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Long Term tax gain tax

One of the biggest items that came out from the recent Budget has been the reintroduction of Long Term Capital Gain (LTCG) tax. This tax is applicable on gains arising from sale of  :

  • Equity Shares in a listed company on a recognized stock exchange
  • Units of Equity Oriented Mutual Funds; and
  • Units of a Business Trust

The proposed tax is applicable to above assets if:

  • They are held for a minimum of 12 months from date of acquisition
  • The Securities Transaction Tax (STT) is paid at the time of transfer. However, in the case of equity shares acquired after 1.10.2004, STT is required to be paid even at the time of acquisition

(As per Notice by Ministry of Finance, dated 4th February, 2018)

There are two major points in regards to the proposed regime:

  1. The LTCG tax will be at a flat 10% for any long term gains in excess of Rs 1 lakhs, starting from Financial Year 2018-19 i.e. 1stApril, 2018. In other words, all long term capital gains realized up until 31st March, 2018 will be exempt from the proposed tax.
  2. There is a “Grand Fathering” clause, which in essence ensures that all notional/realized long term capital gains up to 31stJan 2018 will remain exempted from the proposed tax. This means that effectively the closing price of 31st Jan 2018 would be the cost price for LTCG calculations.

How would the Long Term Capital Gains Tax be calculated?

If you sell after 31.3.2018 the LTCG will be taxed as follows:

The cost of acquisition of the share or unit bought before Feb 1, 2018, will be the higher of :
a) the actual cost of acquisition of the asset
b) The lower of : (i) The fair market value of this asset(highest price of share on stock exchange on 31.1.2018 or when share was last traded. NAV of unit in case of a mutual fund unit) and (ii) The sale value received

Scenarios for computation of Long Term Capital Gain

  • Scenario 1:An equity share has been purchased on 1st Jan, 2017 at Rs. 100. Its Fair Market Value (FMV) as on 31st Jan 2018 was Rs 200 and it was sold on 1st April 2018 at Rs. 250.

As actual cost of acquisition is less than FMV, the FMV will be considered as cost of acquisition and therefore the LTCG will be Rs. 50 (Rs. 250 – Rs. 200)

scenario 1

  • Scenario 2:An equity share has been purchased on 1st Jan, 2017 at Rs. 100. Its Fair Market Value (FMV) as on 31st Jan 2018 was Rs 200 and it was sold on 1st April 2018 at Rs. 150.

Actual cost of acquisition is less than FMV. However the sale value is also less than FMV. Therefore the sale value will be considered as cost of acquisition and therefore the LTCG will be NIL (Rs. 150 – Rs. 150)

scenario 2

  • Scenario 3:An equity share has been purchased on 1st Jan, 2017 at Rs. 100. Its Fair Market Value (FMV) as on 31st Jan 2018 was Rs 50 and it was sold on 1st April 2018 at Rs. 150.

As actual cost of acquisition is more than FMV, the actual cost of acquisition will be considered as cost of acquisition and therefore the LTCG will be Rs. 50 (Rs. 150 – Rs. 100)

scenario 3

  • Scenario 4:An equity share has been purchased on 1st Jan, 2017 at Rs. 100. Its Fair Market Value (FMV) as on 31st Jan 2018 was Rs 200 and it was sold on 1st April 2018 at Rs.50.

Actual cost of acquisition is less than FMV. As sale value is less than both the FMV and actual cost of acquisition, the actual cost of acquisition will be considered as cost of acquisition and therefore there will be Long Term Capital Loss of Rs. 50 (Rs.50 – Rs. 100). Long-term capital loss arising from transfer made on or after 1st April, 2018 will be allowed to be set-off and carried forward in accordance with existing provisions of the IT Act.

scenario 4

Note, there is no clause of indexation on cost of acquisition. Setting off cost of transfer or improvement of the share/unit will also not be allowed.

 

LTCG on these instruments realized after 31.3.2018 by an individual will remain tax exempt up to Rs 1 lakh per annum i.e. the new LTCG tax of 10% would be levied only on LTCG of an individual exceeding Rs 1 lakh in one fiscal. For example, if your LTCG is Rs 1,30,000 in FY2018-19, then only Rs 30,000 will face the new LTCG tax.

What should you do now with your Equity Portfolio?

