Section 80C

New Tax Data Is Unambiguous: Black Money Is A Huge Part Of Indian Economy

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The Income Tax(IT) Department has released some very interesting data today. The data basically reconfirms what we have known all along—that very few Indians pay income tax.

The number of Individuals with a permanent account number(PAN) for assessment year 2014-2015 (which basically means the income earned during the financial year 2013-2014, or the period between April 1, 2013 and March 31, 2014) stood at 4.86 crore. The income tax department calls them effective assessees. In the assessment year 2014-2015, the returns for the income earned in the financial year 2013-2014 had to be filed.

The number grew at a rate of 6% per year, over a three-year period between assessment year 2011-2012(i.e. the income earned during the financial year 2010-2011, or the period between April 1, 2010 and March 31, 2011) and assessment year 2014-2015.

Data from the World Bank tells us that in 2013(considering that we are talking about financial year 2013-2014 here), India’s population was at 127.9 crore. What does this basically mean? This means that around 3.8% of India’s population came under the income-tax net in assessment year 2014-2015.

The government has also released detailed data for the assessment year 2012-2013 (or income earned during the financial year 2011-2012, the period between April 1, 2011 and March 31, 2012).

And this data tells us something interesting as well. For the assessment year 2012-2013, a total of 2.88 crore income tax returns were filed by individuals.  The number of individuals with permanent account numbers for the assessment year 2012-2013 stood at 4.43 crore. This basically means that only 65% of individual permanent account number holders filed a tax return.

Data from World Bank tells us that India’s population in 2011 was around 124.7 crore. This means that only 2.3% of India’s population filed the income tax return in assessment year 2012-2013, when returns for the income earned during the course of financial year 2011-2012, had to be filed.

Hence, the actual number of individuals who file income tax returns is significantly lower than the total number of individuals who have a permanent account number. Also, it is safe to say that the actual number of tax payers would be more than those who file an income tax return, given that some individuals paying income taxes are clearly not filing returns.

The Income Tax department does talk about the fact that in many cases the “tax has been deducted at source from the income of the taxpayer but the taxpayers has not filed the return of income.” This gap is huge despite the so-called attempts of the government to simplify the tax-filing process every year. It tells us that the simplification process is clearly not working.

There are more interesting data points for the assessment year 2012-2013. The average individual had a returnable income of Rs 3.77 lakh and paid a tax of Rs 39,823. Further, the total number of tax payers with a returned income of greater than Rs 10 lakh is just 13.32 lakhs. The returned income is defined as the total income after taking deductions allowed under chapter VI-A deduction into account.

The chapter VI-A deductions essentially refers to deductions allowed for investments made into the Employees’ Provident Fund, the Public Provident Fund, tax saving mutual funds, life insurance policies and so on (Section 80C).

It also allows deductions of premium paid for buying a medical insurance policy for self as well as parents (Section 80D). Then there are deductions allowed for interest paid on an education loan (Section 80E), royalty on books (Section 80 QQB) etc. Deductions are also allowed for donations made to charitable institutions (Section 80G).

In most cases, a maximum deduction of Rs 1.5 lakh is allowed under Section 80C. This was limited to Rs 1 lakh earlier.  The point being that the Chapter VI A deductions in most cases can’t be over a couple of lakh rupees. Hence, there is a difference between total income of an individual and the returned income. Other than Chapter VI A deductions, there are other deductions allowed as well (interest on home loan being one).

Even with these limitations, the total number of tax payers with a returned income of greater than Rs 10 lakh at 13.32 lakhs in assessment year 2012-2013, is a very low number indeed. In fact, there were only 1.02 lakh tax payers with a returned income of more than Rs 50 lakh.

What does this tell us? It tells us that a major part of the country continues to be outside the income tax net. Of course, a major reason for this remains the fact that most Indians don’t earn enough to be paying income tax.

But it also tells us that there are many Indians out there who should be paying income tax but they don’t. The consumption patterns of luxury items clearly tell us that. And so does the price of real estate in many parts of the country. A major portion of the black money goes into real estate. Black money is essentially money which has been earned and has not been declared for tax purposes.

To conclude, the new data published by the Income Tax department is another indicator of the huge amount of black money that is a part of the Indian economy. Clearly no surprises there.

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

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

Rahul Gandhi Needs a Lesson in Inflation

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Rahul Gandhi, in his new avatar, as the angry young man (yes at 45 he is still young), has a thing or two to say on most issues. Let’s take the latest decision of the Narendra Modi government to cut the interest rates on the public provident fund(PPF) and the small savings schemes like Kisan Vikas Patra(KVP) and National Savings Certificate(NSC). Interest rate cuts ranging from 40 basis points to 130 basis points have been carried out. One basis point is one hundredth of a percentage.

Earlier the interest rates ranged from 8.4% to 9.3%. Now they are in the range of 7.1% to 8.6%. These interest rates come into effect from April 1, 2016.

