Category: Houses for army officers

24 Nov 2012
Unexpected Windfall by Income Tax Tribunal for Sellers of House Property

Unexpected Windfall by Income Tax Tribunal for Sellers of House Property

On 31 October 2012, the Income Tax Appellate Tribunal (ITAT) delivered an order that is set to bring an unexpected relief to millions of home buyers in the country. It clarified that the interest paid on home loans is an expense to the home buyers and hence is to be counted as a cost to them. Thus, when they sell the house, the capital gains on its sale will be the sale price less the purchase cost and all the interest that they paid on its home loan, if availed of.

So far, capital gains on the sale of a house were its sale price less the purchase price. The only relief available was for LTCG (long-term capital gains) (ie, if the house was held for at least 3 years after its possession) where the cost of purchase and its improvement could be indexed to the CII (Cost Inflation Index). For short term capital gains, no indexation relief could be availed of. As far as the interest on housing loan was concerned, its advantage was available under Income Tax Section 24(b) where yearly relief of Rs 30,000 or 1.5 Lakhs for self-occupied property, and interest paid less the rent for rented out property was available. There was no relief available on capital gains for the interest paid.

The case under consideration of the tribunal was of a tax payer C Ramabrahmam, who borrowed money for buying a house property. He claimed deduction for the home loan interest paid while computing income from house property. When he sold the house, he also treated the interest paid as his ‘cost of acquisition’ of the house and claimed deduction there too. The income Tax assessing officer disallowed it. Matter went to the first appellate authority, Commissioner (Appeal), who allowed the claim of the taxpayer. Income Tax department appealed but even the ITAT has now sided with the tax payer holding that deduction under IT Section 24(b) deals with house property while the capital gains IT Section 48 deals with only the gains and the two can co-exist separately since they are covered under different heads of the income.

To illustrate the effect of this ruling, consider the case of a person X who buys a house for Rs 30 Lakhs in 1997, takes a home loan of Rs 24 Lakhs (80% of value) paying an EMI of Rs 23,672 for 15 years at average 9% per annum interest rate. The total interest outgo is about Rs 18.6 Lakhs over 15 years. Let’s say he sells it for Rs 1.87 crores in 2012 (taking a good 13% per annum appreciation). Using normal method of indexation, his cost of acquisition comes to Rs 73.77 Lakhs, capital gains is Rs 1.13 Crores and he pays a tax of Rs 35 Lakhs on it if he is in 30% tax bracket. However, if the ITAT judgement delivered now stands, his cost of acquisition (counting indexed payment of interest also) would be Rs 1.12 Crores, capital gains would be Rs 74.6 Lakhs and he would have to pay a tax of only Rs 23 Lakhs. Thus, he saves tax to the extent of Rs 12 Lakhs, ie a saving of about 35% of tax.

Now the question uppermost in everybody’s mind should be – will this ruling by the ITAT go unchallenged by the Income Tax department, given the large revenue loss that the Govt is likely to face. It is very unlikely that the Govt will let the matters lie at this point. The course open to Income Tax Department now is to go to the higher courts – first High Court, then Supreme Court and if even then there is no favourable ruling, a change in Income Tax Act itself should not be ruled out. What if anybody files his Income Tax Return as per new ruling in the intervening period? It will have to be allowed by the Income Tax assessing officer but chances of it being rolled back are also equally high if the Income Tax department gets a favourable ruling at any stage.

Another pertinent point is – will the interest paid at different points of time be allowed to be indexed? In case the interest is allowed as a cost as per the recent ruling, to my mind, there should be no dispute that indexation will have be allowed in the interest cost, as it is allowed currently in the cost of improvement or renovation of the house property.


With regards,

Col (retd) Sanjeev Govila, CERTIFIED FINANCIAL PLANNERCM

CEO, Hum Fauji Initiatives,
Your Long-term Partner for Wealth Creationhttps://humfauji.in/income-tax-filing-armed-forces-officers/
9999 022 033, 011 – 4054 5977, 011 – 4214 7236,  humfauji

 

Visit our Blog,  humfauji.in/blog or facebook page  http://www.facebook.com/HumFaujiInitiatives or follow us on Twitter  https://twitter.com/#!/humfauji  to get latest insight on matters financial

 

04 Apr 2012
Taxation of House Rent Allowance (HRA)

Taxation of House Rent Allowance (HRA)

We often come across people who consider HRA as the amount which is given in-lieu of accommodation and hence fully exempt from tax. There are an equal number of people who consider it as fully taxable – hence, if they get, say, Rs 20,000 as HRA per month, they consider that they are effectively getting only Rs 14,000 if they are in 30% tax bracket. None of the above is actually true, as explained below.

HRA is the amount paid by the employer to an employee as a part of the salary package. HRA is given to meet the cost of rented accommodation taken by the employee for his stay. A person can claim exemption on his house rent allowance (HRA) under the Income Tax Act if he stays in a rented house. The exemption of HRA is covered under Section 10 (13A) of the Income Tax Act and Rule 2A of the Income Tax Rules.

Two conditions should be met to avail the exemption on HRA:

  • The rent must actually be paid by the assessee for the rented premises which he occupies.
  • The rented premises must not be owned by him.

Please do not confuse the above two conditions as ‘conditions for grant of HRA’ – it is not so. These are the conditions to be met if you wish to seek Income Tax exemption on HRA which has been granted to you by your employer.

While calculating HRA, we effectively calculate the amount that is exempt from being considered as part of the salary. This implies that complete HRA will be considered as part of the salary, except the amount as calculated below.

