TaxSaving

NHAI Bond Yields

31 comments Written on February 8th, 2012 by
Categories: Bonds, TaxSaving

The recent issue of tax-free bonds – that is, the interest is tax free – by the National Highways Authority of India (NHAI) has listed on the NSE. There are two bonds – a 10 yr at 8.2% and a 15 yr at 8.3%. You can also buy these bonds now, if you have a broker. (The codes are NHAI-N1 and NHAI-N2)

Note: Please read the excellent comments by Anon. The interest rate is a weird beast which I've had to use XIRR to calculate.

Since the interest is paid once a year on Oct 1, every passing day accumulates interest inside the bond, so the price keeps going up. The bonds are Rs. 1000 each, so if the yield remains the same, they will go from Rs. 1000 on Oct 1 all the way to Rs. 1082 (on the 10 yr) on Oct 1 the subsequent year. (Actually it will be till Sep 16, which is the record date, but I'm not going there!). Interest will be paid and the bond price will fall by that amount (Rs. 82 in this case).

Here’s a sheet that shows you updated calculations based on current prices:

I’ve included the yield calculation for the 30% and 20% brackets (I doubt the 10%’ers will care)

The listing has been good, at 1032 / 1041, which is about 3% higher. That’s not great by equity standards , but for bonds it’s a nice deal. Let’s wait for the three others (PFC, IRFC and HUDCO) to list as well.

(Bookmark this page – it will update prices automatically, you can come back next month to check, if you like)

Posted in Bonds, TaxSaving

Direct Tax Code: Book Profits and Buy Back?

11 comments Written on March 3rd, 2010 by
Categories: DirectTaxCode, IncomeTax, Stocks, TaxSaving

With the Budget revealing that the Direct Tax Code will be implemented from April 2011, a few choices have to be made now. The DTC brings in capital gains tax back again – even long term capital gains, which don’t get “preferential” treatment as they have in the last few years. Long term capital gains – where the purchase is over a year ago – is currently NOT taxed, and earlier they were only taxed at 10% max.

From April 1 2011, all capital gains booked will be added to your income and taxed appropriately in your tax slabs. (Upto 1.6 lakhs – no tax, 1.6 to 10 lakhs – 10%, 10-25 lakhs – 20% and above that, 30%).

Then why is capital gains any different from other income? Answer: Long term gains are “indexed” – meaning, the government understands that when you sell an asset, you should consider inflation. If you bought something for Rs. 100 three years ago, and inflation was an average of 6% in the last three years, then the Rs. 100 is actually worth Rs. 118 today – three years of simple 6% inflation. (Note: the actual number will be slightly higher due to compounding effects). So if you were to sell that asset for Rs. 140 today, your gain isn’t Rs. 40 – it’s only Rs. 22; since you are only taxed on gains, it lowers your tax incidence by 50%!

For more details on indexing read: http://blog.investraction.com/2006/12/long-term-capital-gains-ltcg-applies.html.

The wider slabs, too, give you a lower tax payout. Yet, some of us have held stocks for a LONG time. Maybe 5 or more years. The gains are probably huge – some of them above 50%. If we sold them anytime after April 1, 2011, then we’d pay tax on the entire gain! This is of course unacceptable, given there is a cheaper way out.

You can sell all these shares today and buy them right back. Then, the gains will be assumed to be booked today – on which there is a capital gains tax of ZERO. That sorts the past gains. From here onwards, only the gains from the NEW purchase price to whenever-you-sell will count for taxation post April 1, 2011.

Example: In my family we own some shares of Hero Honda bought in the nineties. The effective cost price today, after all their bonuses, is about Rs. 12 per share. The share is at Rs. 1750+. Even if I indexed everything like crazy, my cost price won’t go beyond Rs. 100 per share – we have to pay taxes on about Rs. 1600 per share if we decide to sell after April 1, 2011!

The right thing to do then is to sell shares, get the money and buy them right back, because we want to be invested in Hero Honda. That takes care of the full gain till now – no tax on the 1600 rupees – and if Hero Honda goes to 2000 when we sell, we’ll only pay tax on Rs. 250.

