You must file your tax returns – here’s why

For all tax paying people the August 31st now looms as the deadline, by which you need to submit your tax returns for last FY. New tax payers find it quite overwhelming, many people just avoid it through ignorance or laziness and others depend on their CA or Tax consultants to get it done. It is important to understand the need for filing tax returns and also how one can do it in a fairly easy manner.

First things first – why do we need to file a tax return in addition to paying our taxes? The answer is simple too – our tax deductions are automatic in some cases, partial in others and not there at all in some. It is therefore important for the IT authorities to determine whether you have taken all of your income into account and paid relevant taxes for the same. A few examples will make it clear :-

  • For your salary income TDS is deducted as per your tax calculations fully.
  • For your rental income of any property there is no TDS unless rent is more than 50000 per month. Here too the TDS is at 10 %.
  • For your FD interest TDS is charged at 10 %.
  • For your PO MIS interest, no TDS is deducted.
  • For your Savings bank interest, no TDS is deducted.
  • For your Capital gains from asset sales, no TDS is deducted.

As you can see from here if you just depend on TDS and think you have paid all your taxes, you are quite mistaken. Ideally you should be calculating your tax liability based on your overall income, during the year, and pay advance taxes to cover up the additional tax payment required. These advance taxes can be paid any time during the year and for a quarter the cut off date is normally 15th of the last month. So for the second quarter of this FY, the advance tax payment deadline should be 15th September. If you have extra taxes to be paid, based on your first quarter income then make sure that you pay it off by that date. For the last quarter of the FY, the date is 15th March.

However, if you have not done it this way in the last FY then what is your choice now? You need to file your tax returns with accurate information so that your total tax liability for last FY can be determined. If the tax deposited so far is less than this, you will need to pay the balance tax. This is easily done in the income tax website. In case you do not have an account there, create it using your PAN for registration.

What happens if you do not file the tax return? For one there is no real option and you will be fined heavily if you delay filing beyond July 31st. Also anything associated with your PAN can always come under scrutiny and the first thing IT authorities will check is your Tax return form. If you have not filed it, or filed it with inaccurate information then you are going to face a much sterner examination.

So all said and done, you will need to file your tax returns. In case you are not up to doing it yourself use a Tax Return Professional ( TRP ) to help you. You can, of course, go to a CA but they are more expensive and unless you have multiple sources of incomes that need complex book keeping I will not advise it.

There are some posts in the blog where I show you how you can take care of your income tax and learn enough to calculate your taxes and file returns on your own. It is actually quite simple to do once you lose your initial reluctance.

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E-Filing tax returns – How to derive your taxable income correctly?

First the good news – due to increased volume of tax payers this year, the deadline for filing IT returns is extended by a month till August 31st. So, if you were one among the many who were late, you can still go ahead and file your returns now. With the penalty for filing delayed returns starting from this year, it makes immense sense do it on time. It is the right thing to do, you have a chance to rectify it if required, your refunds get processed quicker.

It is important to understand that you need to account for ALL income when you are trying to arrive at your taxable income in a Financial year. In fact, some of these incomes may well be exempt from taxes but it still needs to be declared in the form. In the terminology of Income tax, there are 5 heads in which you need to categorise your income. These are as follows:-

  • Salaries
  • House property
  • Profits or gains from Business or Profession
  • Capital gains
  • Other sources

Let us look into these income sources one by one. For most people filing tax returns, salaries are the bulk of their income. This will be your source, if you are employed by a company or business or another individual and get paid for your time. It does not matter whether you work full time or part time, as long as there is an Employee – Employer relationship, the income can be classified as salaries. When you need to give data for your tax filing purpose, note the following :-

  • Your Employer has to give you Form 16 which will record the total salary paid including the monetary value of perks, exemptions allowed for different allowances like HRA and Transportation, Exemptions under 80 C, 80 D etc.
  • The Form 16 also shows the total tax deducted as TDS and the tax liability. This is why some people think that is enough for tax return filing. However, this is not true as you will be having other sources of income in most cases.