Even with the reinstatement of this tax, we believe that equities are still an efficient post tax investment avenue. We would therefore continue to recommend to remain invested in equities provided the investment horizon is long. Alternatively, if you require monies in the short term, this may be a sound window to book profits and shift to less aggressive avenues.

 

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6th-Bimonthly-Monetary-Policy-300x200

RBI has been proven right on its past decisions on interest rates, and in line with consensus views post the Budget, the Monetary Policy Committee (MPC) decided to keep the repo rate and reverse repo rate unchanged at 6 percent and 5.75 percent,respectively. The MPC also decided to keep the policy stance as neutral, and indicated that further rate hikes or rate cuts will depend on incoming data. It does seem like a long pause on interest rates is in store. The MPC voted 5-1 in favour of status quo, with one member expressing a preference for a rate hike.

Since these were in line with market expectations, both bond and equity markets had already priced in this scenario, and thus they did not react much to this announcement.

The CPI projections for inflation going forward were higher than projected in the last policy, with inflation expected to continue to be elevated at 5.1%p.a in Q4, and 5.1% -5.6% p.a, in H1 2018, due to pressure from higher commodity prices, oil and possible impacts of MSP hikes and increased customs duties, along with greater pricing power for companies to pass on these costs to end consumers.

Growth for 2017-18 is projected at 6.6% ( lower than 6.7% expected earlier) , and projected for 2018-19  at 7.2 %  overall. This recovery is expected on the back of better bank credit growth, an increase in capacity utilisation, GST stabilisation and bank recapitalisation.

Governor Patel ascribed the recent sharp rise in bond yields to various global and domestic factors; including higher US rates, oil prices, increase in inflation, cyclical pick- up in demand in the economy as well as fiscal slippages from the government.

 

Your Investments

With the RBI referring to a recovery in the economy, it does seem that whilst they will continue to track data closely, strategies that are focused on interest rates staying elevated should be the preferred choice.  Considering that real rates of return (returns from fixed return investments less inflation) continue to be significantly positive, we continue to believe that investing in fixed income is attractive, as equities continue to trade at significant premiums to long term price to earnings ratios in spite of the recent correction.  It may be a good idea to continue to have fixed income exposure through a combination of largely accrual, short to medium term, and hold to maturity strategies. Considering the bank recapitalisation, investors could also consider credit opportunities funds for a small portion of their portfolios. For investors willing to continue to look at interest rates having periods of downward volatility, dynamic bond funds that have the flexibility to move across bond maturities, can be explored for 10% – 15% of the fixed income portfolio.

 

Your Loans

Whilst RBI’s decision to hold rate cuts could indicate status quo on rates, we think that the rapid increase in bond yields and its negative impact on bank balance sheets could create upward pressure on loan rates, with banks possibly raising rates going forward.

Reserve Bank introduced the Marginal Cost of Funds based Lending Rates (MCLR) system with effect from April 1, 2016. With the introduction of the MCLR system, it was expected that the existing Base Rate loans shall also migrate to MCLR system. It is observed, however, that a large proportion of bank loans continue to be linked to the Base Rate. Since MCLR has proven to be a better tool to transmit interest rates, RBI has decided to harmonize the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. This is likely to help borrowers who are still on base rate linked loans.  An ombudsman scheme to improve customer grievance handling for loans taken from NBFCs has also been introduced.

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Ulips

 

Unlike a pure insurance policy, a Unit Linked Insurance Plan (ULIP) is a product designed to give investors the benefits of both insurance and investment under a single integrated plan. ULIPs are insurance + investment plans suited for investors with long investment horizons. They work well with investors who may not otherwise keep the discipline of investing as they usually come with long lock ins and high exit costs.

The tempting benefit ULIPs offer is the administrative convenience of not needing to execute the two legs of transactions i.e. insurance and investments separately.

From our experience with investors, we understand that there’s a good chance you already own a Unit Linked insurance plan (ULIP) that either your parents bought for you, or you landed up buying one in the hurry scurry of tax related investments, only to realize later that one should not be mixing insurance and investments.

In the case that you may have purchased a ULIP or you may be contemplating to buy one, it is critical to know a few important items related to them so that you are more aware of what you have or might get yourself into.

