No Dividend Distribution Tax for Debt Funds?

The Direct Tax Code has no DDT for debt or non-equity funds. Currently, for liquid funds, dividends are taxed at 25% plus the surcharge and cess, which adds up to nearly 28.5%. (Which I argue is still better than a fixed deposit)

So what’s the catch? Dividends will be taxed for non-equity funds, as if they are your income. Plus, there’s a dividend “withholding tax” – a sort of Tax Deducted at Source – 10% for residents (for >10K dividend), 20% for NRIs and companies.

That makes dividend income equivalent to a fixed deposit, where you get paid a certain amount of interest every year and the bank holds back 10% as TDS. It also makes life more cumbersome – you now need TDS confirmations for each non-equity mutual fund (dividend option) that you hold. (Luckily, now the system is automated, so your TDS credit is visible online. Register here.)

Impact: Growth Plans will make more sense to the investor. Even if you want regular income, just sell regularly, and that gets qualified as either a short term gain or a long term gain depending on how long you’ve held. Short term gains on non equity funds get taxed at your marginal rate too, but have no withholding tax, which is better for cash flow. Long term gains give you indexation benefits for inflation, which is great for debt funds. For a return of 8%, if 6% is inflation, you will pay tax on 2% – again, much better than FDs where you pay tax regardless of inflation.

Example: Take a fund or FD that makes 1% a month, and you put 50 lakhs in it. Assume you’re in the 30% tax bracket.

Investment	Interest	Withheld	What you get	Tax Pd later	Net Return
Fixed Deposit	50,000	5,000	45,000	10,000	35,000
Fund (Dividend)	50,000	5,000	45,000	10,000	35,000
Fund (Growth)	50,000	0	50,000	150	49,850

This is for the first month, since your gain is very little. If you buy 500,000 units at Rs. 10 each, the NAV would have gone up to Rs. 10.1, you will sell 4950 units to get your Rs. 50,000 – that has 49,500 of principal and Rs. 500 of capital gain. Tax at marginal rate = Rs. 150.

As the gains increase, the tax amount goes up, steadily (since now more of the return is gain). But after about 24 months – the longest you need to hold for going into the “long term” bracket – you get the first 6% free of tax due to indexation, and are only taxed on what’s above that (again, at your marginal rate). In the 25th month, the same 50,000 will consist of 10,600 gain and remaining as principal – yet, the long term gain concept keeps that tax at only 2,500. That is far cheaper than the mutual fund (dividend) or FD, where the total tax is Rs. 15,000 every month.

That means: Monthly Income Funds need to be relooked. So does every non-equity fund where dividend was used as an option. With the 10-20% equity kicker in them, they make sense for a reasonable income plan, but the monthly income as dividends will be taxed at a high rate. You might want to use the growth plans instead.

Downside: You need to have the discipline to sell every month, and you’ll need some work in the year to calculate your tax liability. The difference, though, is substantial, even at the 10% marginal tax bracket.

At Yahoo: Too Few Investors

I speak about the lack of active investors over at Yahoo: Too Few Investors.

A question [1] was asked in the Rajya Sabha of the Namo Narain Meena, MoS in the Finance Ministry about how turnover was distributed in the National Stock Exchange (NSE) among different classes of investors. The answer was enlightening - 30.9 lakh different entities traded in the cash segment of the NSE in the first quarter (April to June) of this financial year.

But this is top heavy; of the entire turnover in this period, just 451 entities were responsible 50% of the total. Of these, around 156 were "proprietary" traders, meaning members trading on their own behalf, rather than for clients. In the Futures and Options segment, about 557,000 entities traded in this period, with just 106 accounting for 50% of the turnover - again, 58 of this was prop-trading.

The minister's response to yet another question [2] revealed that more than 60% of both cash and derivative markets are "intraday" trades - that is, both the buy and sell are executed on the same day.

This triggered angry reactions from parts of the media, some saying that the market is really a casino for concentrating volume in the hands of a few. And that the rampant speculation, evident by high intraday trading, is benefiting only a few people.

