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How Tax Benefit Claimed In Earlier Years Can Be Reversed

Every year, people reduce their tax liability, by claiming various deductions and exemptions allowed under the Income Tax Act.

However, at times they default on the terms and conditions stipulated for enjoying such tax benefits. Income Tax rules clearly specify that,under such circumstances, these benefits could be revoked. And, the taxpayer would become liable to now pay the tax that s/he had saved in the past.

Quite often people are not fully aware of the rules. So the default is not a deliberate tax evasion, but an unintentional mistake.

Some instances of such ‘accidental’ tax reversals are discussed below.

A. On home loan principal repayment
As you are aware, home loan EMIs are eligible for tax benefit.

‘Interest’ part of the total EMIs payable during the financial year, can be deducted from the total taxable income — subject to a maximum of Rs.2 lakhs. This benefit is available u/s 24.

And, ‘Principal’ part can be deducted from the total taxable income — subject to the limit of Rs.1.50 lakhs, specified for various investments and expenses put together u/s 80C.

Not many taxpayers are aware that the tax deduction claimed, for the principal amount repaid, can be reversed.

This will happen if the property is sold in less than FIVE years from the end of the financial year in which the possession of such property was obtained. Consequently, the principal amount claimed as deduction in the past, would become ‘deemed’ taxable income for the year in which the property is sold.

Thankfully, the interest part is not touched. That benefit remains at it is.

B. On a life insurance policy
Buying a life insurance policy remains one of the most popular ways to save tax.

Unfortunately, people don’t plan their taxes in advance. And then, when the March deadline approaches, insurance becomes the most easy and obvious option.

In this rush, however, they often overlook the long term commitment involved. High number of lapsed policies, especially in the first few years itself of the policy term, is witness to this fact. It is not easy to continue paying premiums, year after year, for decades.

Sadly, this results in a double loss.

One, you lose a part or the entire premium(s) paid.

Two, you have to forgo the tax benefit claimed.

The income tax rule here is that you should have paid at least (a) two years premium for the moneyback or endowment type of traditional policies and (b) five years premium in case of ULIPs, if the tax benefit claimed in the earlier years is not to be cancelled.

Else, the deduction claimed becomes your deemed income in the year of policy cancellation.

Related: Fine print of claiming tax benefit on life insurance premium decoded


C. On the Employees Provident Fund (EPF)
Under EPF, a specified portion of the employee’s salary is deducted every month and invested in his or her EPF Account. The employer too contributes a similar sum to the same.

While the employer’s contribution is tax free, the employee’s contribution is allowed as a deduction u/s 80C.

This tax benefit gets nullified if the accumulated sum is withdrawn before the expiry of five years of continuous service. Given the frequent job changes in recent years, this has become a common phenomenon.

Accordingly, the 
a) tax benefit on the employee’s contribution, claimed in the previous years would become part of taxable income,
b) interest earned on the employee’s contribution would be taxed under the head ‘Income from other sources’, and
c) employer’s contribution together with the interest earned on the same, would be taxed as ‘Profits in lieu of salary’.

D. On the capital gains from sale of property
Sale of property held for more than three years, is eligible for exemption from the capital gains tax, provided you invest the capital gains
a) either in another property (without any limits) or
b) in the specified bonds issued by REC or NHAI (maximum up to Rs.50 lakhs).

(Note: There are certain prescribed time limits for the aforesaid investments.)

However, to ensure that this exemption is not reversed and you become liable to pay the capital gains tax, you have to keep the ownership of the newly acquired property for at least three years.

If the new property is sold within three years, you will have to pay full tax as per your marginal income tax slab rate BOTH on the gains on the new property AND the exempted capital gains on the old property.

[Imp: With effect from FY 2017-18, the period of 3 years, for exemption from capital gains tax, is proposed to be reduced to 2 years.]

Concluding: You should be very careful in claiming your tax benefits. Otherwise, you may have to pay a heavy price in the future, if you fail to comply with the underlying conditions.

Disclaimer : This post is sponsored by TomorrowMakers.

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