Income from House property is relevant if you own one or more house property. You need to remember the following while filling up this schedule:-

  • Even if you are staying at the house, it still needs to be documented in the ITR returns. For self occupied houses the income will be nil.
  • If the property is rented you have to show the actual income from it. Many people think that for a single house there is no need to declare income – this is completely incorrect and you must never get into this.
  • Standard deduction on income from house property is at 30 % and you can also charge for any taxes or other regulatory expenses incurred in the house.
  • Interest can be charged up to a maximum of 2 lacs per house.
  • After all these deductions from rent received during the year the total income from House property will be calculated.
  • If you have a single house and it is not occupied by you and not rented out, then you can take the income as nil.
  • If you have 2 or more properties there will be a deemed income from all other properties except the first one, even if none of them are rented out.

Most salaried people earlier did not have any income from business or profession but it is becoming more commonplace now. There are of course, many others who do not have a salary but have income from business or profession. While looking at income from this head, you need to keep the following in mind:-

  • If your Business turnover is more than 2 crores or your professional income is more than 50 lacs, you will need to maintain a set of Accounting books and these will have to be audited as per laid out procedure.
  • For others the business income can be taken to be 8 % of gross receipts in business and return filed accordingly.
  • For professionals with less than 50 lacs gross receipts, you can charge 50 % expenses and take the rest as income.
  • In case you are showing income on presumptive basis, as in the above 2 cases, you will not be able to charge any other expenses to the business.
  • If the above does not work well for you, there is always the option of maintaining books, getting them audited and filling up the returns in a more complex manner.
  • For example, if your business turnover is 1 crore but your profits have only been 2 lacs, you will have to maintain books and proceed accordingly.
  • For a professional earning 40 lacs but having 30 lacs as business expenses, it will again make sense to maintain books and show only 10 lacs as income.

Capital gains can arise out of the sale of any asset such as Real estate, gold, Equity, Debt etc. The important things to be kept in mind are as follows:-

  • Short term capital gains are added directly to your income, Long term capital gains will get indexation benefits.
  • For equity LTCG requires holding period of 1 year and is taxed at 10% from the Financial year 18-19. So if you sell your shares after holding them for a year now, you do need to pay taxes on your capital gains. For the last year, these gains are exempt from tax, however, you do need to report it.
  • For debt LTCG is applicable after 3 years of holding and indexation benefits are there. The tax on the Capital gain post indexation is 20 %.
  • In order to save on Capital gains you can put the gains in Capital Gain bonds.
  • For real estate, as long as you invest the capital gains to buy something new it will not be taxed.

Other income is literally everything else from dividends, interests, lottery earnings, winnings from horse races etc. Some common mistakes people do are as follows:-

  • Where TDS is not deducted at all, such as in Post Office MIS, you must declare the interest as taxable income.
  • Where 10 % TDS is deducted as in Bank FD, you must again declare the total interest earned. 
  • Even if no TDS is deducted as you have given form 15 G / H to the bank, the interest earned by you must be declared.
  • Interest exempted from taxes such as interest from Tax free Bonds etc need to be shown too at the appropriate locations.
  • Dividends are again tax free in your hands but need to be shown.

I hope with this you will be able to get all your income recognised correctly. After this you will need to look at taxes paid and if any other liability is there still. We will take this up in the next post as this is already too long.

My experience in E-filing of ITR 3 in 2018

I have been using the Income tax e-filing site for a long time now and have been a tax payer since I started working in 1988. Of course, in those days all tax filing was manual and I used my offices to calculate taxes, pay them and also file the returns. Till 1998 or so this worked quite well as I had only my salary to work with as my source of income.