In my view this is outrage at the wrong issue. That our markets are top-heavy isn't a surprise. Of the 1,400 stocks traded on the NSE, just the top 50 account for more than half of the total market capitalization - the Nifty 50 market cap is Rs. 34 trillion (lakh crore) of the total NSE market capitalization of 64 trillion. Just the top 15 stocks account for 1/3rd of the NSE market capitalization. (All data from the NSE web site) In terms of traded volumes too, most of the trades happen in the largest stocks, both from the data on NSE and from the Minister’s replies. Our markets are top-heavy and will be for the foreseeable future.

(Read the whole article)

Comments as usual are deeply appreciated.

More Yahoo Columns:

• Survivorship Bias (Comments)
• The Problem with Multi-Level Marketing (Comments)
• Planning for the Grim Reaper (Comments)
• Of Options and Choices (Comments)
• Credit Default Swaps (Comments)
• Four Investing Myths Busted (Comments)
• (The Whole Lot)

Will India’s Share of World GDP Mean Revert?

An interesting presentation on the Asian Financial Sector by Pedro Rodeia, Head of Asian Financial Institutions Group at McKinsey. (Thanks Arvin for the tip!)

Awesome presentation, and for an insider who can invest in Indian banks, very useful.

Oil Bill up 51%, Trade Deficit at $43B

India’s Oil Bill is 51% higher than last year for the April to June quarter. Sure, the average oil price has moved up from $60 average last year to about $70 average today. There is also the fact that since oil payments may have been hedged at lower levels (remember oil was in the $30s in December 08).

The oil bill for this quarter is about $25 billion; at $70 per barrel that’s 4 million barrels per day! Even if we presume $75 per barrel, we are at 3.7m barrels per day. Imported, remember – we produce around 700K barrels per day. Now 4 million barrels per day is a lot of barrels – we consume about 3 million barrels of crude per day, and of that we import about 2.3m. If you take last year Q1’s imports that comes to about 3 million barrels per day – meaning the extra must be what we refine and export?

With that assumption do we now import more than a million barrels a day to refine and export? That’s very interesting, because the stuff we buy and refine is largely the heavy forms of crude which is cheaper and has slightly higher margins.

The trade deficit for June was $32 billion and July has gone to $43 billion – at this rate we’ll have about $100 billion as the trade deficit (which is as much as our oil import bill, really). It should be interesting to chart this.

India Direct Tax Code Bill Tabled in Lok Sabha

The Government introduced the Direct Tax Code Bill today. After some serious amount of searching, I found the bill online, after struggling with pages timing out, debugging communication messages and guessing IP addresses. (Read: It was darn easy in the end, but I had spent so much time I needed to make it look like it was a bloody difficult job).

What matters is not that I found it. What matters is what is in it.

First, this bill of the DTC applies from 1 April 2012, so heave a sigh of relief.

For salaried income: Deductions are Employment Tax, Travel allowance (currently Rs. 800 a month), actual reimbursements, employer’s contribution to pension [upto 10% of salary], retirement or provident fund [upto 12%].

Housing rent allowance is fully exempt, without the complex formula – now it is limited to the rent actually paid. Nice.

Property income: Only rent actually received is taxable. You get to deduct local taxed and 20% of the gross rent, plus all interest paid on a loan for that property. If you take on a loan before the property is ready, you get to amortize the interest paid before possession over the subsequent five years, equally.

Securities Transaction Tax stays. We will now pause for a minute to pray for the arbitrageurs that died after that sentence.

Capital Gains: First calculate the gain as selling price minus cost price minus all intermediate costs. For shares and equity mutual funds on which STT is paid and held over a year, ZERO. Rejoice.

Shares and MFs with less than one year of holding – 50% of the gain (or loss) is “ditched” and the rest added to income.

