“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” — Robert G. Allen
Given that the return on savings bank deposits is currently so low, it would be foolish to leave one’s savings sit in a savings bank account.
The more conventional personal investment alternatives are shares/securities, real estate properties and funds. Personal Investments Decisions are primarily guided by important factors such as rate of return, risk appetite of the investor & time frame of the investments. In addition, one more crucial parameter influencing the personal investment decisions is the Taxation aspect.
In the investment portfolios, it is the “effective rate of return” rather than the “rate of return simplicitor” which should be the guiding investment criteria. The effective rate of return is the post income tax return on investments after taking into account any tax savings.
For instance, consider two investment portfolios, “Portfolio A”, consisting of Normal Fixed Deposit (FD) carrying a rate of return of 7% and “Portfolio B”, consisting of a Tax-Saver FD u/s 80C carrying a lower rate of return of 6%, both will time span of 5 years, considering the stipulated lock in period of 5 years of Tax-Saver FD u/s 80C. Although the rate of return appears to be higher in Portfolio A, however, the “effective return”, in both the portfolios, will be as under:
|PARTICULARS||“A” : NORMAL FD||“B”: TAX SAVER FD u/s 80C|
|Investment Amount in INR||1,50,000||1,50,000|
|Rate of Return||7% p.a.
|Returns in Absolute Terms in INR after 5 years
Investment*(1+Rate of Return)^5
|Income Tax Outflow assuming Investor’s Tax
Bracket of 30% *
|Post Income Tax Returns||1,47,268||1,40,514|
|Income Tax Savings Impact**||NIL**||45,000**|
|Total Returns including Tax Saving Impact||1,47,268||1,85,514|
* For simplicity sake tax has been calculated at 30% flat rate ignoring surcharge & education cess.
** Investment in tax Saver FD u/s 80C is eligible for deduction upto Rs. 1,50,000 from the Gross Taxable Income. At the 30% tax bracket, the tax savings impact will come to Rs. 45,000/- (30% of Rs. 1,50,000).
Therefore, the aforesaid example clearly explains that on the basis of rate of return simplicitor, the investor may opt for portfolio A, whereas, a further probe into the effective rate of return criteria, will definitely alter the investment decision of the investor to opt for portfolio B.
The other popular investments options which are eligible for deduction u/s 80C of the Income Tax Act are investments in Public Provident Fund (PPF), Mutual Funds Equity Linked Savings Scheme (ELSS) & Post Office Savings Schemes. The investors may choose any of these based on their individual preferences.
Among several other amendments, the most vital amendment having a direct bearing on personal investment decisions, as brought about by the Finance Bill 2018, is the withdrawal of existing exemption u/s 10(38) of the Income Tax Act, in the case of Long Term Capital Gains (LTCG) arising from the transfer of long term equity shares or units (holding period of 1 or more year), on a recognized stock exchange, and to tax such LTCG, exceeding One Lakh Rupees @ 10%, w.e.f. 1.4.2018.
However, as per the Grandfathering Provisions, The cost of acquisition for the long-term capital asset acquired on or before 31st of January, 2018 will be the actual cost.
However, if the actual cost is less than the fair market value of such asset as on 31st of January, 2018, the fair market value will be deemed to be the cost of acquisition.
Further, if the full value of consideration on transfer is less than the fair market value, then such full value of consideration or the actual cost, whichever is higher, will be deemed to be the cost of acquisition.
In case of a listed equity share or unit, the fair market value means the highest price of such share or unit quoted on a recognized stock exchange on 31st of January, 2018.
However, if there is no trading on 31st January, 2018, the fair market value will be the highest price quoted on a date immediately preceding 31st of January, 2018, on which it has been traded.
In the case of unlisted unit, the net asset value of such unit on 31st of January, 2018 will be the fair market value.
