My take on the budget

The kind of hype and expectation which is normally generated by any budget in India is tough to meet at the best of times. This year was more so due to the demonetization fallout that many of us were affected by. The price of inconvenience was sought and in many cases loss of business and jobs required some level of reparation. Lack of growth and clear decisions regarding black money and political funding also had to be tackled.

Based on all of this, the foremost question will be whether the FM has delivered or not? I would say that he has done it quite well, even though I feel there was room to do more in terms of personal income taxes. The 5 % reduction on the first slab was good but it should have been followed up with similar reductions in the other slabs. The surcharge on the incomes greater than 50 lacs is keeping with the sentiment that the richer people can afford to pay taxes. With the ongoing elections, this is something I can understand, though I do not agree with the approach.

Taxation and black money have been the recurring themes in our economy and polity in 2016 and the FM did a commendable job here. Firstly, he addressed the issue of poor tax compliance and brazen tax evasion in India – it is like an elephant in the room, everyone knew about it but no one mentioned it so far. The FM has put the numbers in context – only 1.7  lacs people saying that they earn more than 50 lacs is abysmally low. With the event of demonetization and the cash being brought into the banking system now, there is real hope that people who had stashed away their ill gotten wealth will now have to face the music. If they declare through IDS 2 then they pay 50 % tax and another 25 % as deposit for 4 years. In case they choose to just take a risk, they will definitely get caught and end up paying 82.5 % tax and in addition get a possible jail term.

As far as the growth part is concerned, the FM has avoided some potentially poor decisions like taxing capital gains on equity etc. On the other hand, reduction of LTCG tenure on property capital gains, shifting the base year to 2001, giving 1 year relief to builders on deemed income will energize the RE sector. With the earlier incentives on housing loans announced by the PM this gives a good fillip to the housing sector, which was much needed.

Agriculture has got a lot of attention in this budget and that is good given a lot of our people depend on it even today. Improvement in agricultural production and rural income will also be able to drive consumption which is vital for corporate growth. We also need to remember that resources are needed here far more, than people like us need it.

The corporate tax relief to companies doing revenues of less than 50 crores in the year 2015-2016, will help the earning of these companies next year. This will be a good push to the elusive earning growth that we have been waiting for. This reform is a harbinger of more things to come and will encourage buying in our stock markets. The fiscal deficit being on track will increase the confidence in the India story as far as the Rating agencies are concerned. FII buying will return and the general mood of our markets in 2017 will be upbeat, though there will definitely be periods of corrections.

Some other good things in the budget was the wait for GST, instead of trying to tinker with Service tax or Excise for 3-4 months. LIC coming up with a 8 % scheme for senior citizens, Companies like IRCTC going public, Safety fund for the Railways, divestment through CPSE ETF next year too are all good measures. Transformation to the Digital economy by stopping cash payments beyond 3 lacs is an excellent idea.

The political funding cap will reduce the impact of goons in our political syatem and this will have the best results in the near future. On the whole, this is definitely a budget in the TEC mode – India is well on the way to Transform, Energize and Clean.

Tax compliance – most people live in glass houses

This post is going to be politically incorrect and many will view it as a harsh indictment on most people. However, it will also be the complete truth and as usual, I do not care much about public opinion when I am writing these posts. Now that you have been given an early warning and have had a chance to stop reading, let me get on with it.

As all of us know there are only about 4.5 crore people in the country today who file their tax returns. This too is after a great deal of efforts by all relevant authorities, the figure used to be less than 2.5 crores only about 5 years back. Now out of this 4.5 crores there are many who pay no taxes, so the number of tax payers is only about 2.5 crores. Among these also, the number of people paying taxes less than 10000 Rs is significant. Now, it does not take a genius to figure out that there must be tax evasion on a massive scale here. Also, even the people who are paying taxes are probably not fully compliant.

Why do people, who are perfectly well educated and understand the importance of taxes do not take the right attitude of paying taxes. Well, the harsh truth is they want to keep the money themselves due to their wanton greed and crooked nature. However, since they cannot take that stance publicly, due to their own image and the inordinate fear of tax authorities, they will come up with several excuses that sound reasonably clever but are completely flawed in reality. Let us look at some of these :-

  1. Our tax rates are too high, cannot afford to pay so much. Yes, this used to be true decades back but the current rates are quite reasonable.
  2. Tax laws are too complex, do not want to get into it. Truth is that arriving at your taxable income and taxes is fairly simple and you have a slew of professionals who can help you with it.
  3. Taxes paid by me will not be used properly. This may or may not be true, but it cannot be a justification for not paying taxes.
  4. Chances of getting caught are not high. People giving this logic are of course admitting that they want to stay crooked as they probably will escape.
  5. Even after paying taxes I will be harassed by the tax authorities. Truth is only 1 % returns get taken up for scrutiny and that too if there are some red flags in them.

