Want to save tax and get fixed returns?

With the stock market touching an all-time high, investors are looking at fixed return alternatives. 

Read on to understand fixed return investments that also give a tax benefit. 

Five year bank deposits

Five year bank deposits are the latest addition to Section 80C. For those of you who prefer depositing money in the local bank, this one is a real boon. Do remember, however, that any deposit with a tenure of less than five years will not be valid for the tax benefit.

The five-year deposit works like any other bank deposit. Which means that, if you need some cash urgently, you can take an overdraft (loan) against it. Generally, the banks will give you around 75 to 85 per cent of the amount deposited as an overdraft. Of course, this will not come free. The interest you pay on this overdraft will be around 1.5 to 2 per cent higher than what you are earning on that five-year deposit. So if you are earning 8 per cent on the deposit, the interest charged on an overdraft will be 9.5 to 10 per cent.

What banks generally do is open a current account with that overdraft amount. You will have to pay interest only on the amount that you utilise.

As of now, you can expect around 8 per cent interest on a five year fixed deposit. Senior citizens will get 0.5 or 1 per cent more.

So, while this option scores high on convenience and safety, the hitch is that the interest earned on bank deposits is taxed.

Public Provident Fund

This one has been the darling of the tax-saving instruments for decades. And not without reason. With an interest rate of 12 per cent, those who invested in it in the past would have reaped great returns. It dropped to 11 per cent, then 9.5 per cent and is now 8 per cent per annum.

To add to its sheen, it also boasts of the Exempt-Exempt-Exempt criteria, popularly referred to as EEE. What this means is that there is a tax exemption on contributions, interest earned and also on withdrawals -- a hat trick of sorts.

You get the tax benefit under Section 80C when you invest in PPF, you pay no tax on the interest earned and no tax on withdrawal.

It can't get better than this, though it can certainly get worse. In the future, the taxation methodology would shift to EET -- Exempt-Exempt-Taxed -- which means that the withdrawals would be taxed.

National Savings Certificate 

On the face of it, this one is identical to PPF, but with a lower tenure. While NSC offers the same interest rate of 8 per cent per annum, it is computed on a half-yearly basis, while PPF is calculated on an annual basis. On this point, NSC scores.

Let us say, on April 1, 2006, you invest Rs 30,000 in both, PPF and NSC. A year down the road, you would have Rs 32,400 in your PPF account but Rs 32,448 in your NSC. As the years go by, the difference is all the more pronounced.

However, this benefit is nullified when you take the tax benefit of PPF into account. The interest you earn on NSC is taxed. Under the current tax regime, the various heads of income are:

i. Salary
ii. Income from house property
iii. Capital gains
iv. Profits and gains from business or profession
v. Income from other sources

The interest you earn from NSC is included under the head 'Income from other sources'.

This interest, though taxed, is eligible for deduction under Section 80C. Generally, it is advisable to declare accrued interest on NSC on a yearly basis. So, over the period of six years, you could declare the interest income for each year. In such a case, it does not amount to a huge sum.

If this does not appeal to you, then you can claim the entire amount in the year of maturity under Section 80C.

While PPF is an ongoing account, NSC is a one-time investment available in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000.

Employee Provident Fund 

The EPF is a retirement benefit scheme available to salaried employees. Under this scheme, a stipulated amount decided by the government (currently 12 per cent) is deducted from the employee's salary and contributed towards the fund. The employer makes an equal contribution.

The flexibility exists for an employee to contribute more than the stipulated amount if the scheme allows for it. However, the employer is under no obligation to increase his contribution. Let's say the employee decides 15% of his salary must be deducted towards the EPF. In this case, the employer is not obligated to pay any contribution over and above the stipulated amount of 12%.

The amount accumulated in the PF is paid at the time of retirement or resignation. If you have worked continuously for a period of five years, the withdrawal of PF is not taxed.

PF can be transferred from one company to the other if one changes jobs. Even if you have not worked for at least five years but are transferring the PF to the new employer, it is not taxed. What's more, the tenure of employment with the new employer is included in computing the total of five years.

The message: If you withdraw it before completion of five years, you pay your tax, unless your employment is terminated due to ill-health.

Infrastructure bonds

The party is over for this one.

At one time, it was mandatory to invest in them. And financial institutions like ICICI and IDBI garnered phenomenal amounts of money due to this stipulation. Now that the investor has the flexibility to bypass this investment, this is exactly what is being done. The financial institutions, too, have not been coming out with issues.

Of course, if you are very risk averse and want your money back as quickly as possible, this one seems to be the only tax saving option suited to both those requirements. Provided, of course, the financial institutions come out with an issue.

Part II Want to save tax?

Value Research is a mutual fund research organisation.