Tax planning for salaried individuals

Rupesh Maheshwari , Last updated: 29 December 2008
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SEMINAR ON

TAX PLANNING FOR

SALARIED INDIVIDUALS

RupeshKalantri BCom 2^nd Year,

ERO 0133506

Jorhat

carupesh16@gmail.com

Salary Concept and Definition

Normally, the term ‘Salary’ signifies the consideration for services rendered by a person. The person who renders the services is called the ‘employee’ while the person who receives the services and pays the consideration is called the ‘employer’. The expression ‘employment’ means existence of relationship of master and servant between the employer and the employee. This relationship is governed by a contract of employment whether expressed or implied which is absolutely essential in order to tax the amount so received under the head ‘Income from Salaries’. Thus, a medical practitioner, an advocate or a chartered accountant not employed by the employer but appointed as a consultant or a retainer cannot be called an employee and the amount so received by such persons will not be taxable under the head ‘Salaries’. Further, where such persons are appointed in a regular job under a contract, verbal or written or implied, then they constitute employees and their remuneration is taxable under the head ‘Salaries’.

Sec 17 of the Income Tax Act, 1961, gives an inclusive definition of salary. Broadly, it includes:

a) Basic Salary;

b) Fees, Commission and Bonus;

c) Taxable portion of cash allowances;

d) Taxable value of Perquisites;

e) Retirement Benefits etc.

Although all the components of salary income are included in salary, there are certain incomes in each of these categories which are either fully exempt or exempt upto a certain limit. The aggregate of all the above incomes, after the exemption(s) available, if any, is known as ‘Gross Salary’. From the ‘Gross Salary’, the following deductions are allowed u/s 16 of the Act to arrive at the figure of ‘Net Salary’.

a) Deduction for entertainment allowance u/s 16(ii);

b) Deduction on account of any sum paid towards tax on employment u/s 16(iii).

Tax Planning

Broadly speaking, tax planning is not a one day show; rather it is a gradual arrangement of one’s financial affairs in such a way that there are no violations of the legal provisions of the Income Tax Act. Though, it is a legal obligation of every citizen to pay the taxes honestly under the law, the taxpayer is legitimately entitled to plan his taxes in such a manner that his tax liability is reduced to a minimum. Tax planning is needed for:

a) Minimizing litigation between the taxpayer and the tax administrators;

b) Healthy growth of economy; and

c) Employment generation.

Concepts used in Tax Planning

1). Tax Evasion

Tax Evasion means not paying taxes as per the provisions of the law or minimizing tax by illegitimate and hence illegal means. Tax Evasion can be achieved by concealment of income or inflation of expenses or falsification of accounts or by conscious deliberate violation of law.

Tax Evasion is an act executed knowingly willfully, with the intent to deceive so that the tax reported by the taxpayer is less than the tax payable under the law.

Example: Mr. A, having rendered service to another person Mr. B, is entitled to receive a sum of say Rs. 50,000/- from Mr. B. A tells B to pay him Rs. 50,000/- in cash and thus does not account for it as his income. Mr. A has resorted to Tax Evasion.

2). Tax Avoidance

Tax Avoidance is the art of dodging tax without breaking the law. While remaining well within the four corners of the law, a citizen so arranges his affairs that he walks out of the clutches of the law and pays no tax or pays minimum tax. Tax avoidance is therefore legal and frequently resorted to. In any tax avoidance exercise, the attempt is always to exploit a loophole in the law. A transaction is artificially made to appear as falling squarely in the loophole and thereby minimize the tax. In India, loopholes in the law, when detected by the tax authorities, tend to be plugged by an amendment in the law, too often retrospectively. Hence tax avoidance though legal, is not long lasting. It lasts till the law is amended.

Example: Mr. A, having rendered service to another person Mr. B, is entitled to receive a sum of say Rs. 50,000/- from Mr. B. Mr. A’s other income is Rs. 200,000/-. Mr. A tells Mr. B to pay cheque of Rs. 50,000/- in the name of Mr. C instead of in the name of Mr. A. Mr. C deposits the cheque in his bank account and account for it as his income. But Mr. C has no other income and therefore pays no tax on that income of Rs. 50,000/-. By diverting the income to Mr. C, Mr. A has resorted to Tax Avoidance.

3). Tax Planning

Tax Planning has been described as a refined form of ‘tax avoidance’ and implies arrangement of a person’s financial affairs in such a way that it reduces the tax liability. This is achieved by taking full advantage of all the tax exemptions, deductions, concessions, rebates, reliefs, allowances and other benefits granted by the tax laws so that the incidence of tax is reduced. Exercise in tax planning is based on the law itself and is therefore legal and permanent.

Example: Mr. A having other income of Rs. 200,000/- receives income of Rs. 50,000/- from Mr. B. Mr. A to save tax deposits Rs. 60,000/- in his PPF account and saves the tax of Rs. 12,000/- and thereby pays no tax on income of Rs. 50,000.

