Chapter 7 Section 80C of the Income Tax Act

Whether you are a salaried employee or a self-employed professional or even a homemaker, it is unlikely that you have not heard of Section 80C. Over the past, this section has assumed various forms. It originally started off as an exemption from total income under the banner of Section 80C. This was later converted to a tax rebate under Section 88 where the tax was rebated at 20% of the contribution from the total tax payable. However, this has once again been shifted to the exemption format under Section 80C, which is where it stands today. The limits of Section 80C vary from time to time depending on the annual Union Budget announcement. Currently, the total exemption under Section 80C is restricted to Rs.150,000, which is the consolidated blanket exemption available.

Understanding Exemption vs. Rebate

What is the difference between an exemption and a rebate? A rebate is a direct reduction from the tax payable, whereas an exemption is a reduction in the taxable income. From the point of view of an individual assessee, exemption is more useful in the above case.

In case of exemption, the amount is deducted from the total taxable income, hence, the effective tax shield on the investment of Rs.150,000 is Rs.46,200 (31.2% of 150,000). Of course, if your income is above Rs.50 lakh, then there is also a surcharge of 10% payable and if it is above Rs1cr, a surcharge of 15% is applicable. In such cases, the effective tax shield becomes even higher. On the contrary, in case of rebate, you get only 20% rebate under Section 88, which makes it less effective for an individual assessee.

The exemption of Rs.150,000 under Section 80C of the Income Tax Act is applicable for all eligible contributions made during the financial year. For example, all incomes and investments made between April 01st 2017 and March 31st 2018 pertain to the Financial year 2017-18 corresponding to the Assessment Year 2018-19.

What is 80C in Income Tax and who is eligible for this exemption?

Section 80C comprises various investments and expenses that are eligible for tax deductions. A taxpayer can claim maximum tax deductions of Rs.1.5 lakh for a particular financial year (FY) from his/her taxable income through investments made by him/her under section 80C of the Income Tax Act, 1961. Even if your total eligible investments are above Rs.1.50 lakhs, the exemption for the purpose of Section 80C is only restricted to a contribution of Rs.1.50 lakhs.

Only individuals or Hindu Undivided Family (HUF) will be eligible for claiming tax deduction u/s 80C. Broadly, there are two classes of outlays that qualify for the 80C exemption: Eligible Investments and Eligible Expenditures

SECTION 1 – ELIGIBLE INVESTMENTS UNDER SECTION 80C OF THE INCOME TAX ACT

The following investments are eligible for deductions u/s 80C. An investor can choose to either invest in all the available tax-saving instruments or in some of them. Remember, that the total umbrella exemption is Rs.150,000 and the individual is free to choose which specific investments he or she wants to opt for. We cover below some popular instruments where a person can invest in to claim the exemption under Section 80C of the Income Tax Act.

Employee Provident Fund (EPF) & Voluntary Provident Fund (VPF)

EPF is a retirement benefit scheme that is available to all salaried employees. The employer and the employee both have to contribute equally (12% of basic salary) to the provident fund account of an employee. The government is now proposing to reduce the mandatory contribution from 12% to 9%. An employee can contribute a higher sum of money through voluntary contributions (VPF). Only the employee’s own contribution to provident fund qualifies for 80C deductions. The employer contribution is tax-free in the hands of the employee and does not qualify for benefits under Section 80C of the Income Tax Act.

Who is eligible: If the employee’s basic salary exceeds Rs.15,000 per month, he/she has an option to join the scheme, otherwise, he/she has to compulsorily contribute towards provident fund.

Are they liquid: A person cannot withdraw his/her PF balance for as long as he/she continues to work, except in special circumstances (flat, construction, marriage/education of children, etc.). In case, he/she quits the job and does not take up employment within two months with an employer covered by the PF Act, he/she can withdraw the entire balance. Any withdrawal from the PF account is totally tax-free under most circumstances. Provident funds are long-term investments, and hence, they are not liquid.

