They may not be aware, but even honest individuals can end up evading tax. Find out if you also fall foul of tax laws and how to stop doing it.
Do you know somebody who is guilty of evading taxes? Most people would, because the Income Tax Act has created more criminals than any other legislation in the country. Don’t think all tax evaders are suspicious-looking characters with wads of unaccounted money stacked in lockers. Even seemingly honest and upright citizens could be underpaying tax. It’s a malaise more widespread than the common cold. From school teachers to engineers, from banker to sales executives, millions of Indians may be liable for penalties, even prosecution, for under-reporting their income or not paying the due tax.
In most cases, however, the taxpayer is an unwitting offender, an innocent criminal, who doesn’t even know he is falling foul of the tax laws. A survey of salaried taxpayers, who filed returns through Taxspanner.comin 2011, shows that 96% did not report any income from other sources. “Every salaried person would have a savings bank account and some interest income would definitely accrue to the balance every six months. This income has to be reported in the tax return but is overlooked by most taxpayers,” says Sudhir Kaushik, co-founder and CFO of Taxspanner.com.
Not reporting the interest income in your savings bank account is a minor offence compared to other, more serious, lapses. Take the wealth tax payable on certain assets if their combined value exceeds 30 lakh. If someone has a second house that is lying vacant, its value is included. Rising gold prices may be a reason to smile if you have lots of it in your locker, but physical gold attracts wealth tax. Given that investment worth thousands of crores of rupees has flown into the realty sector and gold in the past three years, and prices have shot up 100-200%, the wealth tax collection has risen at a suspiciously slow pace of 30-35% during the same period. “Tax authorities don’t seem too bothered about wealth tax evasion,” says Homi Mistry, partner, Deloitte Haskins and Sells.
This doesn’t mean the taxman is not doing his job. The 10-figure alphanumeric number that is your PAN is under constant surveillance. Almost every financial transaction now requires PAN. Whenever someone makes a high-value transaction or investment, the bank, fund house, brokerage or credit card company has to report it to the taxman. “Tax officials can peek into your financial life by just keying in 10 figures into theircomputerised database,” says Delhi-based chartered accountant MK Agarwal. The best way to avoid getting caught on the wrong foot is to pay your taxes honestly. But this is possible only if you are aware of where you are going wrong. We have identified 10 common tax traps in which honest taxpayers often fall. Find out if you are also making these tax mistakes and how to stop doing so.
1 Ignoring income from investment in the name of spouse, kids It’s a common practice to invest in the name of your spouse or children. What you should be aware of is the clubbing provision for the income earned through such investments. Any money received from a spouse is taxfree, but if it is invested, the income from that investment is added to the income of the giver and taxed accordingly. So, if you bought a house in your wife’s name, any income from that house, whether as capital gains when you sell it, or as rent, will be treated as your income. If she did not contribute any funds for buying the house, you will be taxed for the entire income. Similarly, if a husband has invested in fixed deposits in the name of his wife, the interest earned will be treated as his income.
The rules are slightly different in case of investments in the name of minor children (below 18 years). The earnings are treated as the income of the parent who earns more. However, the taxman has softened the blow here. There is an exemption of 1,500 a year per child up to a maximum of two children.
If you are still bent on making such investments, there is a way out. Invest in tax-free options, such as the PPF or tax-free bonds from infrastructure companies like NHAI, IRFC, Hudco, etc. However, the 1 lakh annual investment limit in the PPF is the combined limit for you and your child. Also, tax-free bonds don’t offer a very high interest. You can also consider investing in Ulips, where the income is tax-free. Keep in mind that the income from a Ulip may not remain tax-free if it doesn’t meet the conditions laid down by the Direct Taxes Code (DTC).
Another way to avoid clubbing is to invest in mutual funds. This is a very effective way to invest for children because you can defer the tax liability indefinitely. While equity and balanced funds are anyway tax-free after one year, for others the tax is levied only when you withdraw the amount. If the sum is withdrawn after the child has turned 18, it will be treated as his income, not yours.
