Rajiv Gandhi Equity Savings Scheme (RGESS)

Who is Eligible?

RGESS is available to all resident individuals whose gross total income is less than 12 lakh and who are investing in equity for the first time. A first-timer has been defined as the one who has not opened a demat account as a 'first holder' before the notification date of 23 November 2012, even if his name appears in a joint demat account opened before this date. The investor who has opened a demat account as first holder before the notification date but has not bought any shares or traded in the futures and options segment will also be considered as a first-time investor.

How can you get tax benefits?

To avail of tax deduction, an investor has to open a new RGESS designated demat account or designate for this purpose his existing demat account, where no trading has taken place before 23 November. He needs to submit a declaration in Form A, certifying that he has not traded before 23 November 2012, to the depository participant, who in turn forwards it to the depository for verifying the status and designate him a new retail investor. He can then start buying the eligible securities, which include stocks from BSE-100 or CNS 100 index. The listed shares of navaratna, maharatna and miniratna pubic-sector undertakings, and initial public offers (IPO) of PSUs, whose turnover is more than 4000 crore, are also eligible for investment. One can avail of tax benefit by investing in the eligible mutual fund schemes too.

What's the lock-in period?

Unlike other tax-saving schemes, the lock-in period here is split in two. The first year is a fixed lock-in and the investor cannot sell, pledge or hypothecate the shares. The next two years are flexible and he can sell, but has to buy other eligible securities with the proceeds. All eligible securities in an RGESS designated account are automatically subject to the lock-in periods. If an investor wants to buy more designated shares and keep these outside the lock-in clause, he has to give a declaration in Form B within a month of the transaction date. The tax benefit under Section 80CCG is withdrawn if these conditions are violated, but if the changes are due to involuntary corporate actions it's not affected.

What are your savings?

While there is no restriction on investment, only 50,000/- is considered for tax purposes. Of this, only 50%, or 25,000/-, is allowed as deduction. Since RGESS is for people with income less that 12 lakh, they will fall in the 10% or 20% tax bracket. The maximum savings under this will be 5000/- for people in the 20% tax bracket and 2500/- for those under 10% (beyond the Section 80C benefits). Besides, the tax deductions will be available for the all the 3 years.

Stocks or mutual funds?

Since direct investment in equity needs expertise and first-time investors are unlikely to have it, they should refrain from investing directly in the market. The risk is also high because 50,000/- is not enough to create a well-diversified portfolio. A better option is to go through the mutual fund route.  Various mutual fund houses have also started filing offer documents for eligible schemes with Sebi, while their new fund offerings (NFO) too are expected soon.

Investment Tax

How are your investments taxed

All financial instruments go through three stages -- Investment, Earning and Withdrawal. Since the tax rules vary across these phases, find  out how much tax you will have to pay on your investment.

• PF & VPF  - This is the most common investment. The interest rates are decided by EPFO Trust. 
• PPF - This assured return scheme is market linked, with 1 lakh annual investment limit. 
• Insurance Policies - Budget 2012 says that for tax benefits, the cover should be 10 times the annual premium. 
• ELSS funds - TAx-saver with the shortest lock-in period of three years may get scrapped under the DTC.

TAXATION 

(E-E-E)

The Exempt-Exempt-Exempt model means all three stages are tax-free. You get tax deduction at the time of investment, the earnings are tax-free, as are the withdrawals.

• Unit linked pension plans - Upto 33% of the pension corpus withdrawn on maturity is tax-free. Rest to be put in annuity. 

• Pension policies - Annuity income is taxable as income at the normal rate applicable to the investor. 
• NPS - Launched with much fanfare, it has not done too well. May be overhauled and improved soon.

TAXATION

(E-E-T)

The Exempt-Exempt-Tax regime gives tax deduction at the time of investment and the earning is tax-free, but withdrawal is taxed as income at marginal rate.

