Playing it safe with your tax-saving investments

With March 31 just a month away, it's that time of the year when we scout for investment options to save taxes. Many of you may have been claiming deductions towards payment of insurance premium, investment in PPF, etc., for several years now; others who have just started out on their career could be exploring these options.

Both for the seasoned investor and for those testing the waters, the landscape may change in 2012, if the Direct Taxes Code (DTC), a proposed replacement for the Income-Tax Act, is enacted in its current form. So, what is changing and how should it impact your choice of tax-saving instruments today?

Eligible savings and investments tweaked

At present, deductions of up to Rs 1 lakh are allowed from gross total income, under Sec 80-C. Payment of life insurance premium, tuition fees for children, investments in ELSS (equity-linked savings scheme), ULIPs (unit-linked insurance plans), five-year bank deposits and provident fund contributions all fall under this limit.

Over and above this, there are deductions allowed for some expenses such as rent paid, donations and payment of medical insurance premium.

Under DTC, a similar Rs 1 lakh deduction for savings is available under a new Sec 69. What has changed is, however, the combination of instruments offered. Life insurance premium and tuition fees, which at present fall under the Rs 1-lakh limit, are pulled out and clubbed with health insurance premium.

Together, you can claim a maximum deduction of Rs 50,000, over and above Rs 1 lakh on these three expenses. A small, easy to understand change, isn't it ?

However, a closer look at the change shows that the taxman is trying to restore the now lost concept of ‘insurance', which has, over the years, been clubbed with ‘investment'. Here's why.

First, the combined cap of Rs 50,000 on three investments put together means that the amount claimed as deduction for life insurance premium needs to be lower than now.

Second, a condition that premium paid is deductible only if it does not exceed 5 per cent of the capital sum assured (it is currently 20 per cent), also points to the idea of a low premium, which, predominantly, is available in term (pure life insurance) products. Even if it is available in other types of policies, it is said that the term of the policy typically needs to be longer to get the deduction benefit under the new law. Also, receipts from the insurance company seem to be tax-free only on counts such as receipt on death of the insured and receipt on completion of the original contract, provided the premium paid is less than 5 per cent of the sum assured.

Term policy, a safe bet

All this means there is some uncertainty for popular schemes, such as money back, endowment plans and ULIPs.

Besides, deduction for payment towards annuity and deferred annuity products don't seem to be mentioned in the Bill, although the discussion paper released in June 2010 did mention that annuity schemes, along with pure life insurance schemes would qualify for exemption.

We need to wait and watch for any announcements on this. Contribution to some pension funds and ULPPs (unit-linked pension plans) may also be among the products where the tax exemption rules are not clear.

This implies that for existing policy holders and for those applying for such policies this year and next, the way premiums and maturity proceeds are treated today may be different from the way they will be treated later, if the DTC becomes law. However, a transitional regime might be provided, say experts.

So, if you are buying a new policy this year and don't like suspense or nasty surprises, term insurance seems to be the best choice.

The Direct Taxes Code asks us “to look at insurance, not as a financial product, but as an instrument for financial security of the family on the happening of a contingency”, said a tax-practitioner we spoke to.

The slightly tricky part done away with, let's go back to the Rs 1 lakh limit. Currently, investments in tax-saving mutual funds (ELSS), NSC (National Savings Certificate), five-year fixed deposits of banks, Senior Citizens' Savings Scheme (SCSS) and post-office time-deposits are eligible for deductions.

All these choices seem to have been done away with in the present DTC version.

Fillip for long-term savings

Nevertheless, you can make one-off investments in these instruments until the Direct Taxes Code replaces the existing law. By taking these off the list, the scope has, no doubt, been narrowed. But the lawmakers are also sending out a clear message.

Consider this — the ELSS has a lock-in of three years; an FD, five years; the NSC has a six-year term. The message is that you are expected to lock in for much longer terms (not just 3-5 years) when it comes to granting tax sops.

Secure options

That said, what are the avenues that could provide a safety net if the new tax laws come into effect?

The revised discussion paper proposed to provide the EEE (Exempt-Exempt-Exempt — that is, no tax at the time of investing, on the returns or on final proceeds) method of taxation for Government Provident Fund (GPF), Public Provident Fund (PPF) Recognised Provident Funds (RPFs) and the pension scheme administered by PFRDA.

Hence, these are expected to be “notified” when the law comes into force.

The NPS (New Pension Scheme) is also set to become attractive if its structure is tweaked to suit the conditions for EEE status, which the government proposes to do.

Hence, to play it safe today, over and above the contribution to employee provident fund that your organisation may be making from your salary, you can consider the PPF and NPS options to make maximum use of the Rs 1 lakh limit.

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