Rahul Gandhi’s office tweeted to say that “slashing interest rates on small savings – on PPF and KVPs, is yet another assault by the Modi Govt on hard working middle class people.” He further said that “this Govt has failed farmers, failed the poor & now it’s failing the middle class. Modiji ppl are seeing through your event management politics.”

While the Modi government has taken the middle class for granted on other issues, like not passing on the benefits of the fall in oil prices in the form of lower petrol and diesel prices, or trying to tax the Employees’ Provident Fund corpus of private sector employees, the same cannot be said in this case. Before I get into explaining this, we first need to understand the meaning of inflation and how it impacts investment returns.

What is inflation? Inflation is essentially the rate of price increase. If the price of a product in March 2015 is Rs 100 per unit and it jumps to Rs 110 per unit by March 2016, the rate of inflation is said to be 10%. So far so good.

What does it mean when people say inflation  is falling? It doesn’t mean that the prices are falling. It means that the rate of increase in price rise is falling. Allow me to explain. Let’s extend the example considered earlier.

The price of a product in March 2016 is at Rs 110 per unit. Let’s say by March 2017, the price of the product has increased to Rs 115.5 per unit. This means that the price of the product has risen by Rs 5.5 or 5%. The inflation is 5%. Hence, the rate of price rise has fallen and the price of the product has gone up.

A fall in the price of the product would mean the price of the product going below Rs 110 per unit, by March 2017, which is a totally different thing.

This is a very important point which many people don’t understand and hence, it is worth repeating. A fall in the rate of inflation does not mean lower prices, it just means that the rate of price rise is falling or has slowed down.

Now let’s get back to Rahul Gandhi and the Modi government’s decision to cut interest rates on PPF and other small savings schemes.

The rate of interest on offer from April 1 onwards, ranges from 7.1% (on the one-year post office deposit) to 8.6% (on the Senior Citizens Savings Scheme and the Sukanya Samriddhi Account Scheme). What is the prevailing rate of inflation? Inflation as measured by the consumer price index in February 2016 had stood at 5.18%.

What does this tell us? It tells us that the rate of interest on offer on PPF as well as other small savings scheme is higher than the prevailing rate of inflation. This means that the money invested will “actually” grow and not lose its purchasing power. The real rate of return on these schemes is in positive territory. The same cannot be said for the period when Rahul Gandhi’s Congress Party was in power.

Inflation as measured by the consumer price index was 10% or higher between 2008 and 2013. In fact, the inflation during the period stood at an average of 10.1% per year. What was the interest that the Congress led UPA government was paying on PPF and other small savings schemes?

The rate of interest varied from anywhere between 8-9%. This, when the prevailing rate of inflation was greater than 10%. Hence, the money invested in these schemes was actually losing purchasing power.

This is not the case now. Investors are actually earning a “real” return on their investment. Some people told me on the social media that even with lower inflation, prices are not really falling. As I explained earlier, lower inflation does not mean falling prices. It just means that the rate of price increase has slowed down.

Also, it needs to be mentioned here that investments made into PPF and other schemes like Senior Citizens Savings Scheme, National Savings Certificate and Sukanya Samriddhi Account Scheme, enjoy a tax deduction under Section 80C. Hence, the effective rate of return on these schemes is higher than the interest that they pay.

I guess these are points that Rahul Gandhi needs to understand. Editors of media houses who have run headlines saying how the middle class will be hurt because of the cut in interest rates, also need to understand this. While “middle class hurt” makes for a sexy headline, that is really not the case.

Also, it is worth mentioning here that the Modi government is trying to introduce a certain method in the calculation of the interest to be paid on these schemes. The interest will now be linked to the rate of return on government securities and will be calculated every three months.

Indeed, this is a good move and brings a certain transparency to the entire issue. Further, people up until now have been used to interest rates on PPF and small savings schemes remaining unchanged for long periods of time. But now with a quarterly reset in these interest rates coming in, they need to get used to the idea of these interest rates changing on a regular basis.

This is something that needs a change in mental makeup and will happen if the government persists with this. Also, it is important in the days to come the government ensures that the rate of interest being paid on PPF and small savings schemes is higher than the rate of inflation. That to me is the most important thing than the current rate cut.

The column originally appeared in the Vivek Kaul Diary on March 21, 2016

SBI’s FlexiPay Home Loan Basically Looks Like a Marketing Gimmick

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In yesterday’s column I discussed why the State Bank of India(SBI) has launched the FlexiPay home loan. This home loan allows a borrower to borrow up to 120% of what he would have been able to do in the normal scheme of things.

Further, the borrower has the option to pay only interest on the home loan for the first three to five years. The EMI, which will lead to the principal being repaid as well, kicks in only after that.

The question to ask here is, how much will this benefit the borrower. Or is this just a marketing gimmick which the country’s largest bank has come up with in order to issue more home loans. It is clear that SBI wants to give out more home loans, given that they have a very low default rate in comparison to the other kinds of home loans that the bank gives out.

