Inspite of my repeated warnings, I find that many people have fallen into the NSS trap. I had evolved some strategies to extricate oneself out of this trap without much loss. Now, thanks to the various concessions contemplated by the budget, exiting from the trap without any loss has become more viable than ever before. Before the strategies, let us take a look at the trap.
The Trap
The National Savings Scheme, 1987, was unfortunately very popular with all taxpayers. The lure of 100 per cent income rebate in the year of contribution, u/s 80CCA was so attractive that almost all assessees poured their money into NSS-87. Even those in the lowest tax zone of 20 per cent subscribed to NSS oblivious to the fact that for them, the 20 per cent tax rebate offered by sec. 88 was exactly equal to the 100 per cent income rebate. To illustrate, take the instance of an assessee having taxable income of Rs 75,000. Since this is only an illustration (see box), I have taken the current tax rates and not those during the year of contribution.
Yes, taxpayers at the higher end did save a little more through NSS in place of PPF, but the advantage was short-lived. NSS withdrawals are fully taxable whereas PPFs are totally tax-free. Many who were on the verge of retirement contributed heavily to NSS thinking that after retirement with their salary income having stopped, they would be able to withdraw from NSS without any tax liability. However, on retirement, since the investment income from retirement benefits, more or less, matched their erstwhile salary they were truly trapped. All they do now is helplessly watch their funds grow at the niggardly rate of 11 per cent p.a., until death. Fortunately, NSS corpus is not taxable in the hands of the legatees.
Much later, w.e.f. 1.4.91, exactly when the accounts opened in 1987 could be closed, the rules were amended to levy tax deduction at source (TDS). The rate of TDS is 20 per cent for all withdrawals over Rs 2,400. This has a very curious effect. The rebate in 1987 being 50 per cent, (raised to 100 per cent in 1988-89), those in the 20 per cent bracket saved only 10 per cent tax whereas those in the 30 per cent bracket saved 15 per cent. Yet, the TDS is 20 per cent! After the current budget, those in the 10 per cent bracket will have to watch TDS being cut at 20 per cent. This is the way the authors of the legislation treat us.
Focus of the strategies
The new concessions are the focal points of our strategies. As there is no increase in the base level of income, the income chargeable to tax will be lower. More so, because
Tax rates slashed: This is a boon. Not only have the marginal rates been slashed, but also the tax zones have been enlarged substantially. Now, assessees with taxable income between Rs 40,000 to 60,000, after claiming deductions u/ss 80L, 80D, 80G etc., have to pay only 10 per cent, instead of the previous 20 per cent. Income between Rs 60,000 and Rs 1.2 lakh was taxable at the rate of 30 per cent and now is lower at 20 per cent. The upper limit has been raised to Rs 1.5 lakh!
Then again, the marginal rate was a high 40 per cent over Rs 1.2 lakh, which has now been cut to 30 per cent over Rs 1.5 lakh.
Standard deduction enhanced:- Sec. 16(i) & Sec. 57: The standard deduction for salaried employees was Rs 15,000 or 33.33 per cent, whichever was less. The ceiling has now been raised to Rs 20,000 for all employees. The recipients of family pension have their standard deduction governed by sec. 57 where the ceiling is lower; this has been raised to Rs 15,000.
Rebate for senior citizens: Sec. 88B: They were entitled to a rebate of 40 per cent if gross total income (before 80L, 80D, etc) was under Rs 1.2 lakh. Now, all seniorcitizens, irrespective of the size of their income, will get 100 per cent rebate or Rs 10,000, whichever is less. So a senior citizen with a total income of Rs 1 lakh (after 80L, 80D, etc) will be completely out of the tax net. Over this level, he will be directly in the 20 per cent tax zone upto an income of Rs 1.60 lakh and 30 per cent thereafter.
No tax on dividends from shares: With a view to boosting the sagging share market, the Finance Minister has conceded the long-standing demand of the market players to abolish double taxation on dividends.
