Most individuals, start scouting for investment opportunities to save tax in the last quarter of the financial year. This is when pressure from their Human Resources department to submit proofs starts building up. Normally, the HR department accepts tax-saving proof till the first week of February and that is when the investment activity gathers steam. That brings us to the more fundamental question: Should tax planning be a year-end activity or should it be a round-the-year activity?
Ideally, tax planning should be a round-the-year exercise. There are five distinct advantages in phasing your tax planning through the year.
Synchronising inflows and outflows
This is something a lot of taxpayers ignore. As an employee or a businessman, your incomes are periodical and regular. Typically your salary gets credited each month, or in business your inflows are in the first week of each month. By adopting a more regular approach, you can, for example, do Systematic Investment Plans (SIPs) in Equity Linked Savings Schemes (ELSS). You get the benefit of rupee cost averaging and you also plan your taxes simultaneously. You can avoid unnecessary financial stress at the end of the year. Your allocations to Section 80C, Section 80D all can add up to quite a bit. If you have liquidity problems in the last quarter, you may even end up borrowing. A monthly / systematic approach is cost-smart and also syncs with your flows.
Avoid delayed submission of investment proof
This is a normal risk for most taxpayers. Typically, the finance department of your company does not accept tax investment proofs after the first week of February. Any investment made after that will not be considered by your employer, for deciding the amount of TDS deducted. That means you end up paying excess tax during the year and waiting for tax refund after you file returns in July. Instead, if you start regular tax investments in the beginning of the year, you have enough proof to submit to your HR department by February.
Helps optimise tax flows
If you get a bonus or increment during the year, your tax liability also increases proportionately. If you are planning to cluster your tax investments in the last quarter, it will add up to the tax saving pressure. Otherwise, you will have to pay more taxes during the year. The advantage of year-end tax planning is that you have a plethora of products available, but last minute tax-saving investments also end up going into unsuitable avenues. If you plan in advance and do a monthly allocation towards such possibilities, you will be better off in post-tax terms and you can avoid last minute surprises.
Make time work in your favour
This is another advantage of tax planning when you do it on a systematic basis. Instead of investing Rs 1.20 lakh as lump sum in an ELSS fund to save tax under Section 80C of the Income Tax Act, you can structure it as a SIP of Rs 10,000 each month. This gives you two distinct advantages. Firstly, the fluctuations are captured in the form of lower cost and that improves your ROI at the end of three years. Secondly, the lock-in for ELSS is from the date of investment, so each month of your ELSS keeps coming out of the lock-in. It is a kind of a double advantage for you.
A sub-set of your financial planning process
In the past, investors would just buy life insurance policies and invest in Public Provident Fund, at random, to reduce their tax outflows. That is not the way it is done any longer. You start with a plan and work backwards to achieve your goals. Planning taxes is one of the four pillars of your long-term plan, apart from return enhancement, risk minimisation and liquidity management. When you look at your tax planning in this manner, a regular and round-the-year approach looks a lot more sensible.
The writer is head of research & ARQ, Angel Broking