Articles

There are two important things one should consider while investing.Investments made by individuals has two aspects to their composition.

* The earnings on the investment.

* The benefit that will accrue while making additional investments into the same instrument.

While putting more money in the same instruments adds to the corpus, accumulation of the earnings has a similar impact on the kitty.

However, there is a difference - the manner in which the earnings are treated for the purpose of different calculations can go a long way in impacting further investments in a particular instrument and, hence, the separate manner in which these are treated needs to be considered.

It is very vital to consider the impact of the earnings for various tax-saving investments, as there are varying ways in which similar earnings are treated. Depending on the objective of the investment, the reaction of the investor will also vary and this is most likely to impact even future investments in the area. The tax incidence on the earnings and its treatment as additional investment will also make the choice of a specific route important for the individual and decisions would be based accordingly. It is important that this is considered because the total tax-saving investment limit has to be reached and if this can be done without a lot of effort, then it is better for the taxpayer.

Consider a situation where there is a benefit for the individual in terms of the earnings on a particular investment being counted as an eligible further investment. Once this is done, it can be included in the overall eligible figure for tax savings. In the case of the National Savings Certificate (NSC), the payout on the instrument is available only at the time of maturity, which is six years after the investment. Meanwhile, each year there is an amount earned on the instrument and this accumulates with the capital. If there is an NSC bought for Rs 10,000, then in the first year there is an interest accumulation of Rs 816, as the figure is compounded half-yearly at 8 per cent. In this situation, the figure earned for the year (Rs 816) is first considered as income, but at the same time it is considered as reinvested in the instrument and hence will be included in the overall investment limit for the year. This will reduce the requirement for additional investment for that figure during the year.

The other situation where this arises is with respect to amutual fund scheme like the Equity Linked Savings Scheme (ELSS) that has tax benefits for investments up to Rs 1 lakh. In this case, if the dividend reinvestment option has been chosen, then the dividend declared during the year is converted into additional units at the applicable net asset value (NAV). If an investor has 5,000 units of a scheme and the fund declares a dividend of Rs 2, after which the NAV falls to Rs 20, then the Rs 10,000 of dividend will get converted to 500 additional units at Rs 20. This will be considered a new investment because new units are allotted. This saves the investor from making additional investments but will still meet the taxsaving investment target. What is important is that in case there is a dividend payout option or a growth option is chosen in the scheme, then the same benefits will not be available for the individual.

There are also other instruments where the same logic will not be applicable. This will require the investor to be alert about the manner in which all details are considered. Take the Public Provident Fund (PPF), where there is interest earned each year which is tax-free in the hands of the receiver. The interest here is not paid out, but it accumulates, and is even considered for the calculation of interest next year. This, however, does not count as being added to the investment for the next year. Only additional and new contributions made in the scheme till a total of Rs 70,000 in a year would be considered for the purpose of the tax benefit, while other items like interest accumulation and so on are not to be considered.

There are also tax benefits on fixed deposits with banks. These are special deposit schemes with a five-year lock-in by banks. Where an accumulation option is chosen, then this is withdrawn only at the time of maturity of the deposit. In such a situation, the figure earned and accumulated is not considered for the purpose of additional investment.

In sum, the benefits for the individual vary significantly according to the instrument. Only where the benefits are clearly provided will the figure be considered a new investment for tax benefits. Where this is not allowed, then there will have to be other routes chosen for the purpose of completing the overall benefits on the tax front.