• NSCs - These are now market linked like the PPF and available in 5 and 10 years options.
• Tax-savings FDs - Best tax saving option for risk averse investors. Higher rates for senior citizens.
• Senior Citizens Savings Scheme - A popular option that is market-linked, and has an investment limit of 15 lakh per person

TAXATION

(E-T-E)

The Exempt-Tax-Exempt arrangement offers tax deduction to investment but earning is taxed. The withdrawal is tax-free given the tax is paid out at the growth stage.

• Stocks - If held for more than a year, no tax on capital gains. You pay 15% tax if sold before a year.
• Equity funds - Just like stocks, there is no tax if held for more than a year. All dividends are tax-free
• Balanced funds - Though up to 40% of portfolio can be in debt, these enjoy the same tax benefits as equity funds
• Tax-free bonds - These bonds issued by infrastructure companies carries a low coupon rate 

TAXATION

(T-E-E)

No tax deduction here for the investor. He invests post-tax income but the earning and withdrawal are tax-free if the investment is held for at least one year.

• Non Equity hybrid fund - After a year, profit from sale is taxed at a lower rate of flat 10% or 20% after indexation.
• Debt funds -Tax-efficient way of investing in debt. After a year, profits are treated as capital gains.
• FMPs - Similar to FDs, but profits are taxed at a lower rate. Very popular among HNIs

TAXATION

(T-E-T)

Here again, the investor puts in post-tax income. While there is no tax during the growth stage, the earning is taxed at the time of withdrawal.

• Recurring deposits - Lock into high rates even if you don't have a lump sum. No TDS, so must pay tax yourself.
• Post office MIS - Monthly income is fully taxable without any TDS. Onus is on the investor to pay tax.
• Fixed deposits - TDS only up to 10% if interest is more than 10,000 a year. Here, too onus is on investor.
• Bonds - Income from tax-saving bonds is taxable. Pay tax if you fall in the higher tax bracket

TAXATION

(T-T-E)

This is possibly the least tax-efficient regime with no tax deduction offered and earning fully taxable. With income taxed every year, there is no tax on principal at maturity.

Wealth Tax

Wealth tax came into existence on 1st April 1957. It is termed as most significant direct tax. As per the wealth tax act, wealth tax is applicable to the following: 

•  An individual person
• A group of people who own a property
• A company or organization  
• A Hindu undivided family (HUF)
• A representative or heir of a dead person
• Non corporative tax payer

Wealth tax is the most neglected child of the direct taxes family. However, remember that ignoring wealth tax can lead to serious problems for a taxpayer, with the penalty ranging from 100% to 500% of the unpaid tax. In extreme cases of willful default, a taxpayer may be punished with imprisonment ranging from six months to seven years.

The laxity on the part of the government has encouraged taxpayers to ignore their wealth tax liability. Though financial assets do not invite wealth tax, real estate and gold, two favourite investment options of the rich, are included. In the past 4-5 years, crores of rupees has flowed into real estate, while gold prices have more than doubled in the past three years.

However, this is not reflected in the wealth tax collection, which has grown at a tardy pace, to say the least. However, this could soon change. A committee has been formed which has sought stricter punishment for tax evasion. The panel wants the minimum imprisonment for income tax and wealth tax evasion to be three years.

Most investors in real estate have no idea about the t ax implication of buying a second property. A second house won't attract wealth tax only if it is rented out for at least 300 days in a year. It can be a double whammy for the owner if the house is lying vacant, for he will not only have to pay tax on the notional rental income, but the value of the house will be added to his net taxable wealth. This is why savvy investors prefer to put money in commercial real estate, which does not attract wealth tax.

An increased focus on wealth tax compliance can bring in significant revenue for the government. The best part is that there cannot be any political opposition to such a move because the law already exists. All that the government needs to do is invoke it more seriously, that's it.

However there is good news in store. The original DTC had proposed to raise the threshold of assets for wealth tax to 50 crore INR and reduce the tax to 0.25%. It had also sought to bring financial assets under the tax ambit. The revised DTC has not specified the limit, but has hinted that financial assets will bot be included and that the threshold limit needs to be raised.

