TAXATION- Concept Book

‘Foreign exchange asset’ means any ‘specified asset’ which the assessee has acquired, purchased with or subscribed to in convertible foreign exchange. Such ‘specified assets ‘are as follows: • shares in an Indian company. • debentures issued by an Indian company which is not a private company as defined in the Companies Act, 1956. • deposits with a non-private Indian company. • any specified securities of Central Government. • units of the Unit Trust of India. • such other assets as may be notified by the Central Government. The income derived from such a foreign exchange asset is called investment income. “Investment income” means any income derived (other than dividends referred to in section 115-O) from a foreign exchange asset. “Long-term capital gains” means income chargeable under the head “Capital Gains “relating to a capital asset, being a foreign exchange asset which is not a short-term capital asset. Flat Rate for Investment Income and Long-term Capital Gains [Section 115E]: Where the total income of a non-resident Indian consists only of investment income and capital gains arising out of the transfer of long-term foreign exchange assets, tax payable by him shall be the aggregate of: • income-tax on investment income at the rate of 20%; • income-tax on long-term capital gains at the rate of 10%; and • income-tax on his other total income. Exemption on capital gains arising from transfer of long-term foreign exchange asset [Section 115F]: Where the non-resident Indian transfers the original foreign exchange asset and within a period of six months of such a transfer deposits or invests the whole or part of the net consideration in: • any specified asset or • any notified savings certificates referred to in section 10(4B) then, • the capital gains arising on such a transfer will be dealt with as follows : CFP Level 2 - Module 2 – Taxation - India Page 495

If the cost of the new asset, referred to in (a) or (b) above, is not less than the net consideration in respect of the original asset the whole of such capital gain shall be exempt. If such cost is less than the net consideration, the exemption will be limited to: Total capital gain * Cost of new asset /Net Consideration Note: • When the new asset consists of deposits, the cost means the amount of such deposits. • Net consideration means the full value of the consideration received or accruing as a result of the transfer as reduced by any expenditure incurred wholly and exclusively in connection with such transfer. • Where the new asset is transferred or converted (otherwise than by transfer) into money, within a period of three years from the date of its acquisition, the capital gain, exempted as above, shall be chargeable as long term capital gain of the previous year in which the new asset is transferred or converted. Short Term Capital Gains 1. Referred to in section 111A @ 15% - No slab benefit is available 2. Other short term capital gains taxable at the normal applicable rates non-residents at normal rates applicable to an individual. Flat Rate of Tax on Winnings from Lotteries, Crossword Puzzles etc. [Section115BB]: Under section 115BB, gross winnings from lotteries, crossword puzzles, races including horse races (other than income from the activity of owning and maintaining racehorses), card games and other games of any sort or from gambling or betting of any nature whatsoever shall be chargeable to income-tax at a flat rate of 30% on the gross winnings. Tax on Non-resident Sportsmen or Sports Associations [Section 115BBA]: This section is applicable where the total income of an assessee, • being a sportsman (including an athlete), who is not a citizen of India and is a non- resident, Includes any income received or receivable by way of participation in any game CFP Level 2 - Module 2 – Taxation - India Page 496

or sport or advertisement or contribution of articles in relation to any game or sport in India in newspapers, magazines, journals • being a non-resident sports association or institution, includes any amount guaranteed to be paid or payable to such association or institution in relation to any game or sport played in India. The income-tax payable shall be the aggregate of - • The amount of income-tax calculated on the income referred to in clause (a) or clause (b) at the rate of 20%; • the amount of income-tax with which the assessee would have been chargeable had the total income of the assessee been reduced by the amount of income in clause (a) and (b) No deduction in respect of any expenditure or allowance shall be allowed under any provision of this Act in computing the income referred to in clause (a) or clause (b). Return Need not be Filed [Section 115G]: Where the total assessable income of the non-resident during the previous year consisted only of investment income and long-term capital gains relating to foreign exchange assets and tax on such income has been deducted at source then he need not file a return of income under section 139(1). Benefits Available Even after the Assessee becomes a Resident [Section115H]: Where a person, who is a non-resident Indian in any previous year, becomes assessable as resident in India in respect of the total income in any subsequent year, he may furnish a declaration along with such a return to the effect that the provisions of this chapter shall continue to apply to him in relation to the investment income derived from any foreign exchange asset being debentures, deposits, securities of Central Government and such other notified assets. If he does so, then these provisions will continue to apply to him till such assets are transferred or otherwise converted into money. CFP Level 2 - Module 2 – Taxation - India Page 497

Option to the Assessee [Section 115-I]: A non-resident Indian may elect not to be governed by these provisions. For this purpose he has to declare in the return regarding his option not to be governed by these provisions. In such a case the total income and tax payable there on will be computed in accordance with the other provisions of this Act and consequently, the provisions of this chapter will not apply to such non-resident assessees. Special Concessions in the Case of Individuals not being Citizens of India: Although basically the law of income-tax is applicable alike to both citizens and noncitizens of India, and there is no difference in the general principles for computing the total income under the Income-tax Act, however, on a consideration of the peculiar circumstances in which a foreigner might come to or live in India, certain concessions and reliefs are granted to them. Shipping Business of Non-residents [Section 172]: For the assessment of freight earned in India by ships belonging to or chartered by a non- resident, a special mode of assessment is prescribed under the Act. Under this section, no vessel owned by a non-resident can leave any port in India, unless the port authorities grant a tax clearance certificate. Such a certificate shall not be granted unless the master of the vessel produces a certificate from the Income-tax Authorities showing that the taxes payable have been paid or satisfactory arrangements for their payment have been made. Where the non-resident owner has an agent in India from whom tax is recoverable on a regular assessment, the Assessing Officer in such cases, may grant a port clearance certificate, valid for one year on receipt of an application in his behalf. If the Assessing Officer is not satisfied that there is an agent in India who can be assessed on behalf of non-resident, he shall make a separate assessment in respect of the income of each vessel, before it leaves the port. In such cases, 7½% of the amount paid or payable in or out of India on account of carriage of passengers or goods to the owner or charterer, is deemed to be his income accruing in India in respect of the carriage. The income of the non-residents from shipping business must be computed under section 44B. It is the responsibility of the master of the ship to prepare and furnish to the Assessing Officer return of the full amounts paid or payable to the owner or the charterer, on account of the carriage of goods or passengers. On receipt of such a return the Assessing Officer assesses the CFP Level 2 - Module 2 – Taxation - India Page 498

income and determines the amount of tax payable thereon, at the rates applicable to a company which has not made prescribed arrangement for the declaration and payment of dividends within India. This sum is payable by the master of the ship. The time limit for completing such assessments is 9 months from the end of the financial year in which the return under section 172(3) is furnished. However, in respect of returns filed on or before 1.4.2007, assessments are required to be completed on or before 31.12.2008. After the close of the previous year, it is permissible for a non-resident person on whom tax has been charged on an adhoc basis in respect of the income of a vessel to apply along with a return of his income that he may be assessed on the basis of the business income that actually arose to him in the previous year. On completion of the regular assessment the tax paid towards the adhoc assessment shall be adjusted against the amount due from the assessee and the excess or deficiency if any, shall be refunded to or recovered from the non-resident. Recovery of Tax in Respect of the Income of a Non-resident [Section 173]: In the case of the non-resident the tax on the income which is deemed under section (9)(l)(i)to accrue or arise in India and is taxable as such may be recovered - (i) by deduction of tax at source; or (ii) by an assessment on the non-resident directly or (iii) by an assessment on the non-resident’s agent in his representative capacity. Any arrears of such tax may also be recovered from any of the assets which may at any time come within India. But the arrears cannot be recovered by +`filing a suit in the foreign country where the non-resident principal resides since the Courts of one country have no authority to enforce the revenue laws of another. Generally the proceedings for the recovery of tax cannot be commenced after the expiry of one year from the last day of the financial year in which the demand is made. But section 231 specifically provides that this one year period of limitation does not apply to recovery of tax under this section from the non-residents’ assets in India. This section applies only where the income is covered by section (9)(1)(i); it cannot be made to apply for the recovery of taxes in respect of the income which is not deemed to accrue in India. CFP Level 2 - Module 2 – Taxation - India Page 499

