Arbitrage Funds

Arbitrage is a term used to describe the purchase of a product which is then immediately sold to make a profit. Arbitrage is popular in the stock market or as a means to make profit from goods being sold at differing prices in varying markets.

Let’s take an example of arbitrage. Suppose a tailor sells a shirt for Rs. 400/- the cost for him is Rs. 300/- He makes a profit of Rs. 100. One day when he at the cloth manufacturer, he meets another tailor who also makes shirts and sells. The cloth and accessories are the same, his fitting is also more or less similar, but he sells his shirts for Rs.250/- So our tailor to increase his profits, buys from the other tailor at Rs. 250/- and sells for Rs. 400, increasing his profit to Rs. 150/- per shirt. This is arbitrage, basically taking advantage of the price difference in the other market for the same product.

The above type of arbitrage is available in the financial markets as well. In the financial markets there are 2 types of markets, one is cash and the other is derivative. There is always a price difference in both these markets. So if one buys in the cash market and sells in the derivatives market it will be called an arbitrage trade.

Now if it was so easy everyone would have been doing it. But here is the catch. In the cash market you can buy today and sell tomorrow. But in the derivatives market it is a contract which is valid for a fixed period. One just pays a premium initially and at the end of the contract period, s/he has to settle it by paying the difference between the then prevailing price and the contract price. So if your bet goes wrong, you could lose big. But since you have done the opposite in the cash market, the loss will be minimal.

Arbitrage funds returns are very similar to debt fund or fixed deposits, but this product is treated as an equity product. The reason is tax.

Therefore it is very important that you know about the tax treatment and investment options before making any investment decisions.

For income tax purpose, as mentioned above arbitrage mutual funds are classified as Equity oriented funds.

·         Long Term Capital Gains on Arbitrage Fund

      o   If you make a gain / profit on your investment in an Arbitrage Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.

      o   The long term capital gains on Equity oriented funds will be taxed at 10% if the total Long Term Capital gains is more than Rs. 1 Lakh in a year. It is tax free till March 31, 2018.

·         Short Term Capital Gains

   o   If your holdings of an Arbitrage Equity mutual fund scheme are less than 1 year old i.e. if you withdraw your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.

      o   The capital gain tax rate of 15% is applicable on Short Term Capital Gains of Arbitrage Fund.

   o   Kindly note that interest income on Fixed Deposits will be charged at as per your income tax slab rate.

   o   The Short term Capital gains on Debt mutual funds too are taxed at as per your income tax slab rate if the holding period is less than 3 years.

So, as per the current tax laws, the Arbitrage Funds have clear tax advantage over Fixed Deposits or Debt Mutual Funds.

 

 

Transfer and invest funds legally

Many persons who have not filed returns are getting intimations from Income Tax department. The main reason is to identify and find out if the amount invested by that person has escaped tax. Many of them transfer money to senior citizens to gain the extra percentage in bank fixed deposits. Why do all that and put the senior citizen through all the pain and pressure in their old age because of income tax intimations, when there are easier ways to save tax and better ways to increase your tax free income. Here are some options

• Whenever you transfer amounts to your relatives invest in tax free investments, first benefit is amounts transferred to relatives is free of gift tax and the second would be that since it is invested in tax free investments the income would be tax free. The income received can be reinvested anywhere after that and would not be clubbed with the income of the person giving gift.
• You can invest in your minor child’s name for tax free income up to Rs.1,500/- per child (max 2 children), so taxable income generated in minor child’s name is tax free to the extend of Rs. 1,500/- per child. Also once the child becomes an adult, the income generated would not be clubbed with your income.
• Invest your money in equity, either in the form of direct shares or units of Equity Mutual Funds, any investment kept for more than a year is free of capital gains tax. Any dividend received is also tax free.
• In case you are investing in your parents name ensure that the income generated does not exceed the taxable income slab.

Just do the above and become tension free, your family will also be happy.

Are we saving tax and making money?

Last year the government had increased the deduction under section 80C to Rs. 1,50,000/-. This year there has been no change, but an addition has been made in section 80CCD for investments in NPS. Let us look at our options with the changed scenario.

