army armed forces officers - Hum Fauji Initiatives

Col Arun Kumar Karmakar is retiring next month and had approached Hum Fauji Initiatives to take him ahead with his retirement planning, tax planning and investment of his retirement portfolio to his and his family’s best advantage.

The goal-based retirement plan made for him by Hum Fauji was under the process of discussion with his Relationship Manager (RM) and Asst Manager (AM) in the company when news came about the amendment done in budget proposals wherein Long Term Capital Gains (LTCG) status and indexation provisions of debt mutual funds were removed. He got confused about whether the debt MFs included in the plan made for him by Hum Fauji still remained relevant to him.

The conversation between him (AKK) and his RM took place as follows:-

AKK: With no LTCG benefits available, I think the debt mutual funds should be removed from the portfolio prepared by you and we should stock up on bank FDs, corporate FDs, Senior Citizens Savings Scheme (SCSS), Govt Bonds etc recommended by you.

RM: Sir, LTCG and indexation benefits are just one of the benefits offered by Debt MFs. There are so many other benefits that debt MFs give you over traditional investment avenues that we recommend you to continue with them in your retirement plan.

AKK: Tax saved is money earned. If I don’t save tax, then why should I invest in them.

RM: Sure Sir, we should surely try to save tax wherever possible and if you see the plan made by us, we have already done that at every step. But any plan based entirely on tax concessions is bound to trouble later since tax laws can be changed any time by the Govt, as in the current instance.

AKK: All this is very fine but I fail to see how debt MFs give me any edge over other avenues now.

RM: Sure Sir, I would like to tabulate it for you so that the two types of instruments can be compared

Aspect	Bank FDs	Debt MFs
Safety	Very safe.	As safe as you want – wide choice and flexibility available. For max safety, take MFs investing only in bank FDs and Govt Bonds and still get better returns and benefits
Mark to Market (M2M)	No such facility available which actually would disadvantage as rate go down from here	Huge advantage. Current interest rates are at their peak. As they go down, long term debt MFs will gain in value while FDs will give you lower interest rates
Systematic Withdrawal Plan (SWP)	Anything earned from bank FDs is fully taxed	This is the best way to take additional income or pension since it can save up to 80% of the tax that you would comparatively pay on your pension, bank interest, SCSS interest and other similar instruments.
TDS	Tax Deducted at Source irrespective of FD being cumulative or non-cumulative	No concept of TDS for resident Indians
When taxed	Taxed every year on interest earned – actual or notional – irrespective of the tenure of the FD	Taxation only when redeem MFs. Big advantage if your taxation is going to be lower later, say after retirement or getting disability pension. Could also invest in minor children’s name now or if major children not likely to earn or be in a high tax bracket for a long time to save tax.
Tax Saving on gains	No set off of FDs’ tax on interest against any other loss	Short Term Capital Gains (STCG) of MFs can be set-off against short-term capital losses (STCL) of other instruments like equity, equity MFs and others.
Tenure	Have to decide beforehand and would face issues of penalty if money requirement occurs before or after FD maturity	No tenure laid down – absolutely flexible. Withdraw when you wish or may not withdraw the whole life even though invested for a different tenure in mind initially
Liquidity	Any time but penalty imposed on premature withdrawal	Full or partial liquidity within 1-4 working days. Exit load may or may not be there depending on the fund chosen by you. Typically, no exit load beyond One year
Choice	No choice – a FD is a FD and nothing else	Huge menu available. Choose as per your requirement and returns desired
Anything else	Bank FDs much older product, hence occupy Indians’ mind space. Best only for creating Emergency Fund	Latest products with huge innovations; active investing as per interest rate scenario; and flexibility of investing and withdrawal

Sir, I hope I’ve been able to convey to you that, with the recent tax change, only one aspect of debt MFs has changed while all other advantages remain.

AKK: OK, convinced about the bank FDs Vs debt MFs comparison. But aren’t SCSS and corporate FDs now better than debt MFs after this taxation thing?

RM: Sir, corporate FDs surely give you better interest than bank FDs. You should have them in your portfolio for diversification and better returns. The corporate FDs suggested by us are top-of-the-class combination of safety and returns. But SCSS, even though giving a good 8% interest and have high safety, suffer from four main disadvantages:-

Interest is fully taxable. So, you will actually get 5.6% in hand after tax.
Even if you do not want the interest, it is compulsorily given to you and you have no choice.
Since you have already taken out the interest, there is no compounding in SCSS which is a big disadvantage since you anyway do not need the monthly additional income that is compulsorily given to you.
Bank or Post Office clerk will tell you to put this quarterly interest of SCSS in a Recurring Deposit (RD) and you will get ‘9-12% total interest’. This is a wrong calculation. You get an average of the interest rate of SCSS and RD and get taxed twice on the interest at SCSS as also RD.

So, we recommend only a limited amount to be invested in SCSS.

AKK: OK. Let us not delay the discussions any further and go ahead with the plan as prepared by you!

RM: Sure Sir.

Also Read: Will You Miss Out This Tremendous Safe Investment Opportunity?

Have you sold your house and earned a hefty amount in profit but do not want to pay any income tax on this profit? Is there any legitimate way to do this? Yes, there are more than one ways. We explain below how income tax can be avoided (of course, totally legally) on Long Term Capital Gains (LTCG) earned from the sale of a house (a flat or an apartment or an independent house – any residential property) which you have held for at least 3 years.