3.1.3. Double Taxation Relief Double taxation arises where various sovereign countries exercise their power to subject the same person to taxes of a similar character on the same income. This may happen when he is taxed on the basis of his personal status, i.e., his nationality, domicile or residence as well as on the basis of place where the income is earned or received. To avoid double taxation of the same income in two countries, the Central Government may enter into an agreement with the Government of any Country outside India: for the grant of relief in respect of income on which income-tax has been paid both under this Act and Income-tax Act in that country, or for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country. Income not Taxable in the hands of Non-Resident 1. Income accruing to the non-resident on the sale of plant and machinery on instalment basis is not taxable. 2. Foreign Agent of an Indian Exporter: He is not liable to income-tax in India for the commission remitted to him by Indian exporter because he operates in his own country and no part of his income arises in India. 3. Non-resident person purchasing goods in India: A non-resident will not be liable to tax in India on any income attributable to operations confined to purchase of goods in India for export even though the non-resident has an office or an agency in India for this purpose. 4. Sale by a non-resident to Indian customer: Where the contracts to sell are made outside India and the sales are made on principal to principal basis, a non-resident is not assessable if he extends credit facilities. In cases where the non-resident has an agent in India but he sells directly to Indian customers, he will not be assessable notwithstanding that he pays an over-riding commission on all sales in India. CFP Level 2 - Module 2 – Taxation - India Page 500

Sub-Section 3.2: Tax Implications – Various Avenues and Techniques 3.2.1. Need and Importance of Tax Planning Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. Need and Importance of Tax Planning Tax Planning is needed for following reasons: Reduction of tax liability. (i) Minimization of litigation. (ii) Productive investment. (iii) Healthy growth of economy. (iv) Economic stability. (i) Reduction of tax liability: One of the supreme objectives of tax planning is the reduction of the tax liability of the taxpayer and the resultant saving of the earnings for a better enjoyment of the fruits of the hard labour. By proper tax planning, a taxpayer can oblige the administrators of the taxation laws to keep their hands off from his earnings. (ii) Minimization of litigation: Where a proper tax planning is resorted to by the taxpayer inconformity with the provisions of the taxation laws, the chances of unscrupulous CFP Level 2 - Module 2 – Taxation - India Page 501

litigation are Certainly to be minimized and the tax-payer may be saved from the hardships and inconveniences caused by the unnecessary litigations which more often than not even knock the doors of the supreme judiciary. (iii) Productive investment: The planning is a measure of awareness of the taxpayer to the intricacies of the taxation laws and it is the economic consciousness of the income earner to find out the ways and means of productive investment of the earnings which would go a long way to minimize his tax burden. The taxation laws offer large avenues for the productive investment of the earnings granting absolute or substantial relief from taxation. A taxpayer has to be constantly aware of such legal avenues as are designed to open floodgates of his well-being, prosperity and happiness. When earnings are invested in the avenues recognized by law, they are not only relieved of the brunt of taxation but they are also converted into means of further earnings. (iv) Healthy growth of economy: The saving of earnings is the only basement upon which the economic structure of human life is founded. A saving of earnings by legally sanctioned devices is the prime factor for the healthy growth of the economy of a nation and its people. An income saved and wealth accumulated in violation of law are the scours on the economy of the people. Generation of black money darkens the horizons of national economy and leads the nation to avoidable economic destruction. In the suffocating atmosphere of black money, a nation sinks with its people. But tax planning is the generator of a superbly white economy where the nation awakens in the atmosphere of peace and prosperity, a phenomenon undreamt of otherwise. (v) Economic stability: Under tax planning, taxes legally due are paid without any headache either to the taxpayer or to the tax collector. Avenues of productive investments are largely availed of by the taxpayers. Productive investments increase contours of the national economy embracing in itself the economic prosperity of not only the taxpayers but also of those who earn the income not chargeable to tax. The planning thereby creates economic stability of the nation and its people by even distribution of economic resources. CFP Level 2 - Module 2 – Taxation - India Page 502

3.2.2. Tax Planning vs. Tax evasion and Avoidance Tax Evasion Unscrupulous citizens evade their tax liability by dishonest means. Some of which are: (i) Concealment of income; (ii) Inflation of expenses to suppress income; (iii Falsification of accounts; (iv) Conscious violation of rules. These devices are unethical and have to be condemned. The courts also do not favour such unethical means. Evasion, once proved, not only attracts heavy penalties but may also lead to prosecution. Such an evader of tax is not a good citizen and tax evasion as a means to reduce tax liability cannot be advocated by any one. Tax Avoidance Tax avoidance is minimizing the incidence of tax by adjusting the affairs in such a manner that although it is within the four comers of the taxation laws but the advantage is taken by finding out loopholes in the laws. The shortest definition of tax avoidance is that it is the art of dodging tax without breaking the law. In the case of tax avoidance, the tax payer apparently circumvents the law, without giving rise to a criminal offence, by the use of a scheme, arrangement or device, often of a complex nature but where the main purpose is to defer, reduce or completely avoid the tax payable under the law. The evil consequences of tax avoidance are manifold and may be summarized as under: Substantial loss of much needed public revenue, particularly in a welfare State like ours. a) Serious disturbance caused to the economy of the country by piling up of mountains of black money directly causing inflation. b) Large hidden loss to the community by some of the best brains in the country being involved in the perpetual war waged between tax avoider and his expert team of advisers, lawyers and accountants on one side, and the Tax Officer and his perhaps not so skillful advisers on the other side. CFP Level 2 - Module 2 – Taxation - India Page 503

c) Sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it. d) Ethics (or lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of artful dodgers. Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. Distinction Between Tax Planning, Tax Avoidance and Tax Evasion Tax planning, tax avoidance and tax evasion are three different approaches to the same objective viz., to reduce tax liability. However, they have different characteristics.  Tax planning is perfectly legal as the-object of tax reduction is achieved by making use of the beneficial provisions in the tax laws.  On the other hand, tax avoidance is also legal though technically satisfying the requirements of law.  Tax evasion is a method of evading tax liability by dishonest means like suppression, conscious violation of rules, inflation of expenses, etc. Tax planning imply compliance with the taxing provisions in such a manner that full advantage is taken of all exemptions, deductions, concessions, rebates and reliefs permissible under the Act so that the incidence of tax is the least. Tax planning, therefore, cannot be equated to tax evasion or tax avoidance. Tax planning may be regarded as a method of intelligent application of expert knowledge of planning corporate affairs with a view to securing consciously provided tax benefits on the basis of the national priorities in keeping with the interest of the State and the public. CFP Level 2 - Module 2 – Taxation - India Page 504

'Tax avoidance' is when the tax payer apparently circumvents the law, without giving rise to a critical offence by the use of a scheme, arrangement or devise often of a complex nature whose sole purpose is to defer, reduce or completely avoid the tax payable under the law. In other words tax avoidance is a method of reducing incidence of tax by taking advantage of certain loopholes in tax laws. Tax evasion is a dubious way of attempting to solve tax problems by suppression of income, conscious violation of rules inflation of expenses, etc. Tax evasion, therefore, cannot be construed as tax planning because it amounts to breaking of law whereas tax planning is devised within the legal framework by availing of what the legislature intended. There is no dispute in accepting tax avoidance is different from tax planning but the subtle difference between tax avoidance and tax planning is often over looked. Thus, any legitimate step taken by an assessee towards maximizing tax benefits keeping in view the intention of law will not only help him but the society also. All those who do the tax planning, could help themselves in efficient and economic conduct of their business affairs without getting entangled in the controversy of tax avoidance or evasion. 3.2.3. Tax Planning vs. Tax Management Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. Tax Management Tax management refers to the compliance with the statutory provisions of law. While tax planning is optional, tax management is mandatory. It includes maintenance of accounts, filling of return, payment of taxes, deduction of tax at source, timely payment of, advance tax, etc. Poor tax management may lead to levy of interest, penalty, prosecution, etc. In some cases it CFP Level 2 - Module 2 – Taxation - India Page 505

may lead to heavy financial loss if proper compliance is not made, e.g. if a loss return is not filed in time it will result in a financial loss because such loss will not be allowed to be carried forward. Tax Planning v/s Tax Management 1. Tax planning a wider term and includes tax management. Tax management is narrower term and is the first step towards tax planning. 2. Tax planning emphasizes on minimization of tax burden. Tax management emphasizes on compliance of legal formalities for minimization of tax. 3. Every person may not require tax planning. Tax management is essential for every person. 4. Tax planning helps in decision making. Tax management helps in complying the conditions for effective decision making. 5. Tax planning helps to claim various benefits of tax. Tax management helps in complying the conditions for claiming tax benefits. 6. Tax planning involves comparison of various alternative before selecting the best one. Tax management involves maintenance of accounts in prescribed form, filing of return, payment of tax, etc. 7. Tax planning looks at future benefits. Tax management relates to past present and future. 3.2.4. Deferral of Tax Liability Investment earnings such as interest, dividends or capital gains that accumulate tax free until the investor withdraws and takes possession of them. The most common types of tax-deferred investments include those in individual retirement accounts (IRAs) and deferred annuities. By deferring taxes on the returns of an investment, the investor benefits in two ways. The first benefit is tax-free growth: instead of paying tax on the returns of an investment, tax is paid only at a later date, leaving the investment to grow unhindered. The second benefit of tax deferral is that investments are usually made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate. CFP Level 2 - Module 2 – Taxation - India Page 506

