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2016-02-05T00:18:00.001-08:00

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Some Tax Saving Strategies

2011-10-16T06:15:00.000-07:00

People are always concerned about the Tax and Tax related issues. They don’t like to pay huge amount every year as income tax to the government instead search for alternative ways to save tax. Is there any way to save Tax? Yes, there are many ways to reduce the Tax burden. In this article we are going to discuss about the Tax saving Strategies after the Budget 2011.

Highlights of Union Budget 2011

1. The basic tax exemption limit has been increased to Rs 1,80,000 which will provide tax relief of Rs 2,060 to all tax brackets.

2. For senior citizen the exemption limit has been increased from Rs. 2,40,000 to Rs. 2,50,000/-

3. For senior citizen the qualifying age reduced from 65 years to 60 years.

4. New tax slab for senior citizens of over 80 years in age (Super Seniors) who will not be required to pay taxes for income upto Rs 5,00,000

5. The Rs 20,000 exemption limit for investments into Infra bonds continues for this year also

6. The Govt. is also thinking of doing away with the requirement of filing returns if salary is your only source of income and TDS is being deducted.

Ways to save Tax

Following are the ways to save tax after the budget 2011. There are so many sections which will help you to save tax in different ways. Here we are trying to point out some of the techniques to save tax.

· Restructuring of Salary

· Section 80C

· Medical insurance

· Medical Treatment

· Infrastructure bonds

· Donations

· House Rent Allowance

· Home Loans

· Leave Travel Allowance

· Tax on Bonus

Restructuring of Salary

Restructuring of your salary may not be possible always. But if your company permits, or if you are on good terms with your HR department, restructuring a few components of your salary could really help in reducing your tax liability. Following are the components which should include in your salary.

· Food coupons

· Medical allowance

· Transport allowance

· Education allowance

· Uniform expenses (if any)

· Telephone expenses

· Company Cab

Food coupons are exempt from tax up to Rs 60,000 p.a. So opt for food coupons instead of lunch allowances. Opting for the company car instead of using your own car will help you to reduce high prerequisite taxation.

Produce bills of actual expenses incurred for all these allowances to reduce tax.

Section 80C

Section 80C offers a maximum deduction up to Rs. 1, 00,000. You can avail this benefit by investing in different investment options. Utilize this section to the fullest by investing in any of the available investment options. A few of the investments are as follows.

· Public Provident Fund

· Employee Provident Fund (EPF)

· Life Insurance Premium

· Unit Linked Insurance Plans (ULIPs)

· Equity Linked Savings Scheme

· National Savings Certificate

· 5 year fixed deposits with banks and post office.

· Home Loan principal repayment

· Tuition fees paid for children’s education, up to a maximum of 2 children.

Deductions: Upto Rs. 1,00,000

Infrastructure Bonds (Section 80CCF)

In addition to the Rs 1,00,000 deduction under 80C, a deduction of Rs 20,000 is also available for investments in notified Infrastructure Bonds

Deductions: Upto Rs. 20,000

Medical Insurance (Section 80D)

By taking medical insurance for you, your spouse/ children and parents, you can avail tax benefit. For medical insurance of self spouse and dependent children you can avail a deduction up to Rs. 15,000. If you are taking medical insurance for your parents above 65 years you will get deduction upto Rs. 20,000.

Deductions: Upto Rs. 35,000

Medical Treatment(Section 80DD)

Amount spent for the medical treatment of dependents with a disability qualify for tax benefits under Section 80DD. In this case, deductions up to Rs. 50,000 or 75.000 can be claimed based on the importance.

Deductions: Upto Rs. 75,000

Donations(Section 80G)

Donations to specified funds or charitable institutions

Deductions: There is no upper Limit

House Rent Allowance (Section 80GG)

Are you paying rent, you can get deduction on house rent paid even if you are not receiving any HRA (House Rent Allowance). The least of the following could be claimed as deduction under Section 80GG :-

· 25% of the total income or,

· Rs 2,000 per month or,

· Excess of rent paid over 10% of total income

·
This deduction will however not be allowed, if you, your spouse or minor child owns a residential accommodation in the location where you reside or perform office duties.

· If HRA forms part of your salary, then the minimum of the following three is available as exemption.

· The actual HRA received from your employer

· The actual rent paid by you for the house, minus 10% of your salary (this includes basic + dearness allowance, if any)

· 50% of your basic salary (for a metro) or 40% of your basic salary (for non-metro).

Home Loans (Section 24)

You can use your home loan efficiently to save income tax. The principal component of your loan, is included under Section 80C, offering a deduction up to Rs. 1, 00,000.

At the same time the interest portion offers a deduction up to Rs. 1, 50,000 separately under Section 24.

Leave Travel Allowance (Section 10(5))

Use your (LTA) Leave Travel Allowance for your holidays, which is available twice in a block of four years. In case you have been unable to claim the benefit in a particular 4 year block, you could now carry forward one journey to the succeeding block and claim it in the first calendar year of that block. Thus, you may be eligible for three exemptions in that block.

We will see few more tax saving strategies in further articles. As DTC is going to change some clauses these may change. Will update it accordingly. Till then any comments are welcome.

Taxation of salary components - Part 2

2011-09-16T10:36:00.000-07:00

Continuing the previous article on taxation of salary components, in this part I will discuss taxation on various allowances and perquisites among the components.

