Tax Planning: Know What is Tax Planning and its Types

Knowledge Centre Team October 13, 2020 120 Views 4 Minute Read

What is Tax Planning?

Tax planning refers to financial planning for tax efficiency. It aims to reduce one’s tax liabilities and optimally utilize tax exemptions, tax rebates, and benefits as much as possible. Tax planning includes making financial and business decisions to minimise the incidence of tax. This helps you legitimately avail the maximum benefit by using all beneficial provisions under tax laws. It enables one to think of their finances and taxes at the beginning of the fiscal year, instead of leaving it to the eleventh hour.

Why should you do Tax Planning?

There are some fundamental objectives of tax planning. Tax planning diminishes tax liability by saving the assessee the maximum amount of tax by arranging their financial operations according to tax decisions. It also conforms to the provisions under taxation laws, thereby minimizing any litigation. One of the biggest benefits of tax planning is that the returns can be directed to investments. It is the most productive way to make smart investments while fully utilizing the resources available due to tax benefits. Investing tax money generates white money to flow through the economy, aiding in the country's economic development. Tax planning hence contributes to the economic stability of the individual as well as the country.

Tax Planning in India

There are a lot of tax saving options available in India for taxpayers. These options provide a variety of exclusions and deductions that help to reduce the overall tax burden. Deductions are provided from Sections 80C to 80U, and eligible taxpayers can claim them. These deductions are applied to the total amount of tax owed. It is totally legal and, in fact, a wise decision when tax planning is done within the boundaries set by the respective authorities. However, employing unscrupulous methods to avoid paying taxes is prohibited, and you could face penalties. Tax avoidance, evasion, and preparation are all ways to save money on taxes.

What are the Types of Tax Planning?

Now that you know as to what tax planning is, let us look at three types of tax planning.

1. Short and Long-range Tax Planning

Tax planning done every year for specific objectives is called short-range tax planning. On the contrary, long-range tax planning refers to practices undertaken by the assessee, which are not paid off immediately. Simply put, short-range planning usually occurs towards the end of a fiscal year while long-range planning occurs in the beginning.

2. Permissive Tax Planning

Tax planning is deemed permissive when carried out under the provision of a country’s taxation laws.

3. Purposive Tax Planning

It is a tax planning method for a particular objective. It may include diversification of business and income assets based on residential status and replacing assets if necessary.

Objectives of Tax Planning

Tax planning is a major part of your overall financial planning. A reduced tax liability means fewer burdens on you, which will lead you to plan your financial goal as per your dreams and needs. Here are a few objectives of tax planning:

1. Reduced tax liability
2. Productive investment
3. Growth of economy
4. Litigation minimization
5. Economic stability

How to Get Started with Tax Planning?

Anyone can start planning their taxes in a few simple steps:

1. Start by taking your total income into account. This is the starting point of the process and requires you to accurately assess your annual and monthly income.

2. Evaluate the taxable aspects of your income. Housing and rent allowances included in the salary on top of base pay are not taxable. However, profits made from investments could add to taxable income. Therefore, understanding one’s taxable income is a requisite to be able to plan taxes.

3. Make use of deductions to reduce the total taxable income. This can be done by structuring salary and proper planning of investments. For example, interest from a fixed deposit is taxed at the same rate as income tax, while a debt fund held over e years is taxed at 20%. So if you fall in the 30% tax bracket against the taxable income of 10 lakhs and above, debt funds are a more tax-friendly option.

4. Invest in tax-saving instruments. There exists a wide range of deductions available to eligible taxpayers in Sections 80C through 80U of the Income Tax Act, 1961. Other options such as deductions and tax credits are listed under the Income Tax Act, 1961. Investment options include Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) in mutual funds, National Saving Certificates (NSC) or 5-year bank deposits. Life insurance, health insurance premium and home loan payments can let you avail tax savings.

A simple example is, if an individual’s income is 6.5 lakhs per annum and they invest 1.5 lakhs in the notified schemes, they can bring down their taxable income to 5 lakhs- consequently reducing tax liability to NIL as a person having taxable income upto Rs 5 L available for rebate of Rs 12,500 u/s 87A. The savings can then be put to productive use. With a simple assessment of your income and some basic tax rules; planning your taxes can ensure your overall financial security.

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