Till that happens, make sure you pay your wealth tax and file the return to avoid a massive from the tax.

Quick facts about wealth tax

What is Taxable ?

Wealth tax is payable if the value of the following unproductive assets exceeds 30 lakh INR on the last day of the fiscal year.

• More than one property, if it is unoccupied
• Gold and ornaments
• Art and artefacts
• Luxury cars, watches, yachts and aircraft
• Over 50,000 INR in cash.

 How much is taxable ?

• The tax is 1% of the value of the assets exceeding 30 lakh INR. For example: If the value of these assets adds up to 75 lakh INR, you have to pay 45,000 INR (1 % of 45 lakh) as wealth tax.
• There is no surcharge or cess on wealth tax 

What is exempt from wealth tax ?

• Any one residential property. Taxpayer can choose whichever property he wants to exempt
• Commercial property
• Financial assets (stocks, bonds, Ulips, mutual fund, gold funds and bank balance)
• Any outstanding loan taken to purchase the asset on which wealth tax is payable.

Filing deadline and form to use

•  Wealth tax return has to be filled by 31st July. If the assessee is liable for an audit, the last date of filling in 30th September
• You have to use the four-page Form BA for filing the return
• If you miss the last date, you can still file the return before the expiry of one year from the end of the assessment year

What is the penalty ?

• 1% interest for every month of delay
• Tax evasion invites penalty ranging from 100% to 500% of the evaded amount
• In extreme cases, the imprisonment ranging from six months to seven years, with fine, if the wealth tax exceeds 1 lakh INR

Know your PAN

Whether you are an Indian citizen or an NRI, if you are filing taxes or have financial transactions in India you will almost always need a PAN card. 

What is PAN?
A Permanent Account Number (PAN) is a ten-digit alphanumeric number, issued in the form of a laminated card, by the Income Tax Department of India. Each set of numbers is unique to the individual, HUF, company, etc. (We will take a closer look at those numbers in a moment.). PAN is a permanent number, is unaffected by a change of address, even between states and is not transferable. It is illegal to own more than one PAN.

The PAN’s primary purpose is to bring a universal identification key factor that links and tracks various documents and information regarding taxes and financial transactions, such as loans, investments, buying and selling real estate and other business activities of taxpayers. By tracking the above it indirectly prevents tax evasion through non-intrusive means.

You can consider this number to be similar to the Social Security Number issued in the United States to USA citizens and other legal residents.

Structure of the PAN
The structure of the new series of PAN numbers is based using Phonetic Soundex code algorithm to ensure that each number is unique. The following list is “constant permanent parameters” that assist in the creation of phonetic PAN (PPAN) number:

• Full name of the taxpayer
• Date of Birth/Date of Incorporation
• Status
• Gender in case of individuals; and
• Father’s name in case of individual (including in the cases of married ladies). 

The Date of Issue (DOI) of the PAN card can be found on the right hand side of the photo on your PAN card.

The 10 Digit Alphanumerical Sequence
Let’s take a look at the breakdown of the 10 digit alphanumerical sequence:

1. The first five fields are called the core fields and are alphabetical in nature.
2. The first three letters of the core field are an alphabetical series running from AAA to ZZZ.
3. The fourth character of the PAN must be one of the following, depending on the type of assessee:

• C — Company
• P — Person
• H — HUF (Hindu Undivided Family)
• F — Firm
• A — Association of Persons (AOP)
• T — AOP (Trust)
• B — Body of Individuals (BOI)
• L — Local Authority
• J — Artificial Juridical Person
• G — Govt

(Example – Company = AAACA; Artificial Juridical Person = AAAJA; HUF = AAAHA; etc.)

     4.  The fifth character of the PAN is the first character of the following:

• Your surname in the case of “P” or;
• For all others you would use the first letter of the name of the Entity, Trust, Society, Organization, HUF, etc.

