TAX PLANNING? TIME TO REVISIT THE IDEA

TAX PLANNING? TIME TO REVISIT THE IDEA

Every last quarter of any financial year, we find a deluge of articles focussing on tax planning. Where there is smoke, there must be some fire too. With years of messaging, we do believe that the investor approach to tax planning would have improved. However, the entire concept of tax-planning itself needs to be repainted in a very different light. In this article, we will attempt to deviate from the traditional approach to tax planning and adopt a fresh look.

1. What is Tax Planning?

The idea of making financial decisions purely from the perspective of saving taxes is very outdated idea. Perhaps the definition of tax planning itself needs to be revised. Traditionally, tax planning would mean an exercise to minimize tax liability by investing in tax-saving avenues. However, the problem with this is the lack of focus on the selection of the right products which fit your need. Rather, the focus is on how tax liability can be minimized.
A contemporary definition of tax planning would be to “ensure tax-saving opportunities are optimally utilized while choosing the right mix of investment/saving products that match your needs/financial objectives”. Here, we bring back the focus to the person rather than the tax sections.

2. Tax Planning Approach

Traditionally, the tax planning process will include an assessment of the extent of your tax liability first. It will help you to ascertain how much would be your tax liability at the end of the year, and accordingly, you can fine-tune your tax-saving investment steps during the year. Next, which tax avenues are already exploited and which are still available for use will need to be assessed. This should serve just as a reference point and should not influence you into buying /exploiting the remaining avenues.
While we cannot find any fault with this process, the entire exercise sounds like an accounting exercise and perhaps rarely one would be following them. We need a change in our approach. Tax planning should be an outcome or by-product of other important things.
The entire process should start at the beginning of the financial year. After identification of your financial goals and investment objectives, a clear investment and insurance portfolio should be designed. Selection of the investment products should be based on the parameters like your risk profile, financial objective, liquidity needs, the risk-return trade-off, etc. For insurance, a proper assessment of needs for the entire family should be considered and the right product should be selected after consulting your insurance advisor.
Exploring the best options available for tax saving within these boundaries should be the last step. If your financial situation permits, and if you have tax avenues remaining unused, you may choose to do product shopping, but this too has to be with proper due diligence. The best tax-savings instruments enjoy the exempt-exempt-exempt (EEE) tax status. EEE means an individual gets tax benefit on investment, on accrual, and at the time of redemption. Similarly, EET would mean that the product will be taxable at the time of maturity /redemption. Investment products generally come with a lock-in period which may extend to even 15 years (PPF) which also needs to be considered while making the final decision. Equity-linked saving schemes (ELSS) of mutual funds are a better option in terms of liquidity as it has the lowest lock-in of three years. However, the returns are market-linked and not guaranteed like that of government-backed products like EPF, PPF, etc.

3. Guiding Rules For Tax Planning

Here are the simple guiding rules on how any tax planning exercise should be undertaken…
 
  • Spend /Buy only if you had done the same if there was no tax saving advantage. In other words, you should have a clear necessity /requirement of the product, independent of tax savings potential. Obviously, the product itself should be great and should pass the scrutiny test based on your needs. There is no need to think only of the 33% of the tax-saving while turning a blind eye and letting go of 66% of your portfolio into a wrong product which you will be stuck with for many years.
  • Do not spend more than what is required. There can be two ways people can err here – going beyond the tax savings required by you and/or going beyond the upper limit permitted under the the IT Act. However, since the focus is on the right mix of products, one may go overboard here. For e.g., an insurance product based on your needs may be beyond the upper limit under the tax laws. This would not mean you compromise on your need and limit the premium only to the extent permitted.
  • Do not over-diversify and blindly invest in every available tax saving avenue. Sometimes, smart sales guys make the last-ditch effort to sale during the January to March quarter when the urgency of tax planning is highest amongst a certain section of investors. Do not let your guard down and be gullible to such sales tactics and messaging.
  • Do not make a last-minute decision. Ideally, the investment /insurance portfolio evaluation should start at the beginning of the financial year. Tax advantage should not be the core element while deciding any such portfolio but a by-product. For e.g., if you have planned to start a SIP of Rs.30,000 in equity mutual funds, Rs.10,000 may be allocated to say ELSS portfolio to take advantage of section 80C.

4. Why Last Minute Tax Planning Is Not Good?

We, humans, have a tendency to procrastinate our work, be it at the office or at the home. Tax planning is no exception. Many of us wait till the end of the financial year to start tax planning. Unfortunately, this approach is not good, it is recommended that tax planning should be done right at the beginning of the financial year, as earlier discussed. Here are the reasons to avoid last-minute tax planning.

The most common mistake that many people commit in a hurry to complete the tax-saving exercise is choosing the wrong product, without weighing the pros and cons properly. One may end up choosing a product just for tax-saving reasons.

When you are investing last minute you may not fully examine the various investment avenues available to you. You may even miss out on better products that may not offer tax benefits.

This will help you avoid the urgent pressures on your finances during the last few months. It would be great is the investments are planned in advance, and you spread the investments throughout the year. This may also put pressure on your monthly incomes due to the immediate outflow of money and may cause unnecessary stress.

When you are investing last minute, there are chances you might make operational mistakes while investing. There have been instances where last-minute applications rejections resulted in failure to meet the 31st March deadline. Not only does your effort go to waste, but you also lose out on the tax-break just because you waited till the last day.

Conclusion

Tax planning simply cannot be considered as a year-end exercise in numbers. It goes much further. We have to somewhere change our traditional thinking when it comes to the word ‘tax’. Tax planning is not the domain of your chartered accounts but of financial product experts /advisors /distributors who can create that perfect fit for you as per your needs. We wish you save tax but much more than that, we wish that you earn a lot more, create wealth, prosper and enjoy financial well-being.