Among individual taxpayers, income tax deductions under section 80C of the Income Tax Act are the most common. It allows deductions up to Rs 1.5 lakh for a financial year on contributions made towards various long term investment options like EPF (Employees' Provident Fund), PPF (Public Provident Fund), NSC (National Savings Certificate), ELSS (Equity-Linked Savings Scheme), etc. The Indian government also allows deductions on interest and principal repayment on housing loans to encourage individuals to purchase home, especially first time home owners.
However, there are conditions to the government's generosity so that these deductions benefits are not exploited in making short term profits. Here are three popular situations where the deductions or exemptions can be reversed for failing to comply with the conditions.
Premature EPF withdrawal
EPF is a long-term high interest yielding investment backed by the Indian government that enables salaried individuals to save for their retirement. Contributions made towards the scheme in a financial year are allowed for tax deduction under section 80C.
However, if the subscriber chooses to withdraw from the scheme before completing 5 years of continuous employment service, tax will be charged on the entire amount withdrawn.
While employer's contribution towards EPF and interest earned on it (both of which are otherwise tax-free) will become taxable as profits in lieu of salary, interest earned on employees' contribution will be taxed as income from other sources.
Note that there are exemptions. If the individual ends employment due to health issues, closure of business or other reasons beyond his/her control, he/she is not liable to pay taxes on the amount withdrawn.
Sale of property bought with home loan
For individuals who purchase a house through home loan can claim income tax deductions under section 24, 80EE and 80C.
On amount spent towards the repayment of the principal of the home loan, deductions can be claimed under section 80C, within the overall limit of Rs 1.5 lakh per year. This deduction is available irrespective of the year for which the payment was made and exemptions are also applicable on payments made towards stamp duty and registration fee. However, these benefits are allowed only after the construction of the house has been completed.
If the house owner ends up selling the house within 5 years from the end of the financial year where he/she attained possession of the property, the tax benefits under section 80C are scrapped off. The amount of tax deduction already claimed in the previous years will be deemed as income for the year in which the property gets sold and the individual will be liable to pay taxes on such income in the same year.
Surrendering life insurance policy
Premium paid towards life insurance policies during a year are also eligible for tax deduction under section 80C of the Income Tax Act. These deductions are only applicable on the insurance policies in the name of the individual, his/her spouse and children.
Further, the premium amount paid that is eligible for deduction is limited to 10 percent of the sum insured. If the policy was issued before 1 April 2012, the limit is 20 percent.
However, if the insurance policy is surrendered within two years of issue, any deductions claimed in relation to the premium in the earlier years would become taxable in the year in which the policy is discontinued.
The insurance company will also deduct the full amount of the premium if the policy is discontinued after one year, apart from the tax outgo on discontinuation. If the policy is surrendered after completing 2 and 3 years, the insurer will pay back only 30 percent of the total premium.