2 Ending life insurance policy before three years Priyanka Gupta doesn’t know it, but the life insurance policy she bought last year could turn her into a tax evader. The 26-year-old marketing executive wants to junk the endowment plan because it doesn’t suit her. She knows she will lose the 45,000 she paid as the first year’s premium, but doesn’t realise that she will also have to pay the tax benefit that she availed of last year. If an insurance policy is terminated before three years, the tax benefits under Section 80C are reversed. Since she is in the 20% tax bracket, Gupta will have to pay another 9,000 when she dumps her plan.
Very few people know this rule and even fewer follow it. In the past five years, roughly 5 crore life insurance policies have been terminated before they completed three years. “The onus of reversing the benefit and paying the tax for the previous year is on the taxpayer. If he doesn’t pay, it amounts to concealment of tax liability and could even invite a penalty,” warns Agarwal.
Of course, this will not be required if the policyholder did not avail of the Section 80C tax benefit on the premium. For many taxpayers, the 1 lakh limit is easily exhausted by other tax-saving options. However, if you had mentioned the policy in the Section 80C break-up in your tax return, then the benefit will stand reversed. There’s a small window of relief here. If you had other tax-saving investments (school fees, pension plans, etc) which were not mentioned in the form, file a revised return with the new Section 80C break-up, excluding the junked insurance plan. This is possible only if you had filed your return by the due date and your assessment has not been completed till now.
“The tax department can peek into your entire financial life by keying in your PAN in its computerised database.” MK AGARWAL
SENIOR PARTNER, MAHESH K AGARWAL & CO
3 Not including interest income in your tax return Isn’t it great that banks now offer 4% interest on your savings bank balance instead of the earlier 3.5%? Some are even giving 6%. Do you know that this small, yet very visible, addition to your income is fully taxable? Not just bank interest, but the interest on infrastructure bonds, NSCs, fixed deposits and recurring deposits has to be declared as income from other sources in your tax return. It doesn’t matter if you have the cumulative option and will get the interest on the bond or fixed deposit only on maturity. Income is taxed on an accrual basis and the tax is paid on it every year. In some cases, the bank or financial institution will deduct TDS before paying you the interest. It doesn’t mean you can ignore the income. TDS is only 10% and if you are in a higher tax bracket, you have to pay more tax. As the table shows, even if a person earning 50,000 a month cleans out his zero-balance bank account within 3-5 days of the payday, he will earn some interest that will have to be reported. If he maintains an average daily balance of even 10,000 in his savings account, he will earn 400 from this source.
“Not knowing about the law is not an excuse. The onus is on the individual, and if you furnish incorrect information in your return, you can be penalised.” RAKESH GUPTA
PARTNER, RRA TAXINDIA
4 Selling a house bought on loan within five years
If you thought the reversing of tax benefits on a life insurance policy dumped within three years was stiff, the rule regarding property is tougher. If a house is sold within five years of purchase, the tax benefits availed of under Section 80C for the repayment of the principal also go out of the window. Again, just as in the case of prematurely terminated life insurance plans, the onus is on the individual to pay the tax arrears. Mind you, one cannot get away by saying that one didn’t know about the rules. Unawareness of the law isn’t an excuse. Even if your return is prepared by a tax professional, you are the one the taxman will haul up. “The individual is liable for any act or omission of the tax professional,” says Delhibased chartered accountant and noted tax lawyer Rakesh Gupta.
In the early stages of a home loan, the principal portion constitutes a smaller part of the EMI while the interest is chunkier. How is that for a silver lining in this dark cloud?
5 Not including ornaments in wealth tax
It never hurts to be too rich, does it? Yes, if you have to pay tax on it. Wealth tax is payable if the market value of certain assets (see graphic) exceeds 30 lakh. The tax is 1% of the combined value of the assets exceeding 30 lakh. Even though Indians have accumulated a lot of wealth over the past few years, the growth in wealth tax collection has been tardy. This is surprising, especially because gold ornaments are among the list of assets that attract wealth tax. Gold prices have more than doubled in the past three years—from about 14,200 per 10 grams in March 2009 to almost 28,000 now. However, wealth tax collection has risen very slowly—from 385 crore in 2008-9 to 504 crore in 2009-10, and 557 crore in 2010-11. Where is the wealth tax that is payable on this gold?
