What the hell is Income Tax? How does it impact my investments?

Before we go further, we have to understand the concept of income tax.

As you all know that we live in a country where the government is supposed to provide us with some basic facilities like defence, police force, law & order, administrative services like cleaning up of roads and provide you with clean water , roads & railways & many many other services.

Some of it is provided by the central government (which sits in Delhi) & some of it by the state government.

Now how does the government pay for all these services ? By levying tax on its citizens. There are many types of taxes.

Income tax is one of the many taxes we have to pay.

Now because of the kindness of the people sitting in Delhi ,they have decided that if you are below 60 & you earn less than 2.5 lacs p.a. then you dont need to pay any tax as you would be barely be able to make your ends meet. ?

If you earn between, 2.5-5 lacs then you pay 5%. If you earn between 5-10 lacs then 20% and above 10 lacs , then 30% of your income you have to give back to the government as income tax.

There may be a additional % you need to pay as surcharge. But for our purpose right now , Iam ignoring it.

So this is how it works. If your income is 5 lacs p.a from your job or business & you have saved some money say 10 lacs over the years which you have invested in an FD from which you earn interest & you also earn some rent say 20,000 p.m. from a flat your aunt left you in her will which you have leased to a tenant.

All the above income will be added together,there are specific rules which your Chartered accountant will apply,regard to your income and you will have to pay income tax to the government.

Now the important part for us is that , say if you are in the 20% tax slab,( ie your total income per year is below 5 lacs ) & you place a fixed deposit with a bank at 8%. Then effectively from your income of 8% , 20% will get reduced ,which will have to be paid as income tax.

In your hand you will get only 8%-1.6% = 6.4%.

for eg : you place a FD of 1 lac at 8% p.a. with a bank. So every year you will get Rs. 8000 as interest.

But out of the Rs. 8000, 20% will be paid out as income tax. That is Rs.1600 will be income tax. In your hand you will only get Rs.6400 .

Effective post tax rate for you then is only 6.4%.

This is how income tax impacts return from your investments.