10 ways to reduce your family's taxes
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K.Karthik Raja
Aug 5, 2008, 3:46:36 AM8/5/08
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10 ways to reduce your family's taxes
Typically, taxpayers tend to focus on ways of reducing only their own
tax burden. This is a normal thing to do, but far greater tax savings
are possible when the family as a whole is considered as a tax paying
unit.
By combining the leeway offered by non-taxpaying members of a family,
and judiciously sharing the family income and wealth among all its
members, you will find additional ways of reducing your family's tax
burden. Here is how:
You may like to explore the following possibilities of sharing of
income and wealth within the members of your family in order to lower
the overall tax liability.
Create an HUF (Hindu Undivided Family) so that the family property and
family income is assessed separately from that of the individual
members of the family. Tax practitioners can help you in creating an
HUF in a perfectly legal manner.
Open as many assessment files as possible for the members of your
family, including minor children.
Keep separate accounts for all the gifts received on birthdays and
social functions so that they can form the sources of future income
through suitable investments.
To avoid problems of the clubbing provisions, you may consider making
a gift to your would-be spouse or your son's would-be-spouse. Such pre-
marital gifts do not attract the clubbing provisions.
If you are the karta of your HUF, you may make gifts within reasonable
limits to the members of your family out of the HUF properties and
build their separate assets.
Since the income-clubbing provisions apply only so long as your
children are minors, you may gift them some assets where the income
will be received by them only after they attain 'major' status, e.g.
10-year cash certificates, zero-coupon bonds, etc.
Some smart assessees do not gift anything to their spouses. Instead,
they organise exchange of assets to avoid clubbing provisions, e.g. a
husband exchanges his 1,000 Colgate equity shares with the jewellery
owned by his wife (since Stridhan is the absolute property of the
lady).
Since the accretions to income arising on the transfer of asset does
not attract the clubbing provisions you can gift any amount which can
be invested by your wife or daughter-in-law in 9 per cent fixed
deposit, etc. It is only the interest on such amount gifted that is
included in the income of the individual. The interest on interest
does not attract the clubbing provision.
Since a genuine loan of any amount to your spouse or children does not
attract the clubbing provisions, loan any amount (create evidence to
avoid hassles in future) to children and spouse, which they may invest
in income earning assets.
You can use the Public Provident Fund scheme for building up capital
of your minor children. If you have two children you can open two PPF
accounts and deposit Rs 15,000 in each account every year. You will
get tax deduction under 80C. Moreover, interest on PPF is totally
exempt from income tax. Thus, when children become majors, you would
have created capital for them while enjoying the tax benefits in the
interim.
An example of family-wide tax planning
Let us now consider a comprehensive example of tax planning for a
family of husband and wife with two children.
You can, of course, modify and improve it to suit to your specific
income and tax needs. But it offers several key insights into the
principles and strategies of tax planning.
Gupta's gross salary
A N Gupta is an executive working for a well-known company. His gross
salary per month is Rs 30,000 made up as under:
Salary
Rs 20,000
House Rent Allowance
Rs 6,000
Conveyance Reimbursement
Rs 6,000
Total
Rs 30,000
Gupta lives in a flat owned by his wife and pays a monthly rental of
Rs 8,000. Mrs Gupta pays Rs 12,000 towards municipal taxes.
Under the present rules, the entire house rent allowance received by
Gupta is exempt from tax. Similar is the case with conveyance
reimbursement, assuming that he spends the entire amount.
Gupta's take-home pay
Thus, his take-home-pay is as under:
Rs
Salary
20,000
Less: PF Contrinution (10%)
(-) 2,000
18,000
HRA
(+) 6,000
24,000
Gupta's income from house property
Gupta purchased a flat in his own name by taking a loan of Rs 10 lakh
(Rs 1 million) from his employer @ 6% p.a. repayable over 20 years.
The annual installment is Rs 50,000 and the interest paid during
2008-2009 is Rs 60,000. Gupta gets a monthly rent of Rs 10,000 from
this flat and pays Rs 20,000 towards municipal taxes.
Thus the income from house property of Gupta will be calculated as
under:
Rs
Annual value (Rs 10,000 x 12)
120,000
Less: Municipal taxes
20,000
Net annual value
100,000
Rs
Less: 30% standard deduction
(-) 30,000
Interest on loan
(-) 60,000
10,000
Gupta's family expenses and investments
Gupta's family expenses are about Rs 18,000 p.m. on various household
expenses. Gupta's wife has deposits in banks to the tune of Rs 162,500
earning 8% p.a.
There is a Public Provident Fund account opened by Gupta in his minor
son's name. Gupta deposits varying amounts in the PPF account every
year to minimize the tax liability. This year he invested Rs 21,000 in
PPF account and contributed Rs 5,000 in Unit-linked insurance plan of
the Unit Trust of India.
All the birthday gifts amounting to Rs 50,000 received by his son were
pooled up by Gupta and invested in about 600 shares of Gamma Infotech
Ltd @ Rs 83 in May 2000.
