Finance Minister Nirmala Sithraman in Union Budget 2022-23 has taken away one of the popular tax planning mechanisms called bonus stripping.
From April 1, 2023, investors who previously used a technique known as bonus stripping to reduce their tax liability could no longer do so. It is because of a change in the Income Tax Act that was introduced in the Union Budget 22-23.
This article will look at bonus stripping and how it works.
What is Bonus Stripping, and how does it work?
Bonus stripping occurs when shares or mutual funds are purchased and sold in a way that results in a short-term capital loss that can help to offset capital gains.
So, in this scenario, an investor buys units or shares at a higher price to sell them at a lower price.
Let us take a simple example to explain bonus stripping.
Assume that an investor buys 100 shares of a corporation at Rs 100 per share. After some time, they publicly announce that they are going for a 1:1 bonus issue. As one share is now split into two shares, the share price of the company’s share gets priced to Rs 50. Now, the person has a total of 200 shares.
The person might sell the original 100 shares at Rs 50 each. As per the current rules, they can record this sale of shares as a loss because they bought a single share of the company at Rs 100 and sold it for Rs 50.
So, the investor can use the loss of Rs 5,000 (Rs.100*100–100*50) to offset any capital gains from other transactions.
We also need to keep in mind that the investor still owns the 100 shares they received as a bonus. They may stay invested for one year to take advantage of the LTCG tax on equity units, which is taxed at 10% on gains over Rs 1 lakh.
Budget bans Bonus Stripping
The Income Tax Act currently has a clause prohibiting the set-off of losses suffered through bonus stripping against other capital gains to deter investors from engaging in such practices.
According to Section 94 (8) of the Income Tax Act, if units are purchased within three months of the bonus issue’s record date and sell some units within nine months of the record date, the loss incurred shall be ignored. But till now, the anti-avoidance portion of section 94(8) only applied to mutual fund units. With the latest budget announcement, in addition to mutual funds, the equity shares and units of InvITs, REITs and other alternative investment funds would also not be allowed to offset the losses arising out of the bonus issue against other gains.
The budget has also recommended revising the definition of units to incorporate units of new pooled investment vehicles such as InvITs, REITs, and AIFs.
Another similar concept is dividend stripping. Under dividend stripping, the investors hope to profit from capital losses resulting from post-dividend stock sales at a reduced price. However, as dividends are now taxed in the hands of the shareholder, dividend stripping is no longer relevant.
These changes will take effect on April 1, 2023, and will apply to the assessment years 2023-2024 and the following years.
It is important to file your income tax return on time and you need to make sure that you use the right income tax form for filing your return. Any mistake or omission of income or any other non-disclosure of details in the income tax return can lead to an income tax notice.
There are many reasons why the income tax department sends notices and there are specific sections under which the income tax department sends notices. You need to understand the reason for such notices and respond appropriately within the stipulated deadline. If you get one, there is no need to panic. Stay calm and respond to the notice as a clarification to the query. Responding on time to these notices will help you avoid any penalties or legal action by the income tax department.
Here is the list of tax notices, why they are sent by the income tax department and how to respond to income tax notice.
Notice under section (u/s) 142(1)
Most of the time notices under this section are to ask the taxpayer to file returns for the assessment year for which the return has not been filed. However, this notice may be issued by the income tax department when they need more information on the return you filed.
The assessing officer could ask you, the taxpayer, for information about a tax return that you had filed earlier or it may be any documentary proof that is needed for the claims made. For instance, you might be required to produce your sales books, purchase bills, or proofs of any deductions availed by you, etc. This notice is issued before the assessment of the return that you had filed. You need to file the return or furnish the information requested.
Notice u/s 143(1)
Intimation after processing your income tax return is often sent under this section. This notice will be a statement from the income tax department that provides the income, deductions and tax details and states that the information is in line with the records available with the department. So, this is more of an acknowledgment by the income tax department.
Notice u/s 143(2)
Under this notice, the assessing officer may ask you to produce supporting documents for the claims made in the income tax return. This is sent in the financial year in which the return was filed. After the notice is received, you should reply to the queries raised by the income tax department and submit all the additional documents requested.
Notice u/s 139(9)
If the assessing officer believes that a defective income tax return has been filed, a notice will be served under this section. The defect in the return could be due to errors in using the ITR form, missing information, use of the wrong ITR form, etc. The notice will highlight the defect in the income tax return and will also recommend the solution. Taxpayers are given a period of 15 days to respond to the notice. If you do not respond, your return could get rejected.
