warren buffett

माल्या को पकड़ना मुश्किल ही नही…नामुम्किन भी है

Mallya4545

A WhatsApp forward I received today morning went something like this: “Mallya ka intezar to 17 bank kar rahe hain…Mallya ko pakadna mushkil hi nahi namumkin bhi hai.” The forward was obviously a play on the dialogue that Amitabh Bachchan made famous in his 1978 movie Don.

Meanwhile Vijay Mallya who owes seventeen Indian banks Rs 9,000 crore(or Rs 7000 crore depending on which newsreport you want to believe) seems to have left the country. The attorney general Mukul Rohatgi told this to the Supreme Court today. Mallya left the country on March 2, 2016, the day the banks moved the Debt Recovery Tribunal(DRT) against him.

The banks had approached the DRT in order to stop the severance payment of $75 million (or a little over Rs 500 crore) that Diageo Plc was supposed to make to Mallya, in lieu of him stepping down as Chairman of United Spirits Ltd. Mallya has also entered into a five-year non-compete clause with Diageo. This payment is supposed to be made over a period of five years.

The DRT directed Diageo not to make any payments to Mallya until the case is disposed of. It has set the next hearing date for March 28, 2016. A report in The Times of India seems to suggest that Mallya may have already been paid $40 million out of the $75 million that he had been promised.

The newspaper quotes the fine print of the agreement that Mallia inked with Diageo on February 25, last month: “Diageo will pay $40 million of this amount immediately with the balance being payable in equal instalments over five years. Diageo’s payment obligations are subject to Mallya’s ongoing compliance with the terms of the agreement.”

The question is why are the banks going after Mallya? In India, the banks going after a corporate defaulter is something unheard of. But this time they seem to have the blessings of the RBI governor Raghuram Rajan.

Also, typically when banks lend a big amount, they lend it against a collateral. The idea is that if the borrower defaults, the banks can sell the collateral and recover their money.

So why are the banks going after Mallya instead of just selling the collateral and recovering their money? This is precisely the question that Justice Kurian asked the Attorney General in the Supreme Court today. “How did you give these loans. Was there no secured assets on these loans?” he asked.

It turns out that the banks had lent against the brand value of Kingfisher Airlines, which at that point of time was worth some thousand crores. After the airline shut down the value of the brand crashed, and the banks ended up with nothing. “We had some assets (as security) for the loans advanced,” Rohatgi said.

The Indian Express cites the 2012-2013 annual report of Kingfisher Airlines and writes that the Kingfisher Airlines brand was worth $550 million. The airline’s brand had been valued by the consultancy firm Grant Thorton. Further, it had been registered separately from the Kingfisher beer brand.

The newspaper further quotes CBI sources as saying: “Lending on the brand value of Kingfisher Airlines is a major concern. We have questioned the banks. It is basically an intangible asset. We are digging into the issue.”

A report in The Hindustan Times points out that IDBI Bank lent Rs 900 crore to Kingfisher Airlines against its brand in 2012-2013. By this time, the airline had already started making losses.

The question that crops up here is that do banks normally lend such a huge amount of money against the brand value of a company, which is clearly an intangible asset. Further, do banks lend money against an intangible asset, to a company which is making losses?

Another important point that needs to be made here is that an intangible asset like a brand normally tends to be overvalued. It is precisely because of this reason companies cannot have the value of their brands on their balance sheets unless they have bought it from someone else.

Given this, why lend so much money against a brand? Interestingly, the Kingfisher Airlines brand name was pledged to 14 lenders. As a report in The Indian Express points out: “The airlines brand name was pledged to 14 lenders, including State Bank of India (SBI), IDBI Bank, Punjab National Bank, Bank of India and Bank of Baroda under a debt recast agreement in which loans valuing Rs 6,500 crore were restructured and converted into equity.”

There is a lot of talk in the media about how could banks lend such a huge amount of money against the Kingfisher Airlines brand. The answer is very simple. The lending happened during the go go years of Indian banking when crony capitalists close to the government of the day, got loans way beyond their repayment capacity. Mallya is not the only such businessman, there are many more.

This explains why the Congress party which is quick to seize-in on any issue which would embarrass the government has been quiet on this issue, up until now. And how about the Bhartiya Janata Party, which is the governing party? The party had supported Mallya’s election to the Rajya Sabha in 2010.