3.2.5. Maximizations of Exclusions and Credits As you manage your taxes with both the near and distant future in mind, one important, constant goal will be reducing your adjusted gross income (AGI), which equals your gross income (salary, investment earnings, etc.) after your allowable deductions and exemptions. Maximizing your deductions and exemptions, as well as taking advantage of any tax credits available to you, is a great way to start saving money on your next tax bill. Credits vs. Deductions First things first: How is a tax credit different from a tax deduction? A tax credit reduces your tax dollar for dollar—that is, a Rs.1,000 tax credit actually saves you Rs.1,000 in taxes. By comparison, a tax deduction reduces your taxable income, but it is only worth the percentage equal to your marginal tax bracket. For instance, if you are in the 25% marginal tax bracket, a Rs.1,000 deduction saves you Rs.250 in tax (.25 x Rs.1,000), which is Rs.750 less than the savings with a Rs.1,000 tax credit. The higher your tax bracket, the more a deduction is worth, but a credit is always worth more than a dollar-equivalent deduction. Tax credits reduce your tax bill, but certain restrictions, such as income limits, may apply. The American Taxpayer Relief Act of 2012 (ATRA) enacted in January 2013 makes permanent or extends some credits for child-related tax relief. If you have dependent children, you may be eligible to claim the Rs.1,000 child credit in 2013 for each child under the age of 17. Other family-related credits include the adoption credit and the dependent care tax credit. If you are funding a child’s education, you may be eligible for the American Opportunity Tax Credit (AOTC) through 2017, which is an enhanced, but temporary version of the Hope education tax credit. The AOTC provides a tax credit of 100% of the first Rs.2,000 of qualified tuition and related expenses, and 25% of the next Rs.2,500 per eligible student applicable to the first four years of post-secondary education. All taxpayers may either claim a standard deduction or itemize deductions for personal expenses such as home mortgage interest. Income limits apply to taxpayers who itemize deductions. In general, a taxpayer claims an itemized deduction when the total of qualified deductible expenses exceeds the standard deduction or if the taxpayer does not qualify for the standard deduction. For tax year 2013, the standard deduction is Rs.6,100 for single filers; Rs.8,950 for heads of household; and Rs.12,200 for married joint filers. How is a deduction different from an exemption? Personal and dependent exemptions are reductions in gross income in addition to the standard deduction or itemized deductions. Every CFP Level 2 - Module 2 – Taxation - India Page 507

taxpayer may claim a personal exemption for him or herself, unless he or she is claimed as a dependent on another taxpayer’s return. A married couple filing a joint return can claim two personal exemptions, one for each spouse. Even if one spouse has no income, that spouse is not considered the “dependent” of the other spouse for tax purposes. Exemptions will decrease for high-income taxpayers with AGIs above a certain phase-out threshold. Above-the-Line Deductions Retaining as much of your gross income as possible should be an ongoing objective, not something that happens only at tax time. Above-the-line deductions, if you qualify, reduce your adjusted gross income. They are so named because they are taken on your tax form just above the line where you enter your AGI. Possible deductions include contributions to qualified retirement accounts, student loan interest, alimony, early withdrawal penalties, and certain moving expenses. Long-Term Capital Gains and Dividends As an investor, planning your tax strategy can have a significant impact on your tax liabilities, particularly since the passing into law of ATRA. For investors in the top four income tax brackets, the long-term capital gains rate has been raised from 15% to 20% in 2013. That top rate applies to the extent that a taxpayer’s income exceeds the thresholds set for the 39.6% rate (Rs.400,000 for married joint filers and Rs.425,000 for heads of household). All other taxpayers will have a capital gains and dividends tax at a maximum rate of 15%; however a 0% will apply to the extent income drops below the top of the 15% income tax bracket: Rs.72,500 for joint filers and Rs.36,250 for single filers in 2013. To prepare an effective tax strategy, advance planning is key. The sooner you begin, the greater your savings opportunities will be. Be sure to consult your tax professional to create strategies that are right for your unique circumstances. 3.2.6. Managing Loss Limitations If you make a loss when you sell or dispose of an asset, you may be able to deduct it from capital gains you have made. You may be able to deduct it from gains made in the same year or future years. You can deduct some losses from your income instead. The losses must meet certain conditions and you must claim them within a time limit. CFP Level 2 - Module 2 – Taxation - India Page 508

3.2.7. Deductible Expenditures of Individuals and Business Forms Deducting Business Expenses Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. It is important to separate business expenses from the following expenses: • The expenses used to figure the cost of goods sold, • Capital Expenses, and • Personal Expenses. Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your expenses may be included in figuring the cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense. The following are types of expenses that go into figuring the cost of goods sold. • The cost of products or raw materials, including freight • Storage • Direct labour costs (including contributions to pensions or annuity plans) for workers who produce the products • Factory overhead Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. CFP Level 2 - Module 2 – Taxation - India Page 509

This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million. Capital Expenses You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize. • Business start-up cost • Business assets • Improvements Personal Versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part. For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible. Business Use of Your Home If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Business Use of Your Car If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. CFP Level 2 - Module 2 – Taxation - India Page 510

Other Types of Business Expenses • Employees' Pay - You can generally deduct the pay you give your employees for the services they perform for your business. • Retirement Plans - Retirement plans are savings plans that offer you tax advantages to set aside money for your own, and your employees' retirement. • Rent Expense - Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible. • Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities. • Taxes - You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses. • Insurance - Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession. CFP Level 2 - Module 2 – Taxation - India Page 511

Sub-Section 3.3: Taxability of Various Financial Products 3.3.1. Provident Fund and Small Savings Schemes - Contribution, Interest, Withdrawal and Terminal Value Taxability of Provident Funds See section 2.1 Taxability of Small Saving Schemes: Post office monthly income scheme (MIS) Salient Features: 1. Interest rate of 7.6% per annum payable monthly w.e.f. 01-01-2020 2. Maturity period is 5 years. 3. No Bonus on Maturity w.e.f. 01.12.2011. 4. No tax deduction at source (TDS). 5. No tax rebate is applicable. 6. Minimum investment amount is Rs.1500/- or in multiple thereafter. 7. Maximum amount is Rs.4.50 lakhs in a single account and Rs.9 lakhs in a joint account. 8. Auto credit facility of monthly interest to saving account if accounts are at the same post office. 9. Account can be opened by an individual, two/three adults jointly, and a minor through a guardian. 10. Non-Resident Indian / HUF cannot open an Account. 11. Minors have a separate limit of investment of Rs.3 lakhs and the same is not clubbed with the limit of guardian. 12. Facility of premature closure of account after 1 year but on or before 3 years @2.00% discount. 13. Deduction of 1% if account is closed prematurely at any time after three years. 14. Suitable scheme for retired employees/ senior citizens and for those who need regular monthly income. CFP Level 2 - Module 2 – Taxation - India Page 512

National Saving Certificates (NSCs) 1. NSC VIII Issue (5 years) – Interest rate of 7.9% per annum w.e.f. 01-07-2019 2. NSC IX Issue (10 years) - Interest rate of 8.0% per annum w.e.f. 01-04-2019 3. Minimum investment Rs.100/-. No maximum limit for investment. 4. No tax deduction at source. 5. Investment up to Rs.1,50,000/- per annum qualifies for Income Tax Rebate under NSC - section 80C of IT Act. 6. Certificates can be kept as collateral security to get loan from banks. 7. Trust and HUF cannot invest. 8. A single holder type certificate can be purchased by an adult for himself or on behalf of a minor or to a minor. 9. The interest accruing annually but deemed to be reinvested will also qualify for deduction under NSC - section 80C of IT Act. Public Provident Fund (PPF) 1. Interest rate of 8.0% per annum w.e.f. 01-04-2019. 2. Minimum deposit is 500/- per annum. Maximum deposit is Rs.1,50,000/- per annum 3. The scheme is for 15 years. 4. Investment up to Rs.1,50,000/- per annum qualifies for Income Tax Rebate under section 80C of IT Act. 5. Interest is completely tax-free. 6. Deposits can be made in lumpsum or in 12 installments. 7. One deposit with a minimum amount of Rs.500/- is mandatory in each financial year. 8. Withdrawal is permissible from 6th financial year. 9. Loan facility available from 3rd financial year upto 5th financial year. The rate of interest charged on loan taken by the subscriber of a PPF account on or after 01.12.2011 shall be 2% p.a. However, the rate of interest of 1% p.a. shall continue to be charged on the loans already taken or taken up to 30.11.2011. 10. Free from court attachment. 11. Non-Resident Indians (NRIs) not eligible. 12. An individual cannot invest on behalf of HUF (Hindu Undivided Family) or Association of persons. 13. Ideal investment option for both salaried as well as self employed classes. CFP Level 2 - Module 2 – Taxation - India Page 513

