Public Provident Fund is ideal for building capital and reducing tax liability

The Public Provident Fund (PPF) is an ideal instrument not only for capital-building, but also for assessees to reduce tax liability. This way, a PPF investment offers investors dual benefit. The Income-Tax Act provides all individuals a deduction of up to Rs 1 lakh on certain investments made during the year under Section 80C. Most of these payments are in the nature of life insurance premium, payment for annuity and payment of school tuition fee, but these don't result in formation of capital.

Section 80C also allows deduction in respect of certain investments made in instruments such as national saving certificates, PPF, investment in equity shares of specified companies, subscription to units of mutual funds, term deposits with banks, subscription to bonds, etc. While these do lead to accumulation on capital, the persons for whom these investments can be made differs widely. But the PPF offers a unique advantage - contribution to PPF is the only investment which qualifies under Section 80C even if the contributions are made in the PPF account of children. The limit of contribution to a PPF account is capped at Rs 70,000 in respect of each account.

Thus, contribution to PPF can be used to transfer generation of passive income from parent to child by way of contribution to PPF. An individual can claim a deduction up to Rs 1 lakh in aggregate along with other payments. As mentioned earlier, the limit of contribution to one account is Rs 70,000 and as a parent, you can contribute up to this much to the PPF account of your children.

A PPF investment also takes care of the clubbing provision of the Income-Tax Act - where passive income arising to the minor child is included in the income of the parent - because the interest on PPF account is exempt from income tax. It also takes care of the provisions of the Income-Tax Act of treating receipts in excess of Rs 50,000 without consideration as income in the hand of recipient. Since gifts from relatives are exempt from this provision, your contribution to your child's PPF account will not be treated as his income.

Since the interest on a PPF account is not taxable in anybody's hand, all the interest accrued to the PPF account builds the capital of the child fully without any reduction due to tax component. Let us see now how the capital builds. Suppose you start depositing an amount of Rs 70,000 from the year of your child's birth and extend the account for the block of five years, your child will get an amount of Rs 38,11,973 on the completion of his 21st year - an excellent amount to start life with. (The calculation is based on assumption that rate of interest remains 8% and compounds annually.)

There are more goodies - while working out the above, the reduction in your tax liability owing to the PPF contribution as well as reduction in your child's tax liability on passive income has not been considered. So what are you parents of growing-up child waiting for? Go open a PPF account, which is an excellent way to have your cake and eat it too. Remember that you earn not only an active income by way of salary or profit from business, but also earn a passive income on your investments.