4). Tax Management

Tax Management is an expression which implies actual implementation of tax planning ideas. While that tax planning is only an idea, a plan, a scheme, an arrangement, tax management is the actual action, implementation, the reality, the final result.

Example: Action of Mr. A depositing Rs. 60,000 in his PPF account and saving tax of Rs. 12,000/- is Tax Management. Actual action on Tax Planning provision is Tax Management.

To sum up all these four expressions, we may say that:

Tax Evasion is fraudulent and hence illegal. It violates the spirit and the letter of the law.

Tax Avoidance, being based on a loophole in the law is legal since it violates only the spirit of the law but not the letter of the law.

Tax Planning does not violate the spirit nor the letter of the law since it is entirely based on the specific provision of the law itself.

Tax Management is actual implementation of a tax planning provision. The net result of tax reduction by taking action of fulfilling the conditions of law is tax management.

Tax Planning for Salaried Individuals

Conceptually, tax planning for salaried assessees can be segregated into two broad categories namely:

1. Salary Restructuring; and

2. Investing in Tax saving devices.

1. Salary Restructuring: Salary Restructuring is a lesser known domain of tax planning. It is common among salaried assessees to complain about having to pay huge taxes. An employee can structure or restructure his salary so as to reduce the tax outgo on his total salary by including exempt allowances and reimbursements. Instead of going for high basic salary one should opt for perquisites which are either exempt from tax or which in some cases, are valued at a lower amount than the actual expenditure. For example-

a) Rent Free Accommodation or House Rent Allowance should be availed particularly in case of employees who do not own a house or a flat.

b) Expenses on purchases and maintenance of employees’ uniform can be paid or reimbursed by the employer and the same is not considered as a perquisite u/s 10 (14).

c) If any allowance is received for education and hostel stay of employees’ children from the employer, exemption can be claimed u/s10 (14).

d) Telephone facility received by an employee at his residence is not taxable in the hands of the employee as against telephone allowance which is fully taxable.

e) The employee should avail the facility of motor car (as also its maintenance and running expenses) from the employer. The perquisite value is nominal considering actual expenses on car.

f) An employee should opt for medical reimbursements which are exempt upto Rs.15, 000.00 p.a. as against any medical allowance which is fully taxable.

g) In case, the employer is liable to pay Fringe Benefit tax (FBT), then amount of fringe benefits, shall not be taxed in the hands of the beneficiary employee. Again, if salary is received in arrears or in advance, one can claim relief u/s 89 (1).

2. Investing in Tax Saving Devices: In very simple terms, the major several avenues for tax saving instruments are specified u/s 80C of the Income Tax Act that allows investments in certain notified instrument to reduce tax liability. Though, one can save as much as possible in these instruments, however the Income Tax Act has specified a ceiling limit of Rs. 1, 00,000.00 beyond which the tax benefits are not allowed. Investments can be made in different instruments viz. Life Insurance Premium, National Saving Certificates (NSC), Public Provident Fund (PPF), Banks Fixed Deposits with a maturity period of five years or more, Post office (CTD) accounts, refund or repayment of housing loan, contribution towards GPF/SPF/GSLI etc. Health Insurance Premium to the extent of Rs.15,000.00 u/s 80D is eligible for tax deduction in addition to Rs. 1,00,000.00 as mentioned earlier. However, it is very important on the part of assessees to plan as to where to invest and how much to invest considering the features of investments such as tax benefits, safety of principal, liquidity, stability of income, capital growth etc. Here are some tips for you:

a) Check the gross amount that is expected to be deducted towards Employees Provident fund (EPF) during the financial year. The total amount deducted from your salary will be eligible for investments u/s 80C.

b) Always check the Lock-in-Period of the investments. Tax saving investments have a minimum lock-in period i.e. the period during which withdrawals are usually not allowed. If the same are withdrawn, these will be taxable in the year of withdrawal. For example, National Savings Certificates (NSC) has a lock-in period of six years, Public Provident Fund (PPF) has a lock-in of 15 years, Equity Linked Saving Schemes (ELSS) has a lock-in period of three years. Insurance policies have even greater period of lock in.

c) Try to diversify your saving in different instruments. For instance, if you have already invested a fair portion of your money in equity, avoid an ELSS i.e. equity linked saving schemes. At present in the era of market crash almost all the ELSS investors have been given negative returns. Thus, to avoid such a situation, an investment planning chalked out in the beginning of the year may reduce the tax liability and yield maximum returns on such investments.

For details see Appendix-I.

