4 things that can go wrong if you invest just to save tax Why should we worry about this? We may end up with an asset allocation that wont serve our goals and needs. We may give up operational flexibility while choosing products. We may not be able to access the asset for other important uses
Uma Shashikant
Chairperson, Centre for Investment Education and Learning
Our neighbor has gone to his village to sell his ancestral property that has been passed on through the generations. Neither he, nor his father have ever worked or lived on that land. He does not expect his son to work there either. However, the decision to sell the property has not been easy and he has been dithering over it for nearly a decade now.
There have been various obstacles even after he began to consider selling. The property is divided in various ways. The ownership rights are in the joint names of grand uncles and uncles. There are various combinations of HUFs, with children and grandchildren residing all over the world. Some of these joint owners are deceased and their heirs have rights to the properties.
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Why has nothing been done all these years? After all, the family has long moved away from pursuing agriculture as the core profession. The answer is a single word that holds the power to skew investment decisions to this day—tax. No one with a stake in the property wants to pay capital gains tax. They would prefer to kick the ball down to the next generation and let things lie rather than settle and share whatever is left.
This obsession with tax avoidance is prevalent to this day. Many of my retired friends, who pursue alternate professions in consulting, advisory, teaching, mentoring and such services, sulk when they hear about taxes. They would rather earn less than the maximum annual threshold than register for GST and keep their books clean.
My worry is about the impact of this orientation on investments and assets, and the enormous misallocation of wealth it results in. A friend of mine asked me about a PPF account she had forgotten about. We used to invest `10,000 every year in the names of the children, she said. Now, the children are well over 30, and this account holds precious savings that need procedural paperwork to access.
We know of many who buy insurance and tax-saving schemes during this season, without considering whether the product will fit into their financial goals or not. The tragedy of failing to pay premiums on policies, allowing these to lapse, is still taking place. Senior citizens consider the post office savings as their first choice, and insist that that scheme for retired investors offers the best tax-saving. Many common investors view tax concessions as choices that ‘must be optimised’. Why should we worry about this?
First, we may end up with an asset allocation that won’t serve our goals and needs. If a young couple is saving for the long term, and has a steady salary income to meet all their routine expenses, their portfolio needs growth assets. Investing in interest-bearing income assets only to save taxes will slow down the growth of their corpus. Over a 20-year saving horizon, the rate of return on equity is likely to far exceed that of debt. That compromise might be costly.
Second, we may give up operational flexibility while choosing products. How easy it should be to invest, borrow, liquidate, access gains or incomes should depend ideally on our life stage. We may not have a stable savings ratio yet, or have some income instability that increases our liquidity requirements. Investing in products with lock-in features, only to save taxes, might hurt us.
Investing in children’s names is another level of complexity. Once they turn 18, they are legally the owners of the assets. Parents will not be able to operate the account, but will have to complete the paperwork for conversion from minor to major, registering the signatures and other identity documents. Investing in haste to save taxes can result in many operational mishaps. We have seen instances where the son hasn’t modified the nomination and his mother claims the insurance and investments, leaving his widowed wife to fight it in the courts.
Third, we may not be able to access or release the asset for other important uses. We know of young earners locking their savings in flats too early in their careers. They then suffer locational inflexibility, and cannot liquidate portions of their chunky assets for any large financial requirement. We also know of parents who pass on flats and houses to their children primarily because they dislike the huge capital gains tax.
Then there are those with multiple residential flats, who won’t sell them to fund higher education, business ventures, or housing plans for children, but only agree to pass it on. Most of them have admitted that they hate to lose the appreciated value of the house to taxes. They want to keep the gain, but not pay taxes on it.
Fourth, we may complicate bequest from the choices we make primarily for purposes of saving taxes. These issues get compounded if the children live abroad. They may be residents of a foreign country, ineligible to hold some of these investments. They may find it difficult to repatriate the funds. They may be unfamiliar with the law and rules there to manage, sell or transfer the assets they have inherited.
Simple assets like bank deposits, equity shares, bonds and mutual funds may not always offer tax benefits, but may be easy to hold, monitor, sell, transfer, operate electronically and bequeath. The taxes that may ensue may be less painful if viewed as a price to pay for convenience. Today’s investors may not suffer the punitive tax regimes of the past that encouraged tax evasion and the cash economy. Even if they had, we have come a long way ahead.
This tax season, consider the assets you own, and review these for your motivation to hold them. If there are other reasons why these assets fit your needs and your wishes for bequest, make sure they are convenient and easy to hold and operate. If you have assets bought and held just to save taxes, consider the consequences of that orientation. Do not choose kicking the can along the road as a strategy, for it is not strategy but denial. Your assets deserve better.
(The auhtor is CHAIRPERSON, CENTRE FOR INVESTMENT EDUCATION AND LEARNING)
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This story originally appeared on: India Times - Author:Faqs of Insurances
