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Often when we are investing we look for the return, the risk etc and one thing that gets ignored is the Tax.  Ignoring the taxation part while investing proved expensive to me personally,I  had to pay more tax.  Death and Tax are  inevitable and as a wise man has said  “Start with the end in my mind“.This article is to bring out the importance of the taxation part BEFORE we make investment. It talks about the three stages of investments, deciphering the acronym like EEE, EET, ETE, Tax saving instruments and the new Direct Tax Code.


Situation 1: Two years back Financial adviser advising  Ram to invest in Debt Mutual Fund with Dividend option.
Financial advisor: “The market is very volatile. You should invest in the Debt Mutual Fund with dividend option. The Dividend is free and you can take out money any time you want”Ram went ahead and invested 5 lakh in a short term fund with Dividend option. He was happy that he is getting the dividend every month. Then after one year is over he needed money so he went ahead and sold his short term fund. When time came to file the income tax his Chartered accountant told him that he has Long Term Capital Loss and he needs to carry it forward for 8 years. Ram was shocked. He knew that he when dividend is paid the NAV of the mutual fund goes down. But this would give him a Long Term capital loss, he didn’t consider that. Infact he didn’t know that!.


Situation II: Financial Advisor advising Tanya to invest in National Saving Certificates.
Financial Advisor: “Maam you do not need the funds for next 6 years and you want safety too. Invest in NSCs they will give you return of 8.6% , your interest is reinvested and as it is government backed it is 101% sure”.
Tanya bought the NSC. After 6 years when time came to file the returns she was shocked to know that she had to pay Tax on all the interest she had earned since first year. If only she had known that she can declare her interest every year in her income tax returns she would have been able to exhaust her 80C limit. Even without the 80C limit she would pay less tax everyyear than paying so much in one go.


These cases are not of misselling by Financial advisers and  Ram and Tanya knew what they were investing in. But what they had not discounted was tax in investment and how much would they get in end.  One should invest with tax in mind. George Bernard Shaw had said  Beware of false knowledge; it is more dangerous than ignorance.

Financial advisor

Three stages of investment

When one invests in any financial instrument then there are 3 stages:

  1.  Investment Stage: when one invests
  2.  Earnings Stage: when one gets benefit(earns interest) on investment.
  3. Withdrawal Stage: when one withdraws the whole or part of your investment with benefit i.e. interest or accrued interest

Example: Suppose you invest Rs 100 in a financial instrument for 15 years at the rate of 8% interest.

At stage one, you make an investment say of Rs 100.
At stage two, this investment gathers a return say Rs 8 of interest that is not paid out but accumulated taking the value to Rs 108 at the end of one year.
At stage three, you withdraw from the product say after 15 years you get back Rs 317 as the initial investment earns 8 per cent each year at a compound rate.

Now lets look at Taxation part in each stage of investment.

Investment Stage or Contribution Stage

In this stage one makes the investment so no tax is levied at this stage. But one can save tax if one invests in some Tax Saving instruments. Given the importance of savings, the Government from time-to-time provides various incentives for promoting savings. In India, the saving behavior of the people is largely motivated by the tax incentives or benefits attached to any saving instrument.

Tax saving instruments cover Sec 80C, 80D, 80E, 80G, Section 24 etc.  Section 80C states that qualifying investments, up to a maximum of Rs. 1 Lakh, are deductible from one’s income. This means that one’s income gets reduced by this investment amount (up to Rs. 1 Lakh), and one ends up paying no tax on it at all! This benefit is available to everyone, irrespective of their income levels. Thus, if you are in the highest tax bracket of 30%, and you invest the full Rs. 1 Lakh, you save tax of Rs. 30,000.  More on Tax Saving Instruments here.

Accumulation Stage or Accrual stage

This is the time when you earn from your investment. For example, if you invested in the Fixed Deposit, you get interest on the amount invested or if you invested in stocks you get the dividend on your stocks.
This can be taxed or not depending on where you have invested? For example: (As of now) If you invest in PPF then the interest is not taxed. If you invest in Stocks, dividend is not taxed provided you have paid STT. If you invest in Fixed Deposit then interest is taxed.

Withdrawal Stage or Maturity stage

 When one withdraws the invested amount along with the benefits such as interest.For example when Fixed Deposit gets mature you get the full amount with interest. For example, the amount that you get at the maturity of yourPublic Provident Fund (PPF) account is not taxed but amount invested in Fixed Deposit would be taxed.

To complicate the matters Income tax department has come up with acronyms or three letter words for tax at the three stages such as EEE or EET

Confused EEE EET ETE
The letter E stands for Exempt from Tax and T for Taxable. So EEE would stand for Exempt from Tax in investment stage, Exempt from Tax in Accumulation stage and Exempt from Tax in withdrawal stage. Now try with me
EET would stand for Exempt from Tax in investment stage, Exempt from Tax in Accumulation stage and Taxed in withdrawal stage.
ETT would stand for ______________in investment stage, ______________ in Accumulation stage and _________________in withdrawal stage.

Tax saving instruments

Tax-saving instruments are largely covered under Section 80C, Section 80D (medical insurance) and Section 24 (home loan interest payments). Other deductions include donations under Section 80G and interest payments under Section 80E for education loan. Section 80C covers investments with fixed and assured returns as well as variable and marketlinked products.

Fixed and assured returns are low-risk in nature. They are

  • Notified five-year bank deposits,
  • life insurance plans such as pure term and endowment,
  • Public Provident Fund (PPF),
  • National Savings Certificate (NSC) and
  • Senior Citizens Savings Scheme (SCSS)

Market-linked products include

  • Pension MF schemes,
  • Equity-linked savings schemes (ELSS) and
  • Unit-linked insurance plans (Ulips).

Pension MFs are suitable for those investors with medium risk appetite. ELSS and Ulips are largely meant for those who can take high risks

Following table shows the 80C section

80 C


So let’s apply E or T at different stages of investment  for some of the financial instruments as of today in the financial year 2011-2012 or assessment year 2012-2013.

Direct Tax Code or DTC

The Direct Taxes Code (DTC) is said to replace the existing Indian Income Tax Act, 1961.  If approved, the DTC shall come into force on the April 1, 2012, and shall be applicable for income earned during the financial year 2012-13.
A  draft DTC along with a discussion paper was first released on 12 August 2009, for public comments. Based on feedback from various stakeholders, the Government released a Revised Discussion Paper (RDP) on 15 June 2010 addressing 11 of the major identified issues. The RDP was also available for public comments for a brief period up to 30 June 2010. The Direct Taxes Code 2010 was placed before the Indian Parliament on 30 August 2010, after it is approved by both houses of the Indian parliament, and receives the President’s assent, it would be enacted as law. The implementation of the DTC is now deferred to by a year to 1 April 2012.
A brief overview of DTC is as given below for more details Read Economic Times article


Start with the end in mind. Consider Tax while investing. Do you, while  investing, think of tax? Have you also had to pay tax because you were not aware of Taxation part? Did this article help you?