The Concept Behind Tax Rates

What’s your tax bracket? You must have heard this question quite often. But has anyone ever asked you about your effective tax burden? Did you ever thought about your effective rate of tax? Have you ever tried to calculate it?

We keep on carping about the high taxes by keeping in view only maximum marginal tax rates, without ever giving a thought to the exemptions and deductions we avail.

Taxes are determined based on your taxable income. Taxable income is broken down into different brackets or slabs, each to which a different tax rate applies. The highest tax slab rate relative to a taxable income is called marginal tax rate. Put simply, the highest rate of tax applicable on your marginal or additional income is called marginal rate of tax and is the rate you pay on your last rupee of income.

Marginal vs. Effective Tax Rate

Marginal tax rate is important because while making investment decisions, you need to consider your marginal tax rate. However, marginal tax rates do not fully describe the impact of taxation.

The effective tax rate refers to the actual rate of tax borne by you. It is the average rate of tax which you actually pay on your total earnings / income (i.e., both taxable plus non-taxable income). It is obtained by dividing the total amount of tax paid by you by your total earnings expressed as a percentage and indicates your effective tax burden which is always lower than your maximum marginal rate.

Two basic reasons for substantial difference between your marginal tax rate and your effective tax rate are:

1. Your entire income doesn’t get taxed. For example, you are entitled for various exemptions (e.g. HRA, long term capital gains on sale of equity shares, dividends etc) and deductions (such as section 80C and 80d) due to which your taxable income is much lower than your actual total earnings during a particular year.

2. Further, unlike corporate tax rates, your total taxable income doesn’t get taxed at a flat rate. There are different slab rates of tax applicable to individuals. Right now, the lowest tax slab rate is 10% and the highest is 30% (plus surcharge and education cess). Besides, there are certain other incomes which are taxed at concessional rate of tax. For example, short term capital gains under section 111A are taxed at a flat rate of 15% (plus surcharge, if applicable and education cess).

Furthermore, ‘Effective rate of tax’ is also different from ‘Average rate of tax’ which is average rate levied on your ‘Taxable Income’ and is calculated by dividing ‘total tax obligation’ with ‘Taxable income’. Your ‘effective rate of tax’, on the other hand, reveals the average rate of tax for all your income (taxable as well as non-taxable).

Let’s clarify the difference with the help of an example. Suppose that you’re having a total annual income of Rs 17 lakh out of which Rs 4 lakh is exempt (i.e., not taxable) from income tax. Further, let’s say that you are entitled to deductions amounting to Rs 1.6 lakh under various sections of income tax such as section 24(b) and section 80. Thus, your taxable income comes to Rs. 11.4 lakh (which includes short term capital gains of Rs 2,30,000 taxable u/s 111A @ 15%). Based on the tax rates applicable to ‘other individual’ (i.e., neither women nor senior-citizen) for the assessment year 2009-10 (PY 2008-09), the total tax liability works out to be Rs 2,40,760. So, we arrive at an effective tax rate of 14.16 per cent, which is less than half of marginal tax rate and almost two-third of average tax rate (marginal tax rate of 33.99% and average rate of tax of 21.12% ).

Now, finally calculate your effective tax rate.. :)

How to Best Manage Credit Cards

A credit card is a useful tool, when managed judiciously but a lurking danger if you mismanage it.

One of the first things you need to keep in mind is to read the term and conditions, when you apply for a credit card. It could be a laborious process but something that has to be dealt with, to protect yourself from any rude surprises that might be in store for you in times like this.

One hears stories of money being taken from the savings account of a person who has a credit card with that particular bank! Well, banks are allowed to do so, when a default occurs, the clause is covered in the terms and conditions.

Banks also have an auto debit facility to claim a minimum payment on credit borrowed, if in case your account does not have enough funds, banks are allowed to levy a fine, which varies from bank to bank. So ensure you always have sufficient funds, when you opt for the auto debit facility to cover your minimum payment due. But there's more to credit cards.

Profit from your credit card: Credit cards can be useful when you make a profit out of it! Now, how is that possible? Well, it all depends on the kind of card you purchase.

It is best to opt for a lifetime free credit card that does not have an annual fee attached. Also get a card that matches your lifestyle. If you shop a lot, see that your card offers a lot of discounts and cash back rewards for all the shopping you do with your card. If your job allows you to make frequent trips, get a card that gives you several travel friendly schemes on eating out, hotel stays and airline ticket discounts.

