Income Tax Deductions For Donations Made

 

Income Tax Deductions For Donations Made

 

The Indian Income Tax Act allows a deduction from a person’s Gross Total Income for certain types of donations (made by such person). Donations made to any fund or a charitable organisation which is registered and recognised under the Income Tax Act is eligible for deduction u/s 80G and 80 GGA of the Act. This deduction is allowed subject to certain conditions with respect to the fund or charitable organisation and the Total Income of the donor.

 

In this article we examine the provisions of section 80 G from the perspective of a donor.

 

Deduction under section 80 G of the Income tax Act can be grouped under 4 broad categories.

 

The first two categories (1 and 2) are those which are Funds set up by Government and notified as such. Deduction for donations made under these categories is not subject to any qualifying limits.

1.      Donations on which 100% deduction is allowed (without qualifying limit)

2.      Donations on which 50% deduction is allowed (without qualifying limit)

Organisations under category 1 and 2 are typically Government set up funds like National Defence Fund, Prime Minister’s National Relief Fund, University or Educational Institution of national eminence, any fund set up by a State Government to provide medical relief to poor, Prime Minister Drought Relief Fund, etc.

The other two categories (3 and 4) are those which are institutions or notified funds registered under the Income Tax Act and recognised as such. Deduction for donations made under these categories is subject to qualifying limits.

3.      Donations on which 100% deduction is allowed (subject to qualifying limit)

4.      Donations on which 50 % deduction is allowed (subject to qualifying limit)

Institutions / Funds registered under the categories 3 and 4 would typically fall under the NGO category (Fund / Institutions which satisfies the conditions mentioned under section 80 G (5)). These include religious organisations. Donations to a Government or a Local Authority for certain purposes also fall under this category.

 

There are several funds / organisations listed specifically under these four categories. The purpose of this article is to explain the basic mechanism / working of the deduction under section 80 G of the Income Tax Act. The list of funds appearing under these 4 categories are available through a basic google search.

 

We have used the term “qualifying limit” above. Qualifying limit is 10% of Adjusted Gross Total Income. This is Gross Total Income as reduced by deductions under other sections of Chapter VI A other than section 80 G. In other words, Gross Total Income less deductions under sections 80C to 80U except 80G.

 

Having understood the categories of Funds to whom donation can be made and deduction claimed therefor, let us see how to claim this deduction. In order to be eligible to claim deduction, the donation can be made by way of cheque, cash, draft, or any other banking channel. However, cash donation over Rs 2,000 made to a political party is not eligible for deduction. The donor is required to retain proof of donation made.

 

In the Income Tax Return form, the department has introduced a separate table for claiming deduction under 80 G. In this table one is required to fill the details of the donations made and of the donee (donation receiver). This includes the name of the donee organisation / fund, Permanent Account Number, address, mode of donation and amount of donation made. Separate columns are available for the four different categories of donations made (listed earlier in this article). The IT utility made available in the Income Tax Department’s portal, auto calculates the eligible amount of deduction, depending on the qualifying amount.

 

The Income Tax Department now requires the recipient of the donation to inform the details of donation received by them to the Department by filing a form in a specific format. The purpose of this could be that the information uploaded in the Income tax portal by the recipient of the donation would be captured and posted against the donor’s PAN. At the end of the year at the time of filing the IT return, among several other financial information, the donor would also be able to see the details of donations made by them in the Annual Information Statement.

 

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Compound Interest - The Power of the exponential - “N”

 

Albert Einstein is reported to have said that “Compound Interest is the eighth wonder of the world, he who understands it earns it and he who does not understand it, pays it”

Whether Einstein has actually said this or not, the statement is still a profoundly powerful one for those who aspire to make enormous wealth.

As per Investopedia - Compound interest is interest calculated on the initial principal, which also includes all of the accumulated interest from previous periods. In other words, Compound Interest can be defined as “interest on interest”, which makes the original sum grow at a rate much faster than the “simple interest” which is calculated only on the original principal amount.

The formula of compound interest is : A=P(1+r)ⁿ

In this formula - A is the Amount (Original investment plus interest earnings over a period of time), P is the original Principal investment, r is the Rate of Interest and n is the period. One need not be a rocket scientist to understand and appreciate that in the above formula, n is the exponential factor, the key component that adds value to the equation.

To build enormous wealth, it is important to understand and harness the power of compounding. It is important for an investor to understand that being invested in the market and spending more time in the market with the amount invested in it is essential to create wealth.

Most of us have seen a graph of how Warren Buffet’s (the world’s most successful investor) wealth has grown.

 

 

One can see the gradual growth of Mr Buffet’s wealth in the later part of his life. His initial investments have been accumulating at a slow but steady phase. After his age of 52 his wealth starts increasing at an astonishing rate. 620Mn at age 53, 1400 Mn at age 56, 2300 Mn at age 58, 3800 Mn at age 59, 17000 Mn at age 66 and so on.

The caption in the picture mentions that 99% of his wealth was earned after his 50^th birthday. The secret of this growth after the age of 50 is undeniably the first portion of the time scale – i.e. the period between the age 14 to 50. These 36 years laid the foundation.

If we replace the components in the Compound interest formula with the figures from Warren Buffet graph, the thing that stands out is the “N” factor.

Is it possible for a middle class or a lower middle class Indian with a disciplined approach for regular investment to aspire for wealth like this? Can a middle class Indian exploit the power of N?