The penalty for evading wealth tax is quite stiff. The minimum penalty is 100%, which can go up to 500% of the tax sought to be avoided. The DTC is even sterner for tax evaders. It has proposed an imprisonment of a minimum of three months and it can go up to seven years.
However, as Mistry says, “Wealth tax evasion is not on the radar screen of the tax authorities right now.” This could change, though. Worried about the slowdown in tax collection, the CBDT has started a drive against tax evasion.
This should also serve as a cautionary note for those who are pawning gold to raise loans from NBFCs. The taxman may want to know where you got the gold from. It’s easy to say that you got it as inheritance from your grandmother or as a gift at your wedding. Even so, if the value of the assets listed below exceeds 30 lakh, you are required to declare them in your wealth tax return. So, the next time you take 25-30 lakh worth of gold to the pawn shop, make sure that you paid tax on it in the previous years. Incidentally, gold ETFs are financial assets and, hence, not included in the computation of the wealth tax. Some banks even offer loans against gold ETFs. This is, apparently, a better and safer way of unlocking the value of your gold holdings.
“The wealth tax is seen by the authorities as an ancillary tax. It is better to abolish it but this doesn’t mean you can ignore its provisions.” HOMI MISTRY
PARTNER, DELOITTE HASKINS & SELLS
6 Receiving gifts and cash from unrelated persons If you plan to gift your fiancee an expensive diamond ring on Valentine’s day, we suggest you wait till the knot is tied. Gifts of more than 50,000 in a year from an unrelated person are taxable. Your gift might evoke mixed emotions in your fiancee—she will love you for your generosity, but might hate you for your thoughtlessness on tax matters.
However, gifts given by certain specified relatives (see box) are not taxable. However, gifts to spouses and minor children will attract clubbing provisions as specified earlier. Also, gifts received on certain occasions, such as marriage and religious ceremonies, are also exempted. If, however, the value of gifts received on your marriage is inordinately high, the taxman may want to know who the generous givers were.
In case of gifts from unrelated persons on other occasions, there is a limit of 50,000 in a financial year. Not all gifts are in cash, so the fair value of the gift will be used to ascertain its taxability. If you get gifts worth more than 50,000, the entire amount will be added to your income for that year and taxed accordingly. The amount is to be shown as income from other sources in the tax return form.
Gift tax also comes into play when real estate is bought for less than the stamp duty value. If the difference between the sale price and stamp duty exceeds 50,000, the amount is deemed as a gift to the buyer and he is taxed on it.
Gifts only from the following relatives are tax-free
• Spouse
• Parents
• Siblings of self and spouse (and their spouses).
• Siblings of either parent (and their spouses).
• Lineal ascendants or descendants of self and spouse (and their spouses).
7 Not paying wealth tax on second house
Wealth tax can haunt you on another front—investments in real estate. If you have a second house that is lying vacant, its value has to be included while computing your wealth tax liability. If this were not bad enough, here’s worse. Even if the house is lying vacant, you have to pay tax on the notional rental income from the property. This deemed income is calculated on the basis of the market rent in the locality. It’s a fact that many taxpayers are blissfully unaware of. It could make them tax evaders if they don’t pay wealth tax on their property or include the deemed rent in their tax return.
The taxman has given property owners certain concessions on the wealth tax front. Any loan outstanding against the house will be subtracted from the market value of the property. Also, if you rent out your house for at least 300 days in a financial year, it will not attract any wealth tax. The best part is that the taxpayer is free to declare any one property as selfoccupied so that it escapes the wealth tax. So, if you have a 60 lakh property in the suburbs lying vacant, while you live in another 25 lakh house closer to your workplace and the children’s school, you can let the low value house be used for the wealth tax calculation while the costlier property can be exempted. This option can be changed every year.