 

1. Understand the purpose for purchasing the ULIP – tax planning cannot be the sole motive

While tax planning is clearly on the agenda, you should also assess the objective for which you want to purchase an insurance policy. Is the policy being bought for long term wealth creation, retirement planning or building a corpus for your child’s future? A decision that is prompted solely by the need to save taxes often results in the purchase of a wrong or an unsuitable product.

 

2. Check the charges carefully

All Ulips come with a host of charges. Understanding each of them is crucial to understanding if the product is suitable or not. Such charges include:

  • Premium Allocation Charges: As the name suggests, these fees are to cover expenses incurred by the company to allocate funds, do the underwriting, medical expenses, etc.Your agents commission is also covered under this head.
  • Policy Administrative Charges: These are the charges that are deducted on a timely basis to recover the expenses incurred to maintain the policies under the fund.
  • Surrender Charges: Similar to the exit loadin a mutual fund, these are the charges applicable when encashing a part or the full investment in a plan. As we know that in most of the Mutual Funds, exit load is at about one percent. In ULIPs, surrender charges could vary from a few percentage points to very exhorbitant amounts, basically to deter investors from exiting the plan in a short horizon.
  • Mortality Charges: These are the fees that are deducted on a monthly basis to cover the costs borne by the insurerfor providing a life cover to the policy holder. Depending on the age and the sum insured, these charges are deducted for life cover.
  • Fund Management Charges: The allocation of investment in debt and equity requires the insurer to bear the costs of managing the fund.These are charged as fund management charges.
  • Fund Switching Charges: As the name suggests, switching from one fund to another requires the insuredto pay an amount for covering the expenses borne by the company for making the switch.

 

3. Understand the flexibility to Switch

An investor’s need for liquidity, time horizon, and risk appetite will determine the initial allocation but these change over time. ULIPs offer the flexibility of switching between the funds based on changes in market cycles and changes in investor preferences. The number of free switches during a policy year, the cost of switches and the ease of switching are factors that are important evaluation points when choosing a ULIP.

 

4. Analyse and estimatperformance

With the complexity of the ULIP structure plus the huge list of charges and expenses that comes with it, it is difficult to approximate the kind of performance the product may have given during its existence. Always insist with the insurance agent/advisor to show illustrations and data demonstrating how the fund would has performed and is likely perform considering markets ups and downs. More often that not, data would help you decide better on the decision to invest or not.

 

Probably the only benefit, though largely accidental, of an ULIP is that the investor’s money is locked in due to the structure of a ULIP, forcing him to think long term. However, it is needless to say that other options must also be evaluated in comparison to ULIPs before making a choice to invest in them. The most common strategy might be a combination of Pure Term Life insurance policies along with separate investments in Mutual Funds. But like every investment decision, the first step to take is to determine the investment horizon and risk appetite and not get swayed by fancy words or past performance.

 

 

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blog 2With the recent launch of the ICICI Bharat 22 ETF, a lot of buzz around Exchange Traded Funds or ETF’s has been doing the rounds. Most investors may be wondering whether it is worth investing in ETF’s?

So what is an Exchange Traded Fund?

An ETF is a passive investment instrument whose value is based on a particular index and such a scheme mirrors the index and invests in securities in the same proportion as the underlying index. For example, a Nifty ETF will invest in the 50 stocks compromising the Nifty index. ETF’s are freely marketable securities which are traded on the stock exchange.

Since ETF’s trade on the exchange, their value fluctuates all the time during the market trading hours. This is different from the working of a mutual fund scheme which has a single Net Asset Value (NAV) per day that is determined after the trading hours are over.

Theoretically, ETF’s are structured to provide a variety of advantages to investors. The most prominent among them are as follows:

  • Diversification: ETF’s can provide a variety of diversification based on following themes:
  1. Asset classes such as equities, gold, fixed income
  2. Sectors such as financial services, consumption, infrastructure
  3. Based on market cap i.e. large, mid and small cap
  • Low Cost: One of the biggest attraction of ETF’s has been it’s very low cost structure, especially in comparison to Indian mutual funds. The low costs is primarily due to the fact that an ETF is a passive investment i.e. there is no active intervention in stock selection, re balancing based on a certain view. Therefore the costs associated with hiring professionals and the required infrastructure is avoided, resulting in a significantly cheaper product. Furthermore, most ETF’s have kept the expense ratios low to induce significant inflows from institutional investors. Following are examples of some commonly known ETF’s and their respective Expense Ratios
ETF Expense Ratio
CPSE ETF 0.07%
Motilat Oswal MOSt Shares M100 ETF 1.50%
Kotak Banking ETF 0.20%
ICICI Prudential Nifty iWIN ETF Fund 0.05%
SBI – ETF Nifty 50 0.07%
Average 0.38%

