Mar 29, 2010

6 Tips for Year-End Tax Planning



“The avoidance of taxes is the only pursuit that still carries any reward”

—JM Keynes

There is a very thin line between tax planning and tax avoidance. The purpose of this post is not to ask you to go for tax avoidance but rather tax planning which means planning our tax affairs in such a way so as to take full advantage of exemptions and deductions provided and minimize the tax impact on our income within the confines of law.

Here I present a few tips on year-end tax planning which can help you make the most of existing tax breaks:

1. Let your dud stocks help you save tax
Since long-term capital gains from stocks sold on stock-exchange is exempt from tax; long term capital losses from the stocks is also not allowed to be set-off and / or to be carried forward. Therefore you should convert
your short term unrealized losses from stocks into actual loss and reduce your tax liability.

What if you want to retain the loss making stocks for a long term? It’s very simple—just sell it on or before March 31 and buy it back any time from 1st April onwards. In other words, book temporary loss for tax purpose.

In simple words, it is always preferable to book short term capital losses at the end of financial year on your loss making stocks (even if you want to keep them for long term and don’t want to dispose) and buy them in next financial year. By that way, you will be able to lower your capital gains (by utilizing these losses for setting off against your other capital gains) and consequently lowering your tax liability.


2. Use bonus-stripping
Do you know that bonus shares also provide tax arbitrage opportunity? How? What is the relationship between issue of bonus shares and saving tax?

The practice of buying the shares at cum-bonus price and selling the ‘original shares’ at ex-bonus price and booking short term losses in the process is called ‘bonus stripping’ and similar to ‘dividend stripping’.

As per the current IT provisions, while ‘dividend stripping’ under section 94(7) covers both shares as well as mutual fund units, ‘bonus stripping’ as per section 94(8) includes only mutual funds units. Put another way, tax laws allow ‘bonus stripping’ in case of equity shares.

So, if during the financial year, you’ve purchased any shares against which company has further allotted you bonus shares, then you must sell the ‘original holdings’ and book short term capital loss.

But how does it help save tax? Let me explain with the help of an example, suppose you purchased 100 shares of ABC ltd at a price of Rs 300 per share in the month of November 2009. Later on, in the month of January 2010 when the price was ruling at Rs 350 per share, the company came with 1:1 bonus and you were allotted 100 additional shares so that after the bonus issue, you held 200 shares at the adjusted ex-bonus market price of Rs 175 and now the market price is ruling at, say, Rs 200 per share. Now, if you sell the original 100 shares and keep the ‘bonus shares’, you can book a short term capital loss of Rs 10,000 (Rs 20,000 – Rs 30,000) for tax purposes.

Your next question will be: Won’t this tax benefit get set-off against gains from selling bonus shares? Yes, only if sell the bonus shares before one year from the date of allotment. On the other hand, if you sell the bonus units after a period of 12 months, the capital gains will be long term and therefore completely exempt.


3. Invest your short term surplus in FMPs
By investing in a Fixed Maturity Plans (FMPs) at the end of the financial year (i.e., the month of February & March), you an avail double indexation benefit by holding the investments for just 13-15 months.

In other words, at the end of a financial year, Fixed Maturity Plan with duration of 13-14 months becomes the best debt option due to associated double indexation benefit. For more details, see the previous post.


4. Advance tax payment: Way out
Note that even though TDS is being deducted by your employer on your salary income, you are liable for payment of advance tax on your other income like interest, capital gains etc if the tax liability exceeds Rs 5,000.

It is good, if you can calculate tax on your other income and pay the advance tax by yourself. But if you want to avoid the hassle, there’s a way out. You can submit the particulars of ‘other income’ to your employer and request him to deduct tax on your additional income. The employer cannot refuse because it’s a right provided to you under income tax law.


5. Get Form-16, even if tax on your salary income is ‘nil’
Form -16 is more important than your tax-return. Now-a-days everybody asks for it as proof of your income. So how to ensure that your employer issue you a Form-16 even when your salary income is below the basic exemption limit. In other words, how to force the employer to deduct a nominal amount of tax and issue you a TDS certificate in ‘Form-16’

There are two possible scenarios:

o Your income is below taxable limit without availing section 80 deductions: Submit a declaration showing other income such as capital gains, income from house property, interest on savings account, bank FDs, NSC, KVP and NCDs (if any).

o Your salary income goes below taxable limit only after availing section 80 deductions: Don’t submit any proof for tax savings or submit so much evidence so as to bring your taxable salary income to such a level which is marginally higher than basic exemption limit.

In both the cases, your employer would be forced to deduct TDS from your salary income and issue you a TDS certificate in ‘Form-16’.


6. Avail depreciation benefit on cars, books & computers
If you’re a professional and planning to buy a new car, books or a computer, consider purchasing on or before March 31 to avail depreciation benefit for 6 months and thereby save tax.


Also see:

9 comments:

  1. Dear Fisher, Can you explain the last part "Avail depreciation benefit on cars, books & computers", I have a car and computer to claim, may not be this year but readers like me can learn this benefit......

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  2. can a professional avail depreciation benefit?

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  3. Depreiation (rates as specified in IT Rules) is considered an expense for tax purposes.

    Professionals are also allowed to claim depreciation benefit while calculating their taxable income.

    ReplyDelete
  4. Hi Fisher,

    The posts covered so far have been very comprehensive. So thanks for that...it makes life simple for non-tax savvy people. Would it be possible for you to include a post on clubbing provisions. My special area of concern would be with regard to minor children ie., income from investments made on their behalf and if at all any tax benefits accrue U/s 80. Any tax planning suggestions would be highly appreciated. Currently the only earning member is my spouse and he falls under the highest tax bracket.
    Thanks, Nisha

    ReplyDelete
  5. Nisha,

    Right now, there are so many other more pressing issues…anyway, good idea for a future write-up.

    ReplyDelete
  6. Fair enough! :-)...thanks anyways for all the existing information.

    Nisha

    ReplyDelete
  7. Hi Fisher,

    It is better to plan the investment from tax saving perspective early in the year than keeping it for the last few months. This year the MOF has provided another means to save tax by investing in bonds of infrastructure companies and thus providing an additional tax benefit over and above Rs. 1 lac of investment earlier under section 80C. any idea on which of the infrastructure bonds are available on tap right now and what are there interest rates?

    ReplyDelete
  8. But isnt the use of Bonus Stripping dangerous... Bcoz we will have to hold on to that stock for one yr min. to get the benefit of exemption from Long Term Capital Gains Tax...

    And practically what happens is tht Blue Chips barely declare Bonus Shares... its only the small companies who employ this practice and investing in them for an yr is very dangerous

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  9. While purchasing necessary equipment prior to the end of the tax year can be a valuable tax planning strategy, making unnecessary purchases is not recommended. Second, a small business should always attempt to defer taxes when possible. Deferring taxes enables the business to use that money interest-free, and sometimes even earn interest on it, until the next time taxes are due.

    ReplyDelete

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