As you scale up the professional ladder, you will find that taxes catch up mush faster than you expect. At the highest, you end up paying anywhere between 35%-42% as income tax per annum. Paying taxes is a civic duty you can’t escape, but it helps to know how you can take advantage of the most efficient taxation when it comes to your investment growth.
1. Capital gains are better than interest income
For those in the highest tax bracket, investment returns in the form of capital gains are always better and more efficient than earning interest or even rental income.
Interest and rental income are taxed at your marginal rate of tax or your applicable income tax rate, but capital gains tax rate is fixed. Capital gains essentially refer to the change in the principal value of your investment, change in price.
Instead of earning in the form of interest, you earn from the change in price. Capital gains can be long or short term; in case of the former, you have to hold the asset for at least 3 years if it is a bond or even a property investment and one year if it is listed equity. Short term capital gains are applied if the holding period is less than what’s mentioned above.
In the case of listed equity assets, long term capital gains are at 10% and short term at 15%. For bonds and other fixed-income investments, long term capital gains tax is at 20% with indexation, while short term capital gains tax is at the income tax rate.
In all cases, except the last one, it's best to go for investments which structure returns as capital gains.
At a basic salary of Rs 13 lakh a year, you are already contributing Rs 1.56 lakh as mandatory EPF at 12% per year. This means you don’t have to make any separate tax saving investment and the choice of where to invest is then solely left to your asset allocation and goal planning.
2. Structuring income in the form of dividend has no advantage
Until recently, dividend received by an individual investor from a company or a mutual fund scheme was exempt of any taxes. However, this has now changed and dividend received by an individual investor is taxable at the income tax rate applicable to the individual.
For example, if you pay tax at 35% then your dividends received (above Rs 5000) will also be taxed at the same rate. Hence, once again, you are better off relying on capital gains as a form of return rather than seeking dividend income, when it comes to measuring tax efficiency.
3. You may not need to invest in tax saving securities
Under section 80 C of IT Act, you can invest up to Rs 1,50,000 in tax saving investment options like specific mutual funds or public provident fund, which helps you save tax. Your contribution to the employees’ provident fund (EPF) is also deductible under this section.
However, once you are earning a higher salary which makes you eligible for a higher mandatory contribution to EPF, the entire amount eligible under Section 80 C will get covered by EPF. At a basic salary of Rs 13 lakh a year, you are already contributing Rs 1.56 lakh as mandatory EPF at 12% per year. This means you don’t have to make any separate tax saving investment and the choice of where to invest is then solely left to your asset allocation and goal planning.
Be mindful of these tax-related nuances as they can help you minimise that tax outgo just a little bit and ensure that you make the most efficient investment choices.