A. Allowances:

1. Allowances that are fully taxable-

i. Dearness allowance

ii. Overtime allowance

iii. Fixed medical allowance

iv. City compensatory allowance

v. Interim allowance

vi. Servant allowance

vii. Any cash allowance

2. Allowances that are partially taxable-

i. House rent allowance (HRA) [ sec 10(13A)]:

HRA grant to employees is exempt to the least of following:

Metro cities (Delhi, Mumbai, Kolkata, Chennai, Bangalore)	Other cities
1) Allowance actually received	1) Allowance actually received
2) Rent paid – 10% of salary	2) Rent paid – 10% of salary
3) 50% of salary	3) 40% of salary

Notes-

1) Salary here includes = basic salary + dearness allowance + commission as fixed % of turnover

2) Exemption is available to employees who actually pay rent for the period the accommodation is occupied

ii. Special allowances [sec 10(14)]:

1) Children education allowance is exempt upto Rs. 100 per month per child for maximum of 2 children

2) Hostel expenditure allowance is exempt upto Rs. 300 per month per child upto maximum of 2 children

3) Transport allowance exempt upto Rs. 800 per month

4) Tribal area allowance exempt Rs. 200 per month

5) Allowance granted to transport employees to meet expenses (Running truck, etc.) is exempt upto 7)% of such allowance or Rs. 6000 per month whichever is less.

3. Allowances that are fully exempt :-

a) Allowances granted to government employees outside India

b) Allowances granted to high court or supreme court judges

c) Allowances paid by the United Nations Organization

d) Compensatory allowance received by a judge

There are certain deductions allowed from gross salary (Sec 16) those are discussed here:-

a) Deduction for entertainment allowance- e.g. Sumptuary allowance

This deduction is allowed only to Government employees to the extent of least of following-

i. Rs. 5000

ii. (1/5) th of basic salary

iii. Actual Entertainment allowance received

b) Professional tax-

The tax paid by assessee for tax on employment. If profession tax is paid by the employer the deduction for this is maximum Rs. 2500 per year.

B. Perquisites :-

The values of any other benefits apart from those mentioned above are included in perquisites.

(i) Rent free accommodation provided by the employer to the employee.

(ii) Accommodation provided at concessional rate which is not owned by the employer.

(iii) Any benefit provided by the employer to the employee (whether free of cost or at concessional rate).

(iv) Any obligation of the employee met by the employer.

(v) Any sum paid by the employer, directly or indirectly or through a fund, to keep assurance on the life of the assessee or to effect a contract for an annuity( other than a DLI Fund, RPF and Approved Superannuation Fund).

(vi) The value of any fringe benefit which is not chargeable to tax under Fringe Benefit Tax, provided by the employer to the employee.

Note: Following points is to be noted:

(i) Perquisites in point No. (i) to (v) is taxable in the hands of all employees whether specified or not.

(ii) (ii) Perquisites in Point No. (vi) is taxable in the hands of Specified Employees only.

(iii) Specified Employees:

Specified Employee is an employee who

(a) is a director of the employer company.

(b) is an employee who has (shareholding of > 20 %) in the company

(c) an employee who draws Rs. 50,000.00 or more during the P/Y. For calculating Rs. 50,000 all monetary payments is to be included.

v Perquisites which are exempt in the hands of all employees:-

1. Any sum paid by the employer in respect of any expenditure actually incurred by the employee on his medical treatment or treatment of family member A) in a hospital maintained by the government or any local authority or in any other approved hospital
B) IN a hospital approved by Chief Commissioner for the medical treatment of prescribed diseases

2. Group Medical Insurance taken by an employer or reimbursement of medical insurance premium paid by the employee on his own health or on health of any family member

3. Any sum paid or reimbursed by employer for medical treatment not exceeding Rs. 15000

4. Goods manufactured by employer sold to employees at concessional rates

5. Amount spent on training of employees

6. Gifts not exceeding Rs. 5000 per annum

7. Free lunch facility (Exempt upto Rs. 50 per day)

8. Club Facility

Only the exempt perquisites are covered here. There are other perquisites which are provided by an employer as mentioned in the first few points of perquisite above. In case of any suggestion comments are always welcome. Keep commenting!!

Taxation of Salary Components - Part 1

2011-09-01T11:28:00.000-07:00

The term salary in income tax includes any emoluments so received by providing adequate service or with the completion of duties. It includes:-

· Wages, Salary due during the previous year

· Advance salary , Arrears salary, Bonus

· Annuity or pension

· Gratuity

· Fees ,commission, perquisites or profits in addition to salary / wages

· Any payment received for any period of leave not availed

· Cash allowance

· Any sum received under key man insurance policy

And any other payment received by an employee from the employer received during the year.

Employer-Employee relationship –

To charge income under head salary, it is essential that employee has earned such income from his employer. So employer-employee relationship must exist. It is similar to master-servant relation. Exception where employer-employee relationship doesn’t exist:

· Remuneration received by a director of the company

· Remuneration received by partner of a firm

· Salary received by the MP or MLA

The salary income is chargeable to tax under the head “income from salaries” which is due / paid / which represents arrears paid.

Salary payments and its components-

A) Salary payments that are fully taxable:-

1. Basic salary, Wages

2. Advance salary

3. Arrears salary

4. Commission

5. Fees

6. Contractual bonus

7. Annuity

8. Remuneration for extra work

B) Salary payments that are partially taxable:-

1. Gratuity [sec10(10)]

Government employee - Any death cum retirement gratuity received by an employee of the central government, state government or local authority is exempt from tax.

For Non-Government Employees the taxability depends on whether Gratuity is covered under the Gratuity Act, 1972 or not.

1. Gratuity covered under the Gratuity Act, 1972
For the Gratuity covered by the Gratuity Act, total of gratuity received by an employee from various employers in whole of service is exempt from tax to the extent of least of the following three amounts:-
• Rs. 10,00,000/ or
• The gratuity actually received.

·(15÷26)*Last drawn salary per month * Years of service (Round-off if fraction in excess of 6 months)

Note: – Salary here is basic salary + dearness allowance

2. Gratuity not covered under the Gratuity Act, 1972
For Gratuity not covered under the Gratuity Act any gratuity not covered by the Gratuity Act, is exempt from tax to the extent of least of the three amounts-
• Rs.10,00,000/ or
• The gratuity actually received.
• (1÷2) * Average salary of last 10 months * Years of service (Fraction to be ignored)

Note: - Salary here basic salary + dearness allowance + Commission as fixed % of turnover

For Non-Government Employees, gratuity received during period of service is fully taxable.