So who are the people who practice tax evasion on a massive scale? Almost all sections of society and some of the notable ones are as follows:-

  • Professionals like Doctors, Lawyers, Consultants, Architects who insist on getting paid by cash, maintain 2 sets of books and seriously under-report their income while seemingly being tax compliant citizens.
  • Small businesses which deal almost entirely in cash, have very little records and almost pay minimal taxes or no taxes.
  • Individual vendors like a Chaat wala or a Fish seller who are of course not in the tax ambit at all. Now, I have my full sympathy for their plight in life, which is tough to say the least, but as far as taxable income goes they need to file returns if their income crosses the threshold of 2.5 lacs in a year.
  • Small companies and big corporate who have stretched the tax laws to the limit, often quite creatively, to ensure their employees can avoid taxes as much as they can.
  • Individuals who rarely report the right income in terms of House property and other financial assets.

What about the people who do pay taxes more or less correctly? Well, firstly their numbers are really pretty limited, most of them are salaried people who can limit the TDS but cannot really avoid it. However, even here there are serious mistakes or malpractices that are common. Let me state a few of them :-

  • Many people getting rent from a house owned by them so not declare it properly. Some under-report it, some believe that for one house the rent does not need to be declared, some show the house as self occupied etc. The rule is very clear, any income you earn must first be reported, exemptions can be looked at later.
  • This is more tricky, but the law is that if you have 2 houses you need to declare some deemed rent for the second house and add it to your income. It does seem frightfully silly but if it is the law then it has to be followed.
  • Most people do not declare income from their Debt instruments such as POMIS etc where there is no TDS provision. The logic again is that it will be difficult for the tax authorities to find out !!
  • For FD where there is TDS, very few people declare the total interest income and pay the taxes beyond the statutory deduction of 10 %.
  • As far as LTC and Medical bills go the malpractices are quite legendary and most readers will be familiar with them.
  • Capital gains earned are often not reported at all or reported wrongly.
  • Savings bank interest are now exempt till 10000 Rs but all such interest earning must be declared and applicable taxes paid on the amount exceeding 10000 Rs.

Are you seeing anything here that you can identify with? If so, I would seriously suggest that you correct this when you are filing your returns next year. Do not listen to people telling you as to how you can avoid taxes, they are crooks of the first order. You should pay taxes properly because it is the right thing to do, not because you can get caught. In any case, with the IT enabling of records, it will become increasingly difficult not to be tax compliant, so you might as well make a virtue out of a necessity.

Not paying taxes due is a sure shot indicator of being a bad citizen. You can pay your dues and then question the government as to how it is using the taxes. They are accountable to you, just as you are accountable to the tax authorities.

Currency ban objections – too clever by half

So we are now coming down to the nub of the issue. A lot of political parties are trying to get together, no doubt supported by their patrons who have a huge vested interest in this. They have been coming out with a lot of ingenuous arguments as to why the move to ban the currency notes was a bad idea, even demanding for the roll back of the measure, as is their wont. In the last post, I received several comments and responded to a few. I think it will be easier to respond to the comments and other objections all in one place.

