DON’T HAVE TIME TO GO THROUGH BUDGET? HERE ARE 7 THINGS YOU SHOULD KNOW

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Yesterday, while watching my 12th budget speech, at around noon, I fell asleep. The dozen years of watching long and boring budget speeches finally caught up with me.

When I woke up at 1.30 pm, I was extremely hassled at having missed the budget speech, only to realise that I hadn’t missed much.

As far as budgets go, the finance minister Arun Jaitley’s fourth budget was a fairly straightforward one. And dear reader, if you haven’t bothered following it up until now, there is nothing more you need to do, than just read this piece.

So, here are the seven most important things that you need to know about the budget:

a) For incomes between Rs 2.5 lakh and Rs 5 lakh, the rate of income tax has been reduced to 5 per cent. Earlier it was at 10 per cent. This would mean that anyone having a taxable income of Rs 5 lakh or more will pay a lesser tax of Rs 12,500.

b) The finance minister also said that he plans to introduce a simple one page tax return form for individuals having a taxable income of up to Rs 5 lakh other than business income. This promise of simplifying the income tax return form has been made in the past as well. Let’s see how properly it is implemented.

c) Data from past income tax returns shows that during the financial year 2013-2014 only 23.7 lakh individuals declared income from house property i.e. rental income. This basically means that most landlords do not declare their rental income while filing their returns.

Now on, any individual paying a rent of greater than Rs 50,000 per month, will have to deduct a tax of 5 per cent at source. As Sandeep Shanbhag, director of Wonderland Consultants, a tax and investment advisory firm, puts it: “It is also proposed to provide that such tax shall be deducted and deposited only once in a financial year through a challan-cum-statement.”

d) In its war against cash, the government has made it mandatory that no transaction above Rs 3 lakh will be permitted in cash. One thing that it missed out on here is the fact that gold worth lower than Rs 2 lakh can still be bought without showing any identity proof. In fact, this is how jewellers converted demonetised Rs 500 and Rs 1,000 notes into gold, on the night of November 8 and November 9, 2016, when the Modi government suddenly demonetised these notes.

e) Currently, a long-term capital gains tax on immovable property or real estate has to be paid, only if it has been held for three years. The capital gains made on any property sold in less than three years is added to the income for the year and taxed at the marginal rate of tax. The government has decided to reduce this holding period to two years. This is good news for those looking to sell homes bought anywhere between two to three years back.

f) The finance minister also said that “the base year for indexation is proposed to be shifted from 1.4.1981 to 1.4.2001 for all classes of assets including immovable property.” What does this mean? While calculating the capital gains on real estate that has been sold indexation benefits are available. Indexation essentially allows the seller of real estate to take inflation into account while calculating his cost price.
If the property had been bought at any point of time before April 1, 1981, the price as on April 1, 1981, would have be taken into account while calculating the capital gains. This date has now been moved to April 1, 2001. This basically means that anyone who had bought property before April 2001, gets the price of April 2001 as the cost price, while calculating the capital gains. In the process, the capital gains made will come down.
As Jaitley put it: “This move will significantly reduce the capital gain tax liability while encouraging the mobility of assets.” What this means in simple English is that more people will be incentivised to pay income tax rather than carry out a part of their transaction in black.

g) The government has also inserted a section into the Income Tax Act which essentially states that: “set off of loss under the head “Income from house property” against any other head of income shall be restricted to two lakh rupees for any assessment year.” What does this mean? If you have a bought a home by taking on a home loan and are living in it, then you don’t need to worry. Currently, a deduction of Rs 2 lakh can be made against other heads of income for paying interest on a home loan. This continues.

As Shanbhag puts it: “Interest paid on housing loan could be set off against other income (say salary) i.e. the loss from house property could be adjusted against salary income to reduce the final tax liability. On second homes, this was much more significant as the entire interest without any limit (after first adjusting against a real rental income or a notional rental income in case the house was not rented) could then be further adjusted against incomes from other heads (like salaries etc).” Thus, the tax to be paid, could be massively brought down.

As Shanbhag further puts it: “Now, this adjustment against other heads of income has been restricted to Rs 2 lakh per year. Any unabsorbed interest can be carried forward but then will be subject to similar restrictions the following year. In one stroke, the tax arbitrage related to the housing sector has vanished.”

