Do you invest to save tax?

Arnav Pandya

Sometimes an investment that cannot be bought due to unattractive returns and benefits it offers, is actually bought just for the purpose of saving tax. There is a clear way in which every individual has to approach this situation and here are some of the main points that can be considered in this analysis.

Nature of tax benefit

There can be two types of tax benefits that an individual can get when they make a certain investment. The first one involves the benefit at the time of making the investment. It is a deduction that is available when the money is invested. A deduction means that the amount is reduced from the taxable income of the individual so this would end up lowering the tax that has to be paid. This is the kind of benefit that one sees when there is an investment that is covered under Section 80C of the Income Tax Act in instruments like insurance premium, National Savings Certificates, PPF, EPF etc.

The other tax benefit is that the income that is earned on the investment has a beneficial tax treatment. This could either be a part of the income that is tax free or it could be that the entire income is tax free. There is also a chance that the income earned from a specific investment route has a tax rate applicable that is lower than what would be witnessed for similar earnings from other areas. All this would make the route slightly attractive for the investor. Both these types of tax benefits by themselves might not shift the decision to one of investing but it can sometimes help in the overall process.

Usage of limits

There is also a situation wherein there are limits that present for a specific benefit like the deduction under Section 80C where there is an overall limit of Rs 1.5 lakh. It could be that there are other elements or other routes wherein this limit is being used up and in such a position the additional tax benefit actually could be working out to be nothing for a specific investment because it is already being used up. Many times people do not realise this point and they keep making investments under the belief that there is a tax benefit coming to them when this might not be the case. Also it could be that there is a position where the savings in income tax due to the benefit on the income side is also not significant which can turn around the entire working. In such cases it would be better to stay away from the investment and use other options that are more suitable for achieving a specific goal.

Single or multiple investments

Various types of investments have different implications and one aspect that needs to be considered is the kind of money that would have to be invested by the individual over a period of time. Most people look at the present and what they see as the cost in terms of making the investment only immediately. But this need not be the whole story because it could be that there are several investments where there are regular payments that come in year after year. For example, buying a regular premium life insurance policy that expects buyer to pay for certain minimum number of years. In such a situation there is a longer and a larger investment commitment that the individual is making and this also needs to be factored in the calculations. It might not be prudent or suitable for everyone to make long term investment commitments and hence this should be brought into the investment decision making process.