Tax Planning

Updated: 30-12-2022 11:10:15 AM

Tax planning is an activity that responsible tax paying individuals, businesses or organisations undertake to maximise the use of available deductions, exclusions, rebates and allowances to reduce tax liability. In other words, it is a legal way to reduce your tax liability by leveraging approved government tax saving investments and related options.  Tax planning thus keeps individuals and organisations control their finances more efficiently and achieve their financial goals with greater ease.

Objectives of Tax Planning

Tax planning ensures savings of taxes while conforming with the legal obligations and requirements set by the Income Tax Act, 1961. The following are the key objectives of tax planning in India:

• Reducing Tax Liability: Possibly the most obvious objective of tax planning is to help an individual or business reduce their tax liability by taking advantage of available tax deductions and benefit options.
• Strengthening Investment Portfolio: A key part of tax planning for individuals and corporations is related to investing in various notified instruments and asset classes that offer tax exemptions under the Income Tax Act 1961. Tax planning allows them to find different avenues where they can invest their money and get great returns.

• Facilitate Economic Growth: When white money circulates in the market, it benefits the economy of the country and its citizens. Tax planning ensures that citizens grow economically and white money circulates in the market.

Types of Tax Planning

There are three main types of tax planning:

• Permissive Tax Planning: This is one of the most common types of tax planning since it is made exactly as per the provision of the Income Tax Act.
• Purposive Tax Planning: When a taxpayer wants to plan taxes with a particular financial goal in mind, it is known as purposive tax planning.
• Short-range/Long-range Tax Planning: If a taxpayer plans investments and savings based on the exemptions, benefits, allowances and deductions laid out in the tax laws, with a short-range or long-range goal in mind, it is known as short-range or long-range tax planning. In India tax-saving investments are available with a multi-year lock-in period during which redemption is not allowed. Currently ELSS (equity linked savings schemes) have the shortest lock-in period of 3 years.

Benefits of Tax Planning in India

Tax planning should not be taken lightly. It can offer plenty of benefits to an income tax assessee including the following:

• Ensure Good Cash Flow: Tax planning helps you find ways to diversify your investments and generating savings in a sustainable manner that ensures good cash flow round the year. This in essence ensures that you invest and also cover other key expenses without breaking the bank.
• Cushion against Uncertainties: No matter how good your life is right now, uncertainties can never be ruled out. By planning your finances, you can create a cushion against uncertainties and live your life stress-free. This is of course true for both tax planning investments as well as non-tax planning investments too.
• Take Advantage of Tax Savings Allowed Under the Income Tax Act: One of the main reasons to recommend tax planning with short/long term goals is that it helps you take advantage of the various deductions, allowances, rebates, etc. offered under the various sections of the Income Tax Act.

Individual vs. Corporate Tax Planning

Income Tax is paid by individuals for earning an income in a financial year and the tax is calculated as per the total income earned during the applicable financial year based on the various income tax slabs set by the government.

Corporate Tax is paid by companies registered under company law in India on the net profit it makes in a financial year. Therefore, individual and corporate tax planning are quite different and need completely different approaches even though the goal is the same in both cases.

Common Tax Planning Mistakes to Avoid

Here are a few of the most common tax planning mistakes you need to avoid when you get started:

• Failing to Start on Time: Many people fail to start tax planning on time and miss out the opportunities available. This is because some tax planning options offer better results if the taxpayer starts from the initial part of the financial year.
• Ignoring the Power of Compounding: The power of compounding works best in the presence of an essential ingredient – time. The younger a tax payer is when starting investments with the intention of tax planning, the better it is for the creation of wealth through compounding.
• Investing in Insurance Products without Adequate Research: While insurance plans can provide plenty of benefits if chosen wisely, many people pick up an insurance plan at the end of the financial year to save tax.This can backfire since they do not pick the right product or do not plan how to maximise the benefits they can receive by investing in insurance policy.
• Failure to Correctly Calculate Tax Liabilities: Possibly the most common and least discussed mistake with respect to tax planning is making incorrect calculation of tax liabilities. The most common reason for such errors is a hurriedly created plan for saving taxes.

Tax Planning for Individuals using 80C, 80D and Section 24

Here are the important sections of the Income Tax Act that you must know about for proper tax planning:

Section 80C

Key instruments that you can invest in under Section 80C of the Income Tax Act include:

• Public Provident Fund (PPF)
• Life Insurance
• Pension Scheme
• Contributions made towards Employment Provident Fund
• National Savings Certificate (NSC)
• Housing Loan
• Equity Linked Savings Scheme (ELSS)

The maximum limit of exemption offered for investments made under Section 80C is Rs. 1.5 lakh. Currently an additional Rs. 50,000 over and above the Rs. 1.5 lakh limit is offered as exemption for NPS (National Pension System) Tier 1 investments u/s 80CCD of the Income Tax Act, 1961.

Section 80D

Contributions made towards a Mediclaim policy are covered under Section 80D of the Income Tax Act. The maximum cumulative deduction of up to Rs. 75,000 is allowed for self, family and super senior citizen parents. This section also contains provisions for tax deductions for medical expenses made by an income tax assessee.

Section 24

Individuals can avail tax benefits on house property under Section 24 of the Income Tax Act. Homeowners can avail tax deduction of up to Rs. 2 lakh annually in lieu of their home loan interest payments. This is in addition to the tax benefits of up to Rs. 1.5 lakh annually that are applicable to payments made in lieu of home loan principal repayment.

Tax Planning should not be treated as a one-time activity. Taxpayers must make use of all the exemptions and benefits available to them to minimise their tax liability and strengthen their savings and investment portfolio. In order to do this, one needs to keep track of the latest developments in the field of tax planning and also seek professional help from tax lawyers, chartered accountants, etc. as and when applicable.