The government has basically plugged a loophole. Hence, now irrespective of the number of home loans that an individual has, the set off cannot be more than Rs 2 lakh.

The column originally appeared in Bangalore Mirror on February 2, 2017

The Budget Fails India’s Demographic Dividend

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The Economic Survey released on January 31, points out: “Over the next three decades… India… seems to be in a demographic sweet spot with its working-age population projected to grow by a third.”

Estimates suggest that a million Indians enter the workforce every month.  They are India’s demographic dividend. The hope is that as these Indians work, earn and spend money, India will grow at a faster growth rate than it currently is.

This theory works if and only if India’s demographic dividend can find jobs. And the question is where are the jobs?

As per the Report on Fifth Annual Employment – Unemployment Survey, the unemployment rate in India during 2015-2016 stood at 5 per cent. If a person is employed for 183 or more days during the year, he is considered to be employed.

Further, only 60.6 per cent of those who were available for work for 12 months of the year, found work all through the year. Hence, India’s problem is underemployment and not unemployment. There aren’t enough jobs going around for everyone. And in this scenario, the single most important focus of the Indian government should be to facilitate policies and create an environment in which jobs are created.

This should have been the focus of the annual budget of the central government as well. But the budget failed miserably on this front.

Take the case of public sector banks(PSBs) which are sitting on a huge amount of bad loans. In fact, in 2009-2010, 58.7 per cent of all banks loans went to industry. By 2015-2016, it was down to 13.4 per cent. In the last one year, industrial credit has contracted.

Unless, banks give loans to industry how will industries expand and jobs be created? But banks are in no mood to lend to industry given the huge amount of bad loans they have accumulated over the years by lending to industry. The budget makes no effort to come up with a holistic solution for bad loans of banks. Many piecemeal solutions have been tried and they have failed.

These banks require a large amount of capital to continue to function. In the budget for 2017-2018, the government has allocated just Rs 10,000 crore towards their recapitalisation.

An estimate made by Viral Acharya (now one of the deputy governors of the RBI) and Krishnamurthy Subramanian, suggests that in a prudent scenario PSBs would require around Rs 9,97,400 crore of capital. The government clearly doesn’t have this kind of money. In this scenario, it should be looking at exiting out of the ownership of most of these banks. But nothing of that sort has been suggested either in the budget or otherwise.

Over and above the PSBs, the government also continues to run loss-making companies which include an airline, a couple of telecom companies as well as a company which used to make photo-films. There was no mention in the budget about getting out of these companies.

In 2014-2015, the total losses of loss-making public sector enterprises stood at Rs 27,360 crore. Given the government’s total expenditure that is not a lot of money, but at the same keeping these companies going, does take away the focus and attention from other more important areas like education, health and agriculture.

At the same time, another factor that continues to hold back India are its labour laws. The Economic Survey talks about generating jobs in the apparel sector. The sector should be employing a large number of unskilled Indians entering the workforce. It has the ability to generate close to 24 jobs per one lakh rupees of investment. Rapid export growth can create close to a half a million jobs every year in the apparel as well as the leather goods sector.

But that is not happening primarily because an average Indian apparel and leather firm continues to be small and thus lacks economies of scale to compete globally. As the Economic Survey points out: “Indian apparel and leather firms are smaller compared to firms in say China, Bangladesh and Vietnam.”

This situation can be handled by ensuring that we simplify our labour laws. But no government worth its salt has been able to do anything about it till date. Nevertheless, if the government wants to handle India’s demographic divided well, it needs to simplify the labour laws and in the process help companies grow and create jobs.

If that does not happen, it is worth “remembering that demography provides potential and is not destiny”. And the budget was as good an opportunity as any to set this right.

The column originally appeared in Daily News and Analysis on February 2, 2017

 

Modi Should Close Loophole Allowing Political Parties to Launder Black Money

 

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On December 16, 2016, the revenue secretary Hasmukh Adhia said that the political parties are free to deposit old Rs 500 and Rs 1,000 notes in their bank accounts. Adhia also said that deposits in the accounts of political parties are not to be taxed. “If it is a deposit in the account of a political party, they are exempt. But if it is deposited in individual’s account then that information will come into our radar,” he said. This basically meant that deposits made by political parties would not be up for scrutiny.