  • The fake currency being used for terror and other activities is “only” to the extent of 400 crores so it can be tackled through other means.
    • Are you not able to comprehend the damage that can be wrought to our country with that kind of cash?
    • The figure may or may not be right but, even if it is, what is there to stop people who have counterfeiting machines to simply print more?
    • Most people are unable to see the impact of the existing notes becoming inoperative. Think of all the terror operations being stymied as the system is suddenly dried up of the lubricant it thrives on.
    • It may not be a coincidence then that the news of terrorist operations from the Kashmir valley have really come down in the last week.
  • What is the point of banning 1000 Re note and introducing 2000 Re note?
    • You have not understood the purpose of the scheme at all if you are asking this.
    • The idea is to clean up the unaccounted money supply in the system. People who are having it will either have to use it ( no time to do that ) or deposit it in the bank, where it can now be tracked.
    • The 2000 Re note is a logical step as it is mighty inconvenient to deal with smaller denominations, given the inflation we have had in recent years.
    • Yes there is a possibility of new black money schemes ( people are crooked and clever after all ) but it will have to be from scratch now and in one fell swoop, years of accumulated black money has been dealt a body blow.
    • Similarly the 2000 Re note can also be subjected to counterfeiting but all that will take time and the authorities will be way more prepared now.
  • BJP has done it only because state assembly elections are coming up.
    • I am happy to see that political parties are at least accepting the link between elections and black money.
    • Is the argument that we allow black money to continue playing a role in the Indian elections?
    • Are the opposition parties scared that without the power of black money behind them, they have little or no chances in the upcoming assembly elections?
  • The scheme will not earn much taxes etc as people will not declare black money.
    • Once again this is not the purpose of the scheme. Whether the people declare it or not, the cash will be taken out of the system.
    • People were given a chance to come clean through IDS, those who have made a conscious choice not to do so deserve no more leniency.
    • After the deposits are done the IT authorities will definitely take up the suspicious cases. I foresee a lot of taxes being collected through this.
  • Common people are being harassed.
    • The implementation has had several bottlenecks and money supply through ATM and banks should have been handled better.
    • However, for most poor people an exchange of 4000 Rs is adequate as is the withdrawal limit of 2500 Rs per day now.
    • People getting inconvenienced in weddings and functions for lack of cash, can really start paying through checks and direct transfers.
    • The reason for using cash is not really that people only take cash – it is because people with black money want to keep their transactions out of the system by not having any recorded financial transactions.
  • There is very little black money in the system so this will have little impact.
    • Look at pictures of money in sacks and drains, 44 lacs being anonymously being donated to temples, 10 lacs of air tickets being bought etc.
    • Money laundering is the most searched term in Quora in the last week.
    • In a Bengal village an impoverished old lady has deposited more than a crore in her account which had no money earlier.
    • Make no mistake, the people who are intended to be hit by this are suffering greatly. They will do everything possible to thwart the move but the game has changed for them.
  • Many businesses and the stock markets will be affected adversely.
    • I think this may well be true in the short run but does it matter really? Are you going to support black money just so that your investments do not take a temporary hit?
    • Over time, businesses in India such as Real Estate which have for all skewed due to presence of black money will clean itself up and do well in a legitimate way.
    • Respect for India will increase due to this bold measure and that will ensure that our businesses and markets do well in the medium and long term.
  • India depends on cash, cashless transactions will not work here.
    • Again, in case you have not understood this scheme is not talking about cash less transactions at all. 
    • You may need to rethink – same was said about mobile phones a decade back and look at where we are.
    • Once smartphones are available with the right kind of pricing for data plans we will see a surge in cashless transactions. It will happen faster than we can imagine today.

I am sure there are many others but I suppose the point is made. This is a great step for India, many other mechanisms are needed to eradicate black money completely. Do not fall into the trap of wily politicians who are today really cornered about their ill gotten wealth as well as their situation in being unable to influence elections through cash and liquor as they have done in the past.

If we fall for their shenanigans then the fault is really with us.

My take on the high denomination note ban

There are few things in Indian governance and administration that come as a complete surprise and the banning of the high denomination notes was definitely one of the rare examples. Irrespective of which end of the political spectrum we support and whether we agree with the merits of the move, it will have to be said that the speech by the PM on 8th November took the whole nation by storm. The impact has been such that most people affected by it have been shell shocked and ended up behaving rather irrationally.

How do I see it? Well, I personally think it is a great move. Consider the facts – only 3 % of the Indian population pay any kind of income tax. Even out of this meager number, the majority pay taxes of less than 1 lac every year. Any logical person should be able to see that this is an absurd situation. In reality, only the people who are absolutely unable to evade paying taxes, namely the salaried class end up paying it and almost everyone else avoid it to some extent or the other. The amount of undeclared income in the system is not only creating huge fiscal losses to the exchequer but also resulted in a parallel cash economy where almost 25 % of our GDP is unrecorded.