As the sources of income increased, the complexities also did and I got introduced to TDS from Fixed deposits etc and the need to pay extra taxes as Advanced tax. Even though the tax filing was still being done by my office people, I was able to calculate my tax liability with the help of Form 16 and Form 26 AS. With passing years, my sources of incomes were more – a house property, capital gains from equity/debt funds, consulting income, dividends, interests and so on. This was also the time when I engaged a CA to file my tax returns as the ITR 4 was quite involved. As a consultant, I had to show business income and the expenses needed to be maintained along with depreciation claims etc.

In the budget of 2016 the Finance minister did a great service to all professionals like us by saying that you can claim 50 % of all your gross receipts as expenses. So since last year ,I decided to try filing the ITR 3 on my own. When I got the Excel utility first, my heart sank by seeing all the schedules, but on closer examination I realised that not too many of them had to be filled up by me. Before that though, I had to get all my information in order. This involved the following:-

  1. Looking at Form 26 AS to record both TDS by my Clients as well as the Advance tax paid by me in September 2017.
  2. As there was no TDS in Post Office MIS interest, I made a note of it separately.
  3. All my Debt investments were in ICICI Direct and I got the Capital gains statement from there.
  4. I went through all cash receipts in my 2 main bank accounts, ICICI and HDFC and divided those into the following categories for filling in ITR 3 later :-
    • Receipts from rental of my Chennai apartment.
    • Interest from the savings bank accounts.
    • Dividend from Equity MF and stocks.
    • Receipts from my Consulting income.
    • Receipts from redemption of my FMP investments.
    • Receipts from interest in Tax free bonds.

Once the above data was gathered it was just a case of putting these in the right places in the form. Not all schedules needed to be filled and even in the ones which did, not all fields were needed. For example, the P & L schedule that is surely the most complicated, I just had to fill up 3 lines as my income from profession was less than 50 lacs last year.

One important consideration here is to ensure that you are using all possible exemptions from tax and not only 80 C provisions. For example, Medical insurance both for your family and your parents are tax exempt up to 50,000 Rs, Savings bank interest are tax exempt up to 10,000 Rs and donations are tax exempt for charities. Apart from these, I was also able to claim 5000 Rs per month for the House rent exemption, as I am not getting a salary and therefore do not have benefit of HRA.

The good thing about the ITR forms is that you can fill up each sheet and validate them individually, before you proceed to the next one. After you calculate the tax, you can get the overall ITR 3 validated too. Once this is done the XML can be generated. This is where I had an issue. There is a schedule in ITR 3 where you are supposed to declare your assets if your income in the year is more than 50 lacs. I did not fill this up as my income in the FY was not greater than 50 lacs. However, as I had put some income from house property, the software was checking if the asset was declared in the schedule. It was good I could read XML and was therefore able to correct it.

After that it was easy going, the XML had to be uploaded and the acknowledgement had to be e-verified. As my Aadhaar number was already linked to my PAN it was pretty straightforward. The total time taken was about 5 hours – 4 to get all the data in place and only an hour to actually fill up ITR 3.

The most crucial part in filling up these forms is to understand how you can arrive at your taxable income. Note that even income that may not be taxable such as dividends or interest from tax free bonds needs to be recorded in the form.

I will do another post to clarify as to how you can take care of both these issues correctly.

Equity MF dividends – the whole story

After my last few posts I am getting a lot of enquiries from people as to what they should do about their schemes with dividend options now. Many are unclear about the tax and how will it be treated in their hands. In this post I wanted to demystify the dividends from equity MF and suggest ways about how you can deal with them.

To begin with let us understand how a Dividend option of an MF scheme is different from a stock. Any company, whose stock you hold, will pay you dividends from the profits that it makes in a quarter or year. Based on the amount of dividend paid the stock price will normally fall initially but may well rise later. In the case of a Dividend paying MF scheme, the dividends are being paid out from the assets held by the scheme. As some of these assets are liquidated the NAV of the fund will necessarily fall after a dividend is declared. Yes, it may rise again if the stocks in the MF scheme portfolio do well but it is fundamentally different from the stocks.