And there’s another thing: if we sell now, before March 31, 2011 and buy shares back, we will get TWO years of indexation; indexing laws work such that each financial year of purchase is counted for indexing, which means a purchase tomorrow and a sale in April 2011 gives me two years of indexing – 2009-10 and 2010-11 – so I can get the advantage of two year’s inflation before my gains are counted.

To put it simply: If I sell now and buy back before March 31, I will save 12% of future gains as well. If Hero Honda went to 1960 and I sold it in April 2011, I will pay ZERO tax. Not bad at all, in a thirteen month scenario.

Another thing to think about: if you want to buy stocks for the long term, buy them before March 31. No matter when you sell them you get an additional year of inflation adjustment and saves you tax.

Downside notes:

  • Selling and buying back involves payment of commissions and STT. That, for me adds up to less than 1% of the entire transaction value  (not just the gains). Considering the huge gains we have, we are better off than the potential tax of 10% on the whole deal. But to you it may be huge if the gains are not quite as much.  For example if you own 100 shares of Reliance at Rs. 800 for two years and it’s at 1000 today; your indexed gain if you sell now is just Rs. 100 per share, assuming 6% inflation. If you’re in the 20% bracket next year that would only result in a tax of Rs. 2,000. But a 1.5% transaction cost on selling and buying back 100 shares (@ Rs. 1000) today will cost you Rs. 3000. So do the calculations carefully before logging on to your broker’s web site.
  • You need a two day break before you can buy again. The T+2 settlement system ensures that if you sell today you only get money after two working days. That means a “buy again” can only happen then. In the meantime the share could fluctuate in value, so there’s a risk.

The sell and buy back makes sense if you have very high gains and don’t want to pay tax on them.

Posted in DirectTaxCode, IncomeTax, Stocks, TaxSaving

Dividend in ELSS Funds Have An Advantage

4 comments Written on February 8th, 2010 by
Categories: MutualFunds, TaxSaving

Is it worth putting money into ELSS funds as they announce a dividend?

HDFC Long Term Advantage Fund just announced a “37.5% dividend”.

image

The real yield is about 10%. (Rs. 3.75 on something that currently costs Rs. 36.545). Ignore the “37.5%” figure – it’s a remnant of an archaic system that has little or no value for anyone investing today.

We all know that dividends are your own money coming back to you. Technically you shouldn’t be bothered, whether you pay in and take it out as a dividend, or leave it in, it’s of no difference.

But with ELSS funds, there is a difference. The invested money is locked for 3 years, and you get a tax advantage on it. If you were offered a dividend, you could get a tax advantage on the entire amount, while still getting a part of it back as dividend! [The money would otherwise be locked for three years]

Example: You have Rs. 50,000 and you buy the above HDFC fund before Jan 11. You get a tax break on the entire 50,000 – worth Rs. 15,000 to you if you’re in the 30% bracket. And in a few days you’ll get back 10% of your money – or Rs. 5,000, as dividend. Effectively, you’ve saved yourself Rs. 15,000 in tax by investing only Rs. 45,000.

(A few years back, Birla Sun Life did a one-time stunt with it’s tax plan, giving back HALF your money. But they did it in a shady way – pre-announcing the dividend months earlier, which is not allowed by SEBI. Read this article for more details.)

Yields of 10% are not uncommon – and 10% is probably the lower end of the spectrum. Last year, HDFC’s other tax saving fund, HDFC Taxsaver, announced Rs. 5 dividend on an NAV of Rs. 34 – a 15% yield. If you’re looking to save tax but would like to not have to invest ALL the money, buy a tax saving fund that gives you a high yield, just after the dividend is announced.

Also read: Should you invest in tax saving mutual funds? and Mutual Fund Commissions on Tax Saving Schemes.

Posted in MutualFunds, TaxSaving

Should you invest in Tax Saving Mutual Funds?

13 comments Written on January 15th, 2010 by
Categories: IncomeTax, MutualFunds, TaxSaving

If you buy a tax saving mutual fund – an ELSS scheme or something with “taxsaver” in it – you expect a tax deduction. But does it always apply for you?