Mallya in his defence wrote an open letter to the media a few days back. In this letter he said: “In fact, banks have NPAs of Rs 11 trillion and have borrowers who owe much more than the amount allegedly owed by Kingfisher Airlines to the banks—a fact never alluded to or widely reported by the media as in my case…None of these large borrowers (whose debt is significantly more than Kingfisher Airlines debt) have been declared wilful defaulters, but unfortunately, United Breweries Holdings and I have been declared wilful defaulters by certain banks on technical grounds. I have legally challenged these declarations.”

This is true. As of December 2015, the total gross non-performing assets(NPAs) of the Indian banking system stood at Rs 3.9 lakh crore. The loans Mallya and his companies have defaulted on form a small part of the total NPAs of the banking system. But that doesn’t mean Mallya should be allowed to get away with it.

In fact, if the government wants the other bid defaulters to pay up, it is very important that it ensures that Mallya is made to pay up. The way things go with Mallya will act as a benchmark for the other big defaulters.

The trouble with Mallya is that he has a very flashy lifestyle. And it is very evident that he continues to flaunt his money despite having defaulted on the loans. As Raghuram Rajan, governor of RBI recently, put it: “If you are in trouble you should show that you care by cutting down your expenses and not flaunting more spending in public.”

Further, the employees of Kingfisher Airlines continue to remain unpaid. Also, the fact that Mallya gobbled up their provident fund payments as well, did not do any good to his image.

The point being that if Mallya had had a less flashy lifestyle like some other big defaulters have, the banks would have probably not gone after him. There wouldn’t have been a public outcry and all the hungama in the media, either.

To conclude, Mallya’s fall is an excellent example of a businessmen going beyond his core area and ending up in huge trouble. Mallya ran a successful liquor business until he thought up of running an airline. And that is precisely where all his troubles started.

Airlines continue to remain a difficult business to run. Only if, Mallya had happened to read what legendary investor Warren Buffett had to say on airlines: “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”

But then Mallya was busy…with his IPL team…with his Formula One team…with his Kingfisher models…with his calendar…

When making a calendar becomes as important as running multiple businesses…guess this is how it ends!

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

The column appeared originally on Huffington Post India on March 9, 2016

 

Overconfidence of the ‘Bengaluru’ entrepreneur

flipkartThe last time I was in Bengaluru in late January and early February, almost everybody I met either wanted to be an entrepreneur or had already become one. I know I am stretching the truth here, nevertheless, the enthusiasm for entrepreneurship that I saw in Bengaluru is clearly missing in Mumbai, where I live, and Delhi, the city where my extended clan does.

A major factor that is needed for an individual to become an entrepreneur is “overconfidence”. As Gary Belsky and Thomas Gilovich write in Why Smart People Make Money Mistakes and How to Correct Them: “If people were not overconfident…significantly fewer people would ever start a new business…That their optimism is misplaced—that they are overconfident—is evidenced by the fact that more than two-thirds of the small businesses fail within four years of inception.”

It is worth clarifying here that overconfidence here does not mean arrogance. So what does it mean? As Belsky and Gilovich write: “What research psychologists have discovered about overconfidence is that most people—those with healthy egos and those in the basement of self-esteem—consistently overrate their abilities, knowledge, and skill, at whatever level they might place them.”

The entrepreneurs work along similar lines. In fact, research shows that even when entrepreneurs are told that their chances of survival are small, they don’t believe in it. As Nobel Prize winning psychologist Daniel Kahneman writes in Thinking, Fast and Slow: “The chances that a small business will survive for five years in the United States is about 35%. But the individuals who open such businesses do not believe that statistics apply to them. A survey found that

American entrepreneurs tend to believe that they are in a promising line of business…Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.”

Given that a whole host of Bengaluru denizens have worked in the United States or know someone who has, it is hardly surprising that the American way of doing things, has caught on, in the city as well. Nevertheless, this overconfidence works in several sways. It encourages people to become an entrepreneur in the first place. Further, it helps them to keep running the business in the face of all odds.

