[Economy] Calculating Income Tax, Tax Exemption vs Tax Deduction, Rajiv Gandhi Equity Saving Scheme

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Mitrapal Philosophy
  1. What are the Income tax slabs in Budget 2012?
  2. How to Calculate income tax?
  3. 3% educational cess
  4. What is the difference between Tax exemption and tax deduction?
  5. Union budget 2012: provisions of Tax Deduction and Tax Exemption
  6. How does RGESS save Rs.5000 In Tax?
  7. The important questions : Food for Thought

You may have read this statement in newspaper, tv-channels.

Rajiv Gandhi Equity Saving Scheme (RGESS) will give maximum benefit of Rs. 5,000 in tax-saving.

What does it mean? Before we can talk about that, let’s see the basics of Income Tax calculation, Exemption and Tax Deduction.

What are the Income tax slabs in Budget 2012?

You know about this already:

Income tax slab (in Rs.)Tax
0 to 2,00,000No tax
2,00,001 to 5,00,00010%
5,00,001 to 10,00,00020%
Above 10,00,00030%

(We are skipping senior citizen provisions)
Time for a very simple question:

if your income is Rs.15 lakhs, how much income tax do you have to pay?

15 lakhs is above Rs.10 lakhs, so you fall in 30% income tax slab.
30% of 15 lakhs equals to 4.5 lakhs income tax.
Sorry 4.5 lakhs is Incorrect Answer. Infact you’re income tax will be quite less than Rs.4.5 lakhs.

Why?

Because income tax is not calculated like that.

Then how to calculate income tax?

Suitcase approach

Imagine there are four suitcases labeled one, two, three, four.
You have to fill up each suitcase with your cash.
But there are some conditions

  • you have to fill these suitcases in serial order: 1,2,3 then 4
  • First suitcase can contain maximum two lakh rupees only. Once it is fully packed, you move to the next suitcase.
  • Second suitcase can hold maximum three lakh rupees
  • Third suitcase can contain maximum five lakh rupees
  • Fourth suitcase can contain any amount of money. No maximum limit.

Step #1: Distribute money in suitcases

Now start distributing your 15 lakh rupees into these four suitcases

suitcase numberMoney packed
One2,00,000
Two3,00,000
Three5,00,000
Four5,00,000
Total15 lakhs

Step #2: Make a new column and apply those four tax slabs

suitcase numberMoney packedTax slab
One2,00,0000%
Two3,00,00010%
Three5,00,00020%
Four5,00,00030%
Total15 lakhs

Step #3: Calculate the income tax to be paid for each suitcase

suitcase numberMoney packedTax slabTax to be paid
One2,00,0000%Zero
Two3,00,00010%30,000
Three5,00,00020%1,00,000
Four5,00,00030%1,50,000
Total15 lakhs2,80,000

The total sum of income tax on all four suitcases =2,80,000 lakhs
So, if your income is 15 lakhs, you have to pay 2.8 lakhs as income tax.
But we forgot some important things: educational cess, tax exemption, tax deduction.

3% educational cess

Cess means tax on the tax.
Union budget 2012, has provision of 3% educational cess.
Meaning 3% of 2.8 lakhs, equal to Rs.8400
Hence the total income-tax that you to pay = 2.8 lakhs +8400= Rs.2,88,400
Now time for two most important parts in the income tax calculation.

What is the difference between Tax exemption and tax deduction?

#1: Tax exemption

Income tax= the tax on your “income”, but you don’t have to pay income tax on certain type of income. For example
Policemen and Army jawans get uniform maintenance allowance: Suppose Rs.1000 to wash and iron their uniforms and to polish their boots every month.
Rs.1000 every month multiplied with 12 months equals to Rs.12,000 every year, apart from the regular salary.
But Budget-2012 says this Uniform Allowance income is exempted from taxation.
So, If an army jawan earns Rs. 2,12,000, then his taxable income is
2 lakhs minus Rs. 12000 exempted= Rs. 2,00,000.
Now calculate his income tax on Rs. 200,000 based on our “suitcase approach”. (ans. Zero tax, because Cash finished at first suitcase.)

Crux: Tax exemption is given on INCOME.

