Paying Tax is better than Saving Tax! – Check out How?

Paying Tax is better than Saving Tax!, Here we are discussed various Methods for Saving Tax in India, In this article we discussed Can Paying Tax is better than Saving Tax, How to Save Income Tax in India, Why we pay tax instant of saving of Tax, Recently we discussed “Income from House Property

LTCG: Paying Tax is better than Saving Tax

THE FACT:

• Long Term Capital Gain (LTCG) is blatantly taxable @ 20%.
• No deduction under Chapter VIA (like u/s 80C towards PPF/LIC/NSC etc) is available against the Long term capital gain.

Tax Saving Options:

A tax payers having long term capital gain have the following two options:

• Pay Tax @ 20% or
• Save Tax by investing in Approved mode.

SAVING LTCG TAX U/S 54EC:

One of the most popular tax saving option for all spectrum of tax payers is to save tax by investing the LTCG in the bonds issued by the

• National Highway Authorities of India (NHAI) or
• Rural Electrification Corporation (REC).

This are very commonly referred to as the “54EC Bonds”.

The maximum amount that can be invested in such bonds is Rs. 50 Lacs p.a. Presently, Interest offered by NHAI/REC on this bond is around 6% p.a.

The fund has an opportunity cost. The fund, if not invested in the 54EC bonds, can be utilized elsewhere having higher return perspectives..

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The questions remains: Is it worth Investing in the bonds considering such a lower rate of interest offered?

This is particularly more important in the current scenario where
a] Bank FDR offers returns in the range of 9% to 11% p.a.
b] Mutual Funds/ Equity investment offering returns in the range of 15% to 20% p.a.
c] Business or Gold/ Silver or Other Investment yielding more than 20% p.a.

Of the two options available with the tax payer, paying or saving, which is favorable? At what rate of return, paying tax is better than saving tax?

Let us analyze the case of Mr. X who has earned a Long term capital gain of Rs. 10 Lacs during the F.Y. 2010-11. For the sake of simplicity, it is presumed that other income of Mr. X is in 30% tax bracket (i.e., 30.90% with Education Cess).

1^st OPTION:

SAVE TAX BY INVESTING IN THE 54EC BONDS:

• The interest rate offered by the bonds is around 6% p.a.
• After investment, the Long term capital gain tax liability would be Nil.
• X have entire amount of Rs. 10 Lacs to invest in the Bonds.
• The interest income from this bond is taxable.
• The value of 10 Lacs invested on 31.03.2011 @ 6% p.a. would be as  under:

Amount Invested Rs.	1000000
Interest offered	6.00%	6.00%	6.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	1000000	1041460	1084639
Interest Income [b]	60000	62488	65078	187566
Tax on Interest Income  [c]	18540	19309	20109	57958
Interest ater Tax [d] = [b-c]	41460	43179	44969	129608
Value of the Fund at the Year End [e] = [a+d]	1041460	1084639	1129608	1129608

RESULT: The value of the fund at the end of 3 years would be Rs. 11.29 Lacs.

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2^nd OPTION:

PAY TAX @ 20% & INVEST THE AMOUNT ELSEWHERE:

If Mr. X pays tax @ 20.60% (including 3% of education cess). He would be required to pay tax of Rs. 2.06 Lacs & would be left with amount of Rs. 7.94 Lacs to invest elsewhere.

The various investments option could be of Investment in:

• Bank FDR with interest in the range of around 9% to 10% or
• Equity Market/ mutual fund or in the business where the yield could vary depending upon the market conditions or the business prospective. Businessmen normally prefer to invest the amount in the business where they may able to earn even more than 20% return on the capital.

Let us compare the value of Rs. 7.94 Lacs invested by Mr. X at different rate

A] If the return is @ 9% p.a.:

Amount Invested Rs.	794000
Interest offered	9.00%	9.00%	9.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	794000	843379	895829
Interest Income [b]	71460	75904	80625	227989
Tax on Interest Income [c]	22081	23454	24913	70448
Interest ater Tax [d] = [b-c]	49379	52450	55712	157541
Value of the Fund at the Year End [e] = [a+d]	843379	895829	951541	951541

RESULT: The value of the fund at the end of 3 years would be Rs. 9.51 Lacs.

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B] If the return is @ 12% p.a.:

Amount Invested Rs.	794000.00
Interest offered	12.00%	12.00%	12.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	794000	859838	931136
Interest Income [b]	95280	103181	111736	310197
Tax on Interest Income [c]	29442	31883	34526	95851
Interest ater Tax [d] = [b-c]	65838	71298	77210	214346
Value of the Fund at the Year End [e] = [a+d]	859838	931136	1008346	1008346

RESULT: The value of the fund at the end of 3 years would be Rs. 10.08 Lacs.

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[C] If the return is @ 15% p.a:

Amount Invested Rs.	794000.00
Interest offered	15.00%	15.00%	15.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	794000	876298	967126
Interest Income [b]	119100	131445	145069	395614
Tax on Interest Income [c]	36802	40617	44826	122245
Interest ater Tax [d] = [b-c]	82298	90828	100243	273369
Value of the Fund at the Year End [e] = [a+d]	876298	967126	1067369	1067369

RESULT: The value of the fund at the end of 3 years would be Rs. 10.06 Lacs.

D] If the return is @ 18% p.a:

Amount Invested Rs.	794000.00
Interest offered	18.00%	18.00%	18.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	794000	892758	1003799
Interest Income [b]	142920	160696	180684	484300
Tax on Interest Income  [c]	44162	49655	55831	149648
Interest ater Tax [d] = [b-c]	98758	111041	124853	334652
Value of the Fund at the Year End [e] = [a+d]	892758	1003799	1128652	1128652

RESULT: The value of the fund at the end of 3 years would be Rs. 11.28 Lacs.

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E] If the return is @ 21% p.a:

Amount Invested Rs.	794000.00
Interest offered	21.00%	21.00%	21.00%
YEAR	I	II	III	TOTAL
Value of the Fund at the beginning of the year [a]	794000	909217	1041154
Interest Income  [b]	166740	190936	218642	576318
Tax on Interest Income [c]	51523	58999	67560	178082
Interest ater Tax [d] = [b-c]	115217	131937	151082	398236
Value of the Fund at the Year End [e] = [a+d]	909217	1041154	1192236	1192236

RESULT: The value of the fund at the end of 3 years would be Rs. 11.92 Lacs.

Now back to the place from where we have moved. What should Mr. X do?

If Mr. X is able to earn the return of more than 18.05% p.a., he may conclude that

“PAYING TAX IS BETTER THAN SAVING TAX”