Notice u/s 131(1A)
If the assessing officer thinks that you have concealed income while filing your return, you will get a notice under this income tax section. This is a summons or an intimation that the assessing officer will enquire into your income or the books of accounts. It empowers the tax authorities to demand the production of the necessary information or related documents. There is no specific time limit to serve this notice and you may need to present your documents to the assessing officer. You need to be prompt to comply.
Notice u/s 148
If the assessing officer feels that some information has been concealed in the return that was filed earlier, the return can re-opened for reassessment and a notice is sent under this section. You need to respond with the required information.
Notice u/s 245
This is an intimation that is usually issued when the tax refund for an assessment year is adjusted against any tax demand which is due. You need to make sure that the income tax return filed is in sync with the 26 AS tax credit statement.
Above mentioned notices are common in nature. If you don’t want these notices, it’s good to file your return properly and carefully. However, even if you get an income tax notice you can respond to the notice online. Note that for the notices you can either reply using the e-proceedings section in your account on the income tax filing website or you can file a rectification return to correct the information in your tax return. Now that you know how to respond to an income tax notice online, you can do it in minutes.
Your taxable income is the final amount on which you pay tax after adjusting for all the tax breaks and benefits that you are eligible for. Here’s how to calculate it
Most people tend to confuse their total income with their taxable income. As most of the salaried individuals know only their take home pay and leave the tax calculation to their employers, they are not aware of their taxable income.
So, what is taxable income? It is the final amount you get after deducting all those tax benefits and exemptions applicable. Once you get the taxable income, you pay tax as per the respective tax rate that applies to you. However, calculating our taxable income isn’t that easy.
To calculate your taxable income, the Income Tax department has divided income sources into five categories. These are income from salary, income from house property, income from business and profession, capital gains and income from other sources. While most of these categories have some tax exemptions that you can avail, the others don’t have any exemptions. You will need to calculate your income under each source when you file your Income Tax Return (ITR). Here’s a look at each of these income sources.
Income from salary
Salary income will not only include your basic salary, it will include all your allowances and perquisites. To calculate your income from salary, you need to take your basic salary, allowances such as House Rent Allowance (HRA), dearness allowance, travel allowance, commissions and other allowances. You need to also include any bonuses to get your gross salary.
Note that allowances are taxed either fully, partially or are exempt. Allowances that are fully taxable include dearness allowance, city compensatory allowance paid to those who live in metros such as Mumbai, Delhi, Bengaluru, Chennai, overtime allowance and deputation allowance/servant allowance. Partially taxable allowances areHRA, entertainment allowance (except those paid to Central and State Government employees, special allowances for uniform, travel, research, personal expenses such as children’s education.
Fully exempt allowances are foreign allowance given to employees working abroad, allowances of judges working in the High Court and Supreme Court, allowances received by the employees of the United Nations Organization.
Perquisites are taxable for all employees. Perks include rent free accommodation, concession in accommodation rent, interest free loans, movable assets, educational expenses and insurance premium paid on behalf of employees.
You will need to deduct the tax exempted income such as HRA and travel allowance from your gross salary to arrive at the income from salary.
Income from house property
Any rental income that you might earn from letting out your property is a part of income from house property. Even if you have a vacant self-occupied house, you will need to take into account the deemed income from the self-occupied property.
To calculate your income from house property, you will need to calculate Gross Annual Value (GAV) of your let-out house property. For this, you will need to know the rent received by you, the municipal value, and the fair rent from the property. Then, you will take the higher of the three as the GAV of your property.
Once you have the GAV, the municipal tax will have to be subtracted from the GAV to arrive at the Net Annual Value (NAV) for our house property. The NAV may be a positive or negative figure. From the NAV, you will need to deduct any interest that you pay on the home loan for the property that you let out. Note that 30% of the NAV is allowed as a deduction towards repairs, maintenance, etc. irrespective of whether you spent the amount or not. However, this deduction is not allowed if the GAV is nil.
A business is any economic activity carried on for earning profits. Business profit need to be calculated using the profit & loss account (P&L) of the business. In P&L account, the expenses are divided into partly allowed and disallowed under the Income Tax Act. On the credit side of the P&L account, you can find income that is tax free/not taxable under the category business or profession.
You could use the presumptive tax method if your business is eligible for it. Presumptive taxation for businesses is covered under section 44AD of the Income Tax Act. Any business having a turnover of less than Rs. 2 crores can opt to be taxed presumptively. Get the help of a chartered accountant if you don’t understand the income calculations.
