For the last few years, the trend has been to impose higher taxes on high net worth individuals (HNIs) and ultra HNIs in order to compensate for concessions given to other segments of the society. This was evident in 2015, when the government introduced an additional 2 per cent surcharge on those with a taxable income of Rs 1 crore to include them into the HNI class. Also, there was more focus on ensuring higher tax compliance as well as disclosure of wealth outside India by HNIs.
The leaning continues in the current budget as well, as the 15 per cent surcharge on annual income over Rs 1 crore has been maintained, while a 10 per cent surcharge has been brought on incomes between Rs 50 lakh to Rs 1 crore. In effect, an individual with an annual taxable income of Rs 60 lakh will have to pay about Rs 1.5 lakh more in tax. Thus, tax planning for HNIs becomes more critical now.
NEED FOR SENSIBLE TAX PLANNING
It is important for HNIs to seek realistic tax planning as well as follow a sensible investment plan to sustain their wealth. Let’s look at some of the current options to achieve this:
INVESTMENT PLANNING:
Listed equity investments: India’s growth trajectory demands a substantial allocation to equities that should be held at least over a year to qualify for tax benefits. Any profit from the sale of a security asset is considered as capital gain, and long-term capital gains on sale of listed Indian equity shares are tax exempt, provided securities transaction tax (STT) is paid on both purchase and sale of shares. On the other hand, gains from transactions in shares held for less than 12 months are considered as short-term capital gains, and hence are subject to a 15 per cent levy.
Equity mutual funds: Gains on equity mutual funds are akin to taxation of listed equity investments, wherein they would be tax-free if held for more than 12 months and subject to short-term capital gains tax of 15 per cent if held for less than a year. However, it is pertinent to note that unlike listed equity investments any dividend received in respect of investment in any mutual fund, both equity and debt, is tax free in the hands of the investors.
Debt mutual funds: If an investor has lesser appetite for equities, a variety of debt mutual funds may be considered. Income from debt funds will be treated as long-term capital gains if exited after three years of making the investment and taxed at 20 per cent after allowing the benefit of indexation (and 10 per cent without indexation), meaning substantial savings compared to an investment in fixed deposits. If sold within three years from the date of investment, they would attract short-term capital gains wherein the income would be added to one’s annual income and taxed as per the individual’s income tax slab.
Deposits in Non-Resident External (NRE) or Foreign Currency Non-Resident (FCNR) deposits: For risk-averse NRI HNIs, term deposits made in NRE or FCNR accounts are an option as there is no cap on the amount of deposits and interest received and they are exempt from tax under the Income Tax Act in India.
Real estate investments: The period of holding of immovable property has been reduced to two years from three years to regard it as a long-term capital asset. Indexation benefit is available in arriving at long-term capital gains arising from sale of real estate investments.
ENTITY PLANNING:
Incorporation of companies: The Finance Bill 2017 reduced the tax rates for domestic companies with turnover below Rs 50 crore to 25 per cent from 30 per cent. Though the issues of triple taxation (i.e. corporate tax, dividend distribution tax and the tax on the dividend income in shareholders’ hands) continue to remain unaddressed, for HNI families that are engaged in medium-scale businesses in the growth stage and do not plan to declare significant dividends in the next few years, it may be a good strategy to convert businesses run in partnerships or proprietorships into companies, as it brings a straight reduction of 5 per cent in tax rates.
Hindu Undivided Family (HUF): The rate of tax for income slab of Rs 2.5 lakh to Rs 5 lakh has been reduced to 5 per cent from 10 per cent for individuals and HUFs. Take, for instance, a Hindu family of a father with two married sons. If the father continues to have his HUF and each son has his own HUF, each of these entities will have separate taxation, and if each of the HUFs earn income, this would result in a lower overall tax impact as compared to having a single HUF entity. Further, various deductions under sections 80C, 80D and so on are available to HUFs as well as individuals.
Irrevocable trusts: If structured appropriately, irrevocable trusts can work as tax efficient vehicles besides being used for succession planning. Moreover, there is no capital gains tax on settlement of shares (transfer to the trust) in an irrevocable trust with relatives as beneficiaries. There can be planned transfer of shareholding into such trusts in a way that the dividend tax incidence in the hands of the trust (recipient) is reduced by keeping the aggregate dividend income close to Rs10 lakh. However, with the 2017 Budget making STT payment on share acquisition a pre-requisite for availing the capital gains exemption, the same should be planned wisely and cautiously.
In high growth countries like India, wealth would be distributed increasingly at a fast clip, creating a significant number of new affluent individuals and families in the HNI or emerging HNI categories. In the changing environment, it is vital to review the choice of the business vehicle and investment options to optimise one’s tax incidence.
The choice of entities and investments is dependent on various other factors like stage of family, nature and stage of business, risk appetite and investment horizons to name a few. It will be best to seek timely advice from experts to help one plan one’s affairs efficiently.
Sahal is head of wealth planning at Sanctum Wealth Management.