#2: tax deduction

If you spend your income on certain activities, you won’t have to pay income tax on that much amount of your income.
E.g.50% deduction, if you invest in Rajiv Gandhi Equity Savings Scheme. (RGESS)
Suppose you earn nine lakh rupees a year and invest Rs.20,000 in RGESS,
Thus , your taxable income
= nine lakh rupees minus 50% of Rs.20,000 (invested in RGESS)
= 9 lakhs-10,000
= Rs. 8,90,000
Now calculate the income tax on Rs.8,90,000 using our suitcase approach.
Crux: Tax Deduction is given on SPENDING

Union budget 2012: provisions of Tax Deduction and Tax Exemption

Here are a few examples.
Note: I’m not filling up the minute details and you don’t have to mug this list.

Tax Exemption (on INCOME / Salary)Tax Deduction (on SPENDING)
  • Transport / Conveyance Allowence
  • Child education allowence
  • Leave travel allowance (LTA)
  • Medical Allowance
  • Uniform / Dress allowance
  • Gift from relatives
  • Agricultural income
  • House Rent income
  • Rajiv Gandhi Equity Saving scheme.
  • Tax saving mutual funds (ELSS)
  • Five year tax-saver bank Fixed deposits
  • Public provident fund (PPF)
  • National Savings Certificate (NSC) or
  • National Service Scheme (NSS)
  • Employer contribution into New Pension Scheme (NPS)
  • Life insurance/Unit Linked Insurance Plan (ULIP) premium
  • Employee’s contribution towards Employee provident fund (EPF)
  • Home loan principal amount payment.
  • Post office tax saving deposit or tax saving bonds
  • Pension scheme/Retirement plans (Secion 80CCC)
  • Tuition fees paid for children education
  • Medical Treatment of family (upto Rs.40k)

What is Tax-Planning?

It means use of Tax-Exemption and Tax-Deduction provisions in such a way that you can save maximum amount of tax.

Who is Tax-Adviser / Tax-Consultant?

  • These are extremely knowledgeable and experienced Chartered Accountants, MBA and Tax Lawyers.
  • They make customized tax-saving plans according to your requirements.
  • Big players in Tax Consulting = Ernst & Young, KPMG, Price waterhouse Coopers (PwC).
  • Recall that Vodafone Essar deal: Saving Capital Gains tax in Caymen’s Island. These Big Players help in such huge tax-saving deals.

Black Money and Agro-Income

  • In above table, you can see that Agriculture income is ‘exempted’ from income-tax.
  • Lot of film stars forge documents and show they own ‘farm-lands’ and they’re ‘farmers’.
  • Game is simple. They take 5 crores from film producers or 50 lakhs to dance in Dubai.
  • But on paper they show only few lakhs as ‘legit payment received’ and pay income tax on that part only.
  • Remaining money is shown as ‘income from that agricultural land’ and thus totally exempted from income-tax.
  • So this is also one type of ‘Tax-Planning‘, just illegal.
  • Black money = income on which tax is not paid.

Coming back to the opening sentence of this article:

How does RGESS save Rs.5000 In Tax?

You already know the main provisions of Rajiv Gandhi Equity saving scheme

  • Only first-time investors, with annual income less than Rs.10 lakh can invest in the scheme.
  • One person can invest maximum Rs.50,000 only

Ya but still how is Rs.5000/- saved? You’ve to compare two cases to find that out.

Case #1: don’t invest in RGESS

Your income is Rs.9 lakhs, and you don’t invest in RGESS and don’t get any other tax deduction or tax exemptions.
The total taxable income is Rs. 9 lakhs.

suitcase numberMoney packedTax slabTax to be paid
One2,00,0000%Zero
Two3,00,00010%30,000
Three4,00,00020%80,000
Four030%0
Total9 lakhs1,10,000

Thus, in case#1: you’re paying Rs. 1.1 lakh as income tax

Case #2: investment maximum in RGESS

Your income is Rs.9 lakhs, and you invest to the maximum limit (Rs.50,000/-).
Thus, the taxable income is
= Rs. 9 lakhs minus 50% of Rs.50,000 ;because RGESS gives 50% Deduction.
=9 lakhs – 25,000
=Rs. 8,75,000
Now calculate income tax for Rs.8,75,000 using same suitcase approach

suitcase numberMoney packedTax slabTax to be paid
One20000000
Two3000001030000
Three3750002075000
Four0300
Total875000105000

Thus, in case#2, you pay 1,05,000 as income tax.
Difference between Case #1 minus Case #2
=1,10,000 minus 1,05,000
= Rs. 5,000
Therefore all the newspapers, magazines and TV channels shout all the time that you’ll save Rs.5,000 by investing in RGESS. But here is a ‘fine-print’.
This Rs.5000-magic works only if you fall under the 20% tax slab.
If your income is rupees two lakhs and you invest Rs.50,000 in RGESS, you will not save any tax. Why? Because you fall in zero% tax slab. Your annual are not taxable in the first place!
Similarly, if you are in the 10% tax slab, you will get different answers.

Homework:

(No, they’ll not ask this in your exam, this is only for brain exercise)

Calculate the maximum possible tax saving with RGESS, if your annual income is Rs.4 lakhs.

Shortcut tip:

You can get max deduction of 25,000 (that is 50% Deduction of Rs.50000 invested in RGESS)
And your given income 4 lakhs fall under 10%.
So, 10% of 25,000=Rs.2500 saved in tax.
Why does this shortcut method work? Think about it.

Anyways, whether you can save 5000 or 7000 that is not the important question for UPSC, IBPS (Bank PO) or MBA admission interviews.

The important questions are following

  • Why did Pranab come up with Rajiv Gandhi Equity saving scheme?
  • Why are only first-time investors allowed to save money in the scheme?
  • Why is Pranab not allowing people with annual income of Rs.10 lakh or above, to invest in this scheme?
  • Why did Pranab say “this move will improve the depth of domestic capital market?”
  • What is No-Frills demat account and why is Pranab talking about it?
  • If you were in place of Pranab, How will you design the Tax Exemptions and Tax Deductions for the Aam-Aadmi and how will you help the Indian Economy?

Mrunal recommends

  1. (free) NCERT, NIOS, TN-Books 4 History,Geo,Sci
  2. Indian Polity M.Laxmikanth (Hindi | English)
  3. Spectrum: Modern History (Hindi | English)
  4. Maths: Quantam CAT Sarvesh Kumar
  5. Objective General English SP Bakshi
  6. Word Power made Easy -Norman Lowe
  7. Topic wise Solved Paperset by Disha

43 Comments on “[Economy] Calculating Income Tax, Tax Exemption vs Tax Deduction, Rajiv Gandhi Equity Saving Scheme”

  1. give answer please

  2. Really Nice one to understand the income tax…

  3. Thanks for info…!

  4. hi mrunal sir,rajiv gandhi equity savings scheme…….max benefit is 50000rs??????????

  5. sir kindly give the explanation of the above question also…

  6. sir kindly give the explanation for abve also

  7. GUYS IMPORTANT DO NOTE DOWN THE CHANGES IN THE RGESS IMPORTANT FOR THE UPSC EXAM
    *1)THE INCOME LEVEL OF AN INVESTOR HAS BEEN RAISED FROM 10 TO 12 LAKH PER ANNUM AND THE TAX BENEFIT WHICH WAS 50% FOR INITIAL MIN INVESTMENT OF 50,000 HAS BEEN INCREASED FOR 3 YRS FROM 1 YR(EARLIER)
    *=ANY DOUBT IN THE EARLIER PROVISION OF THE SCHEME REFER TO OUR BRILLIANT’S(MRUNAL) ART AND THEN COMPARE IT…

  8. how to calculate for 6 lakhs

    1. 2,00,000 = zero
      3,00,000 = 10% = 30,000
      1,00,000 = 20% = 20,000
      Total = 50,000

    2. With investment in RGESS,
      Net Taxable income will be 5,75,000(if invested 50,000 in RGESS)
      2,00,000 = 00
      3,00,000 = 30,000
      75,000 = 15,000
      Total = 45,000

  9. Sir..for RGESS, now the max limit is 12 lakhs (for earlier 10L) and this 12L is gross total income (and not net notal income , hence no role of deductions play in RGESS) , am i right? Correct me if i am wrong..

  10. And also as the max limit is now 12L, then the max possible tax saving from RGESS would now be more than rs 5000? Am i right sir?

  11. DOUBT in the difference between Tax exemption and tax deduction.

    Interest on Savings Bank deposit is allowable as DEDUCTION upto Rs.10000 under section 80TTA of the Income Tax Act,1961.Interest on savings deposit is an income and not spending,then why is that called/termed as “DEDUCTION” and NOT as “EXEMPTION”.

  12. how much money is to be invested to save 7000 income tax for the calender year 2013-14

  13. hi,

    my salary is 500001 and monthly tax is deducting incometax 800 and 200 other tax.
    i want to save this money.pleaes guide me what procedure needs to be follow.
    and already i have done ING insurance policy of rs 1,35,000. and per year need to pay 55,000.

    1. Check out PPF or VPF..

  14. please provide answers

  15. Why is Pranab not allowing people with annual income of Rs.10 lakh or above, to invest in this scheme?
    Ans:because above 10 lakhs the profit a person gains is only 7500/-(u can check a person getting 11 lakhs and 15 lakhs where they get the same profit by investing in RGESS ==7500/-)

  16. Why is Pranab not allowing people with annual income of Rs.10 lakh or above, to invest in this scheme?
    Ans:because above 10 lakhs the profit a person gains is only 7500/-(u can check a person getting 11 lakhs and 15 lakhs where they get the same profit by investing in RGESS ==7500/-)

  17. thank u sir plrase post the answers for the above questions also

  18. The income tax is calculated on the “Qualifying Amount” after all your savings, exemptions and deductions. NOT on your whole gross annual salary. Say for example, your CTC is Rs.1000000 p.a and you have shown investment declarations for tax exemptions upto Rs.500000, then the tax will be calculated on the balance qualifying amount which is Rs.500000.

    1. But you can tax deduction is allowed only up to 100000 savings

  19. I have been paid Rs.50000 for getting coaching for IAS main examination whether the amount will give rebate for income tax or not

  20. answer for the shortcut tip- tax deduction is calculated on spending so even if the person had spent 50000 on the scheme the total spending is only 25000 so ,acc. to tax deduction 10% of 25000=2500 and that much is deducted from the income.

  21. nicely explained ,,,must be appreciated

  22. sir , how can i get old basic economy articles of yours ???

  23. sir if income is 4lacs then 4lac X 10% = 40,000
    if it is 5lacs then 2lacs X 0%
    3lacs X 10% = 30000
    is this correct …………… less income less tax to be paid na sir

    1. Sir if income is Rs. 4,00,000
      then on 1st 2,00,000- Nil
      and on next 2,00,000- @10%= 20000
      Total Tax payable= 20,000/- 0n Rs.4,00,000 (in no decuction is allowed).

  24. got to know sir

  25. Sir my annual salary is INR 2000000 (Twenty Lakh). I have LIC for INR 90000 per anum, My daughter school fee INR 9000 per month, I pay rent at two place like in delhi where my family staying INR 10000 per month, in mumbai I stay alone INR 6500 per month. My wife had undergone kidney transplant operation last month so I have spent couple of lakhs in hospital. How much tax I need to pay and how I can save some more money from TAX according to a legal law in our country

  26. spectacular job 4 enlightening

  27. very much helpful for me.

    1. @Banani Das the ioc girl….

  28. my annual income is 7lakhs and 25thousand
    how much I have to pay for tax

  29. Kya LIC policy krvsne k baad b tax pay krna pdta hai.

  30. My annual income is 10 Lakhs. please guide how much i have to pay for tax.

  31. gross salary – 40000 , LIP – 6200 ( QUARTERLY ) , OTHER SOURCE INCOME -7600 , PLEASE CALCULATE THE TAX AMOUNT

  32. Hello Mrunal ,

    Could you please explain the deduction under Section 80CCD and if it is not under chapter VIA relief. How can i get tax deduction by contributing to 80CCD.
    Thanks
    Shakti

  33. Hi,

    My Gross annual income is – 336000.
    How much deduction is apply on my annual income.

  34. I didn’t get that short cut method.Can anybody give me explaination?

  35. Hi!!
    I want to know the what is ppf and how will it benefit me to save tax.

  36. No one have ever explained the tax in such simpler manner Great thank to the team.

  37. Govt employee West Bengal interior relif 10 percent deduction for annual income …. Is it possible …?

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