In this article, we will discuss two tools, which, if used optimally, can
save you heavy taxes. When used simultaneously, they create an amazing
synergy in tax savings.
The first tool is your basic tax threshold. Readers would know that the
first Rs 1,10,000 of income is exempt from tax.
For non-senior women, the limit is Rs 1,45,000. For senior citizens (65
plus), the limit is Rs 1,95,000. So far, so good.
The second tool that works hand-in-hand with the first is known as Section
56 of the Income-Tax (I-T) Act.
It basically exempts cash gifts between relatives. Though there is a long
list specified in the section, for our purposes, suffice it to know that as
per the Act, you, your parents, your brothers and sisters and your children
are all relatives of each other.
Now, in order to understand how these two tools can be used for some smart
tax planning, let's take the example of one:
Mehta, who is 49 years old. He happens to be in a senior management job,
which puts him in the highest tax bracket.
His retired parents live with him. His wife is a home maker. And he and his
wife are proud parents of an 18-year-old daughter and a 20-year-old son,
both of whom are studying in college.
Read Mehta's profile once more, if you must, because it is important in our
scheme of things. Also remember that some of the numbers that are going to
be thrown up are astonishingly large. Don't get thrown off because of that.
This is just the power of these tools at work. You can use them at any
income level to suit your particular situation. What's important is
understanding the concept, individual numbers can always be plugged in.
Now, Mehta, like most of us, finds that all tax-saving investments in the
world can help him save a maximum of only Rs 33,900. That's not enough. His
tax outgo is much more.
Moreover, every rupee of post-tax income that he invests, in say, RBI
bonds, Bank FDs and Post Office MIS and the like is subject to the highest
If he doesn't want to pay tax, he is forced to take market risks by
investing in equity shares or mutual funds.
However, he finds the stock market too whimsical for his liking while it
gives a reasonably good return for a period of time, it is risky and
Already suffering from hypertension, no beta blocker in the world could
prevent his pressure from outswinging the market.
It was at this delicate juncture that Mehta was introduced to our tax
planning tools by an old chartered accountant friend. This is what Mehta did
after his brief, but illuminating, chat with his friend.
He gifted Rs 19.50 lakh to his father and a similar amount to his mother.
This gifted money was invested by his parents in a bank FD, yielding 10% per
This basically meant that both Mehta's father and mother earned Rs 1,95,000
as interest from the FD (10% of Rs 19.50 lakh). However, not a penny of this
is taxable as it is not beyond the initial tax slab available to senior
In one stroke, Mehta effectively made an income from Rs 39 lakh of capital
tax-free in the family's hands.
Hade he invested the funds himself, he would have paid full tax on it.
However, since the gift was tax-free and the tax slab was available, this
strategy could be put to work.
Now, Mehta finds that his children have some time to go before they start
earning. His daughter can earn up to Rs 1,45,000 without having to pay tax
and his son can earn Rs. 1,10,000.
But they aren't earning as of now, are they? They are studying and will
continue to do so for the next 5-7 years. So what does he do? He gifts them
around Rs 14.50 lakh and Rs 11 lakh, respectively.
This money, in turn, is invested in a similar bank FD by the kids, thereby
earning Rs 1.45 lakh and Rs 1.10 lakh, respectively. Of course, as explained
earlier, no tax would be payable.
In effect, by using two simple tools that the I-T Act offers, Mehta had
managed to make Rs 6.45 lakh of income tax-free for the family. Putting it
differently, over Rs 64 lakh of capital was deployed.
However, the income there from was totally tax-free. Note that it is not Rs
64 lakh of income that is rendered tax-free, it is the income on a capital
of Rs 64 lakh (around Rs 6.45 lakh) that is sought to be made tax-free.
Now admittedly, Mehta is an extremely rich man. He had Rs 64 lakh to spare
in the first place before trying to make it tax-free. Not everyone will have
this kind of money. However, the example given is an optimal one.
You can use a similar strategy with the funds at your disposal and the
benefit you derive will be proportional. In other words, it's not an all or
none strategy use it to the best of your ability.