Post Office Time Deposit Scheme Salient Features: 1. 1 year, 2 year, 3 year and 5 year time deposits can be opened. 2. Interest payable annually but compounded quarterly: Period Rate of Interest One year 6.9% Two years 6.9% Three years 7.9% Five years 7.7% 3. Minimum amount of deposit is Rs.200/- and in multiples of Rs.200/- thereafter. No maximum limit. 4. Investment up to Rs.1,00,000/- per annum qualifies for Income Tax Rebate under section 80C of IT Act. 5. Interest income is taxable. 6. Facility of redeposit on maturity of an account. 7. In case of premature closure of 1 year, 2 Year, 3 Year or 5 Year account on or after 01.12.2011 between 6 months to one year from the date of deposit, simple interest at the rate applicable to from time to time to post office savings account shall be payable. 8. 2 year, 3 year or 5 year accounts on or after 01.12.2011 if closed after one year, interest on such deposits shall be calculated at a discount of 1% on the rate specified for respective period as mentioned in the concerned table given under Rule 7 of Post office Time Deposit Rules. 9. Account can be pledged as security against a loan to banks/ Government institutions. 10. Any individual (a single adult or two adults jointly) can open an account. 11. Group Accounts, Institutional Accounts and Misc. account not permissible. 12. Trust, Regimental Fund or Welfare Fund not permissible to invest CFP Level 2 - Module 2 – Taxation - India Page 514

Senior Citizen Saving Scheme Salient Features: 1. Interest @ 8.7% per annum from the date of deposit on quarterly basis w.e.f. 01-04- 2019 2. Minimum deposit is Rs.1000 and multiples thereof. Maximum limit of 15 lakhs. 3. Maturity period is 5 years and can be extended for a further period of 3 years. 4. Age should be 60 years or more, and 55 years or more but less than 60 years who has retired under a Voluntary Retirement Scheme or a Special Voluntary Retirement Scheme on the date of opening of the account within three months from the date of retirement. 5. No age limit for the retired personnel of Defence services provided they ful fill other specified conditions. 6. The account may be opened in individual capacity or jointly with spouse. 7. TDS is deducted at source on interest if the interest amount is more than Rs.10,000/- per annum. 8. Investment up to Rs.1,00,000/- per annum qualifies for Income Tax Rebate under section 80C of IT Act. 9. Interest can be automatically credited to savings account provided both the accounts stand in the same post office. 10. Premature closure is allowed after one year on deduction of 1.5% of the deposit and after 2 years on deduction of 1%. 11. No withdrawal permitted before the expiry of a period of 5 years from the date of opening of the account. 12. Non-resident Indians (NRIs) and Hindu Undivided Family (HUF) are not eligible to open an account. Post Office Saving Account Salient Features: 1. Rate of interest 4.0% per annum 2. Minimum amount Rs.50/- in case of non-cheque account, Rs.500/- in case of cheque account. 3. Maximum balance permissible is Rs.1,00,000/- in a single account and Rs.2,00,000/- in a joint account in initial deposit. 4. Interest Tax Free upto Rs.50000 u/s 80TTB for Sr. Citizen and Rs.10000 u/s 80 TTA for other citizens. Addition Rs.3500 u/s 10(15)(i). CFP Level 2 - Module 2 – Taxation - India Page 515

5. Any individual can open an account. 6. Cheque facility available. 7. Group Account, Institutional Account, other Accounts like Security Deposit account & Official Capacity account are not permissible. 3.3.2. Equity Shares - Listed and Unlisted There is no tax implication while making an investment in shares. There are tax benefits to investing in some pre-approved companies as mentioned in the third point below. The tax implication arises only at the time of sale of shares as under: • Any equity share, which has been sold through a recognised stock exchange and on which STT (Securities Transaction Tax) has been paid would be entitled to exemption from Long Term Capital Gains under Section 10 (38) of the Act. Similarly, in case of Short Term Capital Gain of such shares, the gains shall be taxed only at 10%, plus surcharge and education cess. • Under Section 80C, any subscription to equity shares or debentures forming part of any eligible issue of capital, approved by the Court or an application made by a public company or subscription to such eligible issue by a public finance institution in a prescribed form, would be eligible to deduction subject to the condition of this Section. Also, subscription to any unit of a mutual fund, approved by the board in respect of any mutual fund, referred to in Clause (23D) of Section 10, would also be entitled. Tax Implication of a Bonus/Rights Issue on Equity Shares Under Section 55(2)(AA), bonus on equity shares has a zero (nil) cost of acquisition. The holding period is calculated from the date of allotment of equity shares. The net sales proceeds are treated as the capital gain. The period of holding of such issue is reckoned from the date of the allotment of such issue. The cost of acquisition of the rights issue on equity shares is the amount actually paid for acquiring such right according to Section 55(2) (AA) (iii). The holding period is reckoned from the date of allotment. Where there is a transfer of these rights, the cost of acquisition of such rights is to be taken as 'nil' according to Section 55(2) (AA) (ii). The sale price of such transferred rights will be taken as capital gain. CFP Level 2 - Module 2 – Taxation - India Page 516

The period of holding in the hands of the transferor is computed from the date of offer, made by the company to the date of renouncement. In case of the transfer of such rights, the cost of acquisition is the aggregate of the amount of purchase price, paid to the transferor to acquire the right entitlement and the amount, paid by him to the company for subscribing to such right offer of share. The period of holding in the hands of the transferee will be from the date of allotment of such shares. Capital Gains Liability Arising on Sale of Shares i.e. Long-term/Short-term In case of equity or preference shares in a company, if the shares are held for more than 12 months immediately prior to its transfer then it is known as long term capital asset and on transfer of long term capital asset, long term capital arises. Long term capital gains arising on transfer of equity shares will not be chargeable to tax from assessment year 2005-06 if such transaction is covered by securities transaction tax under section 10(38). Taxability of Dividend Income, Received from Investments in Shares Dividend, received from investment in shares, is not taxable in the hands of the recipient. The company, distributing the dividend, is required to deduct tax from the amount of dividend declared. Such tax deducted will not be entitled to TDS for the recipient. STT (Securities Transaction Tax) The Securities Transaction Tax has been introduced by Chapter VII of the Finance Act (No.2) Act, 2004. It provides for a levy of a transaction tax on the value of certain transactions. These transactions include the purchase and sale of equity shares in a company, purchase and sale of units of an equity growth fund, sale of a unit of an equity growth fund to the mutual fund and sale of a derivative. The transaction tax will be payable on all transactions that have taken effect from October 1, 2004. CFP Level 2 - Module 2 – Taxation - India Page 517

S. No. Taxable Securities Transaction Rate Payable by 3 4 12 0.1% Purchaser 1. Purchase of an equity share in a company, where - (a) the transaction of such purchase is entered into in a recognised stock exchange; and (b) the contract for the purchase of such share is settled by the actual delivery or transfer of such share. 2. Sale of an equity share in a company, 0.1% Seller where– 0.001% Seller (a) the transaction of such sale is entered 0.025 % Seller into in recognised stock exchange; and Page 518 (b) the contract for the sale of such share is settled by the actual delivery or transfer of such share. 2A. Sale of a unit of an equity oriented fund, where – (a) the transaction of such sale is entered into in a recognised stock exchange; and (b) the contract for the sale of such unit is settled by the actual delivery or transfer of such unit 3. Sale of an equity share in a company or a CFP Level 2 - Module 2 – Taxation - India

unit of an equity oriented fund, where - 0.017 % Seller (a) the transaction of such sale is entered 0.125 % Purchaser 0.01% into in a recognised stock exchange; and Seller (b) the contract for the sale of such share or 0.001 % Seller unit is settled otherwise than by the 0.2% actual delivery or transfer of such share or Seller unit 4. (a) Sale of an option in securities (b) Sale of an option in securities, where option is exercised (c) Sale of a futures in securities 5. Sale of a unit of an equity oriented fund to the Mutual Fund. 6. Sale of unlisted equity shares under an offer for sale referred to in section 97(13)(aa) - sale of unlisted equity shares by any holder of such shares under an offer for sale to the public included in an initial public offer and where such shares are subsequently listed on a recognised stock exchange Surcharge: Nil, Education cess: Nil Note: STT is not applicable in case of Government securities, bonds, debentures,units of mutual fund other than equity oriented mutual fund and in such cases, tax treatment of short - term and long - term capital gains shall be as per normal provisions of law. CFP Level 2 - Module 2 – Taxation - India Page 519

