The market has been volatile for couple of quarters now and many investors have lost money. Many investors are looking forward for fixed deposits where the returns are less volatile and fixed in some cases. At the same time, this is the season of income tax filing and we all wanted to know the options available to save taxes. Tax has always been a complex subjects for investors and salaried employees. Almost all of us find ourselves searching for the best tax saving instruments. In this article, we will discuss some of the options for saving taxes.

 

Infra bonds

Infra bonds help you save taxes on the investment up to Rs 20,000 in a year. The tax savings at the bracket of 30.9% will be about 6100.

Investment

Rate

Tax rate

Tax savings

Net investment

Annual interest

20,000

8.20%

30.90%

6180

13,820

1640

Investors will receive this payment every year for 5 years and the principal in the 5th year (assuming buyback option). Let’s look at the cash flow in the lock in period, i.e. for 5 years.

Year

Year 1

Year 2

Year 3

Year 4

Year 5

Payment

1640

1640

1640

1640

21640

Effective internal rate of return = 18.1%

   

The effective interest rate here assumes the following –

The interest will be reinvested in the bond at the same rate of returns and there are no taxes on it. However, the interest is taxable at the income tax rate of individuals. Factoring tax rate at 30.9%, the returns will be about 15%. This is again a very good return.

 

Tax Saver Bank Term Deposit

Government of India has permitted taxpayers to save taxes on term deposit of 5 years in different banks. This deposit will come within 1 lakh of income tax section 80C.

Tax saver fixed deposits work on the same concept as infra bonds. The calculation for 5 years term deposit will be similar and the effective rate of return will be the same. The difference is that the maximum limit under 80C is 1 lakh and the maximum can be used to save taxes by fixed deposit.

 

Post office monthly income scheme

Popularly known as MIS, post office monthly income scheme can be availed for tax benefits under section 80C. It pays 8% interest every year and 5% bonus at the end of the tenure, effectively taking the rate at 8.9%. Since the interest is paid monthly, if investors invest the monthly income back to the scheme and withdraw at the end of the maturity, the effective interest becomes 10.5%

 

Company fixed deposits

Companies, from time to time, float fixed deposit schemes where the rates are better than banks and other fixed deposit instruments. The income from company fixed deposits is taxable. Let’s look at the effective rate of return from company deposit schemes.

Deposit

Interest rate

Tax rate

Interest in a year

Effective rate

50,000

10.00%

30.90%

5000

6.91%

50,000

11.00%

30.90%

5500

7.60%

It is important to understand that company fixed deposit is very different from bank deposit. Bank deposits are guaranteed by deposit insurance and credit Guarantee Corporation for up to 1 lakhs of rupees if the bank defaults on the payment. In case of company fixed deposit, there is no guarantee in case the company goes bankrupt or defaults on its obligation.

 

Regular Bank Deposit

Banks also offer fixed deposit or recurring deposit to investors. However, the interest earned is taxable with the rate investors fall into. The effective rate of return, post-tax, is shown below.

Deposit

Interest rate

Tax rate

Interest in a year

Effective rate

50,000

8.00%

30.90%

4000

5.53%

50,000

9.00%

30.90%

4500

6.22%

 

Debt funds

Debt oriented mutual funds which invest more than 50% in debt pay dividends to the investors. The investor doesn’t need to pay taxes on dividend income but the company has to pay dividend distribution tax on the dividend paid to individuals. Let’s take an example. Suppose a debt fund’s NAV is Rs 10 and it pays investors 10% dividend, i.e. Rs 1. This dividend will be taxable for the mutual fund. The mutual fund will give dividend distribution tax of 13.84%. This means that the individual will get Rs 0.8616. This is 8.6% returns post tax. This is much better than the fixed deposit returns given by banks on non-tax savers plan.

There are other debt funds which do not pay dividend but the dividend accumulates and adds to NAV of the bond. Once the investor liquidates the fund, he or she has to pay taxes. The short term tax is paid as per the tax bracket investors are into. For the long term gain, investors can wither pay 11.33% or 22.66% depending on the indexation benefit exercised. If investors calculate capital gain with indexation, the tax rate will be 22.66% while it will be 11.33% without indexation. Indexation increases the initial value of the investment by taking inflation and other factors which depreciate the value of money.

Debt funds are riskier compared to other investment options mentioned above because debt funds do keep some part of fund in equities which are market related.

 

Conclusion

There are many ways to save taxes generally using fixed income schemes. The key is to understand that many fixed income schemes may not provide the exact amount as mentioned because of uncertainty attached to it (as in debt mutual funds). Moreover, the risks associated with different schemes are different. For example, the risk in infra bonds is more than risk associated with tax savings term deposit.

 

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