ELSS mutual funds are specially deductible under Section 80C, which applies to everybody. It really means you get a Rs. 100,000 deduction from income (i.e. taxes are calculated after this deduction) – if you spend or invest this 100,000 in some specific areas:

  • Public or Employee Provident Fund contributions
  • the New Pension Scheme contributions
  • National Savings Certificates, 5 year Bank or PostOffice Deposits, NABARD Bonds
  • Insurance premium (Premium < 20% of sum assured)
  • Mutual Funds (ELSS)
  • School fees for two children (includes Pre-school fees, yay!)
  • Principal repayment on a housing loan (or full/down payment on a house)

They all come clubbed in the same 100,000 deduction – meaning if any combination of the above goes above 100,000 – then that’s all you get. First, find out if you’ve already exceeded the 100K deductible. If you have, don’t bother reading ahead.

Since you haven’t yet finished it all up, find out if you’re adequately insured. Hundred of insurance sites have them – for an IE only (no firefox) quick plan, check out this site. Then buy the plain term plan – Religare’s iTerm Plan, sold only online, is the cheapest by a LARGE margin. (I will pay Rs. 21K for a 25 year 1 crore policy, where the average other policy is 33K)

Do not buy ULIPs. They are evil.

If you still have anything left in that 100,000 tax deduction, you might think of ELSS mutual funds. Now you might be in for a surprise with the Direct Tax Code coming into force in 2011.

The DTC moves to an EET regime – Exempt on entry, Exempt on accumulation and Taxed at exit. ELSS is currently EEE – you save tax when you enter, and because of the STT benefit you pay no tax on exit. That will change – after 2011, any exit from an ELSS fund will be treated as “capital gains” and taxed in your tax bracket. If you buy an ELSS fund, the earliest you can exit is 2012-13, by which time the DTC will be active (and yes, it will apply to your old investments as well, unless they change the current draft)

The DTC even charges the withdrawal on the principal (not just the gain) – but it’s currently hazy about whether it will apply to past investments. Dhirendra Kumar at Value Research thinks that it will not apply to past investments and the draft code will be changed. Still, there’s a risk this works against you.

If you really need most of the money back in three years, buy a PPF/EPF instead – at least that has no tax on principal & interest till March 2011.

But the ELSS fund investment is a long term one and in all likelihood you can retain it for several years, only taking out what you might need. Even with tax, the gains from equity may be substantial, and high enough to outperform the PPF/EPF rates (the NPS has done 14 and 11% in the last two years; most ELSS schemes are just about where they were two years back)

With the higher mutual fund commissions too, their future returns are suspect. But I’d say this – it’s probably a better bet to go with a good tax saving fund and keep the money in there till you retire. It’s a good long term saving system with enough liquidity that you can take it out anytime after three years, but won’t because it’ll get taxed. And if you don’t need the money, then please use the NPS – the ultra low management fees juice up the returns substantially.

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Posted in IncomeTax, MutualFunds, TaxSaving

Be careful of investing in ELSS schemes

5 comments Written on December 2nd, 2008 by
Categories: MutualFunds, TaxSaving
I have just received a message that Mahindra Finsmart is offering higher commissions to get investment in four ELSS (Taxsaver) funds:
  • Kotak Tax Saver (5%)
  • ICICI Prudential Tax Plan (4.5%)
  • HDFC Long term Advantage Fund (3.5%)
  • Birla Tax Relief 96 (3.5%)
Now I don't know how this is being paid - most schemes pay only 2.25% as "brokerage" to the agents, out of the entry load. But if larger amounts are being paid, then these schemes will end up paying these commissions out of investors' funds (where else). It may be done slowly and over years - after all, you can't withdraw your funds for three years - and will impact returns.

Be careful when putting your money in - I would essentially avoid all ELSS mutual funds for the time being - a PPF or NSCs are probably better bets.