As Kahneman writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

On the flip side overconfidence also leads many entrepreneurs to launch businesses without any business model in place. Take the case of the Indian ecommerce companies, many of which are headquartered in Bengaluru. A significant number of these companies are operating without any business model, backed by an unending amount of private equity and venture capital money that has been pouring in.

The money that keeps pouring into these companies shows the ability of the entrepreneurs to keep raising money from investors in the hope of their companies making money someday. And this couldn’t have happened without them being overconfident.

As Kahneman explains: “Inadequate appreciation of the uncertainty of the environment leads economic agents to take risks they should avoid. However, optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.”

Given this, at this point of time, ecommerce is the flavour of the season, and anyone raising points about the viability of the entire sector, is usually shouted down upon. Nevertheless, as Warren Buffett said during the course of the dotcom bubble which burst in 2000, “but a pin lies in wait for every bubble.” And that is something worth remembering here as well.

The column originally appeared in the Bangalore Mirror on Sep 30, 2015

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

Kingfisher debacle to United Spirits row: Charting out the great fall of Vijay Mallya

vijay-mallya1Vivek Kaul

Vijay Mallya is too much of a stiff upper lip to have ever read the Urdu poet Mirza Ghalib. But if he has, he would know, that one of Ghalib’s most famous couplets, fits the current situation that Mallya is in, very well.
Sometime in the nineteenth century Ghalib wrote:

Nikalna khuld se aadam ka soonte aaye hain lekin
Bahot be-aabru hokar tere kooche se hum nikle

(We have heard about the dismissal of Adam from Heaven,
With more humiliation, I left the street on which you live…

Source of translation: https://medium.com/@herahussain/poetry-in-the-east-a-journey-of-discovery-of-urdu-poetry-6197767f41b4)

The board of United Spirits Ltd, India’s largest liquor company, has asked Mallya to step down as the Chairman of the company. The liquor baron may have been involved in financial irregularities as per an internal probe carried out by the company.
In a press release dated April 25, 2015, the company said: “The inquiry covered various matters, including certain doubtful receivables, advances and deposits. The inquiry revealed that between 2010 and 2013, funds involved in many of these transactions were diverted from the Company and/or its subsidiaries to certain UB Group companies, including in particular, Kingfisher Airlines Limited…The inquiry also suggests that the manner in which certain transactions were conducted, prima facie, indicates various improprieties and legal violations.”
Mallya in true Indian style has refused to bow out. ““All I wish to say is that I intend to continue as chairman of USL in the normal manner. This includes chairing monthly operating review meetings and board meetings,” he told the Mint newspaper.
Where does this confidence come from? Mallya personally holds 0.01% shares in United Spirits. United Breweries Holdings Ltd (controlled by Mallya) holds 2.90%. Other investment companies controlled by Mallya own around another 1.18%. So Mallya’s holding in United Spirits is down to a little over 4%.
Diageo, the British company to which Mallya sold United Spirits, owns 54.78% of United Spirits. Mallya’s confidence stems from the fact that while selling United Spirits, Mallya and Diageo entered into an agreement, as per which Diageo has to endorse Mallya as the Chairman of United Spirits. This, till Mallya has a stake in United Spirits.
Given this, the stage is set out for a messy legal battle, which will continue for sometime to come. Nevertheless, the question is how did Mallya end up in the mess that he has? One reason was that he took his flamboyant style a little too seriously and ended up starting Kingfisher Airlines in 2005.
Airlines are huge cash guzzlers. As Warren Buffett has said in the past: “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”
Kingfisher Airlines became Mallya’s bottomless pit. Mallya was in a rush to buy planes. He had plans of buying one Airbus A-320 every month until March 2012. All this needed a lot of money. Mallya loaded up on debt from public sector banks. At the same time, Mallya being Mallya could not have run a low cost airline. In a October 2012 article, Tehalka quotes an aviation sector CEO as saying: “Food served in KFA[Kingfisher Airlines], recalls an aviation sector CEO, was about Rs 700-800 per passenger compared to Rs 300 of Jet’s.”
Other than this Mallya was in a hurry to fly Kingfisher to international destinations. A domestic airline was allowed to do that only once it had completed five years of operation. That meant that Kingfisher would be allowed to fly abroad only by 2010. Mallya did not have the patience to wait for that long. He bought Air Deccan in 2007 to get around the regulation. He ended up overpaying for the low cost airline.
Further, he rebranded Air Deccan as Kingfisher Red. By doing this he diluted the premier positioning that Kingfisher Airlines had acquired in the minds of the consumer. The philosophy required to run a premium brand is totally different in comparison to the philosophy required to run a low cost brand. Hence, Mallya buying Air Deccan was mistake. And then changing its name to Kingfisher Red was an even bigger mistake.
So in the end this did not work and Mallya decided to close down Kingfisher Red. He explained it by saying that “We are doing away with Kingfisher Red, we do not want to compete in the low-cost segment. We cannot continue to fly and make losses, but we have to be judicious to give choice to our customers.”
It is very difficult to run a full-service airline as well as a low cost airline at the same time. The basic philosophy required in running these two kind of careers is completely different from one another. The full service Kingfisher also soon ran into trouble leaving Mallya with a lot of debt. He had got terrible publicity for not paying the salaries of employees of Kingfisher Airlines.
Other than running the liquor and the airline business, Mallya also has interests in real estate. Over and above this, he also indulged in expensive hobbies by buying a formula one and an IPL cricket team. Running an airline is a full time business and can’t be done in a part-time sort of way which Mallya did.
The best Indian companies in the last few decades have made money by concentrating on one line of business. Airtel made money in telecom. It did not make money trying to sell us insurance and mutual funds. The same stands true about DLF. Tata, Birla and Ambani, all lost money in the retail business. Businesses over the years have become more complicated. And just because a promoter has been good at one particular business doesn’t mean it will be good at another totally unrelated business. Mallya did the same with his main liquor business, which he is now losing control of.
Over the last few years, Mallya has been battling the banks which have been going after his assets, for all the debt that is unpaid. To conclude, Mallya has always been too busy living his flamboyant lifestyle and that seems to have caught up with his businesses in the end.