(Example - Atanu Gupta [Personal] = AAAPG4444A; Atanu Gupta [HUF] = AAAHL4444A; General Firm = AAAFG4444A; etc.)

     5.   The next four numbers are sequential numbers running from 0001 to 9999.

     6.   The last digit is an alphabetic check digit.

The New Phonetic PAN (PPAN)
The new Phonetic PAN (PPAN) helps to prevent the allotment of more than one PAN to assesses with the same or similar names. If a matching PPAN is detected, a warning is given to the user and a duplicate PPAN report is generated. In these cases, a new PAN can only be allotted if the Assessing Officer chooses to override the duplicate PPAN detection. Under this new system a unique PAN can be allotted to 17 crore taxpayers.

Myths Regarding PAN
Many people believe that PAN cards are used for tax purposes only. That is a myth. PAN numbers are required for the purpose of income tax but not the actual card itself. Photocopies of PAN cards are required as prove of identity in financial transactions such as opening a bank account, purchase and sale of property and motor vehicles, home telephone lines and investments, such as demat accounts and mutual funds, just to name a few.

In Conclusion
It is easy to see the importance of your PAN card and why you need the physical card as well as the allotted PAN number. If you do not have a PAN card, take the small amount of time need to apply for one today.

------investmentyogi

E-Filing of I-Tax

Make sure your e-return is not rejected

If you are e-filing your tax returns, here are the errors you should avoid while sending ITR V 

Your return can be rejected if the guidelines laid down by the Income Tax Department are not followed while filing returns, be it physically or online. If you are e-filing and not using the digital signature, you will have to print out the acknowledgement form, ITR V. Here are the things you should keep in mind while using the option.

Printing ITR V

Printing the ITR V form correctly is critical. Avoid using the dot matrix printer if you want your return to be processed faster. This is because the bar code on the ITR V should be clearly visible for quicker processing, and this can be done only by using the ink jet or laser printers. Take the printout in black ink only. If you are sending two returns, don't print them back to back. Use a fresh A4 size sheet to print each time. Perforated paper or of any other size is not acceptable.

Signing

The signature on the form must be clear and legible. For this a ball-point pen in blue ink only. Also, if you are taking photocopies, make sure you send out the original one signed in blue ink. A photocopy of the signature is not accepted.

Sending

The filing of non-digitally signed returns is completed only when the ITR V reaches the CPC in Bangalore. So, make sure that your ITR V reaches the destination within 120 days of e-filing. In case it does not reach CPC Bangalore within the stipulated period, you will have to go through the agony of filing your tax return again. Earlier, you could not send more than one ITR V per envelope, but now, you can include more than one such form. Do not attach other documents, such as photocopies of Form 16 or TDS certificates along with the ITR V. Even annexure documents don't need to be attached. Dispatch it in an envelope that can hold an A4 size paper without folding it to:

Income Tax Department – CPC
Post Bag No - 1,
Electronic City Post Office,
Bengaluru - 560100, Karnataka

Other filing errors

Taxpayers often make mistakes that lead to deduction or incorrect calculation of taxes. One of these is not declaring the correct break-up of deductions under Section VIA, which includes tax-saving investments in life and health insurance policies, mutual funds, bank fixed deposits, etc. It is essential to have the tax filing details like deductee's PAN details, PAN & TAN of the deductor, total amount paid, total taxes deducted and deposited in Form 16/Form 26AS.

In case of a change in the residential address, make the necessary alterations in the PAN database since the IT Department refers to it for correspondence. Do not mention bank accounts that are closed or even dormant because refunds are unlikely to reach you in such a case.

No response from CPC

The CPC dispatches an acknowledgement on receiving the ITR V. Ideally, it should reach you within three days. If you don't receive it, consider sending it again. You can send it through regular post service or speed post. Do not use the courier or deliver it personally. You can call 1800-425-2229 (Toll free) and 080-22546500 (Direct) from 9am to 8pm on working days to check the status. It can also be done online at http://www.incometaxindiaefiling.gov.in

Exemption-Can't avail

The exemption to file return for income up to Rs. 5 lakh looks good on paper, but nobody will be able to fulfil the condtions. 

