Common sense can help you reduce your taxes

Most people think of tax planners as wise old men in white hair who study the arcane tax laws and come up with brilliant interpretations of little known sections of the income tax law. Many times, it is indeed so. But a number of times, the tax planning consists of simple common-sense approach to understand the final objective and aim to achieve it in a slightly different fashion to obtain a tax effective solution.

My friend Rakesh Mehra’s case illustrates this point perfectly. Rakesh’s father Roshan Mehra is an 84-year old retired IAS officer. He has pension income of Rs 60,000 per month. He lives with Rakesh in Mumbai. Rakesh has a brother Rishi who lives in Delhi. Both Rakesh and Rishi are financially well off. The father Roshan Mehra has a flat in Panvel that he had bought in 2001. Its indexed cost is around Rs 18 lakh. Its current value is around Rs 1.1 crore. He wishes to sell the flat and distribute the sale proceeds equally among both Rishi and Rakesh even while he is living. He does not wish to purchase another flat but still wants to save on capital gains tax to the extent legitimately possible.

In the normal course if Roshan Mehra were to sell the flat he would have taxable long-term capital gains of Rs 92 lakh. If he does not do any tax planning he would have to pay capital gains tax of Rs 21 lakh approximately (calculated at 22.66% of Rs 92 lakh). The balance amount left from the sale consideration of Rs 1.10 crore after paying long-term capital gain tax of Rs 21 lakh would be Rs 89 lakh which he can gift equally to both Rakesh and Rishi who would end up getting Rs 44.50 lakh each.

A straight forward tax planning suggestion was for Mehra to invest in capital gain bonds of National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC) for Rs 50 lakh. This would bring down the taxable capital gains to Rs 42 lakh and the capital gains tax would come down to Rs 9 lakh approximately (20.60% of Rs 42 lakh).

The balance amount left from the sale consideration after the investment of Rs 50 lakh and the tax of Rs 9 lakh would be Rs 51 lakh. Mehra could gift Rs 25.50 lakh each to Rishi and Rakesh. Additionally, he could gift another Rs 25 lakh each after three years when the capital gain bonds mature. In this way Rakesh and Rishi would get Rs 50.50 lakh each in two tranches (instead of Rs 44.50 lakh in scenario one) and Mr Mehra could also enjoy the interest on the bonds during the three-year holding period.

Instead, I suggested that Mr Roshan Mehra gift the flat itself to his two sons. Gifts to close relatives enjoys concessional stamp duty rates in Maharashtra (total cost around Rs 40,000 all inclusive) and there are no income tax implications on any of the parties. The sons could now sell the flat and the taxable capital gains in the hands of each of them would be Rs 46 lakh as the capital gains would be divided up between the two of them in the proportion of their ownership. Each of them would now receive Rs 55 lakh on which they need not pay any capital gain tax if they invest in capital gain bonds of Rs 46 lakh each. Also, Rishi had just bought a residential property in Delhi and hence would not even need to invest in capital gain bonds to claim exemption.

This is a common-sense application of the tax planning maxim called gift the asset rather than gifting the money obtained from selling the asset. Nothing complicated about this tax planning technique. It has many applications as we will see in later examples.

NOT ARCANE

• The tax planning maxim is called gift the asset rather than gifting the money obtained from selling the asset
   
• Gifts to close relatives enjoys concessional stamp duty rates in Maharashtra and there are no income tax implications on any of the parties
   
• A number of times, the tax planning consists of simple common-sense approach to understand the final objective