had tax slabs much higher from the current ones, but the revisions made the slabs come down as well, so even that benefit doesn’t exist to the same extent as earlier.

I have written a few posts about changes related to DTC but they are not very easy to find and when Sowmya left a comment about a primer on DTC – I thought it will be a good idea to have a post that links to the various other posts that I have written on DTC and gives a summary of the changes.

The following table lists down the various changes that will come with the DTC.

You can click through the links in the above table to read more details about each of these topics, and as more clarity comes in about DTC and other topics get added – I will link them through this table as well.

I did a post about some of the better performing ELSS tax saver mutual funds in January this year, and I thought I would revisit those funds to see how they fared during these tough market conditions.

I wanted to see if there was any big variation between these funds, and if there was any way to predict some of that variation at the beginning of the year.

First, the original list of ELSS mutual funds that were around for 5 years or more and had performed well.

Keep in mind that these returns are for a 5 year period ended in January 2011.

I had deliberately kept the list in no particular order because as soon as you order it according to something – say the highest returns – the brain starts telling you that the first fund is the best, and the last fund is the worst – which is what I wanted to avoid.

Now, let’s take a look at how these funds performed in the last 1 year.

All data from Value Research

There is quite a lot of variation in this list, and the Sensex has returned -17.50% in this time period so anything near that number is what you would expect.

The only two funds that were markedly better in this comparison were Canara Robeco Tax Saver and Franklin India Tax Shield.

So, why did these two funds do so well?

I looked at the portfolio of Canara Robeco Tax Saver and Bharti Airtel is their biggest holding with 7% weight in the portfolio, and that stock has returned about 12% in the last year and I think that one stock had a lot to do with Canara’s good performance.

In Franklin India Tax Shield’s portfolio – I see that Infosys is the biggest component at 8.5% which fell only 5% in the last one year period, then Bharti Airtel is the second biggest component at 7.5%, and ICICI Bank is the third largest component which fell 33% in the last year! They also hold Idea Cellular which was just 1.49% of their portfolio in March but grew to 3.5% of the portfolio by September. Idea Cellular has risen about 37.50% in the last year.

Frankly, I’m having trouble explaining why they did so well in hindsight, so it’s pretty clear to me that I could have never picked these two mutual funds at the beginning of the year to say that they will be ones that will perform better than the rest.

So, yes, there was variation, but there is nothing that I can see which would have indicated at the beginning of the year which funds would do well and which won’t.

Finally, let’s place the best performers in both time periods in one table and look at them side by side.

There is very little similarity between one and the other – what did well in the first five year period didn’t necessarily do as well in this year. Perhaps the one fund that catches the eye is Canara Robeco Equity Tax Saver because it is near the top for both these time periods, but it’s anybody’s guess if it would continue with it’s good performance or not.

If I had to pick up a tax saver mutual fund – I would pick two or three out of this list, but I don’t think it is possible to narrow it down any further.

A house loan repayment has two components – principal and interest – and both of these components are treated differently for tax benefit calculation purposes.

The principal amount is covered under Section 80C and has a Rs. 1 lakh limit. This is only available to you if you’re living in the house that you have taken the loan for. That means you can’t use this exemption if the house is under construction or if you are not living in it.

The only exception to this condition is if you work in a different city. If you work in a different city then you can claim exemption on the principal amount of your home loan under 80C.

Tax Benefit of Home Loan Repayment

Section 24: Tax Benefit on the Interest On Home Loan

The interest on the home loan is treated differently, and Section 24 deals with the tax aspect of the interest on house loan repayment.

The maximum limit under this section is Rs. 1,50,000 and you don’t have to actually live in the house to claim this benefit.

The interest payment is deducted from your taxable income and thus reduces your tax liability. There is no limit on the number of houses you can claim this as well as the location of the houses. The only limit is Rs. 1,50,000 on the whole amount.

There are special conditions like when you get the loan disbursed before the construction of the house and pre – EMI interest and Raag has covered these aspects in a lot of detail in his post about tax benefits of a home loan which you can read if you were interested in those details.

IDFC has launched their own 80CCF infrastructure bonds, and these come with a slightly higher interest rate than the other bonds that have been released so far.

They carry a 9% annual interest rate, and IDFC has simplified the issue a little bit by having the option with only one maturity – that of ten years.

Like, the other 80CCF bonds, these will have the the annual interest payment or the cumulative option, and a buyback option after 5 years.

The issue opens on November 21, 2011 and closes on December 16, 2011. In the past they have appeared on online platforms like ICICI Direct and Edelweiss, so that’s one way to buy them, or as Austere suggested you can print the forms online and submit it in one of the collection centers.

And of course, there’s always the option of taking the help of financial advisers like Shiv to apply for them.

Here are some other details about the bonds.

After the lock in period of 5 years, the bond will list on the NSE and BSE.

For whatever it’s worth the issue is rated highly by ICRA and Fitch – both of them rated the issue AAA. To me, it doesn’t make a lot of sense to apply anything more than Rs. 20,000 and that too only on one of these 80CCF bonds, so if you have applied for something already then you are better off investing your money in any other bank fixed deposit which doesn’t have any lock in period and will have a slightly higher interest rate also.

A new question that I see appear a few times with respect to these bonds is if you need to buy it every year to get the tax benefit. I think the source of that question is the confusion between the tax benefit.

Please be cognizant of the fact that the interest is not tax free. The interest will be taxable every year, but the way you get the tax benefit is that the value of bonds that you buy gets reduced from your taxable salary, and that means you have to pay less tax.