The Central Board of Direct Taxes (CBDT) has made millions of Indians smile by announcing that salaried taxpayers with an annual income of up to Rs. 5 Lakh need not file their returns. Or so they think. Given the stiff conditions, it's unlikely that anyone will be able to avail of the concession. Here's why the CBDT's proposal is just a clever play, a theoretical relief that nobody will get.

According to the notification issued on 24th June,2011 a salaried person is exempt from filing his return if he fulfills the following conditions:

• Total income after allowable deductions is up to Rs. 5 Lakh
•  Income is only from salary and savings bank interest
• Salary is from one employer
• Savings bank interest is below Rs.10,000
• Tax due on savings bank interest has been paid and included in Form 16.

The announcement comes at a time when Form 16s have already been prepared and issued to taxpayers. Will it possible to make the necessary changes in the Form 16 at this late stage? The second requirement, that the income should be only from salary and savings bank interest, is patently illogical. How many people who earn more than Rs 3-4 lakh a year will not have income from fixed deposits, mutual funds. stock trading, gold and property? If you invested in fixed deposits or NSCs to save tax or received dividend from your ELSS fund during the year, you don't make the cut for the exemption. Have you given your house on rent for even one month? Sorry, you will have to file returns. Only a person who has no tax-saving investment and lets all his money idle in a saving bank will be eligible.

Let us assume that there is indeed somebody who has no such investments and, therefore, no income other than from his salary and the interest on the bank account. Even then, he may not be able to fulfill the conditions for exemption. The notification says that the tax due on the interest income should have been paid and the income and the tax should be mentioned in Form 16 from the employer. The interest on bank account is credited on quarterly or half yearly basis. The interest from January-March or October-March gets credited after 31st March. You need to be a financial expert to correctly estimate the tax due on this income and pay the right amount. That's not all. You also need to provide these details to your employer in time for the accounts division to mention in your Form 16.

A taxpayer's quest for filing nirvana doesn't end here. If he has changed jobs during the year, a taxpayer won't be exempt from filing his tax returns. Given the high employee turnover rate in certain industries, such as software and IT-enabled services, very few people in these sectors will be able to claim exemption.

If you have managed to fulfill all the conditions, hats off to you.Given the plethora of paper work required to avail of the exemption and the possible repercussions of not filing your return, it seems that spending 30-40 minutes online is a far simpler option.

Education Loan

Education loan helps cut tax

Don't dip into your retirement savings to pay for your children's higher studies. Instead, take an education loan because the tax benefits bring down the effective cost of borrowing.

  While everybody wants their child to have a good education, Indian parents are especially intent on achieving this goad. So focused are they that they are willing to scrounge on basic indulgences to save for their kids' college fees. The problem is that in their efforts to fulfill the needs of the child, they sometimes sacrifice more that they should. They dip into their retirement funds to pay for the education. This is a dangerous strategy because it leaves them financially vulnerable to their sunset years.

We all know that the cost of higher education is raising at a fast pace. Unless you foresaw this trend 10-12 years ago and started investing aggressively for this goal, your savings alone might not be enough to fund your child's higher education. Instead of withdrawing from your Provident Fund or PPF, it's better to bridge the gap with an education loan. It is not only tax-efficient, but helps inculcate financial discipline in the child by making him responsible in his early working years.

It may be argued that taking a loan in these times of high interest rates is not a prudent strategy. You will be paying 12-14% on the loan, while your investments earn only 8-8.5%. However, keep in mind that any loan taken to pay for the education of your child is eligible for income tax benefits. Under section 80E, the entire interest paid on the loan is eligible for tax deduction. The savings in tax can drastically bring down the effective cost of the loan.