ELSS Funds – By far this is the most rewarding of all investment options. With a lock-in period of just three years and tax free returns with regards to both dividend and capital gains. To get the best returns, invest using the SIP option.

ULIPS – With management charges reduced, this is also a good option, which is given by ELSS funds as well. There are a bit expensive as compared to ELSS with regards to charges. The lock-in period is longer, you need to stay locked-in for minimum of 15 years and premium would need to be paid for 15 years. Don’t go by what the Insurance advisor would say, as you would benefit only if you keep paying the premium for the full term. Another advantage is there are free shifts allowed from debt to equity and vice versa, check the number of free shifts allowed.

PPF – Though the interest rate is 8.7%, this would be changed on a regular basis by the government depending on the interest rate scenario, which is likely to come down. You need to put in a minimum of Rs.500/- per year and there is a lock-in of 15 years.

Sr. Citizens Saving scheme – Interest rate is 9.2%, is ideal for people above 60 years with a lock-in of 5 years. Interest is paid quarterly which is taxable.

NPS – A good option for those looking to gain from the additional Rs.50,000 investment option, in addition to section 80C. The amount would be locked-in till retirement and then you would start getting pension from then. Pension would be taxable. The maximum deduction is limited to 10% of your salary for own contribution, but there is no limit on employers contribution. This is only for Tier I accounts.

Bank FD – Should be invested for 5 years, interest is taxable.

NSC - There are 2 types available 5 years and 10 years. Any investment is eligible for deduction. Interest amount received is taxable and also can be claimed under section 80C as investment, as interest is treated as reinvested.

Pension Plans – These are issued by insurance companies, at the end of the period, you have to buy an annuity, which would be taxable on receipt.

Insurance plans - Any premium paid for insuring your own life or that of your child or spouse is allowed as deduction. You have to ensure that the premium paid does not exceed 10% of the assured amount.

In addition to the above there is a deduction available for Principal repayment of Home Loan and Tuition fees.

If you have a housing loan, interest paid on housing loan to the extend of Rs. 2,50,000/- is allowed as deduction, under income from house property for self-occupied property.

Premium for health insurance is has been increased to Rs. 25,000under section 80D for self and family and Rs. 30,000/- for Sr. Citizens.

Make use of the options given to you and save tax. Tax saved is money earned. Invest right and make money.

Residential status for NRI's

Most of the Non Resident Indian(NRI), who come to India often are worried because of the Direct Tax Code. It's not a dark hole, there is always light at the other end of the tunnel.

As per the existing laws, an NRI is liable to pay taxes on his or her global income, if he or she stays in India for a period of more than 182 days in a financial year. But DTC (Direct Tax Code) proposes to shorten this duration to just 60 days.

In January the Finance ministry has clarified that NRI's don't have to worry. They have mentioned that even if an NRI stays in India for 60 days in a financial year, his status does not turn into Indian residents for taxation purposes immediately. As per the DTC proposal, an NRI will be deemed as resident only if he has also resided in India for 365 days or more in the preceding four financial years, together with 60 days in any of these fiscal years. “Only when the two criteria are met, an individual will be considered resident for taxation purposes”.

It was further clarified that even if an NRI becomes a resident in any financial year, his global income does not immediately become liable to tax in India. Global income would become taxable only if the person also stayed in India for nine out of 10 precedent years, or 730 days in the preceding seven years.

Hope with this clarification, NRI's will keep coming to India often.

Taxability on redemption of units from ULIP

So somehow you managed to get trapped into buying a Unit Linked Insurance Policy (ULIP) in the name of Insurance! Now you want to sell the units and get out of it. Is this amount taxable?

Under ULIP units are bought from money invested in the policy. Units purchased are capital assets under the Income Tax Act. So if Units are sold within one year of Investment, you have to pay short term capital gains. So ensure that at least 1 year has passed from the last premium payment date before redeeming your units.

If the units are held for more than a year, they become long term capital gains and long term capital gains are exempt from tax. Securities Transaction Tax would be deducted at the time of redemption of Units.

Now, though we said they would be tax free it would depend on the type of fund the amount was invested in. If the amount was invested in equity oriented funds and held for more than 1 year then the capital gains are tax free, conversely if they are sold within 1 year the short term capital gains tax has to be paid.