Let us now examine the taxation aspect of dividends before and after the budget. When a company declared dividends it was out of the profits where taxes have already been paid by the company. Therefore the dividend that investors received was tax free. In the case of equity MF schemes too they did not pay any holding tax and whatever dividend the investor got was again tax free in their hands. After the budget the situation remains the same for stocks but has definitely changed for MF schemes. These will now have to hold a tax of 10 % before distributing the dividends to the investors. This is the Dividend Distribution Tax ( DDT ) newly introduced in this budget. Remember that Debt funds always had a DDT of more than 28 % earlier and continue to do so.

How does this change things for you now? Well, for one you will have lower dividends for your equity MF schemes due to the DDT. Typically this will be 10 % lower. It will continue to be tax free in your hands. For example, I had invested 2 lacs in the dividend option of a  Value Fund series NFO from ICICI. Every year I would get 15000 Rs dividend from this investment. All things remaining equal, the value of this dividend after the new DDT rule will be 13500. If an investor is depending on these dividends for passive income then he will need to get this shortfall from somewhere else.

In general Dividend option is not a good idea for equity MF now – note that companies pay tax on their earnings and this is reflected in the stock price and also the level of dividend they pay to their investors. Equity MF are investing in these companies and are again paying DDT. Finally when you redeem these investments you will again be charged LTCG tax at 10 %. It will be much better to just deal with the Growth option where you just pay LTCG tax when you redeem your units.

Let us now look at some classes of investors who are currently invested in these MF schemes and what they should do about it:-

  • If you are in the active income earning stage of your life, there is no logic in having Dividend options for your MF schemes. Change all of them to growth. Even if you need the money you will be better off just redeeming some units as and when you need to do so.
  • If you had chosen this option in order to do some explicit profit booking by the Fund houses then your concept was wrong. Fund Managers will churn their portfolios as and when required and these benefits will reflect in the NAV of your scheme. There is really no need to invest in the Dividend option for it. You should also change it to Growth option.
  • People in the retired or FI state may have invested in these schemes as a means of getting regular income. Some Balanced funds have schemes where they distribute a monthly dividend. Note that all of these are subject to DDT now – so either you will get less dividend in your hands or the fund NAV will fall more if the same dividend is to be maintained.

Except in the last case, where some people may want a hassle free receipt of dividend as compared to redeeming units on their own, there is really no point in Dividend options of MF schemes now. In fact, with online redeeming being possible, anyone can sell units of MF schemes rather easily and I will definitely recommend that.

Short conclusion to the story – change all your MF schemes to Growth option right now!!

How should you invest in Mutual funds now?

Whichever way you want to look at it, the Finance minister has definitely sent all MF investors in a tizzy with his LTCG taxation on equity. This was always likely to happen and many investors, used to a diet of high growth with no taxes to account for, are shocked and wondering what they should do with their existing investments and new ones. I will give you a very clear recipe in this post that you can follow effectively.

To begin with, the popularity of MF investment through SIP were due to two main factors. The first was the marketing skills of the Fund houses and the awareness on inflation created by the myriad financial blogs and Facebook groups. Investors realised that traditional investments such as Fixed deposits, PPF, LIC schemes, Bonds etc would not keep pace with inflation and they had to look at equity to a certain extent for meeting their important life goals. For these set of people, investing in MF seemed like a less risky idea as compared to direct equity. The successful model of sales and distribution put in place by Fund houses have ensured that they have mopped up amounts nearing 1 lac crore annually.