For debt MFs or shares transferred off-market or Gold ETFs or things like that: To qualify for LTCG (Long Term Capital Gains) you have to hold the asset for “one year from the end of the financial year in which the asset is acquired”. If you buy on April 1, 2012, you have to hold it till after March 31, 2013 – that’s two years at the extreme. Then, you get to index the costs to inflation. If you’ve bought the asset before 2000, then you must assume indexation from 2000, but you get the option – and I mean it’s your choice to do this if it works in your favour – of using the price on April 1, 2000. This is incredible, for me, because my family owns shares held for over 20 years.

Any other short term capital gains are simply added to income.

There will be a Capital Gains Deposit Scheme where you can dump the proceeds (not just the gains, the entire proceeds) of capital asset sales (long or short term) and not pay tax. You can buy a house or agricultural land to offset cap gains taxes, within a year after the sale or use the Cap Gains Deposit Scheme, to park money upto three years to invest in such a tax-offsetting asset. You get to do this for max two residential properties for a person.

Deductions: Everyone gets a Rs. 100,000 deduction for money put into “approved funds”. What we don’t know – are ELSS mutual funds “approved”? Are "ULIPs” approved? Most likely no to both. They do mention that approved funds are –

• PF, retirement or gratuity funds
• Pension funds
• Any thing else specifically approved

An additional Rs. 50,000 is deductible under 3 heads – 50K is the limit for all of them added up.

• Pure life Insurance – defined as any policy where the premium is less than 5% of the sum assured for ALL years of the policy,
• Health insurance
• Two children’s tuition fees (including pre-school fees). But no donations or “development fees”.

Housing: This gets interesting. First, no principal deduction. Second, interest is only deductible if the house is completed within three years of the loan commencement. (And the pre-completion interest is amortized forward over five equal yearly installments. You don’t get the deduction during the pre-completion phase) The interest deduction limit is Rs. 150,000.

Higher Education loan interest is deductible for seven years, but it’s gotta be from a bank or FI (not relatives) and for a course the govt. recognizes. (Sorry, IIPM. Perhaps even ISB will not qualify!)

Medical expenses get a 40K deduction if you actually spend the money on medical treatment. 60K for treatment of senior citizens. Oh, and if you get insurance, that much is not counted.

Tax slabs: Upto 200,000 a year, no tax.
Rs. 200,000 to 500,000: 10%
Rs. 500,000 to 10 lakhs: 20%
> 10 lakhs: 30%.

It’s progressive, and slabbed. For senior citizens (65+), the first slab is 250,000. For companies, the rate is 30%, and Minimum Alternate Tax is 20% (but you can claim it back within 15 years)

Dividends and Insurance income distribution from “Equity Oriented Insurance Schemes” (ULIPs) get taxed – at 5%. The 15% dividend distribution tax stays. That means to go through equity mutual funds you actually pay a lot – first companies pay 15% tax on dividends, then the mutual funds get a tax hit of another 5%.

Wealth tax: 1% of whatever’s above 1 crore rupees, every year. But not including the house you live in. This is just horrible, but amounts to just 1% more income tax, if you look at it. But if someone has money in illiquid assets like multiple houses, or equity, they’ll find the going tough. Think of the promoters of Indian companies!

With about 35 lakh crores under private sector ownership, that alone will give the government more than 30,000 cr. of wealth tax revenue.

But the section actually doesn’t count assets like shares and bonds! This needs lawyer input but it seems like for wealth, they consider land, farm houses, cars/yacht/aircraft, jewellery and bullion, antiques and paintings, expensive watches, cash, and shares held in foreign companies. Nothing about Indian company shares, or bonds, or mutual funds.

EEE or EET: NPS goes Exempt on withdrawal – commutation of pension (lumpsums) upto 1/3rd or 50% of the amount in different cases.

Life insurance paid on death is exempt. This is still a great way to transfer assets without a will.

All exemptions for donations to non-profits, political parties etc. stay.

Nothing much changes, really, other than a few exemptions gone, and wider tax slabs. Retaining LTCG at zero for equity markets is good, of course, but it won’t last that long. Wealth tax can be a huge issue or a non-issue, if there is clarity on whether it applies on share/bond holding.

To me this is no big deal – just business as usual. But the equity markets have reason to rejoice.