Similarly, debt-oriented funds attract a long-term capital gains tax, while a short-term capital gain would be tax at the investor’s normal tax rate.

For details on ULIPs click here

For details on Taxability click here

Taxability for Indians Returning to India

For the last few years we have been hearing the great Indian growth story. This has lead to a lot of investments in India by NRI’s. With growth there are better career prospects, so many Indians are either returning to India or are planning to return to India. For Indians returning, settling in India becomes a little nerve wrecking because of the plethora of rules and taxation.  

As per the Income tax act, taxation is not based on residential status, but on the basis of physical presence in India. Any income generated in India or deemed to be generated in India is taxable as per the Income Tax act irrespective of the residential status. As per the Act, to be 'Resident' your physical presence in India during the relevant tax year is taken into consideration.

Accordingly, once an individual breaches the threshold number of days presence in India (currently being either at least 182-days during the tax year or at least 60-days during the tax year where he / she was in India for 365-days in the immediately preceding 4-tax years), he / she qualifies as an 'Ordinary Resident' under the Act.

The second situation typically arises in the 2nd or 3rd year of his / her return. In case of ‘Ordinary Resident’, his/her global income is liable to tax. Individuals, who do not breach the threshold limit, qualify as 'Non-Residents' (liable to tax only on income generated or deemed to be generated in India).

In case you had created a fixed deposit before your status changed from Non-Resident, do not rush to close the Fixed Deposit. You enjoy tax exemption on it till maturity. Any interest earned in your NRE saving account is taxable from the date you lose your status as Non-resident.

You might want to return to India, but are not sure if you would like to stay on forever. So what should you do with your NRE account? You can convert is to a repatriable RFC account. This way if you decide to go back you can convert it to an NRE account again. Any interest received in this RFC account is taxable if your status is resident.

Next would be the topic of Wealth tax for returning Indians

Joint Ownership of Property

Most of us buy a property just before we get married or soon after marriage. Now Property may be purchased in own name i.e. singly or jointly. Jointly would be one or more persons, so usually husband and wife or within the family. Once you purchase a property jointly you say that all the owners would have equal rights to use the property.

One of the advantages of joint ownership is if anything happens to one owner the title automatically passes to the other joint owner/s. There are other advantage is, if the joint owners have taxable income and loan you need a loan, you can get a higher loan amount.

All the joint owners will also get the tax benefits. Joint Owners can claim separate deductions for their share in the property. But we have to be careful, while making payments ensure that all the joint owners make payments directly as per their share in the property.

This way there will not be any tax complications in future. As an individual one can claim deduction of Rs. 1.5 Lakhs towards interest payment against loan during a fiscal year. So each joint owner can claim upto Rs. 1.5 Lakhs towards interest payment, subject to the total of all claims does not exceed the total interest actually paid during the year.

So if the joint owners have their own taxable income, its best to go for joint ownership. Tax saved is money earned.

Gratuity

Gratuity law; including commentary on the Payment of gratuity act, 1972


Gratuity is a voluntary extra payment made to employees in addition to the salary promised. Such payments and their size vary from organization to organization. Though by definition it is voluntary in India it is legally guaranteed under the Payment of Gratuity Act 1972. Since it is governed by the act it is taxable. Let us examine the payment and taxability.

Any gratuity received by an employee as calculated under the Payment of Gratuity Act 1972 to the extent of Rs. Ten Lakhs is exempt from Tax. This is with effect from May 24, 2010.

All Organizations which have employed 10 or more persons or have employed 10 or more persons in the past come under the Payment of Gratuity Act 1972.

Gratuity is payable when an employee has rendered continuous service of five years or more. In case of death or disablement the five year limit is waived. The amount becomes payable when the employee leaves the organization either on termination of employment or retirement or death or disablement.

 
Gratuity is calculated at the rate of 15 days of basic salary last drawn for every completed year of service or part thereof in excess of six months. So if you have completed six months or more it would be considered as a complete year. The number of days for a month is considered as 26 days, in case of employees earning monthly salary. So if your basic salary is Rs.10000/- per month and you have completed 5years 7 months. The Gratuity calculated would be 10000 * 6 years * 15 / 26 i.e. Rs. 34,615/- but if it was 5 years 5 months it would be Rs. 28,846/- since the number of years would be taken as 5 years. 