Income from capital gains
If you own investments such as property, stocks and mutual funds and sell them for a profit, you need to pay capital gains tax. You will need to differentiate between long-term capital gains and short-term capital gains for various assets. There are no exemptions for short-term capital gains. For long term capital gains, you can claim the applicable deductions under various sections such as Sec 54, 54EC etc. Deduct the exemptions from your capital gains to calculate your net capital gains.
Income from other sources
Any income that does not fall under any of the above categories will come under income from other sources. Income from other sources includes interest from our savings account, dividends from investments, income from deposits etc. Income from other sources will also include any winnings worth over Rs. 10,000 from lotteries, games, races, gambling and betting such as card games, horse races, etc.
Calculate your taxable income
Add all the income from the five categories to arrive at your total income. Note that some of our income shouldn’t be included as they are taxed at rates that are different from the income tax slab. For instance, short-term capital gains are taxed at 15% and income from winnings is taxed at 30%.
To calculate your taxable income, subtract the tax deductions allowed under Section 80C to 80U of the Income Tax Act from your total income. It will include investments such as Public Provident Fund (PPF), ELSS mutual funds, tax saving fixed deposit, Health insurance premium, etc. You can apply the tax rate as per your respective slab to your taxable income get the final tax you need to pay.
Below is how taxable income is calculated.
Taxable income calculation (For a salaried individual)
Particulars
(Amt in Rs)
Salary Income
900000
Income from other sources
40000
A
Total Income
940000
Deductions
Sec 80 (C)
150000
Sec 80 (D)
25000
Sec 80 (CCD)
10000
Sec 80 (TTA)
5000
B
Total
190000
(A-B)
Taxable Income
750000
Tax Calculation
Up to Rs 2.5 Lac
NIL
Rs 2.5 Lac to Rs 5 Lac (5% of the amount)
12500
Rs 5 Lac to Rs 10 Lac (10% of the amount) i.e. 10% of (Rs 750000-Rs 5 Lakh)
25000
CESS at 3% (3% of 12500+25000)
787
Total tax amount (Rs)
38287
*All figures are for illustration
Make sure that you are declaring all your income and are using all the right deductions and tax benefits while filing your ITR
Equity Linked Saving Schemes (ELSS) or tax saving mutual fund schemes as they are called, help investors to save taxes. This is because investments in ELSS funds qualify for a tax deduction. However, this is possible only if you choose the old tax regime. You can invest in ELSS funds without any tax benefits if you choose the new tax regime.
The investments in ELSS are subject to a lock-in period of three years. ELSS is considered as one of the best options to save taxes and create wealth in the long run. Here is all the information you need on ELSS funds.
Benefits of investing in ELSS
Higher returns
Although the risks are higher, investments in ELSS funds have the potential to deliver significantly higher returns when compared to traditional tax saving investments. While PPF and NSC give you 7.9% per year, the five-year post office deposits give only up to 7.7%. Even the 5-year bank fixed deposits give you much lesser return. However, ELSS can provide you with much more returns than these traditional schemes. For instance, the Axis Long Term Equity Fund which is an ELSS fund has provided annualised returns of 16.7% every year for the last three years. The ten-year return of this fund is at 17.89%. Since ELSS funds are essentially equity schemes, they are able to deliver exponential returns in the long run if you stay invested in them.
Tax exemption
The Income Tax Act allows taxpayers to invest in specific securities and taxpayers can claim it as a deduction from their taxable income. ELSS is one of the approved securities under Section 80C of the Income Tax Act, 1961. Others include Public Provident Fund (PPF), postal savings like National Savings Certificate (NSC), tax-saving fixed deposits and National Pension Scheme. So, investments of up to Rs. 1.5 lakh in these schemes, which includes ELSS, is eligible for tax exemption.
Lower tax
The returns from this fund are taxed like gains from any other equity mutual fund scheme. When you sell your ELSS funds, only long-term capital gains of over Rs 1 lakh are taxed at 10%. So, if your capital gains are less than Rs 1 lakh, you don’t need to pay any tax. Suppose an investor has made a capital gain of Rs 1.2 lakhs on the investment in this scheme, and withdraws the amount after three years, capital gains tax of 10% will be levied on Rs. 20,000. The tax payable will be just Rs 2,000.
Lesser lock-in period
While PPF has a maturity tenure of 15 years, NSC has to be held for five years. ELSS has the shortest lock-in period of three years among all 80C investments.