The company gave a bonus issue of 1:1 in 2001. Thus, the number of
shares increased to 1,200. In May 2007, the son sold these shares @ Rs
251 per share. He is now 19 years old.
Rs
Sale value (Rs 251 x 1,200)
301,200
Less: Indexed cost of acquisition (Rs. 600 x Rs. 83) 551/406 x 49,800
67,586
The acquisition cost of bonus shares is Nil.
Rs
Taxable long capital gains
233,614
The long term capital gains are exempt. However
Transaction tax @0.125 % is payable
292
Post tax proceeds (301,200 � 292)
300,908
Thus, by the time he became of major, Gupta's son had a capital of his
own to the tune of Rs 300,908.
The total picture
Let us now look at the total picture:
1. Mr. Gupta's Income (A.Y. 2009-10)
Rs
Rs
Salary (Rs 20,000 x 12)
240,000
Income from house property
10,000
Total Income
250,000
Less: Deductions
Section 80C
PF (Rs. 2,000 x 12)
24,000
PPF
21,000
ULIP
5,000
Repayment of Loan (principal)
50,000
100,000
Taxable Income
150,000
Tax
Nil
2. Mrs. Gupta's Income
Rs
Rs
i) Income from house property
Annual Value
96,000
Less: Municipal Tax
12,000
84,000
Less: 30% Standard deduction
25,200
58,800
Interest on Bank deposits
13,000
Total Income
71,800
Tax
Nil
3. Master Gupta's Income
Out of his capital, he invests a sum of Rs 300,000 in 8.5% SLR Power
Bonds and earns a tax-free interest of Rs 25,500 p.a.
Summary
Mr Gupta
Mrs Gupta
Master Gupta
Total
Rs
Rs
Rs
Rs
Gross Income
150,000
71,800
25,500
247,300
Tax
Nil
Nil
Nil
Nil
As Gupta needs about Rs 18,000 p.m. for household expenses, let us
look at the family cash flows:
Cash Flows
Mr Gupta
Rs
Rs
Inflow
Salary + House property income + HRA)
408,000
Outflow
PF
24,000
Housing Loan
110,000
Municipal taxes
20,000
ULIP
5,000
PPF
180,000
Net inflow
228,000
Mrs Gupta
1,000
Master Gupta
25,500
Total inflow for the fmaily
254,500
Thus, the cash flow position will be quite comfortable leaving a
surplus of nearly Rs 38,500.
This example of the Gupta family shows how any family can prosper by
careful planning of investments and tax.
Let us repeat once again: don't give importance to the specific
numbers in this example. Try to understand the broad principles,
modify and use them in your specific context.
K.Karthik Raja
Research Analyst.
Typically, taxpayers tend to focus on ways of reducing only their own
tax burden. This is a normal thing to do, but far greater tax savings
are possible when the family as a whole is considered as a tax paying
unit.
By combining the leeway offered by non-taxpaying members of a family,
and judiciously sharing the family income and wealth among all its
members, you will find additional ways of reducing your family's tax
burden. Here is how:
You may like to explore the following possibilities of sharing of
income and wealth within the members of your family in order to lower
the overall tax liability.
Create an HUF (Hindu Undivided Family) so that the family property and
family income is assessed separately from that of the individual
members of the family. Tax practitioners can help you in creating an
HUF in a perfectly legal manner.
Open as many assessment files as possible for the members of your
family, including minor children.
Keep separate accounts for all the gifts received on birthdays and
social functions so that they can form the sources of future income
through suitable investments.
To avoid problems of the clubbing provisions, you may consider making
a gift to your would-be spouse or your son's would-be-spouse. Such pre-
marital gifts do not attract the clubbing provisions.
If you are the karta of your HUF, you may make gifts within reasonable
limits to the members of your family out of the HUF properties and
build their separate assets.
Since the income-clubbing provisions apply only so long as your
children are minors, you may gift them some assets where the income
will be received by them only after they attain 'major' status, e.g.
10-year cash certificates, zero-coupon bonds, etc.
Some smart assessees do not gift anything to their spouses. Instead,
they organise exchange of assets to avoid clubbing provisions, e.g. a
husband exchanges his 1,000 Colgate equity shares with the jewellery
owned by his wife (since Stridhan is the absolute property of the
lady).
Since the accretions to income arising on the transfer of asset does
not attract the clubbing provisions you can gift any amount which can
be invested by your wife or daughter-in-law in 9 per cent fixed
deposit, etc. It is only the interest on such amount gifted that is
included in the income of the individual. The interest on interest
does not attract the clubbing provision.
Since a genuine loan of any amount to your spouse or children does not
attract the clubbing provisions, loan any amount (create evidence to
avoid hassles in future) to children and spouse, which they may invest
in income earning assets.
You can use the Public Provident Fund scheme for building up capital
of your minor children. If you have two children you can open two PPF
accounts and deposit Rs 15,000 in each account every year. You will
get tax deduction under 80C. Moreover, interest on PPF is totally
exempt from income tax. Thus, when children become majors, you would
have created capital for them while enjoying the tax benefits in the
interim.