Computation of Long Term Capital Gains on Shares both Equity and Preference, Listed or Unlisted and Debentures: IF it is not covered by STT Capital Assets If transaction is Long Term covered by STT at the time of transfer Without With indexation indexation Listed equity shares covered 10% In excess of Rs.1 10% 20% by lakh 10% 20% Listed equity shares not 10% covered by NA 20% Unlisted equity shares NA 10% 20% Listed Preference shares NA NA 20% Unlisted Preference shares NA 10% NA Listed Debenture NA 20% NA Unlisted Debenture NA 3.3.3. Equity Transactions - Stock Market and Off Market Equity Transactions: Stock Market Trading in dematerialized securities is quite similar to trading in physical securities. The major difference is that at the time of settlement, instead of delivery/receipt of securities in the physical form, the same is affected through account transfers. Delivery of securities to or from a clearing member is called \"Market Trades\" in the depository system. A simple way of determining whether a trade is a market trade is that, either source or target in a transfer instrument is a CM account; such a transfer is a “Market Trade” CFP Level 2 - Module 2 – Taxation - India Page 520

Equity Transactions: Off Market Trading in dematerialized securities is quite similar to trading in physical securities. The major difference is that at the time of settlement, instead of delivery/receipt of securities in the physical form, the same is affected through account transfers. Trades which are not settled through the Clearing Corporation/ Clearing House of an exchange are classified as \"Off Market Trades\". Delivery of securities to or from sub brokers, delivery for trade-for-trade transactions, by this definition are off-market trades. Securities Transaction Tax (STT) is the tax payable on the value of taxable securities transaction. STT was introduced in India by the 2004 budget and is applicable with effect from 1st October 2004. What all is covered by Securities? Securities definition is as per section 2(h) of the Securities Contracts (Regulation) Act, 1956, but for our purpose, let’s just simply says Securities mean Equity Shares and Equity Derivatives (i.e. Futures and Options). Full definition of Securities is given in Appendix, for information. What are taxable transactions? Purchase and Sale of securities through a recognized stock exchange in India. STT is not applicable on off-market transactions. What rate is STT payable? STT is applicable at different rates depending upon the security (whether equity or derivative) and the transaction (whether purchase or sell). Current STT rates are given below. Note that Service Tax, Surcharge and Education Cess are not applicable on STT. Income Tax and STT Taxation of profit or loss from securities transactions depends on whether the activity of purchasing and selling of shares / derivatives is classified as investment activity or business activity. Treatment of STT also depends upon whether the income from these securities transactions are included under the head “Income from Capital Gains” or under the head ‘Profits and Gains of Business or Profession’. CFP Level 2 - Module 2 – Taxation - India Page 521

Scenario 1: ‘Income from Capital Gains’ This refers to the scenario where the assessee is either Salaried or is engaged in some other business or profession and trading in securities is not the main line of business. In such cases gains or losses from securities transactions are taxed under the head “Income from Capital Gains”. Gains or losses are subject to Short Term Capital Gains (STCG) or Long Term Capital Gains (LTCG) tax depending upon the period of holding, i.e., if the holding period is less than 1 year, gains are classified as STCG and if the holding period is equal to or greater than 1 year, gains are classified as LTCG. Any equity share, which has been sold through a recognised stock exchange and on which STT has been paid, is entitled to exemption from LTCG under Section 10 (38) of the Act. Similarly, in case of STCG of such shares, the gains shall be taxed only at 15%, plus surcharge and education cess under section 111A of the Act. Important points to note: 1. STCG and LTCG rates of 15% and NILare available only if the specified security is sold through a recognised stock exchange. Private deals or transactions, not routed through a recognised stock exchange in India, will not be covered 2. the purchase of the specified securities could be through any mode and need not be through a recognised stock exchange 3. The exemption is not available to transactions where STT has not been paid 4. Since LTCG is exempt, Long Term Capital Loss, arising from these specified securities, cannot be set-off against any other gain/income. This loss shall lapse 5. As per section 40(a)(ib) of the Income tax Act, STT cannot be claimed as an expense in computing the income chargeable under Capital Gains Scenario 2: ‘Profits and Gains of Business or Profession’ This refers to the scenario where main business of the assessee is trading in securities. In such cases the gains or losses are classified as business income, which is taxed at the regular rate of income-tax. STT paid in respect of taxable securities transactions entered into in the course of business shall be allowed as deduction under section 36 of the Income-tax Act. 3.3.4. Equity Oriented Products - Equity Schemes of Mutual Funds, ETFs, ELSS, etc. Equity Schemes of Mutual Funds CFP Level 2 - Module 2 – Taxation - India Page 522

• Dividend/income received by unit holders is exempt in the hands of unit holders, whether units are of equity oriented schemes or of debt oriented schemes. • Mutual Fund company is liable to pay tax on distributed profits @ 25% in case of Individual/HUF/NRI unit holders & @ 30% in case of company unit holders. Rates shall be increased by surcharge @ 10% and cess @ 3%. • For taxation of capital gains on mutual fund units, please refer chapter 2.4. • In case of NRI, tax rates on capital gains shall be as follows: Nature of Purchase Listed/ Section Tax rate security currency unlisted 10(38) 10% above Rs.1 lakh Applies Indian Listed Does not Tax 20% with indexation or apply 10% w/o indexation Equity Shares Unlisted Can’t apply Tax 10% w/o indexation Listed Applies Exempt Foreign Unlisted Does not 10% w/o indexation apply 10% w/o indexation Can’t apply Preference Indian Listed Can’t apply Tax 20% with indexation or Shares Unlisted Can’t apply 10% w/o indexation Tax 10% w/o indexation Debentures Foreign Listed Can’t apply 10% w/o indexation Units Indian Unlisted Can’t apply 10% w/o indexation Listed Can’t apply Tax 10% w/o indexation Foreign Unlisted Can’t apply Tax 10% w/o indexation Listed Can’t apply 10% w/o indexation Unlisted Can’t apply 10% w/o indexation Any Always Applies Exempt currency listed Does not Tax 20% with indexation apply CFP Level 2 - Module 2 – Taxation - India Page 523

Exchange Traded Funds (ETFs) Exchange traded funds (ETFs) are uniquely structured investments that track indexes, commodities or baskets of assets. Like stocks, ETFs can be purchased on margin and sold short, and prices fluctuate throughout each trading session as shares are bought and sold on various exchanges. Twenty years ago, the first exchange traded fund (ETF) was introduced - the SPDR S&P 500 ETF (SPY). Since then, the ETF industry has blossomed into a trillion-dollar-a-year business, with an increasing number of ETFs available to match a variety of investment styles, goals and risk tolerances. ETFs have become standard in many investors' portfolios, due in part to the many benefits of ETF investing, including their tax efficiency. Due to the method by which ETFs are created and redeemed, investors are able to delay paying most capital gains until an ETF is sold. As with any investment, it is important for investors to understand the tax implications of ETFs prior to investing. Here we will introduce asset classes, structures and the tax treatment of exchange traded funds. ETF Asset Class and Structure The way that an ETF is taxed is determined by its method of gaining exposure to its underlying assets, its structure and the amount of time that the ETF is held. Exchange traded funds can be categorized into one of five asset classes: • Equity funds (market indexes, stocks) • Fixed income funds (bonds) • Commodity funds (tangible goods) • Currency funds (foreign currency) • Alternative funds (multiple asset classes or non-traditional assets) For taxation purposes, ETFs are further categorized by one of five fund structures: Open-end funds Unit investment trusts (UITs) Grantor trusts Limited partnerships (LPs) CFP Level 2 - Module 2 – Taxation - India Page 524