Also note that Mehta's profile was an ideal one. Also, not every taxpayer
will have his profile. You father may be having taxable income but your mom
may not be working.
Or your children may be earning already. However, the idea is to use that
particular element in the equation which applies in your case directly.
Beyond a point (barring ideas such as discussed above) tax saving is not
possible. The worst mistake any investor could make is to invest with the
primary objective of saving tax.
The question to ask is would you have made the investment if it didn't
offer tax saving? If the answer is no, don't touch the investment.
It's better to try and optimise, post tax income instead of making a
sub-optimal investment just to save on tax. Or like Donald Trump says, some
of your best investments are the ones that you don't make.
We examined above a simple yet effective tax planning tool. By way of a
background, when the provisions of Sec. 56 (relating to tax on gifts) and
the basic exemption limit below which income is tax-free are used in
conjunction with each other, there emerges an immense potential to earn
We saw how Mehta, who was in the highest tax bracket otherwise, managed to
convert the return on almost Rs 64 lakh of his capital into tax-free income.
This was essentially done by way of effecting gifts of one's post-tax
capital to one's parents and major children, who were not taxpayers
When the recipients of the gifts invest the money, the entire family can
earn income free of tax.
Subsequently, several readers wrote in seeking clarifications.
While space constraints would preclude replying to each and every query,
today's piece seeks to address issues that readers came up frequently with
in trying to put this tax planning strategy into practice.
First and foremost, Dominic has posed a question that seems to be on the
mind of several other readers, too. He asks about the procedure to carry out
the gifts and whether it is necessary to make a gift deed on a stamp paper.
Well, it is better to prepare a gift deed and get it registered (with
related stamp duty), but such a precaution is needed in the case of
high-value gifts, particularly those of real estate.
All that is required is an offer by the donor and acceptance thereof by the
recipient carried out in black and white. In other words, the donor can
offer the gift and the donee should accept the same in writing (maybe
through a thank you note).
It is preferable to mention the relationship between the donor and the
donee and both parties concerned should keep this document on file for ready
reference whenever needed.
Bhairwani and Mondkar, both pose a similar question. They want to know that
gifts given to parents or kids would attract clubbing provisions and/or gift
In this regard, readers ought to know that gift tax is discontinued in
India since October 1, 1998 and hence there is no question of the
transaction coming under the purview of gift tax.
As far as clubbing is concerned, if you recall, Mehta's wife wasn't amongst
Also, both of Mehta's children were above 18 years of age. In other words,
clubbing provisions can and will be attracted in the case of gifts made to
spouse and minor children.
However, family members (except spouse) who are major (above 18 years of
age) can freely be given any amount of money as a gift without the donor
coming into the clubbing net.
Arora inquires if he can give a gift to his minor child and whether the
mode of payment should be cash, cheque or a demand draft.
The first point has been addressed - that giving a gift to one's minor
child will indeed attract clubbing provisions and consequently tax incidence
in the hands of the parent. As to the mode of payment, a cheque would best
suit the purpose.
Deepak Chikramane asks if he gives a gift to his parents, they may have to
file a tax return.
Well, the purpose of the entire plan is that income from the gifted money
shouldn't entail earning taxable income. Hence, care should be taken to
ensure that income from the gifted amount doesn't take the parents' income
above Rs 1.95 lakh.
If the income of a senior citizen is Rs 1.95 lakh or less, there is no
necessity of filing a tax return. Kapoor asks whether this strategy can be
carried out with respect to family trusts and Hindu undivided families.
Regrettably, the answer is in the negative. Remember, the money gifted by a
relative is tax-free. A trust or an HUF, by definition cannot have
relatives, can they?
Kishor Meswani provided a useful suggestion almost an embellishment to the
tax-planning strategy. He suggests that each recipient can potentially be
given a further Rs 10 lakh each.
At the rate of say 10%, this will result in an extra income of Rs 1 lakh,
which, in turn, can be invested in any Sec. 80C instrument. This way, a
further Rs 4 lakh income or Rs 40 lakh of capital can be sought to be made
Added to the earlier Rs 64 lakh, this would mean Mehta and family can earn
tax-free income on a capital of over a crore!