A person doesn’t know how much he/she has to be thankful for until he/she has to pay taxes on it! Exactly, in line with this thought, every return filing season, we count our blessings and find ways to save our taxes. The most popular being Chapter VIA deductions. It consists of expenses or investments eligible for deduction under Sections 80C to 80U. Life insurance premium, employees’ provident fund (EPF), public provident fund (PPF) and equity linked savings scheme (ELSS) investments are popular 80C deductions and medical insurance premium qualifies for 80D deduction.
However, there some instances when in spite of having incurred these expenses/investments you cannot claim the deductions. If the gross total income comprises of either (a) short-term capital gains (STCG) arising out of sale of equity as per section 111A or (b) Any long-term capital gains (LTCG), then you cannot claim the deductions under Chapter VI A (any section from 80C to 80U) from these incomes.
STCG referred to in (a) above are gains arising out of sale of listed equity shares or units of equity-oriented mutual funds or units of business trusts on a recognized stock exchange where securities transaction tax (STT) is paid; they are covered under Section 111A of the Act. Such STCG are taxed at 15% (plus surcharge and cess as applicable). LTCG is on sale of STT paid securities above Rs. 1 lakh is taxed @ 10%. Any other LTCG is taxed @ 10% with indexation or 20% without indexation.
Let’s see some examples: Anamika has just sold some land that she had held for five years for Rs. 10 lakh. The capital gain from the sale of this land amounts to Rs. 7 lakh. Anamika wants to know if she can save tax by investing in ELSS mutual funds. She cannot claim deduction under Chapter VIA from the income comprising of any LTCG. Hence, she will not be able to save tax by investing in ELSS.
Suppose Alka made STCG on sale of debt mutual funds of Rs. 5.50 lakh. She invested Rs. 1.50 lakh in ELSS mutual funds and assumes that she will not be liable to pay any tax as her net income will be Rs. 4 lakh, which will not be taxed due to rebate under Section 87A. In this case, she is correct as the STCG on sale of debt mutual funds is taxed at normal rates and not special rates under Section 111A. Hence, she can claim Chapter VIA deductions from such STCG and she will not be liable to pay any tax due to rebate under Section 87A.
Say, Akash has STCG on the sale of STT paid equity shares of Rs. 6 lakh during the year. He invested Rs. 1.50 lakh in PPF and assumes that he will not be liable to pay any tax as his net income will be Rs. 4.50 lakh, which will not be taxed due to rebate under Section 87A. However, this belief is not correct. Deduction under Chapter VI A cannot be availed on the STCG of STT paid equity shares. Hence, the taxable income of Akash will be Rs. 6 lakh and not Rs. 4.50 lakh. Taxable income being above Rs. 5 lakh, rebate under Section 87A will not be available to him. He will have to pay tax of Rs. 54,600 on income of Rs. 6 lakh less basic exemption limit of 2.50 lakhs.
Let see another example: Rahul earns a salary of Rs. 1 lakh and has STCG of Rs. 5.50 lakhs on sale of STT paid equity oriented mutual fund during the year. He invested Rs. 1.50 lakhs in PPF. He believes his net taxable income will be Rs. 5 lakh (1+5.50 -1.50) and accordingly he will pay nil tax due to rebate under Section 87A. However, this won’t be the case; Rahul can claim deduction under Chapter VIA only from the income which is not STCG under Section 111A or any LTCG. Hence, deduction will be available to the extent of Rs. 1 lakh which is salary income and not complete 1.50 lakh. Accordingly, the net taxable income will be Rs. 5.50 lakh (1+5.50-1) and tax of Rs. 46,800 will be due.
Since equity markets are booming, you may be thinking of booking some profits. Therefore, remember that for tax planning you need to take into account the above provisions and you won’t be able to claim Chapter VIA deductions against such capital gains. Most of us make tax-saving investments on the basis of our estimated income. Any error while arriving at estimated tax liability can impact the tax outgo at the time of filing income tax returns.
Nitesh Buddhadev, CA, is founder of Nimit Consultancy