The other question that I saw today was would you have to pay tax if you exercised the buyback and the answer to that is that buyback doesn’t affect how the bond is taxed.

If you took the annual interest option then the interest will be taxed every year, and if you took the cumulative option then you will be taxed capital gains. The face value of the bond will not be taxed.

I can’t quite think of anything else to cover about this issue – so if you have any comments let’s hear them and a special thanks to Shiv who informs me about these bonds quite in advance. You can always contact him to get hold of these bonds if you are in the NCR area – his phone number is 9811797407.

Section 80U tax deductions are over and above other deductions and are meant for people who suffer from disabilities.

This section can only be utilized if you suffer from the disability yourself and is not applicable for parents, spouse or any other dependents.

They have two classes of disabilities – one where the person suffers from a disability and the other where a person suffers from severe disability.

You need proof from a medical practitioner to decide what kind of disability you suffer from, and a person from disability will get a deduction of up to Rs. 50,000 from his taxable income while a person who suffers from severe disability can get a deduction of Rs. 1,00,000.

TaxWorry has a list of what constitutes disability, and what constitutes severe disability on their site.

You will also find the forms that need to be downloaded on that link.

I can’t quite remember if they propose to have this deduction or any other form of it post the Direct Tax Code, so I’ll update that aspect once I know more about it.

This is fairly simple thing so I’ll stop here, and thank you Furqan for bringing this to my attention!

One of the more popular options covered under Section 80C is the tax saver fixed deposits.

These have a term of at least five years, and given the high interest rate environment we’re currently in – you can find a lot of banks that offer more than 9% on these tax saving fixed deposits.

Here is a list of some of the higher paying ones that I found, and you can see that there are quite a few options that offer over 9.25% if you are a senior citizen.

Even otherwise, there should be a bank near you somewhere that offers 9%, and that’s pretty good as well.

Most banks specify the rate of interest on tax saver fixed deposits on their websites, and then some others say that the rate of interest of the tax saver FDs are the same as other fixed deposits with a 5 year maturity.

Then there are some banks that don’t have anything about tax saver FDs on their website. In the above list those are indicated by an asterisk. For these banks I have included their 5 year interest rate as the rate of interest for the FDs. I’ve assumed that these banks do offer tax saver FDs, and haven’t updated their website, so if you know otherwise then please let me know and I’ll update this list.

Also, a slightly dated ET article mentioned some other points about tax saving FDs – chief among them, that they don’t offer overdraft, sweep in facility, and bank loans that might be of interest as well.

The tax filing season is closing in on us, and you don’t want to leave everything down to the last minute. There are still a few months left, and if you haven’t already started planning for your taxes – now is a good time to start.

I’m going to start a series on tax saving instruments here, and every week I’ll try to write at least one post on a tax saving topic.

This week, I start off with an infographic I created with the hope of giving an overview on the various tax saving instruments especially 80C instruments in an easy to digest and graphical manner.

80C & Other Tax Saving Instruments

I hope this provides a good overview on the various instruments, how much they save and their lock in period.

I was a little wary of including returns because they can vary so much, and it is natural to compare one with the other but that’s not right since the risk profile of the instruments is different.

Please let me know if you see any mistakes, and also if you want to see any other information on this.

Please share it with friends and colleagues if you think this will be beneficial to them, and as usual I look forward to your comments!

Reader Kanti Kiran emailed me with a couple of corrections related to taxation of NCDs post that I wrote yesterday, and I’m going to talk about them in this post.

I said that the cumulative NCD option is not tax free, and that the money you get during the redemption will attract capital gains.

Kanti Kiran wrote to me saying this isn’t correct, and while the amount is taxable, it’s not taxable as capital gains, but as interest income that will be clubbed with your other income and taxed at your regular tax rate.

This is a meaningful difference because people at the highest tax rate will have to pay about 30% tax on this income instead of the lower capital gains tax rate.

There was another reader who weighed in on the subject, and he opined that if there is a coupon rate associated with the NCD, and if that NCD pays out a cumulative option then you have to declare the income every year, and pay tax on that much like the tax on recurring deposits.

However, if there is no coupon rate on the NCD and they pay a lump-sum amount then that will be treated as capital gains. It’s not quite clear to me how a coupon rate gets associated to a cumulative NCD.

I couldn’t find an authoritative source on any of this, so if any of you have practical experience or know for sure how this income should be treated then please leave a comment or email me.

There was also a comment on treating capital gains on these NCDs in the same way that you would treat the capital gains on shares if you buy or sell the NCDs on the stock exchange.

The rationale for treating them as equity funds is that you pay Securities Transaction Tax (STT) on these transactions. I checked with Shiv on the transactions that he has done on the exchange, and he hadn’t paid any STT on the NCD he sold, so it doesn’t look like you can treat capital gains on NCDs in the same way as equities.

The last point was about no TDS on only those NCDs that are listed and are compulsorily in Demat form. You will remember that this is what we talked about when infrastructure bonds were issued last year when many of them were first compulsorily Demat and then turned into physical form, and a bit of confusion ensued.

Since one of the main features of these NCDs is listing in an exchange, and they are seeing a lot of demand from people who have Demat accounts – I don’t see them changing this aspect of the NCD, but it’s a good point to keep in mind.

So, these are the various interpretations of the tax on NCDs that have been shared so far, and I will appreciate any feedback that you may have on this.

Thanks to Kanti Kiran, ankm83 and Shiv for weighing in and giving input for this post, and I apologize to everyone for not getting this right on the first go.