Are you evading tax?

They may not be aware, but even honest individuals can end up evading tax. Find out if you also fall foul of tax laws and how to stop doing it.

   Do you know somebody who is guilty of evading taxes? Most people would, because the Income Tax Act has created more criminals than any other legislation in the country. Don’t think all tax evaders are suspiciouslooking characters with wads of unaccounted money stacked in lockers. Even seemingly honest and upright citizens could be underpaying tax. It’s a malaise more widespread than the common cold. From school teachers to engineers, from banker to sales executives, millions of Indians may be liable for penalties, even prosecution, for under-reporting their income or not paying the due tax. 

   In most cases, however, the taxpayer is an unwitting offender, an innocent criminal, who doesn’t even know he is falling foul of the tax laws. A survey of salaried taxpayers, who filed returns through Taxspanner.com in 2011, shows that 96% did not report any income from other sources. “Every salaried person would have a savings bank account and some interest income would definitely accrue to the balance every six months. This income has to be reported in the tax return but is overlooked by most taxpayers,” says Sudhir Kaushik, cofounder and CFO of Taxspanner.com.
   Not reporting the interest income in your savings bank account is a minor offence compared to other, more serious, lapses. Take the wealth tax payable on certain assets if their combined value exceeds 30 lakh. If someone has a second house that is lying vacant, its value is included. Rising gold prices may be a reason to smile if you have lots of it in your locker, but physical gold attracts wealth tax. Given that investment worth thousands of crores of rupees has flown into the realty sector and gold in the past three years, and prices have shot up 100-200%, the wealth tax collection has risen at a suspiciously slow pace of 30-35% during the same period. Tax authorities don’t seem too bothered about wealth tax evasion,” says Homi Mistry, partner, Deloitte Haskins and Sells.
   This doesn’t mean the taxman is not doing his job. The 10-figure alphanumeric number that is your PAN is under constant surveillance. Almost every financial transaction now requires PAN. Whenever someone makes a high-value transaction or investment, the bank, fund house, brokerage or credit card company has to report it to the taxman. “Tax officials can peek into your financial life by just keying in 10 figures into their computerised database,” says Delhi-based chartered accountant MK Agarwal.
   The best way to avoid getting caught on the wrong foot is to pay your taxes honestly. But this is possible only if you are aware of where you are going wrong. We have identified 10 common tax traps in which honest taxpayers often fall. Find out if you are also making these tax mistakes and how to stop doing so.

Not including interest income in your tax return

Isn’t it great that banks now offer 4% interest on your savings bank balance instead of the earlier 3.5%? Some are even giving 6%. Do you know that this small, yet very visible, addition to your income is fully taxable? Not just bank interest, but the interest on infrastructure bonds, NSCs, fixed deposits and recurring deposits has to be declared as income from other sources in your tax return. It doesn’t matter if you have the cumulative option and will get the interest on the bond or fixed deposit only on maturity. Income is taxed on an accrual basis and the tax is paid on it every year. In some cases, the bank or financial institution will deduct TDS before paying you the interest. It doesn’t mean you can ignore the income. TDS is only 10% and if you are in a higher tax bracket, you have to pay more tax.

You have interest income if you have…
a savings bank account invested in FDs, bonds a recurring deposit account invested in NSCs, Post Office MIS bought infrastructure bonds

Ignoring income from investments of spouse and kids
It’s a common practice to invest in the name of your spouse or children. What you should be aware of is the clubbing provision for the income earned through such investments. Any money received from a spouse is tax-free, but if it is invested, the income from that investment is added to the income of the giver and taxed accordingly. So, if you bought a house in your wife’s name, any income from that house, whether as capital gains or as rent, will be treated as your income. Similarly, if a husband invests in fixed deposits in the name of his wife, the interest earned will be treated as his income.
   In case of investments in the name of children below 18 years, the earnings are treated as the income of the parent who earns more. However, there is an exemption of 1,500 a year per child up to a maximum of two children.
   To escape clubbing, invest in taxfree options such as the PPF, tax-free bonds or in equity options that are tax exempt after a year. You can also consider Ulips and insurance plans.