High interest rates: Though the whole point of having a credit card is to provide you with cashless convenience, it makes money sense to decide, when, how and why you should use it.

Never get tangled in the web of debt, especially when it comes to credit cards. Although it is an ideal resource to tap into, when you need to ramp up funds quickly, the interest rates charged on a credit card are much higher than even those charged on personal loans.

Remember that cash withdrawals from an ATM with your credit card will be charged a processing fee of around 2 per cent and an even higher rate of interest than your regular purchases on the card.

Taking a loan on your credit card: Most credit cards do offer an EMI (equated monthly instalment) facility to pay any loan you take on your credit limit. It normally takes just one or two business days to obtain this loan and this can even be arranged over the phone with no documentation.

However, the difference lies in the high interest rate charged, which can be an annualized interest rate of around 30-42 per cent. The cards that offer a comparatively lower interest rate in the range of 22-26 per cent most often do not have an EMI facility for repayments.

Though a credit card seem like a good bet for short-term fund requirements refrain from using it unless you can make the credit card usage count for some kind of benefit.

Using your credit card purchases for an interest-free period is fine, but remember the bank can do away with interest-free periods anytime it chooses to and can also hike the interest rates, according to its free will. Hence, be wary of a credit card and use it sensibly. Another important aspect in managing your credit card is to keep a careful tab on your credit card statement that should reach you on a monthly basis.

Understanding your credit card statement: Scrutinize your credit card statement to understand your spending pattern. If a bill does not arrive on time for you to pay your dues, report this to the bank immediately. Also keep track of the credit card bill through your online banking account.

The first detail you need to clarify is your name, billing address, card number et al to make sure it’s correct. The second aspect is the total outstanding balance and current due date for payment. This column will also have the previous month's transaction using the card. Here is an example:

Previous balance	Current outstanding amount	Total amount outstanding	Minimum payment due	Payment due date
Rs 5,000	Rs 3,000	Rs 8,000	Rs 320	25-3-09

Minimum Payment Due: The date for the minimum payment due allows you to pay up a small amount upfront and this is usually in place to protect your credit score.

However, as a practice ensure that you pay the total amount due before the minimum payment due date to maintain an impeccable credit score else you will be levied interest on the balance amount pending if you continue to pay the actual amount due in full only after this due date. If you fail to pay even the minimum amount due you will incur a late payment fee as well.

Transaction Details: The second aspect to be scrutinized is the list of purchases or transactions done throughout that particular billing cycle. Go through each particular of this list to see if they match your expense records.

Usually your statement will have a reference number that can be quoted if you feel any charge specified needs to be clarified. Utilizing your reference number for billing errors and unauthorized charges

Always commit in writing within 60 days (this time period varies from bank to bank) of the receipt of your statement the complaint regarding the billing error or unauthorized charges. Include all the following particulars in your complaint:

· Your name, address, account number and reference number

· Error description

· The date and amount of the charge

· Reason cited for the dispute of charge

Check your credit card statement if there is a specific address to which the complaint has to be sent to. This might be at the end of the statement or as part of the fine print, behind the statement.

Your credit card statement also has the other particulars like:

• Credit Limit: This is the maximum limit up to which you can make purchases or withdraw cash on your card. This credit limit can be revised by your credit card company depending on your credit score and your repayment track record.
• Available credit limit: This will be the amount you can still avail after you have made a bunch of transactions using the card. For instance, if you have a credit limit of Rs. 1 L and you have made purchases worth Rs 25,000, then your current available credit limit would be the balance, Rs.75,000.
• Cash limit: This is the actual cash limit up to which you can withdraw on your card, which is included in your credit limit.
• Statement Date: The billing cycle ends on a particular date after which the statement is printed, the interest rates applicable for your card transactions are calculated using this statement date as the starting point.
• Total outstanding Amount Due: This includes past and present credit expenses and other charges levied to your account.
• Reward Points Summary: This provides you cash discounts and other benefits on purchases made when accumulated over a period of time. This column contains all the past points earned and utilized by you till that particular billing cycle.
• Grace Period: A grace period is the number of days you might get as relief before the high interest rates start kicking in for the remainder of the amount that is due. This can be anywhere between 20 and 25 days.

Free ATM Usage

Most of the banks charge a considerable amount to its customers when they use ATM facilities of a different bank to do transactions on their accounts. I myself have paid amounts to the tune of Rs. 61.80 (Usage Fee: Rs. 55.00, Service Tax: Rs. 6.60, Education Cess: Rs. 0.20) for such usages I have made. Part of this usage fee is paid to the bank whose ATM is been used. Considering the costs involved, I always felt that this is an obscene amount.

