Tax planning through the investment route, under the Income-tax Act, 1961 (IT Act), has a wider scope than the commonly known Section 80C benefits

TAX-SAVING measures exist in many forms, from availing certain types of loans, buying certain types of insurance policies, making specified investments to making donations to approved charities. Among these, one tends to favour the investment route due to the prospects of returns and creation of wealth over the long run.

Tax planning through the investment route, under the Income-tax Act, 1961 (IT Act), has a wider scope than the commonly known Section 80C benefits. Tax on investments is done in three ways based on the type of financial instrument, the time of subscription, accrual of income and maturity of the instrument. It is essential to understand each instrument for effective tax planning within one's overall financial plan.

Tax planning under exempt exempt exempt (EEE) route:

Under the EEE route, there is a tax benefit at every stage of investment. Under Section 80C of the IT Act, investments such as public provident fund (PPF), equity-linked savings scheme (ELSS) and life insurance policies qualify under the EEE route. For instance, the investor gets a tax break of up to Rs 1,00,000 for making a contribution in PPF; the interest earned during the tenure of the fund is tax-free and when the investment matures after 15 years, the corpus is also tax-free.

Additionally, under Section 80CCG of the IT Act, the Rajiv Gandhi Equity Savings Scheme is an incentive for first time stock market investors having an income of Rs 10,00,000 or less. Under this provision, an individual has an opportunity to avail a tax deduction of 50 per cent of the amount of invested subject to a maximum of Rs 50,000. Such benefit is over and above the deduction of Rs 1,00,000 available under Section 80C.

Tax planning under exempt exempt tax (EET) route:

In EET instruments, while the first two stages of investment are exempt, one pays a tax at the maturity stage. So, the first step, or your contribution, enjoys a tax break, but subsequently, either during the tenure, or on maturity, you need to pay a tax on your gains.

For example, in case of an investment in National Savings Certificate VIII issue (NSC) six years, investments up to Rs 1,00,000 qualifies for deduction under Section 80C of the IT Act.

The NSC interest is taxable, however, as it is a cumulative scheme (that is, interest is not paid to the investor but instead accumulates in the account), each year's interest, except for the last year, is considered as reinvested in the NSC and qualifies for a fresh deduction under Section 80C of the IT Act. It should be noted that the interest income for all years except the last year is reported as `Income from other sources'. Finally, on maturity, the principal amount is tax-free. However, the final year's interest does not receive a tax deduction, as it does not get reinvested.

Tax planning at a single stage of investment:

Under this route, tax benefit may be partially or completely available at one stage of investment, that is, either on subscription, or income accrual stage, or maturity/sale. Some examples for the same are gains arising from sale of capital assets are exempt where the same are invested in residential property/ specified bonds issued by the government, and also fixed deposits with a tenure of five years.

Under Section 54 of the IT Act, where a house property held for long term is sold and seller entirely utilises such capital gains for purchasing a new house, then capital gains on the sold property will not be chargeable to tax during that financial year.

Investment based tax exemptions and a deduction on investments is to incentivise individuals to save more tax and channelise their savings towards long-term investing benefits. Where the prescribed conditions mentioned for availing a deduction during a particular financial year is violated or not fulfilled in any specified financial years, then such deduction would be deemed as one's income during such year of violation and added to their total income.