2. Commuted pension [sec(10(10A)]:-

Commuted pension means pension received in the form of lump sum amount taken by commuting the whole or part of the pension.

Uncommuted pension refers to pension received periodically.

A. Government employee – Any commuted pension received is fully exempt from tax.

B. Non-government employee – Any commuted pension received is exempt in the following manner:

1) If the employee receives gratuity then 1/3rd of full value of commuted pension will be exempted from tax.

2) If the employee do not receive gratuity then 1/2 of full value of commuted pension will be exempted from tax.

[Example: If 20% of pension is commuted for Rs. 1,00,000.00 then full value of commuted pension will be Rs.5,00,000.00 (i.e.1,00,000/20 x 100) and 1/2 or 1/3 (as applicable) of Rs. 5,00,000.00 will be exempted from tax]

Note:

i) Family pension received by the family member after the death of employee then 1/3rd of the pension or Rs. 15,000.00 whichever is less is exempted from tax and balance will be chargeable in the hands of Member who receives the pension (Pension should not be covered by pension for armed forces).

ii) Uncommuted pension is fully taxable in the hands of both government and non-government employees.

iii) If any employer contributes to the notified pension scheme of Govt. (U/s. 80CCD) then is should first be included in the income of the employee and contribution to the extent of 10% of Salary shall be allowed as deduction. In this case the employee should have joined the service on or after 01.01.2004. [Salary here means Basic + D.A. (if terms of employment so provides)].

3. Leave salary[Sec10(10AA)]:-

Leave encashment while in service is taxable. Encashment of sick leave is taxable.

A. Government employees:- Leave encashment received at the time of retirement is fully exempt

B. Non-government employees: - Leave encashment received at the time of retirement is exempt to the extent of the least of the following four amounts:-

• Leave encashment actually received at the time of retirement.
• Rs. 3, 00,000/-
• Ten months' average salary; (Here the average salary means the average of the salary drawn during the last ten months before retirement),
• Cash equivalent of the leave due at the time of retirement.

Note:-

1. Salary for this purpose means basic salary + dearness allowance (if provided for retirement benefits) and commission as fixed % of turnover.

2. As per the act, leave due per year is maximum 30 days per completed year of service. If company provides leave less than 30 days, then leave due for above calculation will be the lower value.

4. Retrenchment compensation [sec 10 (10B)]:-

The compensation received by an employee is exempted to the least of the following:-

i) Actual amount received

ii) Rs. 5,00,000

iii) Amount calculated as per Industrial Dispute Act i.e. -

(15÷26) * Average salary of last 3 months x Completed years of service and any part in excess of 6 months will be counted as one year.

[Example: Say Mr. X earns Rs. 9,000 p.m. as salary income at the time of retrenchment and worked for 36 years 9 months.

The amount as per Industrial Dispute Act = (15÷26)*9000*(36+1) = Rs. 192115]

5. Voluntary retirement scheme [sec10(10c)]:-

The scheme is drawn to reduce existing strength of the employees of the company. The amount received by an employee is exempted to the least of the following:-

i) Actual amount received

ii) Rs. 5,00,000.00

iii) Last drawn salary x 3 x No. of years worked

iv) Last drawn salary x No. of years left for service

Note:

i) Salary means salary last drawn and includes Basic + D.A. (if terms of employment so provides) + Commission of fixed % of turnover.

ii) The employee has completed 10 years of service and has become 40 years of age or more. This is not applicable in case of public sector companies (i.e. he will be allowed the exemption even if he has not completed 10 years of service and has not become 40 years of age.)

iii) It will be allowed once in the life time of the assessee. It applies to all employees except the directors of the company.

iv) The vacancy caused is not to be filled up.

\6. Leave travel concession:-

This is taxable on the basis of Receipt or due whichever is earlier. The amount of leave travel concession received by an employee for himself or for his family member will be exempted from tax if the amount received is in connection with the following:- > On leave to any place in India.

(Note 1) > On leave to any place in India after retirement from the service or termination of service.

(Note 2) The Exemption shall be restricted to the amount actually incurred by the assessee. The amount actually incurred shall be restricted to the followings:-

Sr. no.

Journey Performed by

Amount of exemption

Air

Air economy fare of the national carrier by the shortest route or the amount spent whichever is less.

Rail

A.C. 1st class fare by the shortest route to the place of destination or Amount actually incurred whichever is less.

Any other mode

Amount of A.C. 1st class fare shortest route to the place of destination or Amount actually incurred whichever is less.

If not connected by rail

If recognized Public Transport system exists

The amount of 1st class or Deluxe class fare on such transport or the amount actually incurred whichever is less.

If no recognized Public Transport system exists

The amount of 1st class fare by the shortest route(as if the journey is performed by rail) or Amount actually incurred whichever is less.

1. Family means spouse, children, and parents, brother, and sister of the employee mainly dependent of the assessee.

2. Only two journeys performed in a block of 4 calendar year is exempted from tax.

3. If an assessee has not availed travel concession or assistance during any of the specified four-year block periods only 1 trip can be carried forward to be availed in the 1st calendar year of the next block. This is known as “carry over” concession.

4. Exemption is available in respect of fare only (Rail fare, Bus fare and Air fare). No exemption can be availed for the expenses incurred in respect of taxi charges, scooter charges, lodging/boarding expenses.

5. Exemption is available to Indian as well as Foreign citizen.

7. Provident fund(PF) :-

Particulars	Recognized PF	Unrecognized PF	Statutory PF
Employer’s Contribution	Amount in excess of 12 % of salary is taxable	Not taxable yearly	Fully exempt
Employee’s contribution	Eligible for deduction u/s 80C	Not eligible for deduction	Eligible for deduction u/s 80C
Interest credited	Amount in excess of 8.5% p.a. is taxable	Not taxable yearly	Fully exempt
Amount received on retirement	See Note 2	See Note 3	Fully exempt

Notes:-

1. Salary = basic salary + dearness allowance (if provided for retirement benefits) + Commission as fixed % of turnover

2. Amount received is fully exempt if employee has rendered continuous service for a period of 5 years or more.

3. Employee’s own contribution is not taxable but the interest earned on it will be taxable under “income from other sources”. Both employer’s contribution and interest is taxed as income from “Salary”.