The irony is even if one withdraws Rs. 100, he has to pay Rs. 61.80 as usage charge. I wonder why the banks are not charging the usage charge as a percentage of the money being withdrawn, while they charge based on percentage for various other services. For example, processing fee for a service such as Balance Transfer on credit card is a percentage of the amount being transferred. The bank would say that despite the quantity of money being withdrawn from an ATM, the service is used anyway, which involves the same set of procedures and that’s why it’s a fixed charge. But here, my question is, how is it different for the processing fee on balance transfer? Isn’t the service being used and the efforts involved are same for various balance transfer amounts? But then one doesn't need to think too much to understand why the banks charge in percentage for services involving higher amounts!

Thus, reading the minds of millions of bank users of India, the RBI has directed the banks to allow free access to ATMs by April 2009. By March 2008 banks that are charging more than Rs. 20 for using a different banks' ATM will have to bring down the charge to Rs. 20. Also, balance enquiry has to be made available free of cost across all ATMs. In order to bring in transparency to the banking system, RBI has also urged the banks to inform their customers before hand, the amount they shall pay for withdrawing money from a different bank's ATM, which would discourage the customers from using a different bank's ATM.

The RBI has also pointed out that in other countries such as UK, Germany and France, customers can access all ATMs in the country, other than the ones managed by non-banks, free of charge. With this move, the Indian banking system is set for a revolution and importantly more customer focussed, it seems.

Avoid Having Multiple Bank Accounts?

A large number of people own savings accounts in several banks. Some are inherited from their previous jobs while some are opened to avoid tax deduction at source on fixed deposits. As the minimum average quarterly balance required maintaining these savings accounts increases in private sector banks, owing multiple savings accounts become a costly affair.

An increasing number of banks have hiked the average quarterly balance (AQB) in metros to Rs. 10,000; while most of them have the minimum AQB amount as Rs. 5000 in smaller cities. Thus, a lot of customer’s money is blocked to keep their savings accounts alive. For example, consider the case of a person having 5 savings accounts of AQB Rs. 10,000 each!

Secondly, having too many savings accounts and the need to maintain minimum AQB in each one of them pose the danger of not being able to meet the minimum AQB in one or two accounts, which leads to penalty charges. This is usually a huge amount in private sector banks (ICICI Bank charges Rs. 750 + Service Charge) as a penalty for not maintaining minimum AQB.

But above all, earning a paltry interest rate of 3.5% for your money in savings account, when you can earn a much higher interest of around 10% in Fixed Deposits, would not be a great idea. That is, if you have less number of savings accounts, less would be the money needed for maintaining minimum AQB in those and more would be the money available for Fixed Deposits.

“If you notice that your savings account balance is over Rs 50,000, normally you would think of transferring some money to a fixed deposit. But if there is Rs 20,000 in multiple accounts, the thought many not cross your mind”, says a financial advisor, which is very true. So it’s better to own as less savings accounts as possible.

Income Tax Slabs - FY 2009-10

In the union budget for financial year 2009-10, the Finance Minister has announced new tax slabs.

For the Assessment Year 2009-10

Taxable income slab (Rs.)	Rate (%)
Up to 1,60,000 Up to 1,90,000 (for women) Up to 2,40,000 (for resident individual of 65 years or above)	NIL
1,60,001 – 3,00,000	10
3,00,001 – 5,00,000	20
5,00,001 upwards	30*

*A surcharge of 10 per cent of the total tax liability is applicable where the total income exceeds Rs 1,000,000.

Note: -

• Education cess is applicable @ 3 per cent on income tax, inclusive of surcharge if there is any.
• A marginal relief may be provided to ensure that the additional IT payable, including surcharge, on excess of income over Rs 1,000,000 is limited to an amount by which the income is more than this mentioned amount.
• Agricultural income is exempt from income-tax.

As you can see, compared to the last change, there is a 10,000 rupees increase in the first slab across all categories, while the remaining slabs remain unchanged. This would lead to a maximum savings of 1000 rupees for a tax payer whose income falls above Rs. 1,60,000. This may not be a significant saving for many.

However the interesting thing to note is that there is no 10% surcharge for incomes above 10 lakhs. This is a welcome

move because I feel progressive taxation is counter productive to an aspiring population. Even though these tax sops would make holes in government's revenues, I guess the government is looking to increase the expendable surplus of the populace so as to boost up the economic downturn.