What is the rate of interest payable on PF: The rate of interest on provident funds is announced by the Provident Fund Commissioner from time to time and changes with the prevailing interest rates in the market. The current rate of interest is 8.65% p.a. to be realigned on a quarterly basis. Interest is accrued and cumulated with your PF contribution.

What are the investment limits for EPF: Both the employer and the employee have to contribute a minimum of 12% of their Basic Pay + D.A. However, this is now likely to be reduced to 9% to leave more disposable income in the hands of the employee. Employees can voluntarily increase their own contribution without any upper limit.

How is EPF taxed at different levels: The EPF falls under EEE (Exempt, Exempt, Exempt) category. Employer’s contribution to the PF account up to 12% of the salary is tax exempt. Employee’s own contribution qualifies for deduction under section 80C within the overall limit of Rs.150,000. The entire accumulated balance (including interest) of PF is tax exempt if withdrawn after a continuous service of five years. Any withdrawal before that invites taxation in the year of withdrawal.

Public Provident Fund (PPF)

This has all the characteristics of a CPF, but it is voluntary and anyone can go to the post office or a bank branch and open a PPF account. PPF scheme is a long-term investment option backed by the Government of India. Many individuals prefer PPF because the effective return on PPF if you consider the tax benefits is very high compared to other debt instruments in India.

Who is eligible: A PPF account can be opened by Resident Indian individuals either in their own name or in the name of a minor child. It can be opened by both salaried and non-salaried individuals. A HUF cannot open a PPF account.

Liquidity of PPF: The maturity period of a PPF account is 15 years, but it can be further extended by five years. Partial withdrawals are allowed after seven years. Premature closure is allowed after five years.

What is the rate of interest payable: The current interest rate is 7.9% p.a. (compounded yearly) to be realigned on a quarterly basis. Again, the interest is not paid out in cash, but is accrued to the PPF corpus.

Are there any investment limits in PPF: The minimum and maximum investment limits are Rs.500 and Rs.1.5 lakh, respectively. You cannot invest more than that per year in a single account.

Tax Treatment: Like CPF, PPF also qualifies for the EEE (Exempt, Exempt, Exempt) status. This implies that there is tax benefit at the time of investment, interest accrual, and redemption.

Equity Linked Savings Scheme (ELSS)

ELSS has become a very popular instrument in the last few years as it combines the benefit of tax exemption under Section 80C of the Income Tax Act along with the wealth creation potential of equity funds. In fact, ELSS is just another equity mutual fund with the added clause of a compulsory lock-in period of three years. ELSS has to necessarily be an open-ended Equity Mutual Fund. ELSS has emerged as an interesting class of mutual fund product as fund managers are able to take a more long-term view in ELSS funds due to the compulsory lock-in period.

Eligibility: The normal Mutual Fund Know Your Client (KYC) regulations need to be adhered to before being eligible to invest in ELSS funds.

Is ELSS liquid: There is a minimum lock-in period and the lock-in is applicable from the date of investment. So, a Jan 2015 ELSS investment will be locked in till Jan 2018 and a June 2016 investment in ELSS will be locked in till June 2019.

Does ELSS offer assured returns: As the return on investment is directly linked to stock market performance, there is no assurance of returns. It is just like an equity mutual fund. However, in the long run, ELSS has wide potential to provide you the best return on your investments. It is more suitable for a person with an appetite to take slightly greater risk. For new tax payers, ELSS is a good way to hit two birds with one stone. You can get the benefit of tax exemption and also see your wealth grow.

Investment Limit: The minimum investment limit is Rs.500. There is no upper limit for investment in this scheme. However, you can only get tax exemption under Section 80C up to an outer limit of Rs.150,000 per assessment year.

Tax Treatment: ELSS is also an EEE category investment, and therefore, is exempt at all three stages of the investment.