C) Salary payments that are fully exempt from tax:-

1) Any payment from an Approved Superannuation Fund

2) Salary from United Nations Organization

3) Salary to non-resident technicians

4) Remuneration to consultants

5) Remuneration to employees of such consultants

6) Remuneration to Foreign Citizens

So these are all salary payments in general and their tax treatment. In further articles, I will post tax treatment on various allowances and perquisites provided by the employer to the employee. Any comments over this are welcome!!

Understanding CTC (Cost To Company) of your Salary and its Components

2011-08-17T04:13:00.000-07:00

Whether you are joining your first job or changing jobs, it is important to understand the difference between Cost to Company (CTC) and take home salary. It will help you in better negotiation with the HR and structuring of the salary.

The CTC, as quoted by employers and the take home pay are two different amounts. Also salary hikes in the form of an increased CTC doesn’t necessarily increase the monthly salary. So what exactly is this CTC and as an employee what all are you entitled for? This article aims to clarify the confusions that often arise in people’s minds when it comes to salary structures.

The Cost to Company refers to the total expenditure a company would have to incur to employ you. It includes monetary and non-monetary benefits, such as monthly pay, training costs, accommodation, telephone, medical reimbursements or other expenses, borne by the company to keep you employed. The total CTC as need not be the actual salary in hand at the end of the month. It is simply a sum of various components put together.

Simply speaking, CTC is the amount that you cost your company. That is, it is the amount that the company spends – directly or indirectly – because of employing you.

Thus, it is the money given to you (your in-hand component), plus the money spent because of you.

First we will see what the components of salary are. Here they are:

Basic
Dearness Allowance (DA)
Incentives or bonuses
Conveyance allowance
House Rent Allowance (HRA)
Medical allowance (Reimbursement)
Leave Travel Allowance or Concession (LTA / LTC)
Vehicle Allowance
Telephone / Mobile Phone Allowance
Special Allowance

All the above are a part of your in-hand salary, and therefore, are a part of your CTC pay as well. Now let’s look at some of the other components of your CTC pay – the parts that inflate your CTC package but may not be actually given to you!

Components of CTC

Companies, offer various attractive components in the CTC to retain and boost the morale of the employees. Where some salary components are fully taxable some are fully tax-exempt. The composition of your CTC and a few of its components could be grouped as below-

1) Fixed Salary – This is the major part of your CTC and forms part of your monthly take home. It commonly consists of:

-Basic Salary: The actual pay you receive for rendering services to the company. This is a taxable amount.

-Dearness Allowance: A taxable amount, this is paid to compensate for the rising cost of living.

-House Rent Allowance (or HRA): Paid to meet expenses of renting a house. The least of the following is exempt from tax.

a) Actual HRA received

b) 50% of salary (basic + DA) if residing in a metropolitan city, or else 40% for residing in
non-metro city

c) Rent paid – 10 % of your salary (Basic + DA)

-Conveyance Allowance: Paid for daily commute expenses. Up to an amount of Rs 800 per month is exempt from tax.

2) Reimbursements - This is the portion of your CTC, paid as reimbursements through billed claims.

-Meal coupons: Many companies provide their employees with subsidized meal coupons in their cafeterias. Such costs incurred by companies in the form of subsidies are included in the CTC. Meal coupons are tax exempt provided it is not in the form of cash.

-Mobile/Telephone Bills: Telephone or mobile expenditure up to a certain limit is reimbursed by many companies through a billed claim, and is a taxable amount.

-Medical Reimbursements: Paid either monthly or yearly, for medicines and medical treatment. The entire amount is taxable. However, up to Rs 15,000 could be tax exempt, if bills are produced.

3) Retirement Benefits - This is available to you only on retirement or resignation.

-Provident Fund: Employers contribute an equal 12% to the provident fund account. This employer’s contribution though received only on retirement or resignation is an expense incurred by the company every month and thus is included in the CTC.

-Gratuity: Companies manage gratuity through a fund maintained by an insurance company. The payment towards the gratuity annually is sometimes shown in CTC.

4) Other Benefits and Perks

-Leave Travel Allowance: It is the cost of travel anywhere in India for employees on leave. Tax exemption if allowed twice in a block of four calendar years.

-Medical allowance: Some companies offer medical care through health facilities for employees and their families. The cost of providing this benefit to the employee could also form part of CTC.

-Contribution to Insurance and Pension: Premiums paid by companies on behalf of employees for health, life insurance and Employees’ Pension Scheme, could form a part of the CTC.

-Miscellaneous Benefits: Other perks which companies include under CTC could be electricity, servant, furnishings, credit cards and housing.

5) Bonus: This is the benefit paid on satisfactory work performance for employee motivation. Though this amount is not assured to the employee, most companies include the maximum amount that can be paid as bonus, to the CTC. The two types of bonuses that are normally paid out are:

-Fixed Annual Bonus: Paid on the basis of employee performance, either monthly or in most cases annually, it is a fully taxable amount.

-Productivity Linked Variable Bonus: Complete bonus amount is paid only on 100% achievement of target, nevertheless it still is included as part of your CTC.

A note on salaries of Government Employees:-

We often hear people say that the salary of government employees is quite low. Although there is truth in this, government salaries wouldn’t seem too less if we look at it from a “CTC” point of view.

When we talk about government salaries, we only talk about the “in-hand” component. But we forget that on a cost-to-company basis, it can be quite substantial.

