How Investing In Politics Can Save You Income Tax

The tax provision under the spotlight provides for deductions through donations made by individual taxpayers to political parties or any electoral trusts and requires that political parties must be registered under Section 29A of the Representation of the People Act, 1951.

The provision is meant to encourage individuals to financially support political parties and claim tax deductions against such donations to lower their tax liability. It is noteworthy that this provision is available to taxpayers only under the old tax regime.

The tax provision under the spotlight provides for deductions through donations made by individual taxpayers to political parties or any electoral trusts and requires that political parties must be registered under Section 29A of the Representation of the People Act, 1951.

The provision is meant to encourage individuals to financially support political parties and claim tax deductions against such donations to lower their tax liability. It is noteworthy that this provision is available to taxpayers only under the old tax regime.

The first question that pops up is what is new? The above mentioned provision has existed for many years and has been amended from time to time. However, now, the tax-saving route comes along with cashback over this provision.

Over the last few years, numerous high-salaried individuals have used the provision of 80GGC to save tax.

The malpractice of giving donation to bogus/questionable charitable trusts and claiming deductions under section 80G is a very old practice, according to tax expert, Ameet Patel. However, he adds that this has now extended directly to political parties. Moreover, proving the legitimacy of the donation receiver is extremely difficult.

The trend to save tax by individuals via this route escalated after the Supreme Court declared electoral bonds unconstitutional. While electoral bonds weren’t transparent, the new trend is leading to tax evasion by high-salaried individuals using this provision in the Income Tax Act.

In the last two years, intermediaries have emerged for political parties, especially regional political parties, that help individuals with conversion. The rates of conversion vary from 5-7.5% depending on the political party and their influence in the region.

How does it work? An individual wants to contribute Rs 10 lakhs per annum. He or she approaches the agent who helps in this conversion. The money is transferred through banking channels to the bank account of the political party. An amount of 5-7.5% as the prevalent rate will be deducted, and the remaining amount in cash is returned to the individual.

At, say, a 5% rate, the individual gets Rs 9.5 lakhs back, saves Rs 3.5-3.9 lakhs in tax, and everyone goes home happy. The cash received is utilised for daily expenses and escapes scrutiny.

The high-salaried individuals are careful to use known parties through trusted intermediaries for only such an amount that can be explained during any scrutiny.

The modus operandi involves payment to a political party using their own banking channels via a trusted intermediary and the return of cash to the individual after the deduction of a conversion rate.

While this route was used by small and medium businesses earlier, increasingly high-salaried individuals have started opting for this route to save tax under the old tax regime. Individuals are permitted to use the old tax regime if they find tax savings higher under the old regime.

"It is mainly beneficial to them (high-salaried individuals) because if they are in a high tax rate of 39% and they are paying a donation for which they get 100% deduction," said TP Ostwal of TP Ostwal & Associates, adding that their income tax is saved to the extent of 39% and when the political parties, after keeping up to 10%, give back the 90%, they save more.

The current tax regulation caps the total deduction to the total income of the individual taxpayers. It also requires the payment to be made via own bank accounts to the banking accounts of the political parties through banking channels such as internet banking, credit cards, debit cards, cheques, demand drafts, etc., to claim deductions under Section 80GGC. The payment receipt is required to be submitted along with the tax documents to claim deductions to the Income Tax Department.

In the past few years, individuals have also been subjected to scamming under this modus operandi in states like Gujarat and Maharashtra involving lesser-known regional political parties. This has come to light after tax authorities sought documents and individuals realized these were not recognized political parties under Section 29A of the Representation of the People Act, 1951.

Patel says tax department has taken action against misuse of 80G and trusts indulging in tax evasion including reopening of assessments of lots of tax payers, the same can take place in this case as well.

According to the Income Tax Department, there are nearly 7.5 lakh individuals who have a gross total income above Rs 50 lakhs per annum, while there are 4.5 lakh individual salaried taxpayers above Rs 50 lakhs salary in the assessment year FY24, i.e., FY23 financial year. Income Tax data for income-wise returns comes with a lag.

"Salaried employees with income up to Rs 1 crore were indulging in all these things, but the money involved was not substantial. They were paying Rs 5-10 lakhs and getting it back. But now the trend has changed. The IT department is aware of these things, and they are sending notices," said Ostwal.

According to the recent returns analysed by the Association of Democratic Reforms, there are 57 regional parties registered in India, out of which 28 parties have declared donations amounting to below and above Rs 20,000. The total amount of donations stood at Rs 216.76 crores in FY23 from 2,119 donor accounts. The top five parties which declared the highest donations in FY 2022-23 are BRS, YSR-Congress, TDP, DMK, and CPI.

As per ADR data, 1,827 individual donors contributed to regional parties, while 8,567 individual donors contributed to national parties. The parties receiving the maximum donations include BRS, TDP, DMK, CPI, CPI(ML)(L), JD(U), IUML, JJP, AITC, and MNS. Many of these parties are expected to report an increase in donations from individuals since FY23.

"Political parties need money lenders. They have got enough black money in cash, so they want somebody who can lend their name and get the money into the records/books and return the cash. This is what is happening; it is not happening for the first time," Ostwal said.

The total donations (above Rs 20,000) declared by the national parties for FY2022-23 was Rs 850.43 crores from 12,167 donations, including 8,567 individual donors who donated Rs 166.62 crores to the national parties during FY 2022-23, ADR said in its recent report.

"This is mainly done with registered regional/small political parties as contributions can be done only to them, but they are not national-level parties. Bigger and national-level political parties have better ways to manage cash," said Ostwal.

Amongst the large parties, BJP leads with 7,945 donations from individuals and corporates, while AAP declared a total of 2,979 donations, followed by Indian National Congress with 894 donations, CPI(M) with 314 donations, and Meghalaya-based NPEP (National People’s Party) with 35 donations.

Registered political parties are exempted from taxation on any amount they receive through donations from individuals, corporates, or electoral trusts.

"Whether you are a small or big political party, any income arising in their hands is totally exempt. There is misuse, therefore," said Ostwal. "Why do you want to give them that exemption?" asks Ostwal. "Political parties should be asked to spend 70-80% like charitable trusts for political purposes. If they go on depositing this money they receive from donations in the bank, that will just accumulate, and money is misused. If the charitable trusts are doing that, the IT department penalizes the charity and genuine charitable trusts are also penalized, but if the political parties are doing it, no action is taken. Nobody wants to bell the cat."

"There is a growing trend of using smaller and regional parties for 80GGC transactions. I think the time has come for the government to review the registration of political parties and their accounts," said Ostwal, adding that they have been given exemptions under the Income Tax Act and that continues under the new bill as well. "Political parties should not be given total blank exemption and should have the same restrictions as charitable trusts; this will reduce misuse of this route."

The high incidence of taxation on high-income and salaried individuals is one of the reasons why tax evasion using Section 80GGC is misused. There are multiple taxes on high-income individuals – companies are taxed, and the dividends distributed by them are then taxed in the hands of the individuals at the slab rate. All these factors increase the tax burden on individuals, said Ostwal.

Maybe it is time for the Finance Minister to reduce the peak tax rate for high-salaried individuals as well.