This statement created a lot of controversy. The finance minister and master spinner Arun Jaitley then took pains to explain that the political parties were not being given any favourable treatment. As he said: Under Section 13A of IT Act 1961, Political parties have to submit audited accounts, income and expenditure details and balance sheets. Post demonetisation, no political party can accept donations in 500 and 1000 rupee notes since they were rendered illegal tenders. Any party doing so would be in violation of law.

Just like anyone else, political parties can also deposit their cash held in the old currency in banks till the 30th of December provided they can satisfactorily explain the source of income and their books of accounts reflect the entries prior to 8 November,” he added.

While it may sound different, both Adhia and Jaitley were essentially saying the same thing. This is how things prevail as of now. Political parties are currently not required to publicly disclose contributions of up to Rs 20,000.

As Sandip Sukhtankar and Milan Vaishnav write in a research paper titled Corruption in India: Bridging Research Evidence and Policy Options: “This rule allows contributors to package unlimited political contributions just below this threshold value completely free of disclosure.”

This basically means that any political party having received individual donations of up to Rs 20,000 in cash can deposit it in bank accounts. This money will not be investigated simply because these donations need not be publicly disclosed. That is the law of the land. And that is precisely what Adhia said: “If it is a deposit in the account of a political party, they are exempt. But if it is deposited in individual’s account then that information will come into our radar.”

Further, the political parties can go through the audits that Jaitley talks about but they still won’t have to publicly declare the names of the individuals and institutions, who have donated amounts below Rs 20,000.

In fact, let’s look at some data from 2014-2015, put together by the Association for Democratic Reforms. As the report titled Analysis of Income & Expenditure of National Political Parties for FY- 2014-2015 and dated June 3, 2016, points out: “Only 49% of the total donations of the parties came from voluntary contributions above Rs 20,000.” This means that 51 per cent or more than half of the total donations of National Political Parties came from donors whose details are not available in the public domain. The BJP, Congress, BSP, NCP, CPI and CPM, form the six national level political parties.

As the report points out: “A total of Rs 648.66 crores (51% of total donations) of the total donations to National Parties was collected during FY 2014-15 from donors whose details are not available in the public domain.”

The report makes several other interesting points:

a) BJP… collected Rs 434.67 crores (50% of total donations) from donors whose details are unavailable.

b) BSP claims not having received any donation above Rs 20,000, hence no donations details of the party are in public domain. The BSP has been declaring this for 10 years now.

c) NCP is only party which has not received donation below Rs 20,000 during FY 2014-15. Thus all voluntary contributions are available in the public domain.

d) As far as the Congress is concerned, 32 per cent of the donations of the party came from unknown sources.

e) The unknown sources of income are essentially raised through ‘sale of coupons’, ‘relief fund’, ‘miscellaneous income’, ‘voluntary contributions’, ‘contribution from meetings/ morchas’ etc.

So as far as dealing in cash is concerned, it continues to be the order of the day for political parties. It is worth mentioning here that we are talking about only six national level political parties here.

The number of political parties operating in India is significantly more. A PTI report dated August 2015 points out: “According to the [Election] Commission, as on July 24, there are 1866 political parties which are registered with it.”

Most of these parties do not fight elections. Then why are they set up in the first place? As former Chief Election Commissioner TS Krishna Murthy recently told The Indian Express: “Many political parties are set up with the sole intention of laundering black money.”

In fact, it is safe to speculate that many of these political parties would have been laundering money in the aftermath of demonetisation as well. The law of the land does not stop them from doing that. All they need to claim while depositing demonetised Rs 500 and Rs 1,000 notes into a bank is that it was donated on or before November 8, 2016.

Having said that, it would be make tremendous sense for the government to release data on the total amount of demonetised Rs 500 and Rs 1,000 notes deposited by the political parties in banks since November 8, 2016. Is the Modi government up for that?

Further, yesterday the Reserve Bank of India (RBI) came up with another rule. An individual while depositing more than Rs 5,000 must offer an explanation to at least two bank employees as to why this could not be deposited earlier. The amount will be credited only after receiving a satisfactory explanation. The RBI wants the explanation to be kept on record to facilitate an audit trail at a later stage. Also, the citizens need to show an identity proof while depositing their old Rs 500 and Rs 1,000 notes into a bank account. On the other hand, political parties can continue to receive donations of up to Rs 20,000 in cash and need not declare who gave those donations. The political parties can deposit the old Rs 500 and Rs 1,000 notes into their bank accounts, and no questions will be asked.