What extras do government servants get? Here’s a sample list:

The 12% of basic that the government deposits in their PF accounts, just like private companies
Membership of government clubs or gymkhanas
Free stay at various circuit houses and government guest houses
Free telephone connection at home
Free car with driver
Reimbursement of newspaper bills
Free use of many libraries
In case of defense personnel (Army / Navy / Air Force), a huge subsidy on items bought from their “canteens” (like groceries, appliances, etc.)

When these things are taken into account and salaries of government employees is considered on a cost to company (CTC) basis, it won’t seem too less compared to the private sector!

Having understood what CTC is:

Each company too has its own way of calculating the cost to company. One must take time to find out what the actual benefits are by asking for the break-up of the CTC so as to know the entitlement.

If you are just joining the company, try to negotiate with the HR as to opting out of some facilities in exchange for increasing the take home.

Understand the expenditure limits and tax angle of perks and benefits, and use them smartly. In further articles we will see tax implications of each of these components separately.

Tax Basics

2011-08-13T08:14:00.000-07:00

Taxes form a major source of revenue for the Government. These are of two types:

a) Direct Tax - Direct taxes like income-tax, wealth-tax, expenditure-tax etc. are those whose burden falls directly on the taxpayer.

b) Indirect Tax - Indirect taxes like excise duty, customs duty, service tax, sales tax, etc form the cluster of indirect taxes.

In personal finance we will deal with income tax which falls on total income of a person. A person includes-

1. An Individual

2. Hindu Undivided Family

3. Firm

4. Association of Persons or Body of Individuals

5. Local Authority - BMC, NMMC

6. Artificial Juridical Person - Trusts (Religious / Educational Trust)

Assessee – An income tax is to be paid by the assesse under this act. Assessee means a person by whom tax is payable, or a person by whom any other sum of money (interest / penalty) is payable.

Assessment Year (AY) – Income tax is charged in an assessment year (1^st April – 31^st March). Income earned in previous year (PY) is charged in AY.

Previous Year (PY) – PY means a financial year immediately preceding AY. It is the year in which an income is earned.

Types of income

Income tax is a tax on all incomes received, or accruing, or arising to a tax payer during a previous year. Incomes from various sources are computed under five different heads as:

1. Salary: Includes allowances, value of perquisites, profits in lieu of salary and pension.

2. House Property: whether residential or commercial, self-occupied or rented.

3. Profits and gains: from business or profession

4. Capital gains

5. Income from other sources: - Includes bank interest, interest on securities, lotteries, crossword puzzles, races, games, gifts from unrelated persons exceeding the specified limit etc.

Gross total income is total income computed before making any deductions under chapter VI-A. Total income is calculated after making deductions and rebate known as taxable income.

Exemption vs Deduction vs Rebate–

Exemption – It is not considered under any source of income while calculating total income of a person.

Deduction – First mention the head of income then claim the deduction.

Rebate – It is allowed on the amount of income tax so computed.

Determination of Residential Status of an individual–

According to Income Tax Act 1961, every person, who is an assessee and whose total income exceeds the maximum exemption limit, shall be chargeable to the income tax at the rate or rates prescribed in the finance act. Such income tax shall be paid on the total income of the previous year in the relevant assessment year. However scope of the total income depends on the residential status of a person. The residential status of a person is determined for each previous year separately.

It is determined on the basis of the physical presence of the individual as against nationality or domicile in India. It is determined for every previous year separately. A person may be a resident in one previous year and non-resident in next year.

An individual may be resident, Resident and ordinary resident, Non-resident or resident but not ordinarily resident.

a) Resident:

An individual is treated as resident in a year if he is present in India, any one of the following conditions to be satisfied:-

i) For 182 days or more during the previous year

ii) For 60 days or more during the previous year and 365 days or more during the preceding four previous years

However this second condition is not applicable for Indian citizen or a person of Indian origin or a person coming on a visit to India or in case of an Indian citizen going abroad as a member of the crew of an Indian ship or for employment

Hindu Undivided Family or Firm or other Association of Persons is Resident of India in any previous year except where the control and management of its affairs is wholly situated outside India in that previous year.

Company is resident of India if

i) It is an Indian company

ii) During the previous year its control and management is Situated wholly in India.

b) Resident and ordinarily resident (ROR)-

For person to be ROR, both the following conditions are to be satisfied-
1) He has been resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y.
2) He has been in India of 730 days or more during the 7 P.Ys preceding the relevant P.Y.
If none or only one of the above condition is satisfied, the individual will be treated as a resident but not ordinarily resident (RBNOR).

c) Resident but not ordinarily resident (RBNOR):

A resident who was not present in India for 730 days during the preceding seven years or who was non-resident in nine out of ten preceding years or resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y. is treated as not ordinarily resident. In effect, a newcomer to India remains not ordinarily resident.

d) Non-resident:

Non-residents are taxed only on income that is received in India or arises or is deemed to arise in India. A person not ordinarily resident is taxed like a non-resident but is also liable to tax on income accruing abroad if it is from a business controlled in or a profession set up in India.

Income Received in India-

Income received in India is included in the total income of all the persons, irrespective of their residential status. Any amount received outside India but later on brought to India is not treated as income received in India. Also past untaxed foreign income (i.e. Income earned outside India) brought to India during PY is not treated as income received in India. Hence not taxable.

So this is all what I wanted to cover in basics of tax. In upcoming articles we will see each and every head of income and their tax implications. Also we will see how you can save tax (legally :)) with little restructuring of the income that you earn. Any additions / comments are welcome.

Till then Ciao!

A Bit About Time Value of Money

2011-08-11T00:24:00.000-07:00

Ever wondered how the value of money grows when invested and falls when not invested? Here comes the concept of time value of money. A rupee today is more valuable than a rupee a year after. This is so because, in such an inflationary period a rupee today represents a greater real purchasing power than a rupee a year after. Also rupee earned today can be employed productively to generate positive returns.
Let us see this by a simple illustration -

Assuming a 5% interest rate, Rs. 100 invested today will be worth Rs. 105 in one year (Rs100 multiplied by 1.05). Conversely, Rs100 received one year from now is only worth Rs. 95.24 today (Rs100 divided by 1.05), assuming a 5% interest rate.
This is how your money grows when invested and degrades when not invested. Now when it is invested, see the difference of earning between interest earned on simple interest method and that earned on compound interest method.

