The Hindu Business Line : A bankable way to saving tax

In Budget 2006, one of the concessions given to individual taxpayers is in respect of term deposits with scheduled banks for a period of not less than five years.

Hence, a taxpayer making a deposit up to Rs 1 lakh can claim deduction under Section 80C, which would result in a tax saving of a maximum of 30 per cent (excluding surcharge and cess).

Table 1 shows the tax saving for assessees (with various income levels) investing in fixed deposit for five years or more.

An assessee can opt for a bank deposit with a tenure of five years or more and enjoy deduction under Section 80C.

This means he can have a flexible investment pattern for each year and there is no fixed commitment like in an insurance policy. Based on the income of the respective years, tax planning is possible by investing in bank deposits.

Whether bank deposits would be the preferred investment for taxpayers is the issue to be decided.

In the case of Public Provident Fund (PPF), the interest is exempt under Section 10.

With the omission of Section 80L from assessment year 2006-07, bank deposit interest is liable to tax. However, there is a lock-in period for PPF unlike in the case of bank deposits.

Table 2 gives the comparative calculations of PPF and bank deposits with demand loan on the bank deposit subsequently.

In the Table it is assumed that the depositor has own sources of funds and, hence, wants optimal tax benefit. Whether bank deposit interest scores over National Saving Certificate VIII is yet another issue.

As in PPF, there is a minimum lock-in period for investments in NSS.

Suppose, Rs 1 lakh is invested in fixed deposit for five years.

An assessee will save at the maximum 30.6 per cent.

He can take a demand loan pledging the deposit to the extent of 80 per cent and, thereby, recover Rs 80,000 immediately.

He has to pay interest at 2 per cent more than the deposit interest towards the demand loan. For five years, the 2 per cent interest will work out to 10 per cent, thereby reducing the net tax saving to 20 per cent.

If the demand loan were used for business, the interest payment on demand loan would be a deductible expenditure, yielding a tax saving of 3 per cent (30 per cent of the interest of 10 per cent). Effective tax saving will then be 23 per cent.

Thus, because of the amendment to Section 80C proposed in the Finance Bill, 2006, a financial strategy may well me to deposit in scheduled banks for five years in March, and, in the next one or two months, take a demand loan to the extent of 80 per cent and, thereby, reduce the resultant tax liability.

More Stories on : Income Tax | Fixed Deposits

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