Capital Gains: After FA92 amended the structure of capital gains tax, there was a controversy on whether the concessional tax treatment of long-term capital gains (LTCG) applies to redemption of bonds/debentures of a public company and units of UTI/MFs. Now, this issue has been put to rest; bonds and debentures will attract only the 20 per cent flat rate but without the benefit of indexation.
This is good news for UTI and MFs. This dictat is applicable only to bonds, debentures and, thankfully, not to mutual fund units.
NRIs: NRIs paid tax at 20 per cent on LTCG whereas FIIs paid 10 per cent. Now, NRIs have been brought on par with FIIs. Total investments by an NRI, with and without repatriation rights, has been increased from 24 to 30 per cent. The tax on such forex receivable by a foreign company is reduced from 30 per cent to 20 in respect of agreements made after 31.5.97.
Strategies
Assesses in the 20 per cent zone or below who are not contributing upto Rs 70,000 to PPF and infrastructure bonds, can now withdraw from NSS and join these schemes to reach the ceiling of Rs 70,000. This includes senior citizens who have a greater flexibility than the junior ones.
Withdrawal from NSS increases the tax liability of 20 per cent or lower, and contribution to PPF gives a rebate of 20 per cent !! This Plus and Minus exercise is extremely convenient.
1) Persons in a higher bracket can use the same strategy but will have to pay some tax. Those in the 30 per cent bracket will have to pay 10 per cent tax. No, this is not true! They can use the LTCG schemes of MFs to close the NSS account without much harm.
Take an assessee who earns Rs 3 lakh on total capital of Rs 20 lakh, invested in Co-FDs and regular income schemes of MFs giving an average taxable yield of 15 per cent p.a. He normally contributes Rs 70,000 every year to reduce taxes and has about Rs 1.35 lakh in NSS and finds he cannot make withdrawals therefrom. The penalty is too heavy.
All that is needed is to transfer all the funds from Co-FDs to LTCG schemes of UTI/MFs or Deep Discount Bonds of public companies. These schemes are known to grow at higher than 15 per cent p.a., even after paying LTCG tax at withdrawal. This is much better than the 15 per cent fully taxable interest from Co-FDs, which were chosen only for funding day-to-day expenses.
This simple action will bring down his regular income to nil level! Thus, adequate space will be created for withdrawal of about Rs 1.2 lakh per year from NSS on which tax payable is Rs 14,000. Contribution of Rs 70,000 to PPF and infrastructure will bring him to nil tax level.
2) Suppose the assessee cannot bring his regular income to the nil tax level because he is earning a high salary or business or professional income and is in the 30 per cent zone. Should he resign himself to fate? The answer is No.
Suppose the assessee has Rs 1 lakh in NSS. If he withdraws the entire sum, his take-home would be Rs 70,000. This he can invest in open-end pure-growth debt schemes of MFs such as the old Birla Income, JM liquid, and the new Tata Income and DSP Merrill Bond Fund. From these sources one can expect to earn after-tax 15 per cent +, in view of the various concessions on the LTCG.
Now, in 10 years, Rs 70,000 grows to Rs 2.83 lakh at 15 per cent and Rs 1 lakh in NSS would have grown to Rs 2.83 lakh at 11 per cent.
In other words, if you are young and give yourself minimum 10 years before you bid adieu to this world, it is beneficial for you to withdraw the entire amount from NSS, pay tax thereon, and invest the after-tax proceeds in the above-mentioned schemes of MFs.
Correction
One small correction. The tax on LTCG on MFs can be saved by investing in the same MF schemes by opting for a lock-in of 3 years u/s 54EA and 7 years u/s 54EB.
If you do not withdraw from NSS until your death your legatee will be closing the account without any tax liability. It is evident that if you survive for over 10 years, the family stands to lose.
Senior citizens (65 years or more) can use this technique more effectively because of FA97, which has given them a rebate of Rs 10,000.
If you give yourself at least 10 years more before you bid adieu to this world, it is beneficial for you to withdraw the entire amount from NSS, pay tax thereon, and invest the after-tax proceeds.