To make it simpler see the diagram

The money earned in future has less value (which is interest factor ) as compared to the money earned today (which can be invested to earn interest on it.

Example:
Mr. Sharukh Khan invested Rs.1000 for Three years in a savings account that pays 10% interest p.a. Mr. Khan Reinvests the 22 interest earned. What would be the total amount after three years?

Compound Interest				Simple Interest
Principal	1000
Interest	10%
	Year	Interest	Corpus	Interest	Corpus
	1	100	1100	100	1100
	2	110	1210	100	1200
	3	121	1331	100	1300

Here you clearly see the difference of earnings. Compounding maximizes your return by making interest portion also participate in growth of money.
Now what about the constant cash flow you receive will change. Here comes the concept of annuity.
An Annuity is a stream of Constant Cash Flow (payment or receipt) occurring at regular intervals of time.

E.g. EMI payment, Payment of life insurance premium
Two types of annuity
1. Deferred annuity / Ordinary Annuity / Regular Annuity - When Cash Flows occur at the end of each Period.
2. Annuity due - When the Cash Flow occur at the beginning of each period.
Example-
1. Deferred Annuity
Mr. Gates deposited Rs. 1000 annually at the end of the year in a bank for 5 years & earns a compound Interest rate of 10% p.a. What will be the value of the deposit after 5 Years ?

N	5
I	0.1
Amount invested	1000
	year	Interest	Value
	1	100	1000
	2	210	2100
	3	331	3310
	4	464.1	4641
	5	610.51	6105.1

2. Annuity due-
Mr. Gates deposited Rs. 1000 annually at the beginning of the year in a bank for 5 years & earns a compound Interest rate of 10% p.a. What will be the value of the deposit after 5 Years?

N	5
I	0.1
Amount invested	1000
	year	Interest	Value
	0	100	1100
	1	210	2310
	2	331	3641
	3	464.1	5105.1
	4	610.51	6715.61

This concludes that it is always better if you receive your annuity at the beginning of the year so as to maximize your returns.
Here arise some concepts-

Present value - It is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money.

Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.

E.g. You have to lend Rs 1,00,000 to one of your friends and He is offering you following choices .
Choice 1 : He will pay you Rs 18,000 per year for next 10 yrs .
Choice 2 : He will pay you 13,000 per year for next 15 yrs .
Choice 3 : He will pay you Rs 8,000 per year for whole life .

Which One should you choose?
You have to see that which choice has the highest worth if you calculate its Value today . So how do you calculate the Net Present Value in this case , where you have Rs X receivable every year for n years . Here you also have to consider present rate of returns which you can assume at 8% .

So We have 3 variables
X : Amount received per year
n : Number of years
r : Present rate of return
NPV = X * [(1+r)^n - 1]/[r * (1+r)^n]
Calculating through this formula , we get the NPV of the choices as
1. 120781
2. 111273
3. 100000

Net Present Value of the last choice is simple , how much money do you put in bank today that will fetch you 8,000 per year forever ? If X is the amount than at 8% interest you get 8,000 , so

8% of X = 8,000
.08 * X = 8,000
X = 8,000 * (1/.08)
X = 1,00,000

If you see the total amount received in all the cases you will realise that the choices with lesser NPV will give you have higher Total amount .

For Case 1 : NPV = 120781 , Total amount received = 1,80,000
For Case 2 : NPV = 111273 , Total amount received = 1,95,000
For Case 3 : NPV = 100000 , Total amount received = Infinite (The amount is paid forever)

The present value of the 3^rd option is less so it is better option. So we see the lowest present value for our future cash flows gives us maximum return of money.

Future value -
You can afford to put Rs. 10,000 in a savings account today that pays 6% interest compounded annually. How much will you have 5 years from now if you make no withdrawals?
PV = 10,000
i = .06
n = 5
FV = 10,000 (1 + .06)⁵ = 10,000 (1.338) = 13,382

End of Year	1	2	3	4	5
Principal	10,000	10,600	11,236	11,910	12,624
Interest	600	636	674	714	757
Total	10,600	11,236	11,910	12,624	13,382

Thus we conclude that Rs. 13382 received after 5 years is equivalent to Rs. 10000 invested today.

Thus to conclude time value of money has greater significance to determine how much your money is worth. So before investing do the necessary calculation and achieve the maximum from your portfolio.

How should you go about managing your first salary ?

2011-08-08T11:01:00.000-07:00

So you got your first salary? Now what next? How should I manage this? Should I save / Invest / Spend all? These are some of the basic questions that comes into mind of young person who has just started earning. For persons who earn their salary from employer, here are the things that you should think of :-

1) How much tax do I need to pay out of my take home salary earnings?
- This is so important because you need to know what will be the net income in your hands after deducting the tax. Here is the overall view of income tax slabs for Assessment year 2011-2012 -

Income Tax Rates/Slabs for A.Y. (2011-12)

Slab (Rs.)	Tax (Rs.)
Less than 1,60,000	Nil
1,60,000 to 5,00,000	(TI – 1,60,000) * 10%
5,00,000 to 8,00,000	34,000 + (TI – 5,00,000) * 20%
Greater than 8,00,000	94,000 + (TI – 8,00,000) * 30%

TI = Gross total Income (Taxable Income)

Women aged 65 years or less

Slab (Rs.)	Tax (Rs.)
less than 1,90,000	Nil
1,90,000 to 5,00,000	(TI – 1,90,000) * 10%
5,00,000 to 8,00,000	31,000 + (TI – 5,00,000) * 20%
Greater than 8,00,000	91,000 + (TI – 8,00,000) * 30%

Senior Citizens (Individuals aged above 65 years)

Slab (Rs.)	Tax (Rs.)
less than 2,40,000	Nil
2,40,000 to 5,00,000	(TI – 2,40,000) * 10%
5,00,000 to 8,00,000	26,000 + (TI – 5,00,000) * 20%
Greater than 8,00,000	86,000 + (TI – 8,00,000) * 30%

After calculating you gross total income (taxable income), you will need to pay the tax on it as per above mentioned tax slabs. There are legal ways to reduce your taxable income as per the law for various investments you do. I will post detailed description in later posts. Here is the overview of the deduction / Exemptions that you can avail of -

Under Section 80C – Maximum of upto Rs. 100000 exemption can be availed. Deduction of an additional amount of Rs. 20,000 allowed on tax savings, for investment in long-term infrastructure bonds as notified by the Central Government.