In fact, as I have been saying repeatedly, the issue of black money cannot be tackled seriously, without making political funding transparent. This needs simple majority in the Parliament. The BJP has a majority in the Lok Sabha and can take the first step towards this. It is likely to be supported by some parties in the Rajya Sabha as well. Even without a majority, the party did manage to get the Goods and Services Tax passed through the Rajya Sabha. So, what is holding it back on this front?

In fact, the Election Commission has suggested thatanonymous contributions above or equal to the amount of Rs two thousand should be prohibited.” But why even allow a window of Rs 2,000? Political parties should move towards a totally cashless way of taking donations.

To conclude what are Jaitley, Narendra Modi and the BJP, doing about taking care of this anomaly? An anomaly which as of now clearly allows political parties to launder black money. Will something be done on this front or are only the citizens of this country accepted to show all the honesty?

Postscript: This is my last piece for the year. Here is wishing the readers a Merry Christmas and a Happy New Year. See you in January 2017.

The column originally appeared on Equitymaster.com on December 20,2016

Why Public Sector Banks Should Not Be Merged

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Over the last few months there has been talk of the government merging public sector banks. The finance minister Arun Jaitley said so in his budget speech in February: “a roadmap for consolidation of Public Sector Banks will be spelt out.”

In an interview to the Business Standard newspaper published on May 15, 2016, Jaitley said, “wait for a few days,” when he was asked for a timeline on consolidation of public sector banks. Between February and May, there have been other occasions on which Jaitley has said that the merger of public sector banks is on the cards.

What is the logic behind the idea of consolidating or merging public sector banks? The government currently owns twenty-seven public sector banks, which is way too many. The idea is to merge some of these banks so that they can also compete globally. The size of these banks varies a lot. The State Bank of India is the biggest public sector banks and its balance sheet is seventeen times larger than the smallest public sector bank.

As Jaitley told Business Standard: “Our public sector banks(PSBs) also must be global players and therefore the idea of consolidating some of them.”

While this is a noble idea, it does not solve the problem of bad loans from which all public sector banks are currently dealing with. This is something that first needs to be solved. It doesn’t help anyone if a weak bank is merged with what looks like a relatively strong bank. And the problem of bad loans of public sector banks still hasn’t gone away. It’s alive and kicking.

As R Gandhi, deputy governor of the Reserve Bank of India, the banking regulator, said in a recent speech: “Merger of a weak bank with a strong bank may make combined entity weak if the merger process is not handled properly. The problems of capital shortages and higher non-performing assets (or bad loans) may get transmitted to stronger bank due to unduly haste or a mechanical merger process.”

Gandhi also pointed out that there was very little past precedent to go on. As he said: “Recent merger of State Bank of Saurashtra and State Bank of Indore into State Bank of India may be seen as basically merger among group companies. The only example of merger of two PSBs is merger of New Bank of India with Punjab National Bank in 1993. However, this was not a voluntary merger.”

Research evidence suggests that mergers tend to work when they lead to firing of employees. When two similar organisations merge, it leads to many sets of people having the same kind of expertise and skillsets. Hence, one set is gotten rid of.

For two banks merging this could mean, shutting down one of the two branches operating in the same area and then firing the employees of the branch which has been shut-down. This will bring down employee cost as well as operational costs. This is a good example of synergy that often gets talked about in case of mergers.

Having said that, nothing of that sort will be possible in India. Even a hint on this front can lead to labour unions going on a rampage. Jaitley made this clear in his interview where he said that consolidation shall be looked at “without adversely affecting labour employment considerations”.

And without fewer employees after the merger of public sector banks, there is very little synergy that will be created.

Also, merging banks will not solve the most basic problem that the government owned public sector banks face—crony capitalism. A large part of bad loans that public sector banks are currently dealing with has been because of lending to crony capitalists. Till the public sector banks continue to be government owned, some set of crony capitalists will thrive.

If the government really wants to deal with this problem, then best way is to start privatising public sector banks. As far as fulfilling its social sector obligations is concerned, the government does not need to own 27 banks for that. Around five to six banks should be good enough.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column was originally published in the Bangalore Mirror on May 18, 2016

Modi Government Wants To Tax Your Provident Fund And That’s Bad News

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Arun Jaitley’s third budget had little to offer for the salaried middle class in particular and the middle class in general. But there was a huge negative point which perhaps no one saw coming.

