Poof! Did you know that your income-tax benefits can be reversed too?

While drawing up a chart of tax-saving investments for the year, don’t forget about the conditions that could nullify the tax benefit under Section 80C. Exiting investments too early could lead to reversal of taxation benefits.

With employers dishing out investment declaration forms these days, many taxpayers are exploring options to minimise tax outgo by claiming the right deductions under Section 80 C for the financial year 2022-23. But that alone isn’t enough to save taxes. You also need to be aware of the riders wherein the tax benefits under the Section 80 C bucket can be reversed.

Deductions come with certain conditions. One can claim these when specified conditions are fulfilled, failing which the entire deduction amount claimed in the previous year will be considered as income for the next financial year,” says Abhishek Soni, CEO and co-founder, Tax2Win, an online financial planning consultancy.

Early withdrawal, expenditure incurred for ineligible purposes and transferring investment or assets prior to the prescribed conditions are just some of the reasons why deductions that you were allowed can be just as quickly reversed, he warns.

So, if you feel an investment is not working out and stop premiums, or even withdraw the money to fulfill a need, there are repercussions.

Terminating insurance

Often, taxpayers scramble to buy life insurance policies before February to meet the March 31 deadline. What many do not realise is that the premium is not a one-time expense and has to be paid in subsequent years also. Many insurance policies require you to pay the premium every year for a few years at least. If you stop paying premium for any traditional life insurance plans within two years of issuance, the premium claimed as tax benefit under Section 80C would be reversed.

The holding period is different for unit-linked insurance plans or ULIPs. Terminating or discontinuing premium payment for a ULIP within five years of issuance of a policy could lead to reversal of tax benefit claimed earlier.

Withdrawing from pension plans

Similarly, surrendering a pension plan before completing premium payments for two years too would result in reversal of the tax benefit claimed under Section 80 C.

The tenor again changes for government employees. “A minimum tenor for pension plans hasn’t been specified under Section 80 C. However, if we go by Section 80CCD, government employees’ pension scheme should be for a fixed period of at least three years. Hence, deduction claimed earlier will be reversed for employees who withdraw before three years,” says Suresh Surana, founder, RSM India, an audit and tax consulting firm.

Limit your premium to avail tax benefits

While choosing a life insurance policy, you must also understand the conditions under which the maturity amount becomes taxable.

Currently, the Section 80C tax deduction benefit is available only for those policies where the premium paid is up to 10 percent of the sum assured. If your premium exceeds 10 percent of the sum assured, then even your maturity amount is taxed in your hands.

These limits are for policies issued after April 1, 2012, prior to which the premium limit was 20 percent of the sum assured.

Home loans

Even for a home loan, the tax benefit is allowed under Section 80 C for the principal section of the loan paid during the year. However, there is a stipulation to this rule—the property cannot be sold for five years from the time you get possession of the house. And if you do sell your house before the limit, you face the double whammy of losing out on the tax benefit and having to pay capital gains tax too.

Also read | No additional Rs 1.5 lakh housing loan tax break for affordable loans from April 1, 2022

“If the house is sold before five years, then the entire amount deducted will be considered as income,” says Soni. However, the housing loan interest deduction claimed under Section 24(b) won’t be reversed under such a condition.

But if your Section 80 C investments were already rounding up to Rs 1.5 lakh (Rs 1 lakh before financial year 2014-15) excluding the home loan principal claimed, then the Section 80 C amount claimed in the year availed would not be reversed.

Alteration in tax bracket

A reversal of tax benefit could impact your tax bracket too as the income could escalate due to nullified tax deductions.

Take, for instance, a person whose taxable income in a year is Rs 4.85 lakh. This means she is in the 5 percent income-tax bracket. However, if she were to withdraw her life insurance policy before the mandatory period and the Rs 45,000 that she had claimed as tax deduction earlier is added to her income, her taxable income suddenly crosses the Rs 5-lakh barrier. In other words, she now falls in the 20 percent tax bracket.

The need to declare premature withdrawals

The question is: If you withdraw your investments after having claimed income-tax deductions, how would the government even come to know of it to be able to nullify your tax benefits that you had claimed earlier?

Remember, “If the deduction claimed under Section 80C is withdrawn, then it will be taxable under the head income from other sources and the taxability will be according to slab rate,” says Soni.

The onus is on the taxpayer to declare such withdrawals. Chartered accountants warn that if you do not, and your income tax return is picked for scrutiny, you would need to provide all proofs.

Mumbai-based chartered accountant Mehul Sheth says, “Practically there are no means to check the reversal of the taxation benefit as the revised returns too need to be filed by December 31 of the assessment year. But if a scrutiny is involved and you are specifically asked about the investments, then you would have to bear the additional taxation, interest and penalty costs.”

The rate of penalty could be 50-200 percent of the tax amount.

One must be careful as many investments specified under Section 80 C are government schemes. “It becomes very easy for the income tax authorities to collect data and identify the potential violations. Assessees have been mandated to link their permanent account number with Aadhaar, which aids them to trace all the financial transactions carried out by the assessee,” says Surana.

Preserve documents

Further, if the income tax department scrutinises the tax return filed in assessment proceedings, they may also require the taxpayer to submit proof of investments that would enable them to trace the investments.

“Details and documents for the purpose of taxation such as investment proofs, rent receipts, salary slips, Form 16, should be maintained for six years from the end of the relevant assessment year,” says Surana.

If an individual has claimed certain expenses deductible under Section 80C in financial year 2022-23, she must preserve the same for six years from the end of the assessment year 2023-24, which would be the end of 2029-30. This means that an assessee should effectively preserve such records for a total period of eight years.

“While assessment can be reopened until four years, cases of concealment of income of Rs 50 lakh or more can be reopened until the end of 10 years,” says Soni.
Khyati Dharamsi is covering personal finance for the past 15 years. Taxation, insurance, mutual funds and gold are her areas of focus.
first published: Sep 9, 2022 09:05 am