I would like to give an example of a friend who wants to set aside an amount of Rs 1,000/- per month, for his just born child. The goal is to build a corpus for the child’s retirement (at the age of 58 of the child)! He wants to invest Rs 1,000/- per month, growing the investment at 10% per year for the next 25 years. At the end of 25 years what ever is the enhanced monthly investment, his child will start contributing that much amount on monthly basis WITHOUT any further enhancement till the child’s age of 58. In other words the father will start with Rs 1,000 per month today, increase it to Rs 1,100/- per month at the 13^th month, Rs 1,210/- per month at the 25^th month, and so on till the 300^th month (25 years) when the monthly investment would become 10,835/-. At this point, his child will start investing 10,835/- per month and would be continuing with this investment pattern WITHOUT any further increments, till his age of 58.

Between father and child, they would have over the period of 58 years set aside (month on month) Rs 54.70 Lakhs Principal. And at the age of 58 of the child the amount, @ 8 % compounded per annum, would have become Rs 5,14.04 Lakhs.

For investors who would prefer equity markets the corpus would become Rs 14,73.29 Lakhs @ 11% compounded per annum and Rs 40,19.55 Lakhs @ 13.68%
compounded per annum.

 (As per Investopedia - the average annual return of the The S&P 500 Index since its inception in 1926 through 2018 is approximately 10% –11%.

As per Economic Times - the Sensex has generated an annual return of 13.68% since its launch in 1986.)

 

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Financial Lessons of RMD

A friend, say RMD, called me today morning. He is 55 years of age. We have been serving him for over 20 years now (since 1997) and helping him mainly with his Income Tax compliance. I talked to him about his query - which was how to deploy a lump sum amount which he would be getting later on in the day today. As I sat down to write this blog, my train of thoughts took me over the past 20 years with my interaction with RMD and his family.

When we started working together, RMD had his own views (probably from his family and other background) regarding investments, loans, etc but still used to take our advice occasionally on these matters.

When we started serving him, RMD was member of a typical low-income joint family, staying in a one room kitchen. He was self-employed. His family owned another small business and RMD used to help out in the family business too. He had 2 siblings elder to him, who were in private employment, who moved out of the joint family in a couple of years. He had to continue to manage the family business, devoting more time without any corresponding financial benefits to him.

Today RMD owns a small apartment in Mumbai (city proper and not suburbs) and a small commercial unit in the suburbs, runs his business which he has been operating since past 25 years and has also taken over the family business as a proprietor. His children are in the verge of completing their education. The family has managed to provide higher education for the children which RMD and his wife could not have even dreamt earlier. He has a very marginal loan liability which compared to his net worth is negligible. In this journey he has learnt some valuable financial lessons.

Getting back to RMD’s story, after he got married, he continued staying in the same place with his parents. In a couple of year, RMD’s family had grown to himself, his wife and a child. He had not generated enough corpus / savings which he could use as a down payment to move into a separate house.

It was at this stage in his life that he consulted us again and started taking our advice more seriously.

His top priority was moving into a separate house with his small family. And he was sure that with his background, his earnings and net worth at that point of time and family pressures he would not be able to do it. So, the first issue which we had to tackle was to show him that it was possible. We knew he was frugal in his spending, so building a small corpus should not be a problem for RMD. What he lacked was conviction that he could do it. A simple back of the envelope calculation gave him confidence that there is no harm in giving it a try.

With what he had already saved, RMD built up a small corpus in the next 2 years as a down payment for an apartment. His regular Income Tax Returns helped him get a home loan for the balance amount. RMD signed the agreement and moved into his new apartment with a pride which only a first-time home buyer can experience. No prizes for guessing that we were one of the first invitees for the traditional pooja in RMD’s new house! Sometimes RMD had to struggle to pay the EMIs, but somehow, he managed to do that without spoiling his credit history. Business was going on, nothing great to mention. The regular business income was now comfortably taking care of the EMIs over and above the routine house hold expenses. RMD had now learnt his first financial lesson (i) If you have a proper plan, and adhere to it in a disciplined manner, attaining your goals become easier in life.

 

At this stage we started noticing that during his visits to our office he would invariably bring along his wife, who would get involved in the discussions.

When the occasional topic of pre paying part of the home loan cropped up, the family chose to earmark that for the children’s education. The family apartment in which RMD was born and where he spent a major part of his life was eventually sold and RMD got a share of the proceeds. This helped him to pay off the home loan fully and he was left with a small surplus.

So far, a substantial portion of regular income was being used to service the loan. Now with the small surplus from his share of sale of family property and the additional monthly income which was hitherto being used to repay EMI, RMD suddenly had a sizeable surplus which his family was experiencing for the first time. And with money you get many relatives who approach you with their fantastic money multiplying ideas. A relative convinced him to buy a commercial property and form a partnership business. After 7 years in the partnership business RMD realised that this business has not provided him the return which he was expecting. We showed him another simple calculation of what he could have earned (conservatively) if he had given the property on rent. He weighed the matter in his mind carefully and did not waste much time in dissolving the partnership. He had learnt two more valuable financial lessons (ii) do not dabble in things which you do not understand and (iii) Consult a financial advisor before taking any major financial decision.

It seems he is taking these lessons very seriously now! Having dissolved the partnership firm and having decided to put up the property for rent, RMD has identified a tenant and fixed the terms of tenancy. And the reason RMD had called today morning was to check how to deploy the Deposit the tenant was to give him for taking the premises on rent.

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