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

The column originally appeared on www.Firstpost.com on Apr 27, 2015

Lessons from the collapse of SpiceJet


SpiceJet_Boeing_737-900ER_Vyas-1
Vivek Kaul

In June 2010, Kalanithi Maran took over SpiceJet. I wrote an article around the takeover, in the newspaper I used to work for at that point of time, starting with the line “It takes a brave man to buy an airline.”
Towards the end of the article I quoted Warren Buffett. This was something the Oracle of Omaha had written in his annual letter to Berkshire Hathaway shareholders, in February 2008. As Buffett wrote: “Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
What made Buffett say this? “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt,” wrote Buffett.
After a shorter version of this piece of wisdom from Buffett, I closed the article on SpiceJet, with the line: “Surely, Maran knows what he is up against.” As it has turned out, I was hoping against hope. SpiceJet is now in major trouble and has had to scale back its operations.
Between October 2013 and September 2014, the company faced losses of Rs 928.9 crore. During the period July to September 2014, the company made losses of Rs 310 crore. This, despite the fact that global oil prices fell during the period.
In the last few months the airline has also used what aviation industry insiders term as the “Christmas tree” option. This essentially means that the airline is taking out spare parts from its aeroplanes and using them for other planes in its fleet. Long story short: it doesn’t even have the money to pay for spare parts.
The commercial aviation business is a huge cash guzzler and has led many a capitalist to his ruin—Vijay Mallya being the latest such example. And as things currently seem Maran’s SpiceJet seems headed that way.
This is not only an Indian phenomenon, it seems to be the case globally. Economist Severin Borenstein examined the scenario in the United States in a 2011 research paper. He found that the airlines had lost around $60 billion (2009 dollars) between 1978 when the aviation sector in the United States was deregulated and 2009. High taxes were a reason for the losses and so was the fall in demand after 9/11.
A February 2014, article in The Economist suggests that profits margins of airlines have been less than 1% on average over the last 60 years. This makes me wonder why do businessmen still want to enter this sector?
Interestingly, airlines made a profit of only $4 per passenger in 2012. Another interesting study carried out by McKinsey points out that in 2010, around $500 billion of capital was invested in the airline industry. The overall cost of capital for this stood at around 7-8%, whereas the return on invested capital was at 2.8%. No wonder investors constantly lose money on airline stocks.
What this tells us is that commercial aviation is a tough business to be in. And why is that the case?There are several reasons for the same:
a) It is a highly capital intensive industry.
b) There is a lot of competition.
c) It gets impacted by a lot of things that are not under its control (the overall economic sentiment, taxes, outbreak of illnesses, price of oil and so on)
d) While the industry has to face a lot of competition, the industries that airlines have to deal with are highly monopolistic. As an article in The Economist puts it “Two firms—Airbus and Boeing—provide the majority of the planes, and airports and air-traffic control are monopolies.” Given this, airlines are not always in the best position to control their costs.
e) For a very long period of time, airlines were run by governments, and hence, profit was not the only motive. Over the last few decades, the world has seen a spate of low cost carriers being launched. These airlines have given tough competition to full service carriers.
These are general reasons as to why airlines find it tough to make money. Some of these reasons apply to SpiceJet as well. But there are other major reasons as to why the airline is in trouble. Unlike Vijay Mallya’s Kingfisher which was confused about being a full service carrier or a low cost airline, SpiceJet was always a low cost airline. There was no confusion on that front.
But like Mallya, aviation is not Maran’s primary business. His primary business is spread across television channels, a cable TV distribution network and newspapers in the state of Tamil Nadu and the other Southern states. Further, these businesses have always had the political protection of the DMK party (Maran is the grand-nephew of DMK boss M Karunanidhi).
