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Tax saving schemes: Wait till March 2007

The finance ministry is considered changing the tax benefits given to many tax saving schemes (Check: Personalfn,Economic Times and My Blog)

Next year’s budget may remove some of the tax exemptions provided under 80C and reduce the personal tax rate. Moreover, some of the exemptions provided may continue, but may be taxed on exit. So if you put in Rs. 100,000 today into a tax saving fund, you will save Rs. 30,600 (highest bracket) tax; but if the ministry has its way, the entire corpus will be fully taxed when you use this money, usually unlocked three years later.

But this deal may still be worth the effort, versus “ditching” tax saving schemes completely. Here’s the logic:

Assumption 1: You have 1 lakh to invest in some tax saving investment.
Assumption 2: In three years, your money grows by 70%.
Assumption 3: FM declares that 80C investments are fully taxable on exit, and tax rate is down to 25%. No change to Long Term Capital gains etc.

Scenario 1: You invest the 1 lakh in tax saving funds today.

Tax today: nil.
Net value after three years: Rs. 170,000 (70% in three years)
Tax if you exit: Rs. 42,500 (at 25%)
Real value to you : Rs. 127,500.

Scenario 2: You pay your tax today, and invest in a diversified fund instead.

Tax today: Rs. 30,600 (at 30.6%)
Net value today: Rs. 68,400.
Net value after three years: Rs. 116,280
Tax if you exit: Nil (no long term capital gains)
Real value to you: Rs. 116,280.

So there is a value is investing, providing the tax rate comes down to 25%. What if tax rate stays at 30.6%, and the FM still taxes investments on exit?

Net values after three years:

Scenario 1: Rs. 117,980
Scenario 2: Rs. 116,280 (stays the same)

The difference is only Rs. 1,600! And for that difference you have to stay invested for three years, and lock in your money.
It’s better then to stay away. And as seen lately, diversified funds seem to do a better job of managing money than tax
saving funds, so you might just make this difference by higher returns. No lock in, same returns, a much better deal in general.

The budget is usually revealed in the last week of February. You have time till March 2007 to make
your 80C investments. You may have to consider the budget proposals carefully; Calculate whether it makes sense, and only if there is a substantial saving, go on.

  • Anonymous says:

    >Hi Shenoy,

    Started reading ur blog, it rocks. Great gyan here.

    1. I would like to consider investing in MFs. Have invested in ULIP, NSC and PPF.

    2. I am a conservative investor and would like to know different options.

    3. I can affort SIP – say 4000/- every month.

    4. My Age is 29 and would like to stay invested for min 5yrs.

    Can you suggest some good MFs. (equity, diversified ….) (which company)

    Your suggestion will greatly help.

  • Deepak Shenoy says:

    >Hi, thanks for the compliments! Here’s my fundae:

    Conservative = no risks at all? Or VERY little risk, or “50-50 between high risk and low risk”?

    I’ll give you my gyan for all the above:
    Conservative, no risks: Choose a debt plan or a gilt fund, like PruICICI Long Term Plan or Reliance Gilt plan. Typical returns are 5-6%

    Very LIttle Risk: HDFC Monthly Income Plan – Long Term (Growth). Returns around 10% or so and has a small exposure to equity.

    50-50 Risk: SBI Magnum Balanced Fund, HDFC Prudence fund. Have done 30% in the last year, but expect 12-15%.

    Much more risk: I know you didn’t ask, but if you want you can put a small amount here: HDFC Equity, SBI Magnum Global Fund or Magnum Contra fund.

  • Anonymous says:

    >Thanks for the advice. In continuation to my previous queries, I have few more.

    1. How about ELSS funds. which is good.

    2. Will MF investments be taxed on redemption.

  • Uma Shankar Ladha says:

    >Deepak, I think you are missing a point here. The tax of 25% will be applied on 70,000 (170000 – 100000). This is because the initial 100000 is already exempted. Hence 25% of 70000 is 17,500 and that would be tax outgo and not 42500. So the net returns would be 52.5% instead of 70% from the ELSS. I think you can modify your post about this.

  • Deepak Shenoy says:

    >Anonymous: ELSS is good for tax saving measures (80C) but if that doesn’t apply to you an equity diversified fund is better. ELSS, like equity, is highly risky. Magnum TaxGain and HDFC Taxsaver are good funds.

    Equity MF Investments are currently not taxed on redemption if redemption is after one year of investment.

    Uma shankar: The 100,000 will also be taxed eventually if the EET regime comes up. I’m not sure if only the 100,000 will be taxed, or the full 170,000 – that will depend on the EET setup. Either ways the 100,000 will be taxed if there is EET.

    Currently of course, you have zero tax – no long term capital gains tax and no principal tax on redemption. The budget in Feb end will tell us what the EET situation is…

  • Tax Guru says:

    >There has been an increase in depreciation for commercial vehicles from 40 per cent to 50 per cent. Such depreciation is available both for business and profession. Would it mean that the assessees engaged in professions such as law, medicine and audit would be eligible for 50 per cent deduction for depreciation for cars used for profession?
    Commercial vehicle should ordinarily mean any vehicle used for the purpose of commerce which will include profession. But “commercial vehicle” is understood in the Notes to the Depreciation Schedule as under: