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 2,00,000 No tax
2,00,001 to 5,00,000 10%
5,00,001 to 10,00,000 20%
Above 10,00,000 30%

(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 number Money packed
One 2,00,000
Two 3,00,000
Three 5,00,000
Four 5,00,000
Total 15 lakhs

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

suitcase number Money packed Tax slab
One 2,00,000 0%
Two 3,00,000 10%
Three 5,00,000 20%
Four 5,00,000 30%
Total 15 lakhs —

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

suitcase number Money packed Tax slab Tax to be paid
One 2,00,000 0% Zero
Two 3,00,000 10% 30,000
Three 5,00,000 20% 1,00,000
Four 5,00,000 30% 1,50,000
Total 15 lakhs — 2,80,000

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 number Money packed Tax slab Tax to be paid
One 2,00,000 0% Zero
Two 3,00,000 10% 30,000
Three 4,00,000 20% 80,000
Four 0 30% 0
Total 9 lakhs — 1,10,000

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 number Money packed Tax slab Tax to be paid
One 200000 0 0
Two 300000 10 30000
Three 375000 20 75000
Four 0 30 0
Total 875000 105000

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?