Further Considerations for Tax Planning

For the purpose of tax planning under the head ‘salaries’, the following propositions should be borne in mind. However, these propositions would hold good only in the context in which they have been made:

a) It should be ensured that, under the terms of employment, dearness allowance and dearness pay form a part of basic salary. This will minimize tax incidence on house rent allowance, gratuity and commuted pension. Likewise, incidence of tax on the employer’s contribution to a recognized provident fund will be lesser if dearness allowance forms a part of basic salary.

b) The Supreme Court has held in Gestetner Duplicators (P.) Ltd. V. CIT [1979], that the commission payable as per terms of contract of employment at a fixed percentage of turnover achieved by an employee, falls within the expression ‘salary’ as defined in rule 2(h) of Part A of the Fourth schedule. Consequently, tax incidence on hose rent allowance, gratuity and commuted pension will be lesser if commission is paid at a fixed percentage of turnover achieved by the employee.

c) As uncommuted pension is always taxable, employees should get their pension commuted. Commuted pension is fully exempt from tax in the case of govt. employees and partly exempt from tax in the case of non govt. employees who can claim relief u/s 89(1).

d) An employee, being a member of a recognized provident fund, who resigns before completing five years of continuous service, should ensure that he joins a firm which maintains a recognized provident fund for the simple reason that the accumulated balance of the provident fund with the former employer will be exempt from tax, provided the same is transferred to the new employer, who also maintains a recognized provident fund.

e) The employer’s contribution towards recognized provident fund is exempt from tax up to 12 per cent of salary. Therefore, the employee should insist on the employer for fixing his contribution to 12 per cent of salary.

f) Since incidence of tax on retirement benefits like gratuity, commuted pension, accumulated balance of a unrecognized provident fund is lower if they are paid in the beginning of the financial year, employers and employees should mutually plan their affairs in such a way that retirement, termination or resignation, as the case may be takes place in the beginning of the financial year.

g) Pension received in India by a non- resident assessee from abroad is taxable in India. If however, such pension is first received by or on behalf of the employee in a foreign country and later on remitted to India, it will be exempt from tax.

h) As the perquisite in respect of leave travel concession is not taxable in the hands of employees if certain conditions are satisfied, it should be ensured that the travel concession should be claimed to the maximum extent possible without attracting any incidence of tax.

Conclusion

From the above discussion, it is crystal clear that although there are numerous avenues through which a salaried assessee can minimize his taxability but still one cannot deny that a person earning from business gets a better option for tax planning than that of his counterpart who earns his income from salaries. For a salaried person, every income is transparent and with the withdrawal of ‘Standard deduction’, the burden is comparatively more on such persons. Most of the salaried individuals invest to save taxes, which is not everybody’s cup of tea. Investment is a complex phenomenon which can be mastered only through constant practice. Investment requires saving, which is not an easy affair and with ever increasing material demands, it is definitely not going to be easy. Just to learn a skill, one has to practice regularly similarly one has to save and plan regularly to learn the art of tax planning. Tax Planning, in true sense, remains a need based exercise and no one strategy could fit all.

Appendix-I

Here is the quick analysis of the income-tax saving schemes.

Particulars	I	II	III	IV	V
Nature of Investment	Bank/Post Office - 5 Years Term Deposit (including Senior Citizen Deposits)	6 Year Post Office Monthly Income Scheme	National Savings Certificate/Kisan Vikas Patra (NSC/KVP)	Life Insurance	Public Provident Fund (PPF)
Brief Description	Short term, easy to operate tax saving scheme	Short term, easy to operate regular income earning scheme	Short Term to Medium Term fixed period schemes	Medium to Long term investment cum life assurance scheme	Long term investment scheme
Investment Limit	Bank FD - Rs.1,00,000 Senior Citizen Scheme - Rs.15,00,000 Others - No Limit	Maximum: Rs.4,50,000 in Single Account and Rs.9,00,000 in Joint Account	No Limit	No Limit	Maximum: Rs.70,000 in a financial year (minimum - 15 years)
Whether Investment eligible for deduction from Income?	Yes.	No.	Yes. However, KVP is not eligible for deduction	Yes.	Yes.
Approximate Return	7.5% p.a. to 9% p.a. *	8% p.a.	7% p.a. to 9% p.a.	Depends on the nature of policy	8% p.a.
Whether Interest/Income Exempt from Income Tax?	No.	No.	No. However, interest on NSC is eligible for deduction for the first 5 years as if it is fresh investment.	Any withdrawal from LIC is totally exempt**	Yes.
Whether Loan can be availed against the Investment?	No. Availing loan would lead to reversal of tax benefits.	No.	Yes.	Yes.	Yes.
Any partial withdrawal possible?	Interest may be withdrawn depending on the scheme. Pre-closures are permitted in certain cases under certain restrictive situations.	No.	No.	In select policies after the specific period	After fourth year of initial subscription
To whom beneficial?	Any person who have funds earmarked for 5 years.	Any person who expects regular monthly income	Persons with surplus fund with unknown maturity period	Persons who wish to cover the life and help the beneficiaries financially	Persons who have long term financial plan with flexibility