National Savings Certificate (NSC):

NSC is the postal department’s saving scheme. Ranked as “highly secured” in the class of investments, it has the following features:

• NSC investments are only open for resident individual investors to invest in. Non-residents, Trusts, and HUFs cannot invest in this scheme.
• NSC comes with a lock-in period of 5 and 10 years, and one can choose the time frame based on one’s requirements.
• The current interest rate on the scheme is 7.9% compounded annually for the 5 year NSC VIII Issue. This rate may change from time to time. However, interest accrued on NSC (no interest is paid out) will have to be shown in your tax returns as interest income, and this is fully taxable although you do not receive any interest in hand.
• Minimum investment limit is Rs.100. There is no maximum investment limit. In the old days this instrument was very popular as cash investments were permitted in NSC and there were no questions raised on the source of income. Now that is not possible and full KYC is essential.
• Interest accrued on the amount invested in NSC is taxable but it is counted as fresh investment and hence qualifies for 80C deduction. The investment is eligible for deduction under 80C and maturity amount is tax-free. Each subsequent year, the interest amount can also be added as Section 80C benefit.

Sukanya Samriddhi Scheme

Sukanya Samriddhi Scheme is an interesting scheme which is currently being publicized by the government. It is intended to take care of the welfare and future of the girl child. Here are some of the key highlights of the Sukanya Samriddhi Scheme.

• Parents/guardians can open an account in the name of a girl child till she attains the age of 10 years. A maximum of two accounts can be opened by a natural or legal guardian for two girls. The account can be opened at public sector banks and post offices.
• The deposit should be made every year till the end of 14 years from the year of opening the account. Partial withdrawals are allowed up to 50% of the balance in the account as per the end of the previous financial year, for the purposes of higher education or marriage after attaining the age of 18 years.  The maturity period is 21 years post the opening of the account.
• The rate of interest currently being offered is 8.4%, compounded annually. This interest is accrued and reinvested in the fund.
• The minimum and maximum investment limits are Rs.1,000 & Rs.1.5 lakh p.a., respectively.
• Sukanya Samriddhi Scheme comes under the EEE category. This implies that it is tax-exempt at the three levels of investment, interest, and redemption.

Senior Citizens Savings Scheme (SCSS)

This is a special scheme for senior citizens aged above 60 to earn a slightly higher rate of interest on their investment compared to the normal investment instruments of a similar category. Following are some of the key highlights of the SCSS scheme.

• An individual aged 60 years or more is allowed to open the account. An individual of the age of 55 years or more but less than 60 years, who has retired under VRS (Voluntary Retirement Scheme) is also permitted to open account if he/she satisfies two conditions. First, the account is opened within one month of receipt of retirement benefits. Second, the investment amount should not exceed the amount of retirement benefits. The cut off age of 60 is on the date of investment.
• The maturity period of SCSS is five years. The account can be extended for three more years after maturity. Premature withdrawal after one year is allowed on deduction of an amount equal to 1.5% of the deposit and after two years by deducting 1% of the deposit. Hence, early withdrawal is not advisable as the loss is quite high.
• Interest rate offered is 8.4% per annum which is paid on quarterly basis. SCSS offers the highest rate of return in the safe investment category and has been specifically designed for the benefit of senior citizens.
• The minimum and maximum investment limits are Rs.1,000 and Rs.15 lakh, respectively. The senior citizen cannot invest in a single name above Rs.15 lakh.
• Interest income is taxable, and taxes will be deducted at source if it is more than Rs.10,000 p.a. Maturity amount is exempt from tax.

5 Year Post Office Time Deposit (POTD)

This POTD can be opened with any of the post office branches near you and only basic KYC is required for opening a POTD account. The following are some of the key features of the 5-year POTD:

• This POTD account may be opened by any individual, and there are no restrictions of age or otherwise.
• The POTD is compulsorily locked in till the maturity period of five years
• The rate of interest is 7.7% calculated quarterly and payable annually.
• The minimum investment limit is Rs.200. There is no upper limit to investment.
• Interest earned under this scheme is fully taxable. The investment is eligible for deduction under Section 80C, and the maturity amount is exempt from tax.

