Savings and Tax Savings

Nearing the end of financial year and emails from the finance department in the office to file in our investment proofs churns out a new idea. Tax is something that most people think is a waste of money. All of us want to pay lesser taxes. For this we are ready to make investments in financial instruments that would give us lesser returns compared to others but would save us tax. All these instruments are in some ways or the other linked to government's idea of savings. It wants us to save money and not spend all that we are earning. And saving money means putting it in a place in the economy where the risk of losing it is very small.

Now how does it help the government in promoting savings when it is actually giving you exemption and is going to get lesser revenue from taxes? The idea would be to use these low risk financial instruments to its own benefit so that instead of taking away 30% of your hard earned money, it is taking away 100% saying that it is safe. It is like borrowing 100% of the money.

Ok fine. So the finance ministry is trying to increase its own sources of income (or Credit limit) by increasing the exemption limit on the savings to upto 5 lac. But why put a limit? Why not allow people to save as much as they want and claim tax exemption on that amount? Well you would argue that in this case govt wouldnt get any taxes as CAs would make your taxable income to ZERO.

Good. Then how about this idea? 5 lac rupees is the limit to invest in tax saving instruments (ELSS, PPF etc). You can also get tax exemption on all the amount that you lend to the government. e.g. a 5 year FD that is owned by government. FD is the least risk financial instrument that I know of. So if you book a 5 year FD with the govt. you get tax exemption on that. Voila! Govt is getting more of the 100% rather than the cheap 30% in taxes.

But why would you put in govt FD? Imagine the situation. Say you put all your money into govt FD except the bare minimum that you want to live. You do so for 5 years. In the 6th year, your FD will mature and now you get the principal amount and the interest. The interest is an income for you so it is taxable but the principal amount is not. So now from the 6th year you can actually start booking FDs of all the taxable income that you have because you have the principal amount from the FD for your living!!!

All this means is that you dont pay tax (30%) but you lend all your money to the government assuming that the govt is a low risk customer to lend to and hence would never default on you.

Would you do that?


Mukesh Agarwal said…
well, the money which you put into savings aka 80C instruments doesnt go towards govt kitty alone; These savings are basically utilized in financing the credit and investment requirements of the economy. Funds under PPF are also used to provide pensions. FDs are deposited with banks, not govt directly and funds under FDs are utilized by banks for credit.
What govt makes sure through 80C instruments is that the funds are invested for sufficient long and known period of time. In short, tax benefits are incentive govt gives you to increase your savings which can be utilised for financing various investment requirements of economy(not necessarliy govt).Remember, there are no free lunches.
VG said…
I certainly dint mean free lunch. I am lending my money to the government for few years so that it doesnt tax me. I think it is a win win situation. Govt gets money for a fixed amount of time and can make whatever profits it wants with that by investing properly. And the profits could be higher than the taxes that I pay.

The reason is that if I invest myself and earn profits, govt is again going to charge tax on that.

So if I say that I am not greedy and I dont want to grow my money. All that I want is instead of paying tax let me lend the whole amount to the govt and let it return me just the principal amount that I had lent.
Rat said…
these are age-old schemes that r still running in our economy. but at least the news(rumours) that the tax slabs are getting revised (upto 10L 10%) is good news to all !
Mukesh Agarwal said…
@girish :
Savings thru 5 yr FD which earn you exemtion on principal but taxed on interest is better than not getting any returns at all on the deposit. If you are talking about the 1 lac limit on such deposits, then yes thats a point taken. But this should be addressed when this limit is increased to 3 L under new tax code.
S Janardhanan said…
There is only one catch in 'lending' a little too much in low risk instruments.

By default, low risk would also mean low return. Thus, if you invest 1 lac now (the max as per present norms) with the govt. for 5years, you would get no more than 30,000 as interest. Which means that after five years you have 1,30,000 with you. However, by that time, due to inflation it would only be worth around 85,000.

It seems to be more money but it isn't.

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