Mutual Funds
Go mutual to beat levy
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As expected, this was a low-impact budget from an investment perspective. No qualitative or quantitative change was made to the tax-saving investments. On the face of it, the stock market’s reaction to the budget has been negative. If one is to believe the obvious explanation, a major culprit is the increased short-term capital gains tax. However, I don’t really believe that this increase will have any lasting impact on the markets. I can’t imagine any situation in which the investing or trading behaviour will change because this tax has gone up from 10 per cent to 15 per cent. However, it will mean that when the time comes to pay the year’s taxes, traders will have to pull out that much more cash to pay tax and in that sense it does reduce investible cash from stocks.
The higher short-term capital gains tax does increase the advantage represented by mutual funds as opposed to trading in stocks directly. When a mutual fund buys and sells stocks, it doesn’t pay any tax. Taxation comes in only when investors redeem such investments. Earlier, this was an advantage of 10 per cent, now it’s 15 per cent.
I think that if the government was prepared to reduce direct tax revenues in the lower slabs, a stronger incentive to save more should have been part of the plan. I've been watching saving and investing behaviour for years and I've always observed that most salaried people, especially in the first and second tax slabs, save only whatever is being directly encouraged by the tax laws. There’s very little discretionary saving that happens.
Perhaps the FM should have used some of the bonanza in his coffers to raise the limit of the tax-saving investments from the current Rs 1 lakh. With inflation, this limit effectively becomes lower every year. If the government wants to be fair (and I’m saying fair, not generous), there’s no reason why the income tax slabs and the tax-saving limits should not be linked in an automatic fashion to inflation.
I believe the major impact will come from the farmers’ loan waivers. Bank shares have been a star investment in the recent past. There are two mutual funds focused on banking and their performance has been better than other schemes. Also, there are some banking funds about to be launched. I believe that the loan waivers will have a deep impact on PSU banks. It is not known how the the waivers will work but I assume the government will repay the lenders on behalf of the borrowers. And since these were loans which were probably never coming back, it could be a bonanza for banks. But Chidambaram may have started a dubious tradition hard for future FMs to put an end to
Small Savings
Post office beckons
The Union Budget 2008 can, quite expectedly, be termed as a populist budget which strives to please all sections of the society. There are considerable benefits for the Aam Aadmi, in the form of higher threshold limits for income tax, hike in maximum deduction u/s 80D for health insurance premia, and inclusion of two more instruments under section 80C.
The good news for senior citizens and risk-averse investors is that investments in Senior Citizens Savings Scheme as well as the 5-year post office time deposits have been made eligible for benefits under 80C. Investments up to Rs 1 lakh in these instruments will now qualify for deduction from the annual income.
e the Senior Citizen Saving Scheme gives an annual interest rate of 9 per cent compounded annually, most of the 5-year tax-saving fixed deposit schemes of banks offer an 8.5 per cent interest rate to depositors who are above 60.
The inclusion of Senior Citizen Saving Scheme (SCSS) u/s 80C thus opens up a high yielding, fixed-income instrument which is likely to win taxpayers’ preference over bank fixed deposits.
Five-year fixed deposits in post offices, which will also now qualify for tax deduction under section 80C, is not as lucrative as bank fixed deposits or senior savings scheme. This is because the post office fixed deposits over 5 years entail an annual interest rate of 7.5 per cent and there is no special incentive for individuals above 60 years in terms of higher interest rate as is available in banks. However, in rural and semi-urban areas where there are few banks, post office fixed deposit will be a good instrument to save tax for risk-averse individuals.
ver, contrary to expectations, there has been no change in the maximum exemption limit under section 80C.
A realignment of income slabs alongside an increase in the basic exemption limit will result in additional disposable income in the hands of taxpayers that can be channelled either into consumption or investment. However, prudence suggests that the additional disposable income be channelled towards long-term investments.
In our opinion, Public Provident Fund continues to remain the evergreen option under section 80C because not only the investment (maximum limit Rs 70,000 in one financial year) qualifies for deduction, even the interest earned on the same (currently 8 per cent per annum) is fully exempt under section 10 without any upper limit. But if you do not have an existing PPF account and are planning to open one, please remember that the maturity period is 15 years.
Insurance
Insurance pulse
Budget 2008 has come as a shot in the arm to individuals who intend to buy insurance policies, especially if one is as cued into savings and investments as the finance minister expects.