Possibility of income
You can opt for dividend pay-outs if you want to receive regular income. You get this income whenever the fund declared dividends even during the lock-in period.
Lower costs
ELSS mutual funds do not have any entry or exit load (but remember there is a 3-year lock-in).
Who can invest in ELSS?
Any one including Non-Resident Indians (NRI) can invest in ELSS funds. However, if you are a resident of the United States of America (USA), investing in Indian mutual funds is not recommended because of Passive Foreign Investment Company (PFIC) related taxation and reporting problems.
ELSS is suitable for investors with a long-term investment horizon of more than three years. As the underlying assets mostly comprise of equity securities which are quite volatile, it is important that the investor have a high-risk appetite.
How much can you invest?
You can invest as little as Rs. 500 in an ELSS fund. While you can claim tax benefits of only up to Rs.1.5 lakhs, you are free to invest as much as you want in ELSS funds.
How to invest in ELSS funds?
You can invest in ELSS like you do for any other mutual fund. The easiest way is online investing. You can invest in ELSS seamlessly through online platforms such as Wealthzi.com or directly through the websites of the Asset Management Companies (AMCs) whose funds you want to purchase.
If you want the conventional mode of investment, you will need to fill a form and submit it at the nearby branch of the fund house.
You can make ELSS investments either as a lumpsum or using the Systematic Investment Plan (SIP) route. Note that each SIP you make will have a lock-in of three years. If you want to redeem your funds after three years, it is best to make a one-time investment. Looking for the best ELSS funds? Get in touch with the wealth consultants at Wealthzi.
When you sell an asset for a value that is higher than the amount you purchased it for, you incur a capital gain. Assets include equities and property. Non-Resident Indians (NRI) who have assets in India needs to pay taxes on their capital gains. This could be taxes on either Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). The definition for STCG and LTCG will differ based on the asset.
Property
When a house property is sold by an NRI after a time of 2 years (reduced from 3 years in Budget 2017) from the date it was purchased, it is considered as LTCG. If the asset has been held for less than 2 years, it will be STCG.
Tax implications will be applicable if NRIs inherit properties on account of legacy. In the event that the property has been inherited, make sure to consider the date of acquisition of the first owner for ascertaining whether it’s LTCG or STCG. In such a case the cost of the property will be the cost of the past owner.
LTCG are taxed at 20% and STCG will be taxed at the pertinent personal assessment tax rates for the NRI. This will depend on the absolute income which is assessable in India for the NRI.
At the point when an NRI sells property, the purchaser is subject to Tax Deducted at Source (TDS) of 20%. If the property has been sold before 2 years from the date of purchase, a TDS of 30% will be applicable.
However, NRIs are permitted to claim exceptions under Section 54 and Section 54EC on LTCG from sale of house property in India.
Exemptions
To claim exemption under Section 54, NRIs need to invest the gains in a house property. Unlike popular perception, you needn’t reinvest all of the sale proceeds in a house property. You need to only invest the LTCG amount to claim the exemption. Your exemption will be limited to LTCG amount.
Note that NRIs can buy the property possibly one year before the sale or 2 years after the sale of the property. NRIs are also permitted to put the gains in the construction of a property. However, the construction must be finished within 3 years from the date of sale.
The house property purchased should be in India for the NRI to claim the exemption. The exemption will not be applicable for properties purchased or constructed outside India.
If you are able to invest your LTCG by the date of filing of your income tax return for the financial year in which you have sold your property, you can deposit the money in a capital gains account. In your income tax return, by claiming this as an exemption from your capital gains you don’t need to pay taxes.
If you can save the tax on LTCG by investing them in certain bonds. These include bonds issued by the National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC). These bonds have a tenure of 5 years and must not be sold before that. Note that to claim this exemption, you will have to invest the LTCG in the bonds before the return filing date. NRIs are allowed to invest a maximum of Rs. 50 lakhs in a financial year in these bonds.
Mutual Funds
For tax on equity oriented mutual funds purchase by NRIs, LTCG is for investments that are more than 1 year. LTCG will be taxed at 10% if the gains exceed Rs. 1 lakh. STCG tax is 15%.
For debt funds, LTCG is for investments that are more than 3 years. LTCG is 20% with indexation benefit and STCG is 30% if the NRI belongs to the highest tax bracket.
Tax Exemption Certificate (TEC)
If an NRI’s actual tax liability is less than the rate of tax prescribed under the Income Tax Act, the NRI can get a TEC from the income tax department. TEC helps eliminate the need to seek refund and any delays in refund.