Now we mentioned that Gratuity is exempt to the extent of Rs. Ten Lakhs. This Ten Lakhs is over your entire life. That means every receipt of gratuity below ten lakhs is not tax free. The cumulative Gratuity received over your life time from one or many suppliers to the extent of Rs. Ten Lakhs is exempt. The moment it crosses this figure the amount above Rs. Ten Lakhs is taxable.

Calculation of Capital gains

We learnt that capital gain is Sale price less purchase price. But how do we arrive at the sale price and purchase price to ensure we pay the correct tax (not excess). Most of the details are taken from the Income Tax India Site.

Let us look at each

SHORT TERM CAPITAL GAINS (STCG)

Short Term Capital Gains is computed as below:

1.    Find the Value of consideration.

2.    Deduct the following

a.     Expenditure incurred wholly and exclusively in connection with such sale

b.    Cost of acquisition (purchase price as well as other charges incurred to acquire the asset)

c.     Cost of improvement

3.    The balance amount is STCG

LONG TERM CAPITAL GAINS (LTCG)

Long Term Capital Gains is computed as below:

1.    Find the Value of consideration.

2.    Deduct the following

a.     Expenditure incurred wholly and exclusively in connection with such sale

b.    INDEXED Cost of acquisition (purchase price as well as other charges incurred to acquire the asset)

c.     INDEXED Cost of improvement

d.    Deduct exemptions available under section 54

3.    The balance is LTCG

Now if you noticed we have mentioned indexed cost. How do we get the indexed cost? The indexed cost is based on cost inflation index (CII). CII is available the Income Tax India site. (Click here) 

Indexed cost of acquisition =

Cost of acquisition   x	CII of year of sale
	CII of year of acquisition

Indexed cost of improvement = 

Cost of improvement  x	CII of year of Sale
	CII of year of improvement

Deduction under Chapter VIA should not be given from LTCG.

COST OF SALE

This may include brokerage paid for arranging the deal, legal expenses incurred for preparing conveyance and other documents, cost of inserting advertisements in newspapers for sale of the asset and commission paid to auctioneer, etc. However, it is necessary that the expenditure should have been incurred wholly and exclusively in connection with the transfer.

Besides an expenditure which is eligible for deduction in computing income under any other head of income, cannot be claimed as deduction in computing capital gains.

COST OF ACQUISITION

Cost of acquisition of an asset is the sum total of amount spent for acquiring the asset.

Where the asset was purchased, the cost of acquisition is the price paid.

Any expenditure incurred in connection with such purchase e.g. brokerage paid, registration charges and legal expenses also forms part of cost of acquisition.

The cost of acquisition of bonus shares is nil.

COST OF IMPROVEMENT

The cost of improvement means all expenditure of a capital nature incurred in making additions or alternations to the capital asset. However, any expenditure which is deductible in computing the income under the heads Income from House Property, Profits and Gains from Business or Profession or Income from Other Sources would not be taken as cost of improvement. 

What are Capital Gains?

A capital gain results from sale of asset such as shares, bonds, real estate, etc. where there is a difference between purchase price and sale price. Capital gain, can either a profit or a loss. When the proceeds from the sale of a capital asset are less than the purchase price it is a capital loss.

When the proceeds from the sale of a capital asset are more than the purchase price it is a capital Profit. Capital gains may refer to investments that arise in relation to real assets, such as property or financial assets, such as shares or bonds.

We have tax on Capital Gain, although relief or exemption would be available in relation to holding period or type of asset or to compensate for the effects of inflation.

Classification of Capital Gains

Capital gain is classified into two types, depending on the period of holding of the asset.

·         Short Term Capital Gain (STCG)

·         Long Term Capital Gain (LTCG)

This classification also varies depending on the type of the asset. So, let’s understand this classification based on the type of asset.

Short Term Capital Gain (STCG)

If the type of asset is a share or mutual fund and held for less than 12 months before selling, the gain arising is classified as STCG. The only condition here is that the share should be sold on a recognized stock exchange, and securities transaction tax (STT) should be paid on it. In case of equity mutual fund, when redeemed the Asset Management company would deduct STT.