An example of family-wide tax planning
Let us now consider a comprehensive example of tax planning for a
family of husband and wife with two children.
You can, of course, modify and improve it to suit to your specific
income and tax needs. But it offers several key insights into the
principles and strategies of tax planning.
Gupta's gross salary
A N Gupta is an executive working for a well-known company. His gross
salary per month is Rs 30,000 made up as under:
Salary
Rs 20,000
House Rent Allowance
Rs 6,000
Conveyance Reimbursement
Rs 6,000
Total
Rs 30,000
Gupta lives in a flat owned by his wife and pays a monthly rental of
Rs 8,000. Mrs Gupta pays Rs 12,000 towards municipal taxes.
Under the present rules, the entire house rent allowance received by
Gupta is exempt from tax. Similar is the case with conveyance
reimbursement, assuming that he spends the entire amount.
Gupta's take-home pay
Thus, his take-home-pay is as under:
Rs
Salary
20,000
Less: PF Contrinution (10%)
(-) 2,000
18,000
HRA
(+) 6,000
24,000
Gupta's income from house property
Gupta purchased a flat in his own name by taking a loan of Rs 10 lakh
(Rs 1 million) from his employer @ 6% p.a. repayable over 20 years.
The annual installment is Rs 50,000 and the interest paid during
2008-2009 is Rs 60,000. Gupta gets a monthly rent of Rs 10,000 from
this flat and pays Rs 20,000 towards municipal taxes.
Thus the income from house property of Gupta will be calculated as
under:
Rs
Annual value (Rs 10,000 x 12)
120,000
Less: Municipal taxes
20,000
Net annual value
100,000
Rs
Less: 30% standard deduction
(-) 30,000
Interest on loan
(-) 60,000
10,000
Gupta's family expenses and investments
Gupta's family expenses are about Rs 18,000 p.m. on various household
expenses. Gupta's wife has deposits in banks to the tune of Rs 162,500
earning 8% p.a.
There is a Public Provident Fund account opened by Gupta in his minor
son's name. Gupta deposits varying amounts in the PPF account every
year to minimize the tax liability. This year he invested Rs 21,000 in
PPF account and contributed Rs 5,000 in Unit-linked insurance plan of
the Unit Trust of India.
All the birthday gifts amounting to Rs 50,000 received by his son were
pooled up by Gupta and invested in about 600 shares of Gamma Infotech
Ltd @ Rs 83 in May 2000.
The company gave a bonus issue of 1:1 in 2001. Thus, the number of
shares increased to 1,200. In May 2007, the son sold these shares @ Rs
251 per share. He is now 19 years old.
Rs
Sale value (Rs 251 x 1,200)
301,200
Less: Indexed cost of acquisition (Rs. 600 x Rs. 83) 551/406 x 49,800
67,586
The acquisition cost of bonus shares is Nil.
Rs
Taxable long capital gains
233,614
The long term capital gains are exempt. However
Transaction tax @0.125 % is payable
292
Post tax proceeds (301,200 � 292)
300,908
Thus, by the time he became of major, Gupta's son had a capital of his
own to the tune of Rs 300,908.
The total picture
Let us now look at the total picture:
1. Mr. Gupta's Income (A.Y. 2009-10)
Rs
Rs
Salary (Rs 20,000 x 12)
240,000
Income from house property
10,000
Total Income
250,000
Less: Deductions
Section 80C
PF (Rs. 2,000 x 12)
24,000
PPF
21,000
ULIP
5,000
Repayment of Loan (principal)
50,000
100,000
Taxable Income
150,000
Tax
Nil
2. Mrs. Gupta's Income
Rs
Rs
i) Income from house property
Annual Value
96,000
Less: Municipal Tax
12,000
84,000
Less: 30% Standard deduction
25,200
58,800
Interest on Bank deposits
13,000
Total Income
71,800
Tax
Nil
3. Master Gupta's Income
Out of his capital, he invests a sum of Rs 300,000 in 8.5% SLR Power
Bonds and earns a tax-free interest of Rs 25,500 p.a.
Summary
Mr Gupta
Mrs Gupta
Master Gupta
Total
Rs
Rs
Rs
Rs
Gross Income
150,000
71,800
25,500
247,300
Tax
Nil
Nil
Nil
Nil
As Gupta needs about Rs 18,000 p.m. for household expenses, let us
look at the family cash flows:
Cash Flows
Mr Gupta
Rs
Rs
Inflow
Salary + House property income + HRA)
408,000
Outflow
PF
24,000
Housing Loan
110,000
Municipal taxes
20,000
ULIP
5,000
PPF
180,000
Net inflow
228,000
Mrs Gupta
1,000
Master Gupta
25,500
Total inflow for the fmaily
254,500
Thus, the cash flow position will be quite comfortable leaving a
surplus of nearly Rs 38,500.
This example of the Gupta family shows how any family can prosper by
careful planning of investments and tax.
Let us repeat once again: don't give importance to the specific
numbers in this example. Try to understand the broad principles,
modify and use them in your specific context.
K.Karthik Raja
Research Analyst.
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