I wish there was a no-load ELSS fund that simply invested in the Nifty, using futures, and put the rest of the money into liquid cash or call markets. This requires no brains - therefore very little management fees. Definitely needs some marketing muscle, though. And this is an industry that survives on commissions, so I doubt it will accede.

Posted in MutualFunds, TaxSaving

Reader Comment: Are Bonus Shares Still Feasible?

3 comments Written on February 6th, 2008 by
Categories: Stocks, TaxSaving
New comment on a Bonus Shares Post, by an anonymous reader:
1. I understand that (at least until recently) it has been very common for Indian companies to issue bonus shares. Companies in India seem more inclined to issue bonus shares than companies in other countries. I understand that this is because, historically, Indian shareholders have obtained very favourable tax treatment in respect of bonus shares issued by Indian companies. However, I see that you have posted a note saying that "It Used to be legal, now it has been plugged. The following article is only useful for historical notes, and is no longer applicable - Deepak, 2007." My question is: Now that the tax benefit has been "plugged", will Indian companies be less inclined to issue bonus shares than they have been in the past? Or, is it the case that there other good reasons for issuing bonus shares which mean that Indian companies are likely to continue issuing bonus shares as often as they have in the past?
Bonus issues have also been favoured for the impression they give: that they are a "bonus", a free incentive. This is not true anymore as the share price goes down by the bonus ratio, but sentiment still indicates that people expect the share price to come back to the original price at some point!

Bonus shares are one way to reduce share price without splitting the share. So for a company whose face value is small - say Rs. 1 - they can't split any further, meaning if they want to keep the share price small enough for retailers to be interested, a bonus would work well. Remember that bonuses only work when the company has huge free reserves, but that's not really a problem for a well established company trading in the 1000s of rupees per share.

2. When Indian companies issue bonus shares, do they usually issue bonus shares "at par value", or instead, do they usually issue bonus shares "at a premium"? Also, does the recent "tax plug" referred to above, affect what is likely to happen in this regard in the future?
Bonuses are usually issued at zero cost, but the face value is the same as any other share. The reason they are considered a "bonus" is that the company capitalises it's free resources, so it doesn't expect you to pay even the face value. You can't have different par values (face values) for shares of the same company. So in this regard there will be no change.

There's something else called "rights" issues, which are usually at a premium but a discount to current market price. Entirely separate discussion and I will post more details on this later.

Posted in Stocks, TaxSaving

How can FMPs save you tax?

10 comments Written on April 10th, 2007 by
Categories: Debt, FD, IncomeTax, MutualFunds, TaxSaving
FMPs, or Fixed Maturity Plans are quite in vogue nowadays - and they all tell you they're going to save you a lot more tax than bank fixed deposits (FDs). How?

Debt funds are simply those that invest in debt securities - like Govt securities, corporate bonds, corporate rated deposits etc. Fixed Maturity Plans (FMPs) are debt funds that have a fixed term - usually 3 to 6 months, and are closed ended, meaning you can only buy in an NFO, not after that.

Many govt securities are 16-20 years to maturity, and to avoid liquidity issues, these and most others are traded in the debt market.

Debt funds are affected by interest rate risk - when the interest rate goes up, the prices of their current securities go down. After all why would you buy an 8% bond for the same value if you have a 9% bond available. So NAVs can flutter around.

FMP Returns are not guaranteed, but usually indicative returns are reached. Why? Because they buy products at the same maturity level, and hold till maturity. So an FMP now may say indicative returns are 9.5% for a 370 day period, which involves them buying securities yielding 10.5% for the period, and holding till maturity. They charge you about 1% as management fees, so the return to you is 9.5%, pre tax.

(If you're thinking - heck, forget them, I'll invest in the instruments myself, banish the thought. The minimum investment can be in lakhs and crores, and some are only available to corporates.)

Even if the interest rate goes up or down it doesn't change the yield for them (since they don't sell or buy the security). How do they give you lesser tax? Two ways.

1. Double indexation. The gains you make are indexed over two years (typical indexation rates are 5% a year) so that you make no gains according to the tax authorities. That involves buying, say, in March of one year and maturing in April of the next year. (Read about indexation)

That gives you two financial years (since years are April-March) of holding, whihc means a typical indexation of 10%+ - so you make 10% or so on interest, and the goverment thinks you made nothing because of two years of inflation, so you pay no (or very little) tax. See for yourself.