If the sale of shares is off-market (that is, if the sale is not on a recognized stock exchange) or non-equity mutual fund, the gain would be classified like that for other capital assets (given below). In this case, the short term capital gain is taxed at 15% of the gain. A short term capital loss can be set-off against short term capital gain, as long as both the sales occur in the same financial year. (Click here for set-off details)

In case of all other capital assets if the capital asset is held for less than 36 months before selling, the gain arising from it is classified as STCG. This short term capital gain is clubbed with your income for the year and is taxed at the rate applicable to you.

Long Term Capital Gain (LTCG)

If shares or mutual funds are held for more than 12 months before selling, the gain arising is classified as Long Term Capital Gain. In the case of long term capital gain arising out of the sale of shares or mutual funds, there is no income tax if STT has been paid. The long term capital gain in this case is tax free.

In case where STT has not been paid the capital gain tax is 10% if the cost of acquisition is not indexed, and it is 20% if the cost of acquisition is indexed. For all other assets, if the capital asset is held for more than 36 months before selling, the gain arising from the sale is classified as Long Term Capital Gain.

The long term capital gain is taxed at 20%. In other words, 20% of the long term capital gain has to be paid as income tax.

Income under the Income tax Act

In my earlier article I had mentioned that filing returns is easy. I had also mentioned that we need to identify all our sources of Income. What are the sources of Income that are taxable under the Income Tax Act? Income Tax Act defines the term Income as an inclusive definition i.e. it includes almost everything. Also it is not necessary that it has to be in cash. It can be in kind or notional as well. If excluded it would be specifically given. As per the Act the term Income includes:

a. Profits and gains of Business or Profession: This includes income from carrying on a business or income earned by doing any profession.

b. Dividend:

c. Profit in lieu of Salary (perquisite): This includes any amount received by an employee from his employer other then the salary amount.

d. Allowances granted to an employee to meet expenses incurred for performance of his duties: This includes allowances such as HRA, Medical allowance, etc given by the employer.

e. Any capital gains: This means any profit on sale of asset.

f. Winning from lotteries, crossword puzzles, races, card game, T.V. Game shows, etc.

Gifts are not treated as income (click here for details).

An interesting part of all this is income includes loss as well, as per the Income Tax Act loss is nothing but negative income.

Now that we have some idea on what can be income let us see the Heads of Income under which our income would be taxed.

Heads of Income

As per the Income Tax any income earned is broadly categorized into five heads of income. The five heads of income are:

1. Income under Head Salaries: This head taxes the income earned by an individual as salary from any firm or organization.

2. Income from House Property: This head taxes rental income received by any person from way of renting of any immoveable property. In case you have 2 houses and have not been given on rent, then one would be treated as rented (you can decide which one) at notional rent.

3. Profits and Gains of Business or Profession: This head of income broadly covers income earned by a person as a result of some business or professional set-up by him. As the head defines Profits and Gains not gross but net and if the net is a loss i.e. negative income would be taken.

4. Capital Gains: This head of income taxes the income earned on sale of any investment in form of gold, precious ornaments, shares, etc or immoveable property. Here you have to segregate between short term and long term.

5. Income from other Sources: This head of income covers any income which is not chargeable to tax under any of the above heads of income. Any income including gambling or profit/loss on running of race horses, camels, interest income , etc are chargeable to tax under this head of income.

Filing of income tax returns is easy

We have been talking a lot of financial planning and tax planning. We did all that, now it’s time to file your returns. When it comes to filing income tax returns we are a bit skeptical. Why? We are scared to get caught on the wrong foot. But if we know that we have not done anything wrong then filing of income tax returns is easy.

Let’s go through what we would need to file our returns.

Identify your income sources
This is the starting point. Identify the various sources from where you got your income during the last year. As far as salary is concerned you do not have to worry, your employer would give you your form 16, which would give all the details. What about those who are self employed or have additional income by doing part time business? Make a sum of gross income and make a sum of all expenses which went into making the income. Now the difference would be the Net Income. Now go through your passbook and ensure that all deposits are accounted for, if there is income other that business or salary then make a list of the same, e.g. Rent, sale of shares or mutual funds, Interest, Dividends, etc. These would need to go into heads of Income from house property, Capital gains or other income.  (Refer to topics under taxation for details.)