The first thing to understand clearly is that we are talking about undisclosed income by cash dealing, not about whether one can take cash or spend in it. For example, if a Doctor takes cash from his patients in a rural area and then declares it as his income and pays taxes on it, there is absolutely no problem. However, we all know that most people who receive large amounts of cash either do not report it at all or under-report it to a large extent. If the number of people living in the urban centers were really earning less than the permissible tax exempt income then the living standards we see around us in these places would be significantly lower. Elections and political parties almost exclusively deal in cash and all parties are guilty of this.

The second thing to understand here are the ills of the system :-

  • The obvious one is less money available to the government for carrying out a lot of development work that the country is badly in need of.
  • Such income streams are clearly inflationary as there is too much unaccounted money in the system chasing too few goods that are available.
  • The real estate sector prices have reached astronomical levels and a big contributing factor has been unaccounted and undeclared money availability with buyers.
  • Even people who are honest about paying taxes are also guilty of one or many of the following practices:
    • Paying for services in cash with the hope of a cheaper rate.
    • Not reporting interest income in their annual returns.
    • Not showing rental income partly or fully.
    • Not reporting capital gains in the right fashion.

The third is to understand that our society is already unequal in terms of income and spending ability and this has only accentuated it over the years. The vulgar display of wealth in weddings, the bribes demanded for almost getting anything done and the compromise of the moral fiber resulting in widespread corruption can all be traced back to the dealings in cash. If unaccounted cash was not an acceptable option, all this will not go away completely but there will definitely be a great reduction to the perverse extent we are facing today in such situations.

I went around a bit and checked with a few people I know, in real life and through the blog to see why there is so much panic in the system. Here are some real life examples :-

  • An Uber driver earning 50,000 on an average per month – never paid taxes.
  • A local milk booth earning more than 1 lac per month in profits – never paid taxes.
  • A Doctor who had more than 15 lacs in unaccounted cash. When I asked him why he had not taken advantage of IDS, he told me he was saving it for buying an apartment.
  • A CA friend who has been inundated with offers of sharing black money if he could help in conversion to white.
  • Some friends of my son, whose fathers are in business, were worried as soon as the speech was made. Clearly shows their awareness about how much cash is at home !!

As they say, the road to hell is paved with good intentions and, despite the good intent, the implementation could have been much better managed. The non-availability of the new 500 Rupee note has been the greatest dampener as the ATM money is getting over soon and replenishing it takes too long. Also, the verification could have been just on the basis of Adhaar card, both for deposits and withdrawal. The general public has been put into serious inconvenience and the poor with little experience with banking system have been really the worst affected.

However, with the release of the new 500 Rupee note and the initial rush being over the situation will now become a lot better. I think in another couple of weeks, things will be back to normal. The impact of the aftermath would have been several times worth the inconvenience that many of us have gone through.

So what are the likely impacts of this move? Let me address that in the next post.

Tax free bonds merit serious consideration

I had written this post on Should you invest in NTPC Tax free bonds at the time the issue came out. As all of you know the NTPC issue as well as the earlier PFC one had been oversubscribed greatly. There are, of course, several other Tax free bonds in the offing, the largest of these will probably be the NHPC one. In the lower interest rate regime unfolding before us, will it be a good idea to revisit investing in these bonds?

Before getting into the 2015 series, let us look at a little history on what happened the last time these bonds were issued. In 2013 there was a slew of such issues and the interest rates then were around 8.8 % for retail investors buying the 15 year tenure bonds. As I have written in other posts, I subscribed a reasonable amount in these bonds, mainly because I wanted a source of passive income as the plan was to give up my regular job by 2014 end. Now, the three main objections that people had against these bonds were as follows – interest rates can increase and you’ll be stuck at 8.8 %, these bonds have no real liquidity and after 15 years the principal will hardly have any value.

Now that the bonds are about 2 years old, let us see whether these objections were relevant or not. The interest rates are going down and even the best rates available for FD today in in the range of 7.5 %, which is of course taxable. What about liquidity? Contrary to what most people thought, these bonds are actually selling in the secondary market at a price appreciation of 10-20 % in 2 years. What is more, you only have to pay 10 % tax on your capital gains if you sell these after one year. As far as the value of principal after maturity goes, that will be true of any debt instrument. So, as far as I am concerned, I feel quite justified in having made the investments in 2013.

Let us now come back to the point whether you should be investing in these as part of your debt portfolio. I have reproduced below a chart from the Economic Times that compares the various options in this space.