However, there was another reason which many are not cognisant about. When the Finance minister change the LTCG indexation benefits from 1 year to 3 years in his first budget, he actively pushed people away from schemes like Fixed Maturity Plans. With declining interest rates, longer holding period and reduced inflation unfavourably affecting the indexation benefits, suddenly Debt funds were really not a good option for people wanting to park their money in short term. The Fund houses responded by coming up with schemes like Arbitrage funds and Equity Savings funds where the safety was greater than pure equity funds, returns were better than Debt funds and the holding period needed to be one year only for getting tax exempt returns. Many Fund houses even offered monthly dividend on Balanced MF schemes which were particularly suited to retired people, in search of a regular monthly income.

Thanks to the FM all this is a matter of the past now. Given the current situation, how should you deal with your MF investments? I have put together some simple guidelines for different types of investors, that will give you a clear road map of what you should do:-

  • If you are an investor whose goals are still some time off:-
    • Keep investing in your SIP as before but add 10 % to the amount for taking care of the eventual taxation.
    • Make sure you have only Growth option schemes in your portfolio as it makes little sense to get dividends now, unless you really need it.
    • If you have set up STP for your monthly flows into SIP, evaluate if this makes sense. You will be taxed for selling the funds now.
    • As churning is detrimental to your returns now, make sure you select the right MF schemes and stick to them for the long term. Yes, you still need to review etc but change the scheme only when really needed.
    • The longer you hold your investments the better it will be for you. Redeem only when you actually need the money, not otherwise.
  • If you are an investor with major goals coming up:-
    • Check out if you can meet your goals through existing Debt investments and keep your MF investments running for a longer term.
    • If this does not work, redeem from your MF schemes only the amount you need right now for the goal. For example if your child’s college fees are 20 lacs in 4 years and 5 lacs per year, then redeem only to the extent of 5 lacs.
    • If the markets manage to go up beyond the Jan 31st levels within March ( this is unlikely, but you never know ), redeem your MF units to the extent of the money you need for your goals in the next Financial year.
    • As before, avoid Dividend options and if you have any MF schemes with these then change it to Growth.
  • If you are retired or in need of regular passive income in your Financially independent state:-
    • If you had set up Arbitrage funds, Equity Savings funds or invested in Dividend option of some close ended equity NFO’s check your taxation impact and decide if it is making sense.
    • If you are a senior citizen take advantage of the 50000 Rs interest exemption and the LIC scheme with 8 % interest.
    • Rearrange your MF investments so that you only get the Dividend amounts that you need regularly. For any sudden or unplanned expenditure, you can always redeem your MF units within a day.
    • Do not churn your MF investments needlessly, you will end up paying more taxes by doing this.
    • Finally, even in the new tax regime, do not give up on equity MF. It is important for you to remain invested as a hedge to inflation.

As you can see from above, there is a need to take stock and possible reorganise your MF portfolio. However equity as an asset class and Mutual funds as an investment vehicle are still the best in the business and you should continue to bet on them.

If you have any specific queries I will be happy to answer them through my Blog or through the two Facebook groups that I run.

 

MF investments and LTCG tax – the real impact

With a lot of heat and dust about the LTCG taxation on equities one aspect of it, namely, the real impact of the tax on an investor’s long term return have largely got very little attention. I was made aware of it through an article by Dhirendra Kumar of Value Research Online and largely agree with what he has said. As many of the investors may have missed out on this, let me try and explain it in this post.

Now, we all know that it is possible for equity to grow at a rate of 12-15 % in a long term period of 10 years and more. Of course, the growth in equity is non-linear, meaning you may well grow 30 % in a year like 2017 and even have negative growth as in 2008 and 2011 etc. If we look deeper into the growth of our MF investments we will see there are clearly 2 parts to it – first is the inflation prevalent in the economy and the second is the real return you get on your investment. For example, if your MF investments have grown by 15 % and inflation during this period was 8 % then your real return is 7 %. In general, your real return can exceed 10 % in a good year for the markets and will be in the range of 4-8 % in other years. Again, if the markets turn negative or are mostly sideways in a year then your real returns may well be negative.