ETF Tax Treatment The combination of an ETF’s asset class and structure, along with how long the ETF is held (short-term gains apply to investments that are held for three years or less, long-term apply when a position is held for more than three years), determines its potential tax treatment. Index ETFs or sectoral ETFs are treated as equity oriented schemes and tax accordingly. Short term Tax is 15% and LTCG is taxed at 10% in excess of Rs.1 lakh. While Gold ETF are taxes as debt funds where STCG is taxed at normal slab rate before 36 months, and LTCG are taxed at 20% after indexation. Same with go with international ETF. Equity Linked Saving Scheme (ELSS) Equity Linked Savings Schemes (ELSS) is a tax saving mutual fund that are open for investments during the year. There are different kinds of tax benefits that the investors can expect with the instrument and hence there is a need to take a careful look at how this entire thing is structured. There has to be a look at the performance of the fund along with the other conditions while making a purchase decision and hence this will require some work. Here are the tax benefits that will come along with the fund. Investment Deduction ELSS funds are one of the eligible options that qualify for a deduction under Section 80C of the Income Tax Act. This means that the investments made into the fund will qualify for a deduction from the taxable income of the individual. This is part of the overall limit of Rs.1 lakh that is available for individuals and they can make the full use of this limit in the instrument. There is a 3 year lock in that is present on the ELSS funds so this will need to be considered at the time of making the investment. The investment will lead to a reduction of the taxable income by the amount of the investment and this constitutes the initial tax benefit. Dividend The ELSS is an equity oriented option as the entire portfolio of the fund is invested into equity shares. This is actually the only pure equity option that is present under Section 80C for the CFP Level 2 - Module 2 – Taxation - India Page 525

individual and hence when it comes to the issue of asset allocation this point needs to be considered. In terms of the receipt of the earning on the fund the dividend that is actually received is tax free in the hands of the investor. There is also no dividend distribution tax that will be levied on the fund at the time of the payment of the dividend so this means of getting the earnings from the fund will be tax free without any indirect impact being present. Capital Gains The other route in which the investor will actually gain from the investment is through capital gains on the amount invested. This happens when the investor get an appreciation in the value due to the rise in the Net Asset Value (NAV) of the fund. Since there is a three year lock in on the fund there cannot be a short term capital gains earned on the investments. So the long term capital gains that is actually earned on the investment will be tax free in the hands of the receiver as there is no tax that is levied on equity oriented funds that have been held for a period of more than one year. There will be a securities transaction tax that has to be paid at the time of the sale of the units but the fund will deduct this amount and give the remaining figure to the investor. On the other hand if there is a long term capital loss that is incurred then the individual will have to discard this from the tax calculation because the loss cannot be set off against any other income. 3.3.5. Debt Products - Bonds, Debentures, Government Securities, Income Schemes of Mutual Funds including Fixed Maturity Plans (FMPs) Debt Products - Bonds Income, Capital Gains and Taxation Distributions Fixed-rate capital securities pay monthly, quarterly or semi-annual distributions that, like interest payments on bonds, are fully taxable to the investor. Investors should be aware that, unlike other bonds, most fixed-rate capital securities include a provision allowing the issuer to defer distributions for up to five years. Although deferral would be permissible only if the issuer also suspended all dividends on its common and preferred stock (like regular preferred stock), investors in fixed-rate capital securities could have their income interrupted if this situation CFP Level 2 - Module 2 – Taxation - India Page 526

were to occur. During such a period, the investor would incur a tax liability on the deferred income, which continues to accrue, typically at a compounded rate, even though it is not actually paid. Investors can avoid such a tax obligation by holding their securities in a tax- deferred retirement account. At the end of the deferral period, the issuer would be required to pay all deferred distributions. Taxability of Income The treatment of investment income from trust and debt securities for federal income tax purposes is unclear under current tax statutes and regulations and may vary depending upon whether the possibility of the issuer deferring payments is, or is not, a remote contingency. If deferral is a remote contingency, payments should be included in income by a holder as such payments are accrued or received, depending upon the holder’s method of accounting. If deferral is not a remote contingency, the income may be treated as original-issue discount (OID) and both cash and accrual investors would be required to report accrued OID even if it is different than the amount received. In general, for investment-grade issuers who pay common stock dividends, payments will be treated as interest, not OID. Ask to check the prospectus for applicability. A holder who purchases such fixed-rate capital securities in the secondary market for a price in excess of the original-issue price plus accrued OID (including income treated as OID) may reduce income accruals by the amount of such excess by including income on a constant yield- to-maturity basis. Consult your tax adviser for specifics. Should the issuer elect to defer payments, the deferred income continues to accrue for tax purposes, even though the investor receives no cash payments with respect to the security. To avoid the impact of a tax liability on “phantom” income that accrues but is not actually received, investors may wish to hold these securities in qualified tax-deferred retirement accounts. Income from partnership securities is generally reported to investors on a simplified K-1 form. In general, partnership issuers use a monthly convention that allocates the income accrued on the underlying debentures of the parent to the persons holding the partnership securities at the end of each month. Accordingly, although partnership investors, like investors in trust and debt securities, are required to accrue such income even during a deferral period, the income only has to be accrued by the partnership holders at the end of each month rather than on a daily basis. For investors who purchase the securities at original issuance, this distinction will only affect the investor who sells a security prior to the end of the month. With respect to a CFP Level 2 - Module 2 – Taxation - India Page 527

trust or debt security, such investor would be taxed on accrued income to the date of sale. However, with respect to the sale of a partnership security, such investor would only pay tax at ordinary income tax rates on income accrued through the prior month end; the portion of the sale price attributable to income accrued during the current month through the date of sale would instead be taken into account in computing a capital gain or loss. Calculating Capital Gains or Losses As with bonds and preferred stock, if fixed-rate capital securities are sold or otherwise disposed of prior to maturity, the investor may realize a capital gain or loss on the transaction. The amount of gain or loss will equal the difference between the amount realized from the sale and the adjusted tax basis, which includes the amount of accrued but unpaid income required to be included by the seller through the date of sale. For example: Purchase price : Rs.25.00 Sale proceeds : Rs.26.10 [including Rs.0.40 in accrued income] Adjusted tax basis : (Rs.25.40) [purchase price + Rs.0.40 accrued income in sale price] Capital gain : Rs.0.70 In the case of a partnership security purchased at original issuance, generally no accrued income will be included in the seller’s adjusted tax basis unless the issuer has deferred income payments. Where the seller had purchased a security of any type in the secondary market, any portion of its purchase price attributable to income accrued prior to its purchase will be included in basis. Although a gain or loss on a sale of a security is generally considered to be capital, special rules apply to shares of securities purchased at “market discount,” i.e., for an amount less than the original-issue price plus accrued original-issue discount. In such a case, a portion of any gain up to the amount of accrued market discount is taxed as ordinary income, unless the seller had elected to include accrued market discount in income on a current basis. CFP Level 2 - Module 2 – Taxation - India Page 528

Debentures Non-Convertible Debentures are simple debentures that cannot be converted into equity shares of the issuing company. These debentures usually carry interest rates higher than Convertible Debentures. For tax purpose, interest earned on NCD held till maturity is considered as Income from Other Sources which is clubbed into income of the debenture holder and taxed as per the applicable income tax slab rate. Selling listed NCD in secondary market before maturity has two implications: a) PNCD sold within one year of issue will give rise to Short Term Capital Gain/ Loss which would be clubbed into debenture holder's income and taxed according to applicable slab rate. b) NCD sold after one year of issue but before maturity will give rise to Long Term Capital Gain/Loss which will be taxed at 10 per cent with added surcharge. No indexation benefits are available on selling listed NCDs in secondary market. Also, Securities Transaction Tax (STT) does not apply in case of debentures. Further, it should be noted that selling the debentures in secondary market will be possible based on its market demand. You would be able to sell only if someone is ready to buy at the quoted price. Every year, bondholders receive their annual 1099-INT forms and dutifully report the numbers that are listed there on their tax returns. However, there is often more to what appears on these forms than the income that is generated from the stated rate of interest. Many fixed income investors are unaware of a number of factors that can impact the amount of taxable interest that they must report at the end of the year. This article will explore each of the major categories of bonds, as well as analyze some of the other issues that factor into what investors must report as income. Government Securities Types of Bonds Bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the CFP Level 2 - Module 2 – Taxation - India Page 529

principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals (ex - semi-annual, annual, sometimes monthly). All bonds fall into one of three broad categories: 1. Government 2. Corporate 3. Municipal Although certificates of deposit (CD) can trade like bonds in the secondary market and are taxed in a similar manner, they are not considered to be bonds. The following is a breakdown of each type of debt. Capital Gains Bonds are instruments which offer tax exemption for transferring gains of long term capital assets. The Investment in these Bonds is to be made within six months from the date of such transfer of capital assets (Land/House Property etc.) for being exempted from Capital Gains Tax under Section 54EC of the Income Tax Act, 1961. The eligible bond under Section 54 EC are: • RECL (Rural Electrification Corporation Ltd) • NHAI (National Highways Authority Of India) Features RECL NHAI Coupon/Interest rate 5.75% 5.75% Tax Status Taxable Taxable Tax Benefit SEC 54 EC SEC 54 EC Minimum ( Rs.) 10,000 10,000 Maximum ( Rs.) 50,00,000 50,00,000 Tenure 5 Years 5 Years Mode of Interest Annual Annual CFP Level 2 - Module 2 – Taxation - India Page 530