Why forthcoming tax-free bonds may be a good bet

You will see from here that these bonds score highly against most other options. Yes, if you are able to invest in actively managed debt funds and track your investments here closely, you may get higher returns as compared to tax free bonds of today. However, keep in mind that with inflation coming down, the cost inflation index will also slow down and this will mean a higher LTCG to be paid when you redeem these debt funds.

I am a strong believer that we have entered into an era of lower interest rates and instead of the earlier mean of around 9 % we will probably settle down at the present 7.5 % or so. In fact, over the next year or so, I will not be surprised if the interest rates actually reduce to 6.5 % or so. In such a scenario it does make sense to lock in the rates at these levels.

Obviously, not everyone should invest in these bonds. Young people who are into building their equity portfolio, should ideally have only PF and PPF as their debt component in their portfolios. However, people looking to set up a passive income, people in retirement, people whose portfolios are laden with tax-inefficient FD must look at these bonds as a good option for investment.

I am perfectly happy with the earlier edition of these bonds and I am sure a lot of you will be thinking the same after 2 years if you invest in this edition. Obviously, a lot of people already think so and this is demonstrated in the investor response to both the PFC and NTPC bonds.

A layman’s guide to capital gains and indexation

It has recently come to my notice that capital gains and indexation are two aspects of personal finance that many investors do not have a clear idea about. I was speaking to one of my friends the other day and he told me that he leaves such things for his CA to worry about. While, you can obviously take help of a CA to decide on how to deal with your taxes, it is important for every investor to understand these, especially in the context of debt instruments.

Let me start with capital gains first. We buy assets, physical or financial at a given price. For example the apartment that I bought in Chennai, cost me about 35 lacs in 2003. You may be doing a monthly SIP of 10,000 Rs in one MF scheme regularly. When we sell the asset at a later date at a higher price, the gain made out of such a transaction is termed as the Capital gain. In other words, Capital gain is the difference between the sale price and the acquisition price. Of course, if you are selling your asset at a lower price then there would be a capital loss. This is normally relevant for depreciating assets such as a car, which will fetch a lower value normally when you sell it after a few years.

Capital gains are part of our income and hence they need to be taxed. For the purpose of taxation these are classified as Short term or Long term. Depending on the asset, if you sell it within a defined time period the Capital gain is categorized as short term. Anything beyond this period will be treated as Long term capital gains. This distinction is very important from a taxation perspective. For example in the asset class equity, if the sale of the asset is within one year of acquiring it then it will fall under STCG. This will then be taxed at a rate of 15 %. So if I buy 500 shares of TCS at 2000 Rs and sell them within 6 months at 3000 Rs, my STCG will be 5 lacs and I will need to pay a tax of 75000 Rs in the year of sale. 

Now for equities the Long term capital gain is applicable after one year and LTCG is currently not taxed. So in the same example as above if my holding period of the 500 TCS shares was more than one year, my LTCG will be 5 lacs but I will not be paying any taxes on it. This is true for any equity based asset such as Equity MF or a Balanced MF where the equity holding is more than 65 %.

It would be nice if LTCG for other assets were like equity but it is unfortunately not so. For Real estate and Debt instruments the LTCG applies only after 3 years. So if you invest in a debt MF today and redeem it in less than 3 years, the gain you make will be STCG and get added to your income. Also, unlike Equity the LTCG is not exempt from tax. However, recognizing the fact that inflation will have an impact on dampening the gain, a concept of indexation is used to calculate LTCG. The way this works is explained below:-

  • Cost Inflation Index of the year 1981-1982 is taken as 100. Based on inflation from that point the index is revised every year. The current index for 2015-16 is announced at 1081.
  • What this really means is an asset bought in 1981 needs to be indexed at around 10.81 times, in order to counter the effect of inflation, the asset cost in 1981 needs to be multiplied by 10.81 to get a fair value of cost in 2015.
  • The LTCG can now be calculated with this indexed acquisition cost figure.
  • For example I purchased my flat in Chennai for 35 lacs in 2003-2004 when the Cost Inflation Index was 463. If I want to sell it in 2015, when the Cost Inflation Index is 1081, the indexed purchase cost will need to be calculated by using the formula 1081/463 x 35 lacs. So the indexed cost will come out to be 81.7 lacs.
  • So if I sell my flat for 1 crore today, the LTCG will be 18.3 lacs.
  • This then will be taxed at 20 % in the relevant year of sale.

How does indexation help in debt investments and how are things changing on that front? I will try to address this in the next post.