(Source: Value Research, mutual fund websites)

  • Suited to Efficient Markets: it is a global observation that passively managed funds have performed significantly better over actively managed funds where markets are more efficient. This is because in developed markets, all related information that should be priced into the equity market already happens, leaving very little space for the fund managers to beat their respective benchmarks.
  • Reduced Risks: Due to its passive structure, the risk arising due to stock selections by a fund manager are reduced. Furthermore, as an ETF comprises the same stocks in the same allocation as in the underlying index, tracking error is significantly reduced to the point of it being almost negligible. Tracking Error is the standard deviation between the returns of the fund and the underlying index. A lower tracking error indicates the fund is that the ETF will mirror the index more closely and therefore its performance will be more consistent with the same index.

Despite many advantages that ETF’s can bring to the table, in India they so far have been primarily avoided for the following reasons:

  • Liquidity: One of the major disadvantages plaguing ETF’s currently is liquidity. As ETF’s are traded on the exchange like any stock, its not always you will have to opportunity to either buy or sell at the desired quantity or price, depending on the type of ETF involved. However an alternative to this problem is the use of a market maker. A market maker is appointed by fund houses. They, on behalf of fund houses, provide quotes for buying or selling an ETF based on the current NAV of that ETF. This helps ensure liquidity for investors. Any investor can approach a market maker for transaction. The difference in their quote and the NAV of the ETF is called “spread”, is the cost for the services. –
  • Lack of awareness: Distributors receive negligible commission for recommending and executing an investment into an ETF. Because of these low margins not much efforts have gone into promoting ETF’s. Thus, most investors are unaware of what an ETF is and how it can add value to their portfolio.
  • Relative Underperformance over long term: While in theory ETF’s should out perform active managed funds in an efficient market, the point to note is that India is still some time from achieving that status. Hence actively managed equity funds, especially in the top quartile, are able to beat the underlying index, and ETF’s over long term horizons. This currently results in alpha creation which ETF’s may take time to match up to. The following table is a comparison between a random mix of actively managed equity funds and equity oriented ETF’s:
  1yr 3yr 5yr 10yr
Aditya Birla Sun Life Frontline Equity 26.62 10.21 16.89 10.61
Franklin Templeton Franklin India Prima Plus 24.86 11.17 18.22 10.87
HDFC Top 200 28.42 8.39 14.99 10.65
IDFC Premier Equity 30.35 11.72 18.68 14.08
ICICI Prudential Nifty 100 iWIN ETF 27.54 8.44    
Kotak Sensex ETF 23.88 5.36 10.7  
Reliance ETF Nifty BeES 26.78 6.7 11.91 5.75
S&P BSE Sensex 25.58 5.01 11.15 5.14
NSE Nifty 100 26.97 7.55 12.71 6.08
source: value express , date (07 Dec 17), returns data CAGR        

As in the Indian economy continues its march towards being recognized as a developed nation, there is fair certainty that ETF’s will have a far larger role to play. However in current scenarios, practical hurdles continue to keep them out of favor among investors. We believe that assigning a small allocation towards ETF’s, after due diligence, is sufficient basis investor’s risk appetite and investment horizon. As Indian Equity markets evolve, so will the ETF space and this will increase investors interest towards them.

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FinalTreasuryManagmentAs the owner and /or CEO of your HR Consultancy firm, cash flow management is a constant topic of discussions with the finance and accounts team.

What do with the excess cash in hand? Where should it be deployed so that it works a little bit more and grows whilst being highly liquid and safe? How does one ensure that enough reserves are maintained to fund working capital expenses during the low business cycles?

What makes cashflow management critical is that it helps the firm maintain the business flow and also balance better returns for idle money. This in turn goes a long way in ensuring operational functioning and continuity. The question is how is this achieved?

First things first, when you talk about treasury management, you are indirectly referring to constant flow of money in very short time periods. And as most boutique/SME’s face volatile business turnovers, money can be required on priority basis at any point. Hence the priority in Treasury Management primarily lies in ensuring liquidity and safety of capital invested rather than high returns.