Ending life insurance policy before three years

Priyanka Gupta doesn’t know it, but the life insurance policy she bought last year could turn her into a tax evader. The 26-year-old marketing executive wants to junk the plan because it doesn’t suit her. She knows she will lose the 45,000 she paid as the first year’s premium, but doesn’t realise that she will also have to pay the tax benefit that she availed of last year. If an insurance policy is terminated before three years, the tax benefits under Section 80C are reversed. Since she is in the 20% tax bracket, Gupta will have to pay another 9,000 when she dumps her plan.
   Very few people know this rule and even fewer follow it. In the past five years, roughly 5 crore life insurance policies have been terminated before they completed three years. “The onus of paying the tax for the previous year is on the taxpayer. If he doesn’t pay, it amounts to concealment and could even invite a penalty,” warns Agarwal.
   Of course, this will not be required if the policyholder did not avail of the Section 80C tax benefit on the premium. For many taxpayers, the 1 lakh limit is easily exhausted by other tax-saving options.

Selling a house bought on loan within five years
If you thought the reversing of tax benefits on a life insurance policy dumped within three years was stiff, the rule regarding property is tougher. If a house is sold within five years of purchase, the tax benefits availed of under Section 80C for the repayment of the principal also go out of the window. Again, just as in the case of prematurely terminated life insurance plans, the onus is on the individual to pay the tax arrears. Mind you, one cannot get away by saying that one didn’t know about the rules. Unawareness of the law isn’t an excuse. Even if your return is prepared by a tax professional, you are the one the taxman will haul up. “The individual is liable for any act or omission of the tax professional,” says Delhi-based chartered accountant and noted tax lawyer Rakesh Gupta.

Not including ornaments in wealth tax

It never hurts to be too rich, does it? Yes, if you have to pay tax on it. Wealth tax is payable if the market value of certain assets (see graphic) exceeds 30 lakh. The tax is 1% of the combined value of the assets exceeding 30 lakh. Even though Indians have accumulated a lot of wealth over the past few years, wealth tax collection has risen slowly—from 385 crore in 2008-9 to 504 crore in 2009-10, and 557 crore in 2010-11.
   The penalty for evading wealth tax is quite stiff. The minimum penalty is 100%, which can go up to 500% of the tax sought to be avoided. The DTC is even sterner for tax evaders. It has proposed an imprisonment for tax evasion.
   This should be a warning for those who are pawning gold to raise loans. The taxman may want to know where you got the gold from. It’s easy to say that you inherited it or got it as gift on your wedding. Even so, if the value of the assets listed below exceeds 30 lakh, you are required to file a wealth tax return.

Not paying wealth tax on second house
Wealth tax can haunt you on another front—investments in real estate. If you have a second house that is lying vacant, its value has to be included while computing your wealth tax liability. If this were not bad enough, here’s worse. Even if the house is lying vacant, you have to pay tax on the notional rental income from the property. This deemed income is calculated on the basis of the market rent in the locality. It’s a fact that many taxpayers are blissfully unaware of. It could make them tax evaders if they don’t pay wealth tax on property or include the deemed rent in their return. The taxman has given property owners certain concessions on the wealth tax front. Any loan outstanding against the house will be subtracted from the market value of the property. Also, if you rent out your house for at least 300 days in a financial year, it will not attract any wealth tax. The best part is that the taxpayer is free to declare any one property as self-occupied so that it escapes the wealth tax. So, if you have a 60 lakh property in the suburbs lying vacant, while you live in another 25 lakh house closer to your workplace and the children’s school, you can let the low value house be used for the wealth tax calculation while the costlier property can be exempted. This option can be changed every year. The valuation of wealth is done at the end of the financial year.

Taking benefit of basic exemption twice in a year
When Gurgaon-based telecom engineer Rahul Awasthi moved to a higher paying job in November 2011, his take-home pay shot up by almost 40% to 78,000. Much of this rise was artificial, boosted largely by the basic exemption and deduction assumed by his new employer. The error was discovered three months later. Tax deductions will shrivel his take-home to less than 65,000 this month. “It’s good that the mistake was detected in time, otherwise I would have had to pay a bigger chunk in tax in March,” says Awasthi. Every time you change jobs, you become a potential tax evader. This is because unless you expressly declare it, most companies will assume that you didn’t have any income in the previous months. As in Awasthi’s case, they are likely to deduct tax only for the income earned for the remaining months of the financial year.
Ignore this at your peril because underreporting your income is a serious offence. This is not about ignoring a few hundred rupees in bank interest or a small fixed deposit in your wife’s name. The tax evasion can be in thousands, so it is not something the assessing officer will merely frown at. “The onus is on the taxpayer because all the facts relating to his income are known to him,” says Gupta. It’s best to inform your new employer about the previous income so that you don’t have to deposit the tax yourself. Even if you have to, banks now allow you to deposit it online.