One of the most popular investment options now a days, i.e. Mutual Funds, work on the prudent investment policy of “Don’t put all your eggs in one basket” i.e Diversification. Mutual Funds can be Equity Oriented Mutual Funds (having 65% or more of their corpus investments in equity or equity linked instruments) or Debt Oriented Mutual Funds (having less than 65% of their corpus investments in equity or equity linked instruments).
|Type of Mutual Fund Scheme||Short Term Capital Gains (STCG) Tax Rate||Long Term Capital Gains (LTCG Tax Rate)|
STCG- Units held for less than 1 year
LTCG- Units held for 1 or more than 1 year
|15%||10% (without indexation benefit on LTCG exceeding 1 lakhs)|
STCG- Units held for less than 3 years
LTCG- Units held for 3 or more than 3 years
|As per individuals’ tax bracket||20% (with indexation)|
The Finance Act 2017 had inserted a new clause (x) in sub-section (2) of section 56 so as to provide that where any person receives/invests in immovable property:
Likewise, where any person invests in/receives any property other than immovable property (shares/securities etc.) –
Fair Market Value (FMV) of Listed/Quotes Shares & Securities is the quoted price in the recognized stock exchange.
FMV of unquoted equity shares = (A+B+C+D-L) x PV/PE, where
A – Book value of all the assets (except those mentioned at B, C and D below) as reduced by income tax paid (net of refund) and unamortised deferred expenditure
B – Fair market value of jewellery and artistic work based on the valuation report of a registered valuer
C – Fair market value of shares or securities as determined according Rule 11UA of Income Tax Rules.
D – Stamp duty valuation in respect of any immovable property
L – Book value of liabilities, excluding paid up equity share capital, amount set apart for undeclared dividend, reserves and surplus, provision for tax, provisions for unascertained liabilities and contingent liabilities
PV – Paid up value of equity shares
PE – Total amount of paid up equity share capital as shown in the balance sheet.
Dividend stripping is an attempt to reduce the tax liability, by an investor, who invests in securities (i.e. shares, stock or debentures etc.) and units (Mutual fund units or units of UTI), shortly before the record date and getting a tax free dividend/income, and exiting after the record date at a price lower than the price at which, such securities/units were purchased and incurring a short-term capital loss. The strategy behind dividend stripping is a two way strategy wherein- Investor gets tax free dividend (i.e. exempted u/s 10(34)/10(35)) Incurs Short term capital loss (i.e. allowed to be set off and carry forward). Record date is the Date fixed by a company or mutual funds for the purpose of entitlement of holders of securities or units, to receive dividend or other income.
In order to curb the aforesaid malpractice, provisions of Section 94(7) had been inserted.
Conditions to be satisfied to attract the provisions of section 94(7):
|Buying or Acquiring||Within a period of 3 months prior to the Record Date||Within a period of 3 months prior to the Record Date|
|Selling or Transferring||Within a period of 3 months after the Record Date||Within a period of 9 months after the Record Date|
|Dividend or Income during the intervening period||Exempt||Exempt|
If all the above mentioned conditions are met, then the short term capital loss, if any, arising to the investor on purchase and sale of such securities or units, not exceeding the amount of dividend or income received/receivable on such securities or units, shall not be considered while computing the total income chargeable to tax. Even, u/s 94(7) the short term capital loss arising, shall not be allowed to be set-off or carried forward, to the extent of dividend or income received.
Section 94(8) of the Income Tax Act – 1961, contains the provisions related to the Bonus stripping. Bonus stripping provides, that the loss, if any, arising to an investor on account of purchase and sale of Original units shall be ignored for the purpose of computing his total income chargeable to tax, subject to the following conditions:
Conditions to be satisfied to attract the provisions of section 94(8):
|Conditions||Units (Not applicable on Shares)|
|Buying or Acquiring of Original Units||Within a period of 3 months prior to the Record Date|
|Allotment of Additional Units||Without any payment on such Record Date|
|Selling or transferring of Original Units||Within 9 months after the Record date|
|Holding atleast one Bonus Unit||On the Date of such sale or transfer of original units|
If all the above conditions are met, then as per provisions of section 94(8) of the Income Tax Act, the loss arising on account of such sale or transfer of the original units shall be ignored for the purposes of computation of taxable income, and the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such bonus units.
In Personal Investments Decisions, among other determining factors like nature & type of investments, rate of return, risk profile & appetite of the investor, time frame of investments etc., the impact of applicability of the relevant provisions of the Direct Taxes on such personal investment decisions, is also a significant and crucial consideration, which can’t be ignored and possessing the requisite knowledge about the same is a sine quo non, for an effective, prudent & lucrative personal investment decision.
Summing up with a well known investment quote of the renowned author, investment strategist & a philosopher, Benjamin Franklin,
“An investment in knowledge pays the best interest.”