Secondly, while significant growth in short term investments should not be expected; it should not necessarily be considered that there are no better options other than the company current account. While Fixed Deposits and Recurring Deposits have been traditional avenues for company owners to park extra monies, they remain inefficient from a taxation perspective. Tax Deducted at Source (TDS) is a definite thorn as tax incidence is occurring even though there are no capital gains received in hand.  Furthermore, falling interest rate scenarios are making them an even less attractive option.

An alternative that should be considered is liquid/ultra short Term/ short term debt mutual funds. Two aspects they score over traditional avenues is (A) they usually do not have any exit penalties  as compared to bank FDs and (B) they are more tax efficient due to tax deferment, as tax incidence only occurs at the time of realised capital gains at the hands of the investor, and they are eligible for indexation benefits as gains from any debt mutual fund investment held for 3 years or longer are taxed at 20% after indexation, thereby improving post tax returns.

In addition, often companies decide to park certain monies with a longer term view. This could be to prepare for possible expansion/acquisition as envisaged in their business plans. But as the requirement of funds is not in the immediate future, short term investment options might not work out in the best interest. Hence separate planning should be considered for such investment purposes.

Last but not least, understanding past company cashflows and extrapolating the data to approximate future cashflows is essential to determine the kind of investment strategy would be ideal. This analysis, while including business growth projections, should also include current liability repayments and expected abnormal gains in the future.

While managing cashflows will indeed be a constant objective, through efficient planning and proper advisory it need not become a source of constant headaches.

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Retirement 1Retirement is usually something that is not considered by most of us till we are nearing it, so naturally we do not plan for it, until it is probably too late. This general ignorance or lack of attention to retirement planning can have far reaching consequences.

Retirement planning in the simplest sense means preparing for life after the tenure of paid work ends.  This does not only include the financial aspect, but other aspects such as what to do during retirement, the lifestyle choices that one can take and what dreams one might want to pursue during the remainder of the years.

While the concept of Retirement Planning applies to pilots just as it does to other individuals, there are certain unique points that are exclusive to retirement planning for commercial pilots. These unique points are crucial while developing a retirement plan for a pilot.

Firstly, under the current DGCA rules, the retirement age in India has been pushed up to 65. This is an entire 5 years longer than the mandated retirement age in most other industries. This translates to more income earning years, probably at the highest salary slab of the industry, since usually pilots around this age are most likely to have their designations as Captain. This extra income earning period is crucial in formulating and ironing out the retirement plan before the pilot ultimately retires. The significant income flowing could be the difference between living a compromised and a fulfilling retirement.

One of the most important things a commercial pilot has to consider is Lifestyle Inflation. Because commercial pilots have one of the best salary packages amongst all industries, they tend to have more lavish lifestyles. And they are comfortably able to match up the ever increasing expenses that come alongside their lifestyle choices. But on retirement, the salary stops. Yet expenses continue to stay, with inflation only adding to it. But more significantly no one would want to compromise on their lifestyle they have become accustomed to. As such it becomes imperative to plan much ahead so that lifestyle compromises don’t become the norm during your golden years.

Just to drive home the impact of inflation, let’s take an example. Consider a pilot Mr. A, currently 30 years of age and has a monthly expenditure of Rs 12 lakhs every year (not a very high amount, from what we hear from our pilot clientele). Assuming he will retire at age 65 and taking an average of 8% lifestyle inflation till retirement,  the same Rs. 12 lakhs expenditure will inflate to approx Rs. 1.75 crores. In other words, to maintain the lifestyle that costs Rs 12 lakhs as of today, Mr. A would require Rs 1.75 Crores annually to maintain the same expenditure choices, forget upgrading!

Furthermore, pilots are used to having extremely busy schedules. So when retirement hits, they are unprepared to handle the ample time in hand. Hence they always look for options to keep themselves engaged. This could mean, taking long leisure trips or finding, researching on and investing lump sums in “exciting investment avenues”, committing money to be part of a start up or just following their long drawn passions or enrol at the local flying clubs just so that they can regularly indulge their lifetime love of flying. All this comes at hefty financial expenditures.

All of the above means that Pilots would need to plan and develop customized retirement plans for themselves to ensure a smooth flight during retirement.

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