There are further ways to get exemptions /deduction from your taxable amount. Will post in another topic.

2) What are my goals?

- Here you should plan where you want to go? If you have no goals set, then you will be randomly investing and as your goals in life come along the way, you fulfill them. It can happen many times that you are not prepared and some important goals is nearby, however you didn’t give much thought to it from many years or months and at the end you have to take decisions in hurry, which you don’t want to take. By setting your financial goals in advance you can get a good idea of what lies in future and start preparation for it (Goal of financial planning).

Goals can be

1. Short term (< 3 years) such as buying a car, marriage expenses, sibling’s marriage, etc.2. 2. Midterm (3 -6 years) such as vacation abroad with spouse, initial child’s expenses, buying a house, etc.

3. Long term (7+ years) such as children’s education, retirement corpus, etc.

So looking at it, it is always advisable to have such goals planned and in place so that planning to achieve these can be proceeded.

A good list of resolutions that you can make – it is really useful. Find it here – Financialresolutions

If you manage to make this up, it is almost half the battle won. Now next is planning to achieve them one by one by proper and prudent investments.

3) Create an emergency fund –

This is by far the most neglected area. Young people don’t think about it and keep on spending lavishly and so they end up in delaying the achievement of their goals. Emergency fund is keeping a good amount of corpus (Normally 3-5 times your monthly salary) in bank savings deposit account / liquid fund so that in case if any contingency (Such as closure of company and you end up losing your job) arrives, you should not be in trouble to tackle it.

It gives you cushion to cover up your expenses in case you lose your job. So ever neglect this fact.

4) Buy an Insurance –

This is important if you have dependents on you (such as wife / children / parents). It provides the risk of loss due to death or incapability of major income earner in the family. The risk is covered by the company for the insurance claim bought by the insurer (upto the amount of risk cover bought by bread earner). And in future articles we will see how term insurance plan is far better than the traditional policies.

5) Take a loan instead of lump sum payment for buying car / bike –

If you are a Businessman or a professional and if you plan to buy car / bike, look at this as better investment. Taking loan instead of lump sum payment has certain advantages. You will get possession of the car / bike and you will have to pay small amount in the form of EMI (Equated Monthly Installments) for certain fixed duration.

The interest components in EMI payment can be deducted from your taxable income under profits and gains from business or profession. So in a way it helps to reduce your tax liability.

6) Investing in postal deposit schemes -

To earn fixed interest payment along with tax saving advantage on your investment, you need to allocate your money into postal deposit schemes provided by India Post. there are schemes such as National saving certificate, Time deposit, Public provident fund (mainly for retirement) which qualify for deduction under section 80C. Investing the maximum allowable amount (per year) in Public provident fund Rs. 70000 at the beginning of every financial year, it will be a benefit as more interest could be credited to your account. So you can take advantage of this.

These are the points I wanted to cover in this article. This topic is incomplete and it is left for suggestions if anyone knows more ways to add things, please add those into comments section. And do visit here as more important stuff is coming your way.. :)

The power of "Compounding" – The 8th Wonder of the world..!!

2011-08-05T22:37:00.000-07:00

“Compounding interest is the greatest mathematical discovery of all time" - Albert Einstein

These words by the great Albert Einstein say it all. And it how in reality is that the power of compounding makes wonders. We have seen bit information about compounding in the previous article; in this we will see it in detail.

All of us must have learnt about compounding and its significance sometime in school. However, an interesting story which explained the power of compounding wonderfully. Here it is…

Once upon a time there was a king known for his generosity and keeping his word. A famous and intelligent prisoner was awaiting his death sentence and was brought in front of the king. The king was playing chess when the prisoner was brought in front of him. Here’s the dialogue that followed.

King: What is your last wish?

Prisoner: Your Majesty, I wish to make provisions for my family to survive after my death.

King: Well! Tell me what you want.

Prisoner: Give me the number of grains of rice on the last square of the chess board, if a single grain was kept on the first square and then doubled on every next square (1 on first, 2 on second, 4 on third, 8 on fourth, 16 on fifth and so on, till the 64th square), and I shall give it to my family before I die.

King: (Thinking what a paltry demand the prisoner had made) Wish granted.

The king then ordered his ministers to have the amount of rice calculated and given to the prisoner. But he was in for a rude surprise. The amount calculated was so large (18 million trillion grains of rice - more than enough to cover the entire surface of the earth) that the king lost his entire kingdom and was indebted to the prisoner all his life.

This can be true even in reality. When the interest on the principal amount is calculated and then added to the principal amount and calculated again in the same manner, we get compound interest. The word compounding means made up of multiple parts.

This means that when the interest is added to principal, the interest that is added earns interest too. This adding of the interest to the principal is termed compounding. We can earn compound interest on a daily, weekly, monthly or yearly basis. The more times the amount is compounded, the more money is made for the investor.

How compounding works?

--- Final value = P(1 + R/T)^TY

P = Principal

R = Rate of Interest

Y = Number of years you want to invest

T = Number of times your principal will compound

Example 1:

Suppose that you have deposited the sum of Rs.15000 in your bank and it pays a yearly interest rate of 5%, compounded on a quarterly basis. Now let us look at what the balance will be after a period of 5 years.