Maran’s lack of experience in the aviation sector started to come out as soon as he took over the airline. After taking over the airline he went around installing his own people to run the place. As a report in the Business World points out “With the change in ownership, everyone at the airline knew that the chief executive officer and chief financial officer would change…The replacements on the board were largely Maran’s own family members and trusted aides but not necessarily people with experience of running a business — leave alone an airline.”
The airline also saw a steady exit of employees who knew how the aviation business operated. Another major blunder committed by the airline was allowing IndiGo to capture the slots in the Delhi-Mumbai route, left vacant by Kingfisher, after it stopped flying.
As the Business World report referred to earlier points out “SpiceJet had roughly six to seven flights a day between the two metros and IndiGo had around seven to eight. Today, IndiGo has close to 15 flights between the two metros. Delhi-Mumbai drives the aviation business in India and accounts for almost 60 per cent of traffic in the country.”
This was more because of the lack of experience of running an airline than anything else. Moral of the story: It is one thing running a business with the protection of a political party and it is another thing running a business which has some semblance of competition.
To conclude, what the failure of airlines like Kingfisher, Air India and now SpiceJet, clearly tells us is that you cannot “also” be in the commercial aviation business. Mallya found this out the hard way. He also ran an airlines business, along with his primary liquor business, real estate business and some sports business. Maran seems to be headed Mallya’s way with his huge losses. The government owned Air India continues to accumulate losses, in a country where Railway infrastructure remains very poor. A report in the Mint newspaper points out that combined losses of airlines in India over a period of seven years ending March 2014, stood at close to $8.6 billion.
What a mess!

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 9, 2014

Warren Buffett’s favourite business book tells us what is wrong with India’s tax system

Warren_Buffett_KU-crop,flip

Vivek Kaul

Business books are soporific. They put me to sleep.
Nonetheless, now and then, one does come across an excellent business book as well. These days I am reading John Brooks’ Business Adventures. The book is a collection of 12 long articles that Brooks wrote for the New Yorker magazine.
In July 2014, Bill Gates wrote a blog titled The Best Business Book I’ve Ever Read. As he put it : “Not long after I first met Warren Buffett back in 1991, I asked him to recommend his favorite book about business. He didn’t miss a beat: “It’s Business Adventures, by John Brooks,” he said. “I’ll send you my copy.” I was intrigued: I had never heard of Business Adventures or John Brooks. Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.” This blog by Gates sent the book to the top of the best-sellers lists almost everywhere.
The third chapter of the book is called The Federal Income Tax. Brooks makes several points in the chapter about the income tax system in the United States as it had prevailed in the fifties and sixties. Some of the points I feel are as applicable to the general tax environment in India today as they were in the United States back then.
As Brooks writes in the context of the federal income tax in the United States: “A good deal of the attention given to the income tax is based on the proposition that the tax is neither logical nor equitable. Probably, the broadest and most serious charge is that the law has close to its heart something very much like a lie; that is, it provides for taxing incomes at steeply progressive rates, and then goes on to supply an array of escape hatches so convenient that hardly anyone, no matter how rich, need pay the top rates or anything like them.”
Long story short: The rich were “supposed” to be taxed at a high rate, but at the same time enough loopholes were built into the income tax laws ensuring that they did not pay the highest tax rates in reality.
A similar sort of scenario prevails in India when it comes to the Income Tax Act in particular and taxes in general. Along with the budget every year, the government of India puts out a statement of revenue foregone under the central tax system.
What is the purpose of this system? “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the latest statement of revenue foregone points out.
The deductions, exemptions and other measures lead to a loss of revenue for the government. As can be seen from the accompanying table the revenue foregone for the government during the year 2013-2014 has been estimated to be at Rs 5,72,923.3 crore.