The valuation of wealth is carried out at the end of the financial year. If a person sells the house before 31 March, its value will not be included in the net taxable wealth. However, this can work both ways. If he strikes a deal to buy the house just before the valuation deadline, the property will attract wealth tax.
8 Both spouses claiming tax benefit on same expenses
Your tax planning for the year has been a breeze because your child’s school fee is quite high. Before you submit photocopies of the payment receipt to your employer for deduction, make sure that your wife hasn’t availed of the same tax benefit. Though it is not expressly specified in tax laws, both spouses cannot avail of the tax benefit for the same expense. Similarly, only one of you can claim the tax benefit for the medical insurance policy bought for the family. Logically, the individual who has made the payment will be allowed to claim the deduction. However, employers seldom question the validity of the tax deductions claimed by the employer in his investment declaration for the year. The Income Tax Department also doesn’t have the infrastructure to track each and every deduction. “These are minor issues that may not be picked up by the tax authorities, but if you get
snared in a bigger tax-related case and there is a scrutiny, they can dig up everything,” warns Delhi-based chartered accountant Mukesh Goel. At that time, you will find it difficult to explain why the deduction was claimed twice. If you have two children, each spouse can claim for one.
“A revised return can only be filed if you had filed your return before the due date and if its assesssment has not been completed.”
SUDHIR KAUSHIK
CO-FOUNDER AND CFO, TAXSPANNER.COM
9 Withdrawing PF within five years of joining a company
Financial experts say you should never withdraw your provident fund when you change jobs, but transfer it to the new employer. Dipping into the corpus before you retire prevents your money from gaining the power of compounding. In the cacophony of the new work environment and the excitement of a higher income, this advice often goes unheard. Although the paperwork is minimal, a lot of people prefer to withdraw their provident fund when they shift jobs, thus putting their retirement planning at risk. This is not the only problem. They may also have to pay tax on the amount withdrawn. Tax laws say that if the corpus is withdrawn before completing five years of continuous service in the company, the sum will be added to the individual’s income for that year and taxed at normal rates.
Your contribution to the provident fund is eligible for tax deduction under Section 80C. If the withdrawal is taxed as income, it means the deduction availed of on the contribution has been reversed. Worse, the cumulative contributions of several years will get taxed at one go, bloating up your tax liability for that year. Here again, there is no TDS and the tax has to be paid by the individual on his own. Not depositing the tax by the due date amounts to tax evasion and exposes you to punitive action by the tax authorities.
Our advice: don’t withdraw the amount unless you are in desperate need of cash. And if you do, make sure you pay tax on it.
10 Taking benefit of basic exemption limit twice in a year When Gurgaon-based telecom engineer Rahul Awasthi moved to a higher paying job in November 2011, his take-home pay shot up by almost 40% to 78,000. Much of this rise was artificial, boosted largely by the basic exemption and deduction assumed by his new employer. The error was discovered three months later. Tax deductions will shrivel his take-home to less than 65,000 this month. “It’s good that the mistake was detected in time, otherwise I would have had to pay a bigger chunk in tax in March,” says Awasthi. Every time you change jobs, you become a potential tax evader. This is because unless you expressly declare it, most companies will assume that you didn’t have any income in the previous months. As in Awasthi’s case, they are likely to deduct tax only for the income earned for the remaining months of the financial year. As the table shows, you may end up paying lesser tax than you are supposed to.
Ignore this at your peril because underreporting your income is a serious offence. This is not about ignoring a few hundred rupees in bank interest or a small fixed deposit in your wife’s name. The tax evasion can be in thousands, so it is not something the assessing officer will merely frown at. “The onus is on the taxpayer because all the facts relating to his income are known to him,” says Gupta.
It’s best to inform your new employer about the previous income so that you don’t have to deposit the tax yourself. Even if you have to, many banks now allow you to deposit it online.
Source : ET Wealth - 13/02/2012......
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