Please Note:

There is no way to save income tax on the short term capital gain earned from the sale of a house, ie a house held for less than 3 years. This mail specifically deals with long termcapital gain only.
For the sake of keeping the discussion simple, we presume that you have taken advantage of the benefit of indexation while calculating your capital gains, where the tax is 20%. If you do not take indexation into account, the rate of tax on LTCG is 10%.
The discussion below applies only to sale of residential house property. For sale of other assets like residential plot, commercial properties, gold etc, other Income Tax Act provisions apply.

There are two ways to save the income tax on the long term capital gain earned from the sale of a house. Let’s understand each in detail.

A. Invest in Bonds – Section 54EC of the Income Tax (IT) Act, 1961

You can save income tax on LTCG from the sale of a house, if the LTCG is invested in specified bonds issued by the National Highways Authority of India (NHAI), Rural Electrification Corporation (REC), Small Industries Development Bank of India (SIDBI), National Housing Bank (NHB) or National Bank of Agricultural and Rural Development (NABARD).

How Much is Exempt

Amount exempted under this section will be either the amount of capital gain or the amount invested in capital gains bonds, whichever is lower subject to a maximum of Rs 50Lakhs. Please note that here it is only the amount of long term capital gain, and not the entire sale proceeds that is being referred to. For example, if you sell your house for Rs 15 Lakhs, and your LTCG from this sale is Rs 10 Lakhs, you need to invest only Rs 10 Lakhs in these bonds to avoid paying any income tax on this gain! Instead, if you invest, say, Rs 6 Lakhs in these bonds, you would have to pay a long term capital gains tax on the remaining LTCG of Rs 4 Lakhs. Thus, you would pay 20% of Rs 4 Lakhs = Rs 80,000 as long term capital gains tax. Remember, LTCG Income Tax rate is 20% (if indexation benefit has been taken) and not your own Income Tax rate.

When to Invest

The investment in these bonds has to be made within 6 months of the sale of the house. The Capital Gains Bonds’ Maturity Period is 3 years. Bonds cannot be pledged, sold or transferred before completion of 3 years from purchase of bonds. In case they are transferred, then the amount of capital gain exempted on investment in these bonds will be made taxable in that year as LTCG.

Interest Rate of Capital Gains Bonds

The interest rate on these bonds varies from one agency to another and changes from time to time. Generally they carry an interest rate of 6% per annum.

Should you invest in Sec 54EC LTCG tax saving bonds or Elsewhere?

Let’s say your LTCG is Rs 10 Lakhs. You have two options: Saving tax by investing in Sec 54EC tax saving bonds, or paying tax and investing the amount somewhere else. Let’s find out what the financial implication of each option is, and which option proves to be better!

Option 1: Save tax by investing in Sec 54EC tax saving bonds

Entire LTCG amount of Rs 10 Lakhs invested in these bonds. The rate of return is 6%. But the interest earned on these bonds is not tax-free. If you fall in the highest tax bracket of 30%, your post-tax return would be 4.2% (6% – 30% of 6% ie (6% – 1.8%)) per year. At 4.2% interest rate, your Rs 10 Lakhs would grow to Rs 11,92,349 in 3 years.

Option 2: Pay tax, and invest in a safe high-yield avenue

On LTCG of Rs 10 Lakhs at 20%, you pay a tax of Rs 2 Lakhs, and are left with Rs 8 Lakhs for investment. If you want to invest in safe avenues, you may go in for, say a Bank FD, since currently bank FDs give interest rate as high as even 9.5%. If you fall in the highest tax slab of 30%, your post-tax return would be 6.65% per year (9.5% less 30% tax on 9.5%). Rs 8 Lakhs would grow to Rs 9,70,449 in 3 years if invested at 6.65%.

Evaluation: If you are planning to invest the proceeds in safe avenues like Bank FDs, then your returns are much lower than if you invest in these Capital appreciation bonds – in that case, investing in the Capital Gains Bonds is better. However, if you wish to go in for higher return avenues like Equity-oriented Mutual Funds, where you may get 12% per annum returns or more over a 3 year period, your post-tax returns will be higher but then you are also getting into a slightly riskier territory. A good mid-way may be to go in for Debt Mutual Funds where returns are slightly more than bank FDs, tax is much lesser and safety is almost the same. Choice finally remains yours on the end-use which will finally guide what option you need to take.

B. Invest in another House – Section 54 (Sec 54 of the Income Tax (IT) Act, 1961)

You can save income tax on the LTCG from the sale of a house, if the long term capital gain is invested in another house.

How much is Exempt

The amount of LTCG exempt from income tax is equal to the amount invested in the new house. You can save the entire income tax on the LTCG from the sale of a house, if the entire LTCG is invested in another house. Again, please note that you have to consider the amount of the LTCG, and not the entire sale proceeds.

When to Invest

The investment in a new house has to be made within a time-range in order to claim exemption (or relief) under section 54EC. This time-range is: Upto 1 year before the sale of the house, or within 2 years after the sale of the house for a ready-built house/flat or within 3 years if the new house/flat is being constructed (and not ready-built). Remember that the new house/flat cannot be sold any time within 3 years after its possession – otherwise the LTCG exemption availed by you will be fully taxed.

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With regards,
Col (retd) Sanjeev Govila, CERTIFIED FINANCIAL PLANNER^CM,

CEO, Hum Fauji Initiatives,
Your long-term partner for wealth creation

9999 022 033, 011 – 4054 5977 (Off), humfauji.in

Category: army armed forces officers

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