Using the above formula, with P = 15000, r = 5/100 = 0.050, t= 4 and y = 5:

Principal at the end of 5 years will be = 15000(1 + 0.050/4) ^20 = 19230.56

This means that an investment of 15,000 will grow to 19230.56 after a period of 5 years.

Example 2:

Assume an investment of Rs. 1000 in a fixed deposit for 3 years, at an interest rate of 10% p.a., compounded annually. Your interest earnings would be as under

Particulars	Amount at the beginning of the year	Interest Earned 10% p.a.	Balance at the year end
Year 1	1,000	1,00010% = 100*	1,100
Year 2	1,100	1,10010% = 110*	1,210
Year 3	1,210	1,21010% = 121*	1,331

At the end of year 2, your interest is calculated on Rs. 1,100 and not Rs. 1,000. That’s where the brilliance of compounding comes into play. Had the simple interest principle been followed, you would have earned interest on Rs. 1000 and hence interest earned in year 2 would have been lower by Rs. 10 and in year 3 it would be lower by Rs. 21.

The above two illustrates if you want compounding works best for you, you need to make sure the two considerations :-

1) Time – Starting investing as early as possible

2) Frequency - The more frequent the compounding is done (i.e. daily, monthly, quarterly,

semi-annually and annually), the better it is.

Under the quarterly compounding option, the amount of money amassed is the highest, followed by semi-annual compounding, followed by annual compounding.

An amount of Rs. 20,000 invested in a fixed deposit at an interest of 10% p.a compounded at varied frequencies and for different tenures :-

	Year
	1	2	3	4	5
Quarterly	22076	24368	26898	29690	32772
Semi-Annually	22050	24310	26802	29549	32578
Annually	22000	24200	26620	29282	32210

See the difference of earnings in quarterly / Semi-annually and annually compounding. This is how the magic is!

With the above explanation, it is clear that compound interest helps you amass wealth by making your money work hard for you.

Albert Einstein rightly termed it the “Most Powerful Force on Earth.” The earlier you start investing, the richer compound interest will make you. Also next time, you look at any fixed interest instrument; make sure your interest is compounded at the maximum available frequency (In order - 1.Monthly, 2.Quarterly, 3.Semi-annually, 4.Annually).

So Is Compound Interest really the 8th Wonder of the world?

From investor’s point of view - yes, it is. There is nothing in the world that can give investors this much return.

Money Grows Like a Tree; Not On It..!!

2011-08-05T10:51:00.000-07:00

Everyone must have heard this proverb, "Little Drops Make an Ocean"! To form an ocean, a collection of little drops is required. It is so true in our daily life as well, an early start can form a platform for success. The same principle holds when it comes to investing one's savings to achieve his/her financial goals.
This is because by starting the investment early in life, person is giving his investment long period to grow. Even if it is a small amount, it still forms a decent saving portfolio for the person. But he has to follow the principle - save prudently, invest regularly and reinvest the returns. Here even his returns participate in further growth of his corpus.

Let's take an example to illustrate this: -
A invests Rs. 2500 regularly every month starting at age 25.
B (of same age as A) keeps procrastinating his investments. And after 10 years he (age 35) starts investing Rs. 5000 per month.
Assumption - Rate of return on their investment is 12 %.

After further 10 years when A and B will turn 45, their corpus will have huge difference as
A will have a corpus 22.78 lakh while
B will have nearly half 11.09 lakh.

Here we see though B invested twice the amount as much as A invested, he lost in duration of his investments. This is the magic of compounding.
Give your money time to grow, it will multiply and come back to you only with some incentive.. :)
That's the real Funda!
Money Grows Like A Tree; Not on Some Tree that one can pluck it at will.
So start early and build your Money Tree!!

What is Financial Planning?

2011-08-05T08:39:00.000-07:00

Financial Planning is the process of meeting your life goals through the proper management of your finances. Life goals can include buying a house, saving for your child's higher education or planning for retirement. The Financial Planning Process consists of six steps

Using these six steps, a person can work out where is he right now with his finances, what he may need in the future and what he must do to reach his goals.

Benefits :-
1. Financial Planning provides direction and meaning to person's financial decisions.
2. Person can also keep himself updated and adapt more easily to life changes and feel more secure that his goals are on track.

Who can practice it ?
               A certified financial planner (CFP) is a qualified professional who uses financial planning process to help a person figure out how to meet your life goals.
               The Planner can help an individual manage budgeting and saving, taxes, investments, insurance and retirement planning.
               The main difference between financial planner and financial advisors (Insurance agent, Mutual fund agent, etc) is financial advisors adopt push their product strategy while financial planners go deep down in understanding the real situation of finances of a person. Planners make and maintain a friendly relation with clients to recommend their suggestions and help client applying these recommendation in proper direction.

So that's it from my side, apart from this if anyone has to add on, your comments / suggestions are welcome.. :)
Keep tracking!

What Professional Investor is all about?

2011-08-04T07:43:00.000-07:00

Hello my investor friends,
              This is my first ever post on this blog and I am sure you will have a question in mind what is it about? Well it is about managing personal finance. What is personal finance? It is basically managing your hard earned money to fulfill your financial goals such as retirement, buying a new house, children's education / marriage, a foreign trip, etc.
             To achieve that you need an effective planning of your finances so that every penny that you earn is put to use for achieving your goals. For that you may need to monitor your savings, curb your spending and see to it that all the savings are wisely invested in various investment avenues ( such as Mutual funds, bonds, various post office schemes, etc).
             For that often many people follow various websites or watching relevant television programmes; many approach to various individual financial adviser (Mutual fund agents, Insurance agent ,etc.) or a certified financial planner who is specialized in providing an effective and particular financial plan for an individual based on his/her age, risk appetite and needs.
So this is about the personal finance. Keep tracking for my further posts.
Thanks.