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Two Ways to Save Tax When You’re Short of Cash

Author: Balwant Jain/Wednesday, February 10, 2016/Categories: Tax

Two Ways to Save Tax When You’re Short of Cash

The Income Tax Act currently allows an individual and an HUF deduction up to Rs.1.50 lakh for investments made in various items including equity-oriented schemes, (popularly known as ELSS or equity-linked savings schemes) and National Saving Certificates (NSC). These deductions are two of the several available under Section 80C. ELSS has become quite popular with investors due to its twin benefits of tax deduction and higher returns on the investments, whereas NSC has popular with people who want to avail tax benefits but do not want to take bear risks associated with equities. But sometimes, due to various investment requirements, individual tax payers are faced with cash crunch and find it difficult to invest the required money to be able to claim the tax benefits. In such a scenario, you can recycle your existing ELSS holdings to claim tax benefits, or invest in NSC and claim tax benefit without fully investing your money.

Recycle your ELSS

The Income Tax Act requires you to hold investments in ELSS for a minimum period of three years. You are not allowed to transfer these investments before completion of the lock-in period. However, if you redeem your ELSS units after the three-year lock in, then you are not charged income tax or exit load on the proceeds.

If you have already completed the mandatory holding period of three years, this is a good opportunity to avail the tax benefits without actually increasing your exposure to the market.

This benefit of tax rebate can be availed without any investment at very nominal costs. All you need to do is redeem those ELSS units which have matured, and re-invest the proceeds in the market. The fund house will charge Security Transaction Tax on the amount of redemption, but that is only 0.01% of the redemption value. Moreover there are neither any entry nor exit loads, so you can buy and redeem units at the same price if it is done on the same day. However, once you reinvest the proceeds from redemption in a fresh ELSS, you will be entitled to relief under the Income Tax Act. This small procedure will help you save tax at between 10% and 30% depending on your tax bracket.

The above method works if you have made lump-sum investments in ELSS. However, what if you have invested periodically through a systematic investment plan (SIP)?

If you have invested by way of an SIP want to save tax without increasing exposure to the market, you should redeem only those units which have completed the mandatory lock-in period of three years. Simultaneously, you can purchase fresh units of the same scheme from the redemption proceeds at the same net asset value (NAV). This will ensure that you are able to avail tax benefits without mistakenly redeeming any investment before its lock-in period.

In case your investments in ELSS were made through SIP and only a few instalments have completed the mandatory three years lock-in period, you can start another SIP as to match the redemption and purchase of units which have already completed the period of 36 months.

However, in case your investments were made in lump sum and have already completed the holding period, you will need to do the redemption and purchase at one go to ensure the continuity at the original cost of your investments.

In addition to the costs incurred on account of Security Transaction Tax on redemption of your old units, this methodology does not have any other tax implications.

Note: At present, all profits booked on ELSS units which have been held for a minimum period of one year or more are exempt from tax on capital gains. However, the income tax deduction claimed u/s 80C on these investments becomes voided and you will have to re-file tax returns for that particular year. However, in our example, since you recycle only those ELSS units which have completed three years, you will face nil tax on capital gains.


Invest in NSCs through a quick loan   

NSCs also offer benefit under Section 80C, but they shield you from the risk associated with equities. If you do not have enough funds to invest immediately but still have headroom for tax benefit, then NSCs could prove ideal for you.

At present, NSCs have tenure of five years. The rate of interest is fixed for the entire tenure at the time of issue of such certificates, so it is not subject to any fluctuation. The present rate of interest on an NSC is 8.5% for five years and the interest is compounded half yearly. Unlike a PPF account, the interest on an NSC is fixed for the whole tenure at the time of issue of the certificate and does not change every year (in PPF, the rate changes on money invested in the past as well).

The most attractive part about NSCs is that you can obtain loans from banks using the certificates as collateral, which is not available in case of another similar product i.e. the tax-saving bank fixed deposits with scheduled banks, though both have the same tenure of five years.

In case you are temporarily facing financial crunch to take benefit of the deduction available under Section 80C, you can buy NSC to meet your limits. Here is how:

If you do not have funds now, you can temporarily borrow from friends or relatives and buy NSCs to the extent of unutilised portion of the deduction available under Section 80C and avail tax benefits on the same.

NSCs offer flexibility with regard to mode of payment, so if you are paying in cash, the certificates will be issued immediately. But if you pay for these by demand draft or cheque, the certificates will be issued on realisation of the instrument. Therefore, it is advisable in such case to tender cash and collect the certificates immediately.

Once you have received the certificates from the post office, you can approach any scheduled bank, co-operative bank or co-operative credit society to grant you a loan against the security of these certificates. It is advisable that you first approach a bank with which you have banking relations to ensure faster processing of your loan application. As per rules governing NSCs, post offices are authorised to mark a pledge in favour of scheduled bank, co-operative banks and co-operatives societies including cooperative credit societies, in addition to certain other entities.

You will have to make an application for marking pledge on your NSC in favour of the lender, which has to be signed by both you and the lender. Once you tender your NSCs together with the application, the post office will mark the pledge on the certificates and return the certificates to the bank. On receipt of the NSCs duly marked as pledged, the bank will disburse the loan. With this, you can repay the money borrowed from your friend or relative for buying these NSCs. 

There are two options with regard to taking loan against security of NSCs. Either you can take a lump sum loan and pay in monthly instalments, or you can obtain an overdraft facility against the security of the NSCs. In case you think your cash flow would be volatile, taking an overdraft account gives you flexibility to use the funds as and when they are needed. However, if you feel that you can repay a certain sum every month, it is advisable to take a lump sum loan. The process for obtaining the loan or overdraft is quite simple and inexpensive, in comparison to other unsecured loans like personal loans or revolving credit facility on credit card outstanding.

Banks normally grant a loan for up to 80% to 85% of the face value of NSCs and the rate of interest charged on the loan is competitive: it is normally 1% to 2% higher than the rate of interest applicable on NSCs. However, this varies from bank to bank. In addition to the above interest, you will have to pay one time processing charges of around 1% of the amount sanctioned. Generally, there are no prepayment charges on loans taken against NSCs.

This way, you can use your existing ELSS and investments in NSCs to tide over your temporary cash crunch and avail tax benefits as well.

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