2. Lower tax rate: All longer term debt fund dividends are taxed at (about) 19% versus FD interest being at your marginal rate (say 30%). Note: short term debt that involves money market and call money is charged higher dividend rates. Also, capital gains for debt funds held over a year is only 10% (without indexation) or 20% without.

Both these are significantly less taxing than FDs, where the interest is added to your income and taxed at your marginal rate.

What's wrong with FMPs? Well, the interest rate is not fixed. You never know how much you'll eventually get. Second, there is usually some penalty for early liquidation (before maturity) that can actually erode your capital. If they put a 0.25% early exit load, and you want to exit in say a month, the NAV may not have moved enough to cover the exit load itself, so your capital also goes! This doesn't happen with FDs.

Lastly, long term FMPs are not available anytime you want them. Most FMPs open in the Jan-March time frame for the double indexation benefit. In fact March is like FMP paradise. But come April and the drought begins, which makes no sense for someone who has just got some cash in April.

Also read: Rediff's FAQ about FMPs.

Posted in Debt, FD, IncomeTax, MutualFunds, TaxSaving

Can I really save Rs. 33,660 in tax?

4 comments Written on January 21st, 2007 by
Categories: Commentary, IncomeTax, MutualFunds, TaxSaving
Mutual funds advertise that you can save upto Rs. 33,660/- per year if you invest in ELSS mutual fund schemes. Does this always apply to you? The short answer is : NO.

Let me tell you when you will save Rs. 33,660.

Let me assume your income is Rs. 15,00,000. (Fifteen lakhs) per year.

If you didn't do ANY 80 C investments, here is how your tax is calculated.

First Rs. 135,000 : no tax
Next Rs. 15,000: 10% tax = Rs. 1500.
Next Rs. 100,000: 20% tax = Rs. 20,000.
Remaining Rs. 12,50,000= 30% tax = Rs. 375,000.
Total: Rs. 396,500.

Since your income is above Rs. 10 lakhs a year, you have a 10% surcharge on tax = Rs. 39,650.

Tax then = 396,500 + 39,650 = 436,150
Add 2% surcharge and you get a payable tax of Rs. 444,873.

If you put in Rs. 100,000 in ELSS funds or other 80c instrucments, net taxable income becomes Rs. 14 lakhs. Tax calc is:

First Rs. 135,000 : no tax
Next Rs. 15,000: 10% tax = Rs. 1500.
Next Rs. 100,000: 20% tax = Rs. 20,000.
Remaining Rs. 11,50,000= 30% tax = Rs. 345,000.
Total: Rs. 366,500.
Add 10% surcharge and 2% cess to get a payable tax of Rs. 411,213.

The difference between the two options is Rs. 33,660. This is only if your income is greater than 10 lakhs in the financial year. (The actual figure you need to be above is Rs. 11 lakhs, since after you invest 1 lakh in 80C instruments, you will have a net taxable income of Rs. 10 lakhs)

So how much can I really save?
Your income may be different, so the rule of thumb is: If your total income is greater than 10 lakhs, you can save upto Rs. 33,660 in tax.

For incomes above Rs. 3.5 lakhs but less than 10 lakhs the maximum tax that can be saved is Rs. 30,600. The funda there is - Rs. 3.5 lakhs minus Rs. 100,000 in ELSS (or 80C instruments) yields a net taxable income of 2.5 lakhs, which is the limit on that tax slab.

And below 3.5 lakhs and upto Rs. 2 lakhs (2.35 for women) you can save between 30,600 and 15,300 (depending on how much your income is).

If your income is below Rs. 2 lakhs (2.35 for women) you will save lesser than 15,300 (again, depending on your income). In fact in this bracket, you should not invest Rs. 1 lakh in ELSS, only that much required to bring your tax to zero.

Posted in Commentary, IncomeTax, MutualFunds, TaxSaving