The higher the taxable income of the individual, the bigger tax benefits. See Table:

Loan Amt: Rs 500000; Interest Rate: 12%; Term: 8 years; EMI: Rs 8,126

 

Check Education Loan Calculator for more figures

For someone in the highest tax bracket, a loan taken at 12% p.a effectively costs 8.71% a year. This is very cheap considering today's regime of high in today's regime of high interest rates, wherein personal loans are available at 18-20%. Also, unlike a home loan, where the tax deduction for self-occupied houses is limited to Rs 1,50,000 in a year, there is no limit to the tax deduction on an education loan. However, keep in mind that most lenders don't give education loans for more than Rs 10 lakh, so a limit is set by default.

An education loan will also help in making your child financially responsible in his early working years. Education loans usually come with an EMI holiday and the repayment can be deferred for up to 1-2 year till the student has taken a job. In the initial years, when the financial responsibilities are few, young people tend to be extravagant. However, if you shift the burden of repaying the loan to your child, he will be more careful with his money and is less likely to blow it up at a discotheque or on gadgets and gizmos. The loan EMI will act as a deterrent and force him to be frugal in his spending.

Eligibility for tax deduction:

You can avail of income tax deduction for the interest under Section 80E only if the loan has been taken for yourself, spouse or children. The interest paid on loans taken for siblings or other relatives is not eligible for income tax deduction.

Collateral requirements:

If the loan is more than Rs 3-4 lakhs, the lender may insist on a collateral as security. This could be immovable property, National Savings Certificates, Fixed Deposits, bonds and endowment insurance policies. This is a necessary formality and one should not shy away from providing the collateral.

Specified lenders:

If you are seeking tax deduction, the loan should be from a bank or financial institution notified for the purpose. No tax deduction is available if the loan has been taken from a private source or an overseas lender. Some charitable institutions are also included in the approved list.

Courses covered:

Full-time graduate or post-graduate courses in engineering, medicine, management, applied sciences, vocational studies after senior secondary or its equivalent are eligible for education loans. This can be from any school, board or university recognised by the Central or state government.

Interest deductible for eight years:

Unlike a home loan, the interest deduction is available for a maximum of eight years. If you take an education loan in 2011 and start repaying it in 2013, the interest deduction will not be allowed after 2021.

Global Income - Tax

5 TAX TIPS if you work abroad 

If you have a job overseas or plan to emigrate, here's how to avoid any tax bloopers in India or the country where you choose to live. 

 1. GLOBAL INCOME IN YOUR TAX RETURN

Governments often demand tax on the global incomes of foreign residents living in their country on a long-term basis. This is set to become more commonplace as governments across the globe, strapped for revenue following the economic crisis, are increasingly exchanging information on tax matters. This is a bid to curb evasion and track money kept in low tax jurisdictions. They are also increasing their focus on high net worth individuals as well as heightening surveillance of accounts held in foreign countries to crack down on financing of terrorism.

Countries such as the US, the UK and Australia now require immigrants who become permanent residents or citizens to report their incomes from all global sources and pay tax accordingly. Temporary residents are not required to declare their global incomes in these countries, but they have to ensure that taxes are paid in the home country. India also requires its residents to pay tax on any income earned overseas, if they ordinarily pay tax in India.

2. WHAT CONSTITUTES GLOBAL INCOME

Global income includes anything earned abroad, from rental income and dividends to interest and capital gains. If you are emigrating from India, make a list of your assets, the cost of acquisition, earnings from these assets and the tax paid on incomes and capital gains. For instance, if you own a house in India that is rented out, it will have to be reported as global income if you become a permanent resident or citizen of another country, but you may not have to pay tax on it. 

Permanent residents in the US also have to report inheritances and gifts received in India, though there is no tax liability on such gains either in India or the US.

Conversely, if you are only a temporary resident in these nations, you will have to continue paying taxes in India on the income earned here. You will also have to comply with all the reporting requirements under the Indian tax laws, such as filing the annual information report if a property transaction exceeds Rs 30 lakh. You won't need to declare this income in the country where you are residing temporarily.