Let’s try and understand whether FlexiPay home loan is a marketing gimmick or does it ‘really’ benefit the borrower. Let’s take the example of a borrower, who in the normal scheme of things, is eligible to take on a loan of Rs 40 lakh. While this number may seem very low to those who live in metropolitan cities, the average home loan given out by HDFC, the largest housing finance company in the country, is around Rs 23.6 lakh. So a home loan amount of Rs 40 lakh is pretty decent by that comparison.

Getting back to the example. Let’s say a borrower is eligible to take on a loan of Rs 40 lakh. In the case of FlexiPay home loan, he will be eligible for a loan of up to Rs 48 lakh (1.2 times Rs 40 lakh). The interest that SBI charges on its home loan is 9.55% (It’s 9.5% for women).

The interest only option of the FlexiPay home loan allows the borrower just to pay interest on the home loan for the first three to five years. As the SBI press release on FlexiPay home loan points out: “Further, to lower the impact of such additional loan amount on monthly repayments in the form of EMIs, the customers availing Home Loan under ‘SBI FlexiPay Home Loan Scheme’ will also be offered the option of paying only interest during the moratorium (pre-EMI) period of 3 to 5 years, and thereafter, pay moderated EMIs.”

The idea, as SBI puts it, is to give the borrower the option to pay a lower amount every month during the initial years. But is this amount really low? Let’s do some maths to understand this point. I had done this in yesterday’s column as well, but on reading it later, I found that the point did not come out as strongly as it should have.

Let’s say the borrower opts for an interest only option for the first five years. He has taken a loan of Rs 48 lakh, as is allowed under the FlexiPay home loan. An interest of 9.55% would amount to a total payment of Rs 4,58,400 during the course of the year.

This means a monthly payment of Rs 38,200 to service the interest on the loan. If the borrower had taken on a normal home loan, he would have got a home loan of Rs 40 lakh. The maximum tenure of an SBI home loan is 30 years. Hence, the EMI on a Rs 40 lakh, 30-year home loan, at an interest rate of 9.55%, would work out to Rs 33,780. This is lower than the monthly payment of Rs 38,200 that needs to be paid as interest on a Rs 48 lakh home loan, if the borrower opts for the interest only option for the first five years.

So there is clearly no moderation in the payment as SBI claims. And that is primarily because the interest to be paid on the FlexiPay home loan is the same as a normal home loan. If the interest were to be lower, then the interest payment would have been lower as well and the moderation claim would have been true to a certain extent. But in that case the bank would have been taking on more risk as well.

Now let’s flip the situation. If the borrower were paying an EMI of Rs 38,200, what is the loan amount he would be able to service. The maximum tenure of an SBI home loan is 30 years. Hence, paying an EMI of Rs 38,200, for a tenure of 30 years, at an interest of 9.55%, the borrower would be able to service a home loan of Rs 45.23 lakh. The EMI for this loan works to around Rs 38,197.

The loan amount of Rs 45.23 lakh is around 5.8% lower than the loan amount of Rs 48 lakh. Hence, is it worth paying only an interest of Rs 38,200 per month for a Rs 48 lakh home loan, when for the same EMI one could get a loan of Rs 45.23 lakh. And that is the question that any borrower should be asking himself.

SBI will not give the borrower a loan of Rs 45.23 lakh under a normal home loan scheme, given the borrower is eligible only for a loan amounting to Rs 40 lakh. But the bank is willing to give a loan of up to Rs 48 lakh under the FlexiPay home loan scheme.

Hence, the borrower should take this opportunity of taking on a higher loan amount of Rs 45.23 lakh, if the need be, under the FlexiPay home loan scheme. But at the same time ensure that he does not opt for the interest only option but repay an EMI. Why do I say that? If the borrower takes on a loan of Rs 48 lakh and opts for the interest only option, he has to pay an interest of Rs 38,200 per month.

Over a period of five years this amounts to Rs 22.92 lakh, close to half the loan he has borrowed. Further, at the end of five years, not a single paisa of the loan amount has been repaid and he has to start repaying the loan. The borrower will have to repay the loan over a period of the next 25 years. For this, he needs to pay an EMI of Rs 42,104 per month, which is 10.2% more.

Now what would have happened if the borrower had opted to pay an EMI of Rs 38,200 per month on a home loan of Rs 45.23 lakh, and repaid it over thirty years. At the end of five years, he would have repaid around Rs 2.03 lakh of the loan already. In the interest only option, not a single paisa would have repaid. Also, it is worth pointing out here that the difference between a loan of Rs 45.23 lakh and Rs 48 lakh is not huge. Further, when a borrower pays an EMI, the principal amount of the EMI is allowed as a deduction under Section 80C of the Income Tax Act. And this deduction will not be available if interest only option is chosen.

What these numbers tell us very clearly is that the FlexiPay home loan looks more like a marketing gimmick to lure in prospective home loan borrowers. The borrowers are better off opting for the EMI option rather than the interest only option.

The column originally appeared on the Vivek Kaul Diary on February 3, 2016