Section 54EC See chapter 2.4 GOI Savings (Taxable) Bonds 1. Bonds may be held by: An individual, NRI, HUF, Charitable institution or University. 2. There is no maximum limit for investment. Bonds are issued at a minimum amount of Rs.1000/- (face value) and in multiples thereof. 3. Interest on bonds will be taxable under IT Act, 1961. The bonds will be exempt from wealth tax under the Wealth Tax Act, 1957. 4. The Bonds will bear interest at the rate of 8% per annum. Interest on non-cumulative bonds will be payable at half-yearly intervals from the date of issue or interest on cumulative Bonds will be compounded with half-yearly rests and will be payable on maturity along with the principal, as the subscriber may choose. 5. Tax will be deducted at source while making payment of interest on the non-cumulative bonds from time to time and credited to Government Account. Tax on the interest portion of the maturity value will be deducted at source at the time of payment of the maturity proceeds on the cumulative Bonds and credited to Government Account. 6. The Bonds shall be repayable on the expiration of 6(six) years from the date of issue Tax Free Bonds Tax free bonds are instruments where interest earned is not taxed. However, there is no deduction for the principal invested in these bonds. These bonds will be eventually listed on the Bombay and National Stock Exchange, so investors will have the option of selling them before the full term of the bond. However, the price you may get for selling before they mature will depend on market conditions. Experts say these bonds make sense only for very risk-averse investors with a lot of cash at hand (say upward of Rs.100,000). CFP Level 2 - Module 2 – Taxation - India Page 531

Fixed Maturity Plans(FMPs) FMPs are debt instruments coming from Mutual Funds. A Fixed Maturity Plan (FMP) is a fixed income scheme and generally is 100% equity free. FMPs have a fixed life and a definite maturity date i.e. they are closed ended schemes and once closed you can't invest in that FMP and hence they are called as Fixed Maturity. Post the maturity date the fund ceases to exist and your investment along with the appreciation is automatically returned back to you. FMPs invest in Commercial Paper, Certificate of Deposits, Debentures, Bonds, Securitized debt, Money Market instruments etc. So, an FMP is also a 100 per cent debt instrument. The maturity amount is not fixed they don't guarantee fixed rate of return, As per SEBI regulations, the portfolio and the indicative returns of the FMP cannot be disclosed by the Mutual Fund house, but they offer better post tax returns. How? How FMP is Better Compare to bank FDs In FDs, the interest income is added to the investor’s income and is taxable at the applicable tax slab (or the marginal rate of tax). As far as FMPs are concerned, the tax implication depends upon the investment option – dividend or growth. In the dividend option, the FMP issuer deducts the dividend distribution tax and thereafter there is no tax liability in the hands of the investors. Whereas in the growth option, returns earned are treated as capital gains i.e. Long Term Capital Gains enjoy indexation benefits and Short Term Capital Gains are added to income of investor and taxed accordingly. Taxability of Fixed Maturity Plans If you invest in an FMP, the dividend is tax-free in the hands of the individual investor. CFP Level 2 - Module 2 – Taxation - India Page 532

If you invest in the growth option of the FMP for less than 3 years, the gains are added to the investor's income and taxed at the investor's slab rate. If you invest in the growth option of the FMP for over 3 years, you pay either 10% capital gains tax without indexation or 20% with indexation. Indexation is the process by which the inflation is taken into account when computing the tax liability to understand indexation. Long-term capital gains (investment of more than 3 years) enjoy indexation benefits. The tax liability is computed using two methods i.e. with indexation (charged at 20% plus surcharge) and without indexation (charged at 10% plus surcharge); the tax liability will be the lower of the two. Short-term capital gains are added to the income of the investor and taxed as per his/her slab. 3.3.6. Income Distribution and Dividends on Various Investment Products See chapter 2.5 3.3.7. Securities Transaction Tax (STT) and Dividend Distribution Tax (DDT) See chapter 2.5 & 3.3 3.3.8. Life and Health Insurance Products, Unit Linked Insurance Plans (ULIPs), Unit Linked Pension Plans (ULPPs), etc. Life and Health Insurance Products Life Insurance is a critical part of an individual's personal insurance portfolio. It's a strategic part of the future security that one must provide for one's family in the face of the inevitable. CFP Level 2 - Module 2 – Taxation - India Page 533

The proper type and the appropriate level of life insurance can be a matter of life and death. Securing the long-term financial security and quality of life for the people you love most is crucial, and the first step in securing it is life insurance. Many individuals also look at life insurance from tax planning perspective. Position Prior to the Finance Act, 2003 It would not be wrong to say that the Life Insurance Corporation has risen to its current stature because of tax concessions given to policyholders. It is the prospect of substantial reduction in tax that has generally induced individuals and Hindu undivided families to take insurance policies. While the premium paid went to reduce the annual tax burden by way of tax rebate, the lump sum received when the policy matures was treated as tax-exempt capital receipts. Any controversy about taxing bonus payments in excess of the maturity value was set at rest when the Finance (No. 2) Act, 1991, inserted Section 10 (10D) in the Income Tax Act, 1961 with retrospective effect from April 1, 1962. It was laid down that any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, would be exempt from tax. Amendment made by the Finance Act, 2003 This established position of exempting maturity proceeds of life insurance policies has been unsettled in this year's Finance Act 2003. Section 10 (10D) is now substituted by a new section with effect from financial year commencing from April 1, 2003 relating to assessment year 2004-05 so as to deny exemption to any sum received under an insurance policy in respect of certain life insurance policies where premium payable in any of the years during the term of the policy exceeded 20 per cent of the capital sum assured. Examples of such plans are Bima Nivesh, Jeevan Dhara, Kotak Insurance Bonds and Birla Flex Plan. CFP Level 2 - Module 2 – Taxation - India Page 534

The reason for bringing the proceeds of tax insurance policies with high premium and minimum risk cover under the tax bracket is similar to the reason for taxing deposits or bonds. Hence, such policies are to be treated at par with other investment schemes. It is difficult to understand how a life insurance policy can be compared with the normal deposit or investment in bonds. Moreover, when tax rebate is also denied, levy of tax on maturity of the policy is unjust. The original amendment in the Finance Bill 2003 was modified to exempt the sum received under an insurance policy issued on or before March 31, 2003 in respect of which the premium payable for any years during the term of the policy exceeds 20 per cent of the actual capital sum assured is taxable. Further, any sum received under such policy on the death of a person shall continue to be exempt. The taxability of such insurance policy at the time of maturity or surrendered arises only when the premium payable exceeds 20 per cent of the capital sum assured as per the terms of the policy and not actual premium paid during the year exceeds 20 percent of the capital sum assured. While calculating the capital sum assured, no account shall be taken of the value of any premium agreed to be returned or any benefit by way of bonus or otherwise over and above the sum actually assured which is to be or may be received to the insurer at the time of maturity. A question will arise as to the computation of income in respect of the amount received. Policy is a 'capital asset' within the meaning of section 2(14). On maturity or surrender there will be a 'transfer' and amount received will be treated as a consideration and premium paid will be considered as cost and indexation benefit will be available. The income so arrived will be taxable as long-term capital gains. CFP Level 2 - Module 2 – Taxation - India Page 535

Tax Saving Life Insurance Plans The Importance of Tax Saving What does one understand by the term, tax savings? The income that an individual earns every year is subject to the Income Tax laws governing that country. The Income Tax rates are not the same for all. The rates varies basis on different income levels.. So the total income tax an individual needs to pay depends upon the annual income he or she has earned in that given year. But, there are many ways by which one can save income-tax.So the question arises that how to save income tax? To extract maximum tax benefits, you need to invest your earnings wisely in different insurance plans. This is where your investments come into play, as a lot of investment plans come with several benefits. With the help of tax deduction, a break granted by the government, one can save tax on premium paid. The maturity proceeds of life insurance product is tax free as well. You could look at long term objectives like investing in a pension plan for a life after retirement or a life cover to secure your family's future. There are a range of tax saving plans available for individuals to gain tax benefits under various sections. This is why it is very important to carry out an extensive research and know about the different products available. Tax Saving through Life Insurance Products To save tax, Life Insurance products play a important role. Under the Income Tax Act 1961, by investing in a life insurance plan, you are allowed to claim deduction on the premiums that you pay when calculating taxable income (subject to conditions of Income Tax Act, 1961). This means, the insurance premiums which you pay helps in reducing your tax outflow. Further subject to conditions, maturity proceed from Life Insurance comes under exempted incomes. This means, no tax to be payable on any benefits received on maturity or on death. Hence Life Insurance Scheme can help you avail dual tax benefits. Also, you are investing in a Life. You can also get Tax benefits on Health Insurance and production product. This helps in reducing the computable tax base, thus resulting in reducing the net tax liability. Tax Planning for Individuals Let's take a look at some of the benefits which an individual person can benefit from tax saving. An Individual/salaried can avail following tax benefits on premium paid by way of deductions from taxable income CFP Level 2 - Module 2 – Taxation - India Page 536