3. MANAGE TAX RESIDENCY

The residency rules determine if an NRI has to pay tax in a foreign country in India.There is no common rule across the globe. Countries such as the UK and Australia, which follow the common law system, use a residency test to determine whether a person is required to pay tax in that country. India too follows this system. So, if you have spent more than 182 days in a country, such as India, the UK and Singapore, during the financial year, or more that 729 days in the previous seven financial years, you will have to pay income tax in that country. This means that if you emigrate mid-year, you will pay income tax in India as well as file returns at the end of the year. In the US, foreign residents are taxed as American citizens if they have either acquired a green card or clear the substantial presence/residency test. This test is far more stringent than the residency rules that apply in India and the UK. An individual is said to have satisfied it if he stays at least 31 days in a calender year and 183 days in the current and two preceding years.

To avoid confusion about the number of days spend in a country and prevent double taxation, it will be useful to maintain a travel calendar as well as details of entry and exit as stamped on the passport. Tax authorities could check your passport to determine the residency status. Don't try to fool those guys as they already have the complete picture of your residency status in the country before taking you into consideration.

4. CREDIT FOR TAXES PAID IN INDIA

India has signed double tax avoidance treaty (DTAT) with about 70 countries, including the US, the UK, Australia, Japan, Germany and Switzerland. This ensures that NRIs can claim foreign tax credit if taxes have been paid on incomes and gains made in India. If, however, taxes paid in India are lower than that required to be paid in the country where the the NRI is residing, additional tax will have to be paid. Before you claim foreign tax credit, ensure that you have all the relevant documents as proof.

5. RESIDENCY RULES & DIRECT TAXES CODE

This current residency rules in India will change when the Direct Taxes Code is implemented, most probable from 1 April, 2012. This change will mean that a person will have to pay tax in India if he spends 60 days (previous 182) in the country during a financial year, or 365 days (previous 729) or more in the previous four financial years.

Inflation Indexation

Use high inflation to bring down your Capital Gain tax

If petrol at Rs 60 a litre and onions a Rs 45 a kg are breaking your back, here's some cold comfort. The high prices could actually help bring down the tax on your long-term capital gains. The taxman understands that inflation is not only burning a hole in your wallet but also destroying the value of your investments over time. So he allows taxpayers to adjust for inflation by opting for indexation in case of long-term capital gains.

Inflation indexation takes into account the rise in consumer prices during the time the investor held an asset and adjusts his buying price accordingly. This lowers the effective profit from the sale of the asset and, therefore, the tax liability.

The key to indexation is the cost inflation index number announced by the government for each financial year. It is used to compute the indexed cost of an asset.

If you sell an asset-property, gold funds and debt-oriented funds --  at a profit, your gains are taxable. If they they are short-term capital gains, they are clubbed with your income for the year and taxed at normal rates. But if the holding period is longer, the gains are treated as long-term capital gains and taxed at a lower rate. The investor has the choice to pay a flat 10% tax on the capital gain or 20% after indexation. 

The taxman has different minimum holding periods for each asset. For debt funds (including fixed maturity plans), debt-oriented hybrid funds (including monthly income plans) and gold exchange-traded funds, this is one year. But for real estate and bullion, the minimum holding period is three years.

Investors in debt funds (especially FMPs) can use the indexation benefit to the hilt. If you had invested in a debt fund at the fag end of a financial year (say, in March 2008) and redeem the investment 13 months later in April 2011, you will be able to avail of indexation benefit of four financial years. In times of high inflation, this can reduce the tax liability to zero.

However, if you exit in February 2011, you will get the indexation benefit of only three years. As the above calculation shows, this may not result in a lower tax liability compared with that in the flat 10% option. so, your debt mutual funds or other assets that are liable for capital gains tax.

High prices could help you lower your tax liability if you opt for cost inflation indexation in case of long-term capital gains. Go through this calculation to find out if you should avail of this option.