NRI will have to write to the Income Tax authorities and the application needs to be sent to the authorities in the same jurisdiction where the NRI holds his/her PAN. If the NRI is purchasing a property to get a tax exemption, the allotment letter has to be submitted to the tax authorities. If there is no allotment letter, NRIs can provide a copy of the payment receipt.
Here are scenarios where the NRI can apply for TEC:
Scenarios
TDS (%)
Actual tax liability (%)
STCG/LTCG on sale of property and re-investment in property/bonds
20%/30%
NIL / Lower than rate applicable
STCG/LTCG on sale of securities
15%/30%
NIL / Lower
Rental income
30%
NIL / Lower
Interest Income on NRO Deposits up to basic tax exemption limit
30%
NIL
The TEC certificate will be binding on the one who is required to deduct tax.
There are two sorts of taxpayers. There are ones who plan their taxes at the last minute and are in danger of committing certain expensive errors. Then, there are those who start their tax planning early and are better-situated to limit their tax outgo effectively. If you’re hoping to have a smooth tax saving plan and want to earn more in the process, you should start planning your taxes early. Here’s how you can do that.
Tax planning should come after financial planning
The most common mistake that people do is buying or investing in financial products that add no value to their life goals. For instance, a single earning member with no dependents buying an insurance policy to save taxes. Understand that financial planning is more important than saving taxes. First, you need to figure out your life goals and how much money you need to achieve those goals. Accordingly, choose suitable investment avenues and make tax planning a part of that process. The investments must first align with your long-term goals. Look at tax efficiency as an added benefit. Are yet to make your financial plan? Get in touch with consultants at wealthzi.com.
Start planning early
Investing in tax saving products at the last minute can reduce the returns that you could have earned on the same amount if you planned well on time. For instance, Rs. 50,000 invested in Public Provident Fund (PPF) in April will earn you more returns over the year when compared to investments made later in the financial year. Even money invested in an equity-linked savings scheme (ELSS) will earn higher returns, if invested in a staggered manner from the start of the year, rather than an amount invested later.
Calculate your tax obligation
Make an estimate of your tax liability for the financial year and use that to determine your monthly tax commitments. It will help you to determine how much your tax liability will be at the end of the year. If there is a change in your income in any month or quarter, you can easily increase or decrease your investments when you compare it to the tax plan.
Consider the allowances
There are several allowances that you might get from your employer. This could include food coupons, mobile reimbursements and internet bills. These lower your tax liability. When you plan your taxes consider these allowances. This will help you not put excess money in tax saving products, leaving you with funds for your household expenses.
Choose the right investments
When you start planning your taxes early, you have enough time to choose the right tax-saving instruments. Early tax planning provides you the time to carefully evaluate the returns offered by your shortlisted financial products and find out which ones are aligned with your financial goals and risk appetite. You should ideally select those investments that can help you achieve your life goals on time.
For instance, if you are near retirement, you may profit more by putting your resources into tax saving fixed income products that are safe, such as PFF, National Savings Certificate (NSC), among others. Then again, in the event that you are young and are looking for an exceptional yield, you should keep certain high-risk tax saving products such as ELSS in your investment portfolio.
It will be relevant to note here that there are different tax savings instruments that come with a lock-in time of 3 years, 5 years, and significantly more. You can pick one according to your life goals and the time needed to achieve them.
Invest in instalments
A typical mistake that people do is committing large sums of money as the financial year comes to a close. This isn’t very prudent. Truth be told, it’s smarter to contribute through instalments to benefit from rupee cost averaging while keeping liquidity worries under control.
As you draw closer to the end of the financial year, you can start increase or stop investing based on the limits under the Income Tax Act. For instance, under Section 80C the limit is Rs. 1.5 lakhs. There is no point investing more in 80C financial products if you have already exhausted the limit. Investing in instalments will help you assess your tax exemptions every month.
April is a good month for planning taxes in light of the fact that most organizations provide salary hikes at that time. It is not a bad idea to invest your bonus in tax-saving products at the start of the year so that you don’t have to worry about tax savings later.
Note the tax changes
There are many tax changes announced in the Union Budget ever year. For instance, earlier if you had capital gains from selling a house, you could use it to buy only one house for tax exemption. However, now you can buy two houses, if the capital gain amount does not exceed Rs. 2 crore. This can be done once in the lifetime of the taxpayer. Make a note of these tax changes that’s relevant to the financial year in which you file our tax returns so that you can save taxes in that year.