Identify deductions
Sum all deductions available under the different sections of 80. If you have salary income and you have submitted the details to your employer, he would have shown it in form 16. Under each head of income there are deductions available, refer to http://en.wikipedia.org/wiki/Income_tax_in_India for details.

Finding out the tax payable
The final taxable income and tax rate differs depending on your category i.e. are you a woman, senior citizen or other individuals

For individual tax payers, no tax for income below Rs 1,60,000
Women tax payers have no tax for income below Rs 1,90,000
Senior citizens do not have to pay tax if their income is below Rs 2,40,000

The income tax slabs for assessment year 2009-10 as per the Finance Ministry website:

Income tax slab (in Rs.)	Tax
Income tax slabs for Individuals
0 to 1,60,000	No Tax
1,60,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%
Income tax slabs for Women
0 to 1,90,000	No Tax
1,90,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%
Income tax slabs for Senior Citizens
0 to 2,40,000	No Tax
2,40,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%

Calculating tax payable
Reduce the total deductions from the gross total income under each head of income to arrive at the actual amount on which the tax is to be paid. Calculate the tax payable based on the slab rates in which you fall. If you have any tax deducted at source (TDS) this should be deducted from your total tax liability.

Filling the correct ITR form
This depends on your source of income. ITR-1 is the form to be filled in by individuals having income from salary or pension and income in the form of interest.

ITR-2 is the form should be filled in by persons who in addition to the above list of income from capital gains, house property and income from other sources.

All self-employed individuals making income from business or profession should fill in the ITR-4 form.

Filing tax return
This can be done offline and online. The income tax department has good excel worksheets which help in creating XML files which can be used for doing online filing(http://www.incometaxindia.gov.in/). Online payment of taxes can be done through e-filing website, and through internet banking.

If you are still not confident contact your chartered accountant.

Budget 2009

Budget came and with it as usual some changes. These changes have an impact on our net take home. Let us see the impact of the budget on us.

The tax exemption limit has been increase by Rs.10000/- that means a minimum tax saving of Rs.1030/-

Big savings is for those whose income is more that Rs. 10 lakhs. No surcharge i.e. a saving of 10% of the tax.

In one of my earlier articles I had given details of Fringe Benefit Tax (FBT), now with the abolition of Fringe Benefit Tax (FBT), employees will now be liable to pay income tax on a lot of benefits on which FBT was paid by the employer. Under the FBT regime, the employer paid FBT on benefits such as contribution to approved superannuation fund, motor car provided by the employer, gift vouchers, meals, travel, club memberships and so on. Not only the employer was paying FBT, such expenses were subject to FBT at much lower rates because of specific valuation percentages, which resulted in a lesser effective rate of FBT. However, with the removal of FBT and assuming that the old valuation rules of perquisite taxation would be followed, employees would be liable to pay tax on the normal slab rates, resulting in a substantial increase in their taxes. Ultimately, the tax saved due to abolition of surcharge may get compensated by the taxation of perquisites in the hands of individual employees. In one of my earlier articles Money saved from short term business trips I had mentioned that allowance received would be tax free, since the employer was paying FBT, but with this being removed it would become taxable.

The scope of the annual deduction under Section 80E in respect of interest on loans taken for pursuing higher education has been expanded to include all fields of study including vocational studies. Students, who have taken an education loan to pursue a course, which was not covered till now, would be able to claim this deduction.

In the article Gifts and Taxability, I had mentioned that non cash gifts/gifts in kind were not taxable. With effect from October 1, 2009, individuals who receive shares, jewellery, valuable artifacts or even property valued at over Rs 50,000 as gifts from non-relatives, will have to pay tax. However, such gifts will be exempt, if received on the occasion of marriage, or by will/inheritance.

For those who pay wealth tax the limit has been increased from Rs.15 lakhs to Rs.30 lakhs.
Earlier Advance tax was payable if the tax payable was more than Rs.5000/- this has been increased to Rs.10000/-