1. Section 80C - Premium paid on Life Insurance policies: deduction upto Rs.1,50,000 Premium paid on pure term, endowment and Ulip product eligible for 80C benefit 2. Section 80CCC- Premium paid on pension policies : deduction upto Rs.1,50,000 deduction is within Rs.1,00,000 limit of Section 80C and 80CCD(1) 3. Section 80D- Premium paid on health insurance policies: deduction upto Rs.75,000/- Rs.25,000 deduction is allowed for self, spouse and dependent children: Additional Rs.25,000 for parents or Rs.50,000 for parents above 60 years of age. 4. Maturity proceeds from Life Insurance policies are exempt u/s 10(10D) subject to specified conditions So go ahead, secure your future by investing in a Life Insurance Policy that reaps in great benefits along with making sure that you are hard earned money stays with you. Tax Benefits on Mediclaim / Health Insurance Premium Section 80D The investments made for paying health insurance premium qualify for tax deduction under section 80D. Deduction Available: Individuals who are less than 60 years of age and amount of health insurance premium paid which is Rs.25,000 or lesser. The policy holder can also claim for further deduction of Rs.25,000 if they have bought health insurance for parents (Rs.50,000 if either of your parents is a senior citizen). This is irrespective whether they are dependent on you or not. There is no deductions for claims made on health insurance for in-laws. Medical expenditure for senior citizen is also covered in 80D upto Rs.50000 if no health policy is given to them. Who can claim? Individuals can claim for tax deduction if they have paid premiums for health insurance coverage for self, spouse, parents and children. For HUF assesses, premium paid for insuring the health of any member of the HUF, can be used for deduction. CFP Level 2 - Module 2 – Taxation - India Page 537

Factors to Consider: The premium could have been paid by any modes of transaction other than cash. The taxable income for the year you claim is applicable for the health insurance premium that you pay. The premium paid should not be paid from gifts received by you. In case of part payment of premium; For Ex; if you pay 50% premium and rest 50% is paid by your parents then the deduction for the amount you paid can be claimed. And parents can claim for their contribution. Section 80DD The expenditure incurred for paying medical bills for your handicapped dependent qualify for tax deduction under section 80D. Deduction Available: It can be Rs.75,000 or actual expenditure. In case of severe handicap conditions it can be Rs.1,25,000 as the deduction limit. Who can claim? The deduction can be claimed by the dependent parents, spouse, children and siblings. In all these cases, dependents must not have claimed any deduction for their disability. Deductions are allowed in either of the following cases. a) Expenditures incurred for medical treatment, training or rehabilitation of a disabled dependent, including amount spent for nursing. b) Any insurance scheme amount paid for the maintenance of your disabled dependent in case of your untimely death. Disability Meaning: It means a person suffering from 40% or more of any of the below disabilities. A severe disability condition is 80% or more of the disabilities. Blindness and Vision problems CFP Level 2 - Module 2 – Taxation - India Page 538

• Leprosy-cured • Hearing impairment • Loco-motor disability • Mental retardation or illness Factors to Consider: The individuals would need to produce a copy of the disability certificate issued by central or state government medical board. Insurance policy should be in your name and made for life. It can pay either an annual or a lump sum amount for the benefit of the dependent on your death. If the disable dependent predeceases you, the policy amount will be returned to you and treated as an income, this fully taxable. Section 80DDB Medical expenses incurred for treatment of specified illnesses, could fetch you a tax benefit under section 80DDB. Deduction Available: For individuals who are lesser than 60 years of age a deduction limit of Rs.40,000 is applicable. If you are a senior citizen above 60 years of age then there is a limit of Rs.60,000. If you are …………………………………………………….. Who can claim? Tax deduction can be claimed by individuals for the expenditure made for treatment of self, spouse, children, siblings, and parents, wholly dependent on you. Covered Diseases: • Neurological Diseases (where the disability level has been certified as 40% or more). • Parkinson’s Disease • Malignant Cancers • Acquired Immune Deficiency Syndrome (AIDS) • Chronic Renal failure • Hemophilia CFP Level 2 - Module 2 – Taxation - India Page 539

• Thalassemia Factors to Consider: If the insurance company, employer... have already made the reimbursement of the treatment cost then the deductions cannot be made. In the case of you receiving partial reimbursement the balance amount can be used for deduction. You need to submit the proof of specified ailment by giving a certificate issued by the specialist working in a government hospital. CFP Level 2 - Module 2 – Taxation - India Page 540

Sub-Section 3.4: Taxation of various Financial Transactions 3.4.1. Transaction in the Nature of Gifts/Prizes/Winnings See chapter 2.5 3.4.2. Agriculture Income Agricultural Income – Section 2(1A) 1. Land must be situated in India, whether urban or rural 2. Even rent received for a land, which is being used by tenant for agricultural purposes, is agricultural income only. 3. Income derived from saplings or seedlings grown in a nursery shall be agricultural income, whether any process has been carried out on land or not. 4 Agricultural income is exempt for all assessees u/s 10(1). 5. Examples – agricultural income: seeds, flowers, vegetables, fruits, grains, pulses, cotton, bamboo. 6. Examples – non-agricultural income: breeding of livestock, poultry farming, fisheries, dairy farming 7. In case of a company which is engaged in agricultural activities, agricultural income shall be exempt u/s 10(1) for such company, but any dividend declared by such company shall be liable to CDT @ 15%. 8. In case of partnership firm engaged in agricultural activities, any salary and/or interest paid by such partnership firm to partners shall be treated as agricultural incomes in the hands of partners and hence exempt u/s 10(1). Calculation of Tax Liability in Case of Agricultural Income Conditions 1. Assessee is an Individual, HUF, AOP/BOI, etc. (i.e. assessee taxable at the normal rate of tax applicable to an individual). (i.e. for firm, company, etc. agricultural income is fully exempt). CFP Level 2 - Module 2 – Taxation - India Page 541

2. Non-agricultural income (i.e. total income) exceeds maximum amount which is not chargeable to tax (i.e. 2,50,000/3,00,000/5,00,000). 3. Agricultural income exceeds Rs.5,000. 4. In case assessee does not satisfies any of the above conditions, then calculate tax on non-agricultural income as per normal provisions and such agricultural income shall have no treatment under Income-tax Act. 5. In case all the above said 3 conditions are satisfied, then calculate tax on assessee’s total income as follows: Calculation of Tax Liability Step 1. Aggregate agricultural income and non-agricultural income and calculate tax on that aggregate as per normal provisions of the act (i.e. LTCG @ 20%, STCG 111A @ 15%, winning from lotteries, etc. @ 30%, and balance @ slab rates applicable, etc.). Step 2. Aggregate maximum amount not chargeable to tax (i.e. 2,50,000/3,00,000/5,00,000) with agricultural income and calculate tax on that aggregate (i.e. aggregate @ slab rates, since no special income included) Step 3. Reduce amount calculated in step 2 from step 1 and balance shall be tax on total income of the assessee. Step 4. Subtract Rebate u/s 87A of Rs.5,000 or add surcharge @ 15%, if applicable. For the purposes of rebate or surcharge, total income shall only be considered without adding agricultural income. Step 5. Add EC & SHEC on tax calculated in step 4 above. Points to be Considered 1. Agricultural income shall be considered while calculating advance tax liability and interest u/s 234B & 234C. 2. Agricultural income shall in no case be included in total income. It shall be included only for the limited purpose of calculation of tax liability. CFP Level 2 - Module 2 – Taxation - India Page 542

Income which is partially agricultural and partially from business Business Business income Agricultural income Growing & manufacturing of Tea 40% 60% Growing & manufacturing of Rubber 35% 65% Growing & manufacturing of Coffee grown & cured 25% 75% grown, cured, roasted & 40% 60% grounded Any other business e.g. potato & chips, On the basis of market value of agricultural sugarcane & sugar, tomato & tomato produce, split the profits in two parts ketchup 3.4.3. Cash Payment Over a Specified Limit Section 40A(3) Where the assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, exceedsRs.10,000, no deduction shall be allowed in respect of such expenditure. Where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the payment or aggregate of payments made to a person in a day, exceeds Rs.10,000: CFP Level 2 - Module 2 – Taxation - India Page 543

Provided that no disallowance shall be made and no payment shall be deemed to bethe profits and gains of business or profession under this sub-section where a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, exceeds Rs.20,000, in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors : Provided further that in the case of payment made for plying, hiring or leasing goods carriages, the provisions of this sub-section shall have effect as if for the words “Rs.10,000”, the words “Rs.35,000” had been substituted. Notwithstanding anything contained in any other law for the time being in force or in any contract, where any payment in respect of any expenditure has to be made by an account payee cheque drawn on a bank or account payee bank draft in order that such expenditure may not be disallowed as a deduction under this sub-section, then the payment may be made by such cheque or draft; and where the payment is so made or tendered, no person shall be allowed to raise, in any suit or other proceeding, a plea based on the ground that the payment was not made or tendered in cash or in any other manner. CFP Level 2 - Module 2 – Taxation - India Page 544