5-year Tax Saving Bank Fixed Deposits (FD)

This is just like any other Bank FD except that it has a five year compulsory lock-in period. These bank FDs were recently added to the list of eligible investments under the Section 80C category. Here are some key highlights that you need to know…

• All resident individuals can open an account. Senior citizens above the age of 60 years are also eligible to open a tax saver fixed deposit account.
• The maturity period is five years, and unlike normal bank FDs, a person cannot liquidate this FD before the completion of five years.
• The interest rates vary from time to time. Since there is a compulsory lock-in period of five years, the rate of interest offered will be higher than your normal 1-year and 2-year FDs.
• The minimum investment limit is Rs.1000. There is really no upper limit for investment, of course, your overall limit under Section 80C will still be governed by the outer umbrella limit of Rs.1.50 lakh.
• Interest income is taxable on maturity. The investment qualifies for deduction under 80C and maturity amount is exempt from tax. The interest income will be added to your total income and taxed at your extant rates of tax.

Unit Linked Insurance Plan (ULIP)

Among the various categories of instruments that are eligible for tax exemption under Section 80C, this has been one of the most controversial among them. This is largely because this ULIP product is a combination of investment and insurance, and hence, has been vulnerable to mis-selling. In a ULIP, a portion of the money invested will be used to provide risk cover and the balance amount will be invested in the stock market. However, investors need to be cautious here that ULIPs have very high loading, and hence, it will be only profitable if held for a period of more than 8-10 years, irrespective of the shorter lock-in period of just five years. Here are some key features of the ULIP.

• An investor can buy a ULIP for self, spouse, or a child. The child can be married or unmarried, dependent or independent, and minor or major.
• Partial withdrawals are allowed after five years. However, for a ULIP to be really profitable after considering the initial loading costs, it takes a minimum of 8-10 years to be profitable. Like ELSS, the returns on the ULIP are also market-linked and there are no assured returns on this.
• There are no upper limits for investing in ULIPs but the deduction under Section 80C will be allowed only up to Rs.1.50 lakh every financial year.
• Investment, withdrawals, and maturity amount are tax-free. The investments qualify for Section 80C, while withdrawals are entirely tax free, as is the redemption.

Illustration 1: Comparing Section 80C investment options

Please not that above rates of return are just indicative and are subject to modifications from time to time

Miscellaneous list of Section 80C deductions

Apart from the abovementioned popular methods of investing in Section 80C investments, there is an added benefit of other such eligible investments. These are not available on tap, but institutions come out with such issues from time to time. They include Infrastructure Bonds issued by Infrastructure companies IDFC and IIFC. In addition, Rural Bonds issued by NABARD (National Bank for Agriculture and Rural Development) are also eligible.

SECTION 2 – ELIGIBLE EXPENSES UNDER SECTION 80C OF THE INCOME TAX ACT

Apart from investments, certain expenses are also eligible for the benefit under Section 80C. Three such key sub-headers under eligible expenses for Section 80C benefit include Life Insurance Premium, Tuition Fees of children, and Home loan principal repayment. Let us look at these in detail…

• Life Insurance Premium is an expense and not an investment. It is paid by the individual to secure his/her dependents in the event of any unforeseen event. Life insurance cover is available as a protection against the death of an individual. While returns on insurance can be calculated for endowment plans (ranges from 4.5 to 5.5%), there are no returns earned on term policies. However, the 80C benefit is available for endowment plans, money back plans, whole life plans, and term plans.
• In the early 2000s, the benefit of Section 80C was also extended to the payment of Children’s Tuition Fees provided the school was located within India. This deduction is available for only two children and is only for tuition fees and not for any capital fees or donations paid.
• Repayment of principal for home loan in case of purchase of property is eligible for deduction subject to the condition that the property is not sold within a period of five years. Apart from the principal repayment of home loan, expenses incurred on stamp duty and registration charges for the purchase of house property also qualify for tax deduction. However, stamp duty and registration only qualify in the year of construction and not after that.

Final concluding points on Section 80C

• All exemptions under Section 80C have to be backed by documentary proof.
• NPS initiated by the Government of India gives an additional amount of Rs.50,000 u/s 80CCD (1B) which is over and above the limit of Rs.1.50 lakhs under Section 80C.
• NRIs can also claim tax benefits under Section 80C.