The Employees Provident Fund(EPF) and other recognised provident funds are a huge mode of saving for the salaried middle class. Up until now the EPF worked on exempt-exempt-exempt or the EEE principle. The money invested in this investment is tax free, the interest earned is tax free and so is the corpus earned on maturity.

What does this mean? As Sandeep Shanbhag, Director, Wonderland Consultants, a tax and investment advisory explains: “In EEE tax saving effected is permanent in nature. This means that once the tax is saved for that particular year, it is saved, per se. When the invested amount matures, it is tax-free.”

Nevertheless, Jaitley has proposed to bring EPF and other recognised provident funds under the exempt-exempt-tax or the EET principle. As Jaitley said during his budget speech: “I propose to make withdrawal up to 40% of the corpus at the time of retirement tax exempt in the case of National Pension Scheme.

In case of superannuation funds and recognized provident funds, including EPF, the same norm of 40% of corpus to be tax free will apply in respect of corpus created out of contributions made after 1.4.2016.”

Before getting into the details of what Jaitley means by this, let’s first try and understand what EET means. As Shanbhag puts it: “When the EET system is put into place, permanent tax saving won’t be possible. This is because, by making an investment, you will reduce the same from your income thereby lowering the tax liability. However, when the amount matures, it would be taxable in that year.”

This essentially means that under the EET system, the money invested in EPF and other recognised provident will be tax-free, the interest earned will be tax-free, but the accumulated corpus will be taxed. Hence, as Shanbhag puts it: “Therefore, this is a deferment of tax and not saving of tax. In other words, you will defer (postpone) the payment of tax depending upon the lock-in of your tax saving investment. However, some time or the other, the investment will mature. At that time, tax will be levied.”

Let’s try and understand this through an example. Let’s say you invest Rs 50,000 every year into EPF, starting from April 1, 2016.

The amount invested can be deducted while calculating the taxable income. Every year the interest earned on this would be tax free. Let’s at the end of 20 years, you earn an average return of around 8.7% per year. This means you would have accumulated around Rs 24.73 lakh. Under the EEE principle this amount is totally tax-free.

Under the EET principle this amount will be taxable. How much tax will you have to pay? Jaitley said during his speech that 40% of the corpus will be tax free.

This means 40% of Rs 24.73 lakh or Rs 9.89 lakh will be tax free. Tax will have to be paid on the remaining Rs 14.84 lakh, if this amount is withdrawn. This amount will be taxed according to the prevailing income tax laws at that point of time.

The question everyone is asking is, why is Jaitley or actually the government doing this? A few years back, the government launched the new pension scheme (NPS). This scheme follows the EET principle.

Up until now, 40% of the maturity corpus of NPS had to be compulsorily used to buy immediate annuities. These are essentially insurance policies which help earn a regular income. The remaining 60% of the corpus could be withdrawn. Nevertheless, an income tax needs to be paid on it.

Jaitley in his budget essentially removed this prevailing discrepancy between NPS at one end and EPF and recognised provident funds, on the other. Now on, 40% of the maturity corpus of the investments made on or after April 1, 2016, can be withdrawn and no tax needs to be paid on it. The remaining 60% will be taxed if you withdraw the amount. The same principle applies for other recognised provident funds as well.

Further, if you use 60% of the money to buy immediate annuities, to generate a regular income, you don’t have to pay any tax on it. Even with this, this is a very anti-salaried/middle class move. This is primarily because of the fact that people use their provident funds to get their children educated as well as married.

They even use it to buy a home after retirement. If they want to do something along these lines, they will have to withdraw money and pay income tax on it.

Also, at the end of the day, it is also about letting the individual decide what he wants to do with her or her money. The immediate annuities currently available in the market do not generate returns which are comparable to other investment avenues like simply investing the money in a fixed deposit or buying tax free bonds, for that matter. Hence, to that extent this is a sub-optimal solution for those who know what to do with their money.

Further, why has Jaitley and indeed the government left out maturing amounts paid on insurance policies and tax saving mutual funds, is a question worth asking. These investment avenues continue to follow the EEE principle. Why is there this discrimination?

If Jaitley and the government do not withdraw this change, all it will do is empower the insurance agents of Life Insurance Corporation and private insurance companies to start another sound of mis-selling to the citizens of this country. And that is not a good thing.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Huffington Post India on February 29, 2016