With this backdrop, we will take an example to understand the impact of the recently introduced LTCG tax on equities on your MF returns:

  • An investor starts investing through SIP in one of the popular MF schemes from April 1st 2018. Let us say the amount is 20000 and he wants to do it for 15 years.
  • At 12 % annual returns he will get about 1 crore, which he plans to use for his daughter’s higher education.
  • His overall LTCG will be to the tune of 64 lacs and the tax thereon will be 6.4 lacs.
  • Now if we assume that the inflation component is 6 % and the real returns are also 6 % then the real returns are to the tune of 32 lacs.
  • In effect you are paying 6.4 lacs tax on a 32 lac real gain – this comes to 20 % and not 10 % as most of us are given to understand.
  • This situation could have been corrected if indexation was allowed but that has not been done in the case of LTCG on equities.
  • The 1 lac exemption etc has very little meaning for people looking at a large goal as it will be an insignificant part as compared to the goal amount.
  • In simple terms you are being taxed on inflation too, which is grossly unfair !!

In terms of the goal itself, you will need to increase your monthly SIP amount by 1281 Rs so that you are having the required goal amount after taxation.

So what can you do from your end to see that you minimise the taxes at least? Well, for one, you can spread the redeeming over the years of college so that the impact will be shared over 4 years or so. This will not affect the total tax outgo but you will feel better that your tax payment at one time does not appear so horrendous.

I hope the intelligent readers would have understood the real dangers here. Even if your real return is much lower, say 10 % you still pay a lot of tax. For the above example at 10 % returns your LTCG is 47 lacs and you pay tax of 4.7 lacs. As a percentage of real return you are now talking of well over 30 %. If your real returns are even lower if the market tanks in that year, then the tax paid as a percentage will be even higher.

The conclusion is a simple one – by not allowing for indexation the FM has really dealt a body blow to long term investors who have been investing seriously over the last several years and have played a stellar role in the success of our stock markets.

What strategies can you adopt for your investments? I will take this up in another post.

LTCG tax on equities – How to calculate?

Since I have started writing this blog there has been three budgets and I normally get a lot of queries after every budget. In this budget, understandably the maximum number of queries have been in the tax treatment of equities, where LTCG has been taxed at the rate of 10 %. I was thinking of doing a post on this but a CBDT circular clarifying the different scenarios has made my task easier.

As I do not believe in reinventing the wheel, let me just reproduce here what the circular says. I am doing this so that people reading my blog have easy access to it:-

The computation of long-term capital gains in different scenarios is illustrated as under‑

Scenario 1 — An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 250.

As the actual cost of acquisition is less than the fair market value as on 31st of January, 2018, the fair market value of Rs. 200 will be taken as the cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 250 — Rs. 200).

Scenario 2 —An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150.

In this case, the actual cost of acquisition is less than the fair market value as on 31stof January, 2018. However, the sale value is also less than the fair market value as on 31st of January, 2018. Accordingly, the sale value of Rs. 150 will be taken as the cost of acquisition and the long-term capital gain will be NIL (Rs. 150 — Rs. 150).

Scenario 3 —An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 50 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150.

In this case, the fair market value as on 31st of January, 2018 is less than the actual cost of acquisition, and therefore, the actual cost of Rs. 100 will be taken as actual cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 150— Rs. 100).

Scenario 4 — An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 50.

In this case, the actual cost of acquisition is less than the fair market value as on 31stJanuary, 2018. The sale value is less than the fair market value as on 31st of January, 2018 and also the actual cost of acquisition. Therefore, the actual cost of Rs. 100 will be taken as the cost of acquisition in this case. Hence, the long-term capital loss will be Rs. 50 (Rs. 50 — Rs. 100) in this case.

I hope with this all the readers would have got a very clear idea on how the tax is to be calculated. However, the more serious issue is the real impact of the tax on your investments you have been making for the long term.

The news on that front is unfortunately not a good one – I will explain in the next post.