Statement of Revenue Foregone

TaxYear(in Rs crore)
2012-20132013-2014
Corporate Income Tax68,720.076,116.3
Personal Income Tax33,535.740,414.0
Excise Duty209,940.0195,679.0
Customs Duty254,039.0260,714.0
566,234.7572,923.3


A simplistic way of looking at it is that the revenue foregone number is greater than the fiscal deficit of the government for 2013-2014, which stood at Rs 5,42,499 crore.
Nevertheless it needs to be pointed out that the statement of revenue foregone is based on certain assumptions. As the statement points out “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.”
So the revenue foregone figure needs to be looked at with these limitations in mind. Having said that, the government of India is losing out on revenue because of the exemptions and deductions. There is no denying that. As can be seen from the above table corporate India is a major beneficiary of the same, like the rich were in the United States, around the time Brooks wrote about the federal income tax.
Getting back to Brooks, he also points out that laws and the regulations were so vast that the critics thought it was an “undemocratic state of affairs, for only the rich can afford the expensive professional advice necessary to minimize their taxes legally”.
This is what is happening in India as well. Companies have an army of chartered accountants and lawyers, working towards legally minimizing taxes, whereas most individual tax payers find it difficult to afford the services of a good chartered accountant who can help them.
Brooks also talks about the favoured treatment of capital gains. This is something that really helps the rich because they are the ones primarily investing in stocks and bonds. In India short term capital gains on equity gets taxed at 15%. There is no long term capital gains tax on equity i.e. if you buy and then sell a share after one year, you don’t have to pay a tax on the capital gains you make when you sell the shares. Equity mutual funds are treated in a similar way.
In case of debt mutual funds, long term capital gains come into the picture if the investment is held for a period of more than three years. Long term capital gains are taxed at either 10% or 20% with indexation, whichever is lower. Indexation allows inflation to be taken into account while calculating the cost of purchase. This brings down the tax significantly.
Now compare this to the common man’s investment—the humble fixed deposit. In this case the interest earned is taxed at the marginal rate of tax. Why is there a favourable treatment for investing in equity? I have often been told that this is because the investor investing in stocks is taking on more risk than the fixed deposit investor, and hence needs to be encouraged through a favourable tax treatment.
This I guess is “bullshit” (pardon my French!) of the highest order perpetuated by those who invest in equity and do not want to pay any tax on it. The amount of risk that an individual wants to take on with investments, is his or her personal preference and should have nothing to do with the prevailing income tax system. Nevertheless that’s the way things stand. Equity gets preferential tax treatment all over the world.
Other than this, the Indian Income Tax Act has a very interesting provision for those taking on a home loan to buy a home. In fact, the Act encourages people to speculate in real estate. There is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income.
We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
In a country where a large number cannot afford to buy a home what is the logic in having a regulation like this one?
The Direct Taxes Code, which is supposed to be replace the Income Tax Act, in its original form simplified the income tax system. In fact, I remember reading a large part of it when it first came out and was very impressed by its simplicity.
But a simple tax code doesn’t benefit those who currently make money out of the Income Tax Act being as complicated as it is. These include chartered accountants, tax lawyers, corporates and the income tax officers. Over the years, the Direct Taxes Code has been revised and from what I am told by those in the know of such things, it has become more or less as complicated as the Income Tax Act currently is.
To conclude, the tax system in India currently favours those who need to pay more taxes. This is something that needs to be addressed in the days to come.

The article originally appeared on www.equitymaster.com on Dec 2, 2014