A single, broad reason stands tall, buttressing the point that has just been made. Simply put, the budget will encourage an investor to include more insurance in the portfolio, increasing the possibility of benefiting from what is considered a sound investment.
ing as the backdrop is the announcement that an extra deduction of Rs 15,000 has been permitted under Section 80D
The fallout is obviously foreseeable: an increase in sale of medical insurance products, leading to greater health coverage. This is significant in view of the fact that medical insurance is yet to become popular in this country. Many quarters — including consumer groups and insurance companies — have expressed the need for higher investor awareness in this regard. To extend the argument further, there may even be greater product innovation on the health insurance front.
Remember, the threshold limit of exemption from personal income tax (in the case of all assesses) has been hiked to Rs 1.5 lakh, up from Rs 1.1 lakh. This represents a net saving of Rs 40,000. Now, this amount can well be invested in tax-saving options under Section 80C. Such tax-savers can easily include ULIPs (unit-linked insurance plans).
For a woman, the threshold limit will stand increased from Rs 1.45 lakh to Rs 1.8 lakh. The lady concerned will save Rs 35,000, which can be similarly used. A similar rationale will apply to senior citizens, for whom the exemption limit has been raised to Rs 2.25 lakh from Rs 1.95 lakh.
Strengthening the general picture is another key announcement — the widening of the pool of savings instruments under Section 80C, courtesy inclusion of Senior Citizen Saving Scheme 2004 and Post Office Time Deposit Account. With this, the usefulness of this section stands truly extended.
Some investors, especially the conservative kind, may use this new provision to step up allocation to such saving schemes and PO deposits. Will they do this at the cost of ULIPs or ELSS (equity linked savings schemes or, to put in customary terms, tax-saving mutual funds)? Merits mention, ULIPs have shaped up well as a single window for investment and insurance.
While this may be a little too early to answer that question, the market will surely wait for a clear trend to emerge on this front. It may be kept in mind here that both ULIP and ELSS are market-determined. In other words, returns delivered by these products depend on the state of the capital market and the skills of their fund managers.
However, a more likely scenario will stem from a shift from a relatively low-yield NSC to SCSS and PO deposit. Again, the market will await concrete proof before it comes to a decision. Interestingly — and a discerning investor needs to be aware of this — the finance minister has brought asset management provided under ULIPs under the service tax net. This, it has been argued, will bring it on a par with asset management service provided by mutual funds.
Miscellaneous
Market twister
Budget 2008-09 has a nasty surprise up its sleeve for investors in India’s equity markets. The finance minister has raised the short term capital gains tax (STCG) on equity investments from 10 per cent to 15 per cent on the ground that dividend distribution tax is also at 15 per cent and STCG should not be lower.
However, it is the same finance minister who had imposed the Securities Transaction Tax (STT) in 2004 on the premise that while he was taxing stock market transactions, at the same time he was giving relief to investors by reducing STCG from 20 per cent to 10 per cent and long term capital gains tax (LTCG) from 10 per cent without indexation benefits, to nil. While he has spared us from any re-imposition of LTCG, the raising of STCG is quite unwarranted, given the fact that it does not contribute much to tax revenues and will only serve to create a further bad sentiment in the stock markets.
A rationale for this tax increase has been that we want more long term investors who will anyway not pay any tax if they hold on to their investments for over a year. However, in the current volatile markets, what if an investor wants to lock into short-term gains he is making? Also, what will happen to market liquidity if short-term traders and investors are progressively discouraged and disincentivised to impart depth to our equity markets? Our markets are one of the costliest in the world in terms of transaction costs and such moves will make them further unattractive.
Commodity Costs
In the same vein, a commodity transaction tax has been imposed on all commodity market transactions on the lines of the STT. Currently, the STT is paid at the rate of Rs 1,700 per crore of turnover on the sale side of transactions in the equity futures and options markets in India. A similar levy will now be imposed on all commodity market transactions. While the laws of equity demand that there should be a uniform treatment for all asset classes, the minister could have imposed this tax at a lower rate and raised it gradually as he did for the equity markets to help the nascent online commodity markets in India to absorb this tax. These markets are already struggling with low volumes due to various government restrictions, and this tax may adversely affect their growth in the short run.
No mortgage Reversal
One very good thing the minister has done is to clarify the taxability of reverse mortgage loans to senior citizens. A reverse mortgage transaction by a senior citizen will not be treated as a sale and neither will the cash flows from the reverse mortgage loan be treated as income in their hands. This should give a lot of
relief to senior citizens opting for such loans.