The amount of HRA exempt is the LEAST of these 3 conditions:

  • Actual amount of HRA received by the person in the relevant period during which the rental accommodation was occupied by him.
  • Amount left after deducting one-tenth (1/10th) of the person’s salary for the relevant period from the actual rent paid by him (Rent paid minus 10% of salary). [Note: No deduction if rent paid does not exceed 10% of salary]
  • In case the house is in Mumbai, Calcutta, Delhi or Chennai, 50% of the salary of the person in the relevant period. In case the house is in any other place, 40% of the salary of the person in the relevant period.

Example to Calculate HRA

The deduction is available only for the period during which the rented house is occupied by the employee and not for any period after that. For example, during the year 2012-13, assume an assessee resides in Pune and gets a salary of Rs 8 lakhs as basic and Rs 3 lakhs as HRA. He pays an actual rent of Rs 2.4 lakhs.

Amount of HRA exempt would be least of the following three conditions:

  • Actual HRA received = Rs 3 Lakhs
  • Excess of rent paid over 10% of salary, i.e., Rs 2.4 lakhs less Rs 80,000 (which is 10% of Rs 8 lakhs salary) = Rs 1.6 lakhs.
  • 40% of salary (as the accommodation is in Pune), i.e., 40% of Rs 8 lakhs = Rs 3.2 lakhs.

As, out of these, Rs 1.6 lakhs is the least, it will be allowed as a deduction from salary for the year. Thus, HRA considered as part of the salary would be 3 lakhs less 1.6 Lakhs = Rs 1.4 lakhs, which will be counted as his taxable income.

Definition of salary

For the purpose of arriving at the deduction available, salary means the basic salary and also includes the Dearness Allowance (DA), if the terms of employment provide for it, and the Commission based on a fixed percentage of turnover achieved by the employee.

When is the deduction not available

The deduction for HRA is not available in case the employee lives in his own house. The deduction is also not available in case the employee does not pay any rent for the accommodation used by him, eg, living with his parents and paying no rent to them.

Feel free to write, mail us at contactus@humfauji.in or Buzz us in on tele numbers 011-4054 5977 / 4240 2032 / 4903 6836 or send us a SMS / Whatsapp on 9999 053 522

 

18 Sep 2011
What are your options in this increasing EMI scenario of your home & other loans?

What are your options in this increasing EMI scenario of your home & other loans?

Maj Manish is a 30 year old officer and his family includes his wife (homemaker), 3 year old daughter, and retired parents. Manish had taken a home loan of Rs 25 lakhs one year back at 8.5% for 20 years with a monthly EMI of Rs. 21696. Apart from repaying the home loan, Manish’s other goals include planning for his daughter’s education, marriage and his own retirement. However, his entire planning is going haywire with his borrowing bank raising his Equated Monthly Instalments (EMIs) frequently ever since he has taken the loan. In one year the interest rate on Manish’s home loan has increased from 8.5% to 10%. The EMI has shot up from Rs 21,696 to Rs 24,043 and the outstanding balance is Rs 24.50 lakhs. Against the original total interest outgo of Rs 13,67,754, now the total interest outgo on the loan in the next 19 years will be Rs 17,59,484 even after paying the 1st year interest of Rs 2,08,892.
Just like Manish, lot of other people are facing the same problem due to the increase in their EMIs. So how can people like Manish tackle such situations? What are the options available to people like Manish?

Reason for rising interest rates

Since the last one year, in its monetary policy announcements, the RBI has been constantly increasing interest rates (Cash Reserve Ratio (CRR), Repo Rate and Reverse Repo Rate) in its battle against the inflation monster. All this has increased the borrowing costs for banks over a period of time. Initially banks were able to absorb the rate hikes and shield their customers against increased EMIs. But banks cannot absorb the rising costs of funds all the time. After initially resisting increasing interest rates, banks started passing the rate hikes to their customers by increasing the interest rates on floating rate loans. Since the last few months, customers have been feeling the pinch of increased rates in the form of higher EMIs on home loans, auto loans and other loans.

Since the last one year, in its monetary policy announcements, the RBI has been constantly increasing interest rates (Cash Reserve Ratio (CRR), Repo Rate and Reverse Repo Rate) in its battle against the inflation monster. All this has increased the borrowing costs for banks over a period of time. Initially banks were able to absorb the rate hikes and shield their customers against increased EMIs. But banks cannot absorb the rising costs of funds all the time. After initially resisting increasing interest rates, banks started passing the rate hikes to their customers by increasing the interest rates on floating rate loans. Since the last few months, customers have been feeling the pinch of increased rates in the form of higher EMIs on home loans, auto loans and other loans.

Pre-payment of Home Loans

Banks allow customers to pre-pay loans. Pre-payment helps the customer to reduce the outstanding amount and thereby reducing the interest burden and also finishing the loan earlier than its normal schedule. Pre-payment can be done in two ways: pre-paying a lumpsum amount at a time or increasing the EMI (5% or 10% or whatever % the customer is comfortable with). Let us explore the two options.

Banks allow customers to pre-pay loans. Pre-payment helps the customer to reduce the outstanding amount and thereby reducing the interest burden and also finishing the loan earlier than its normal schedule. Pre-payment can be done in two ways: pre-paying a lumpsum amount at a time or increasing the EMI (5% or 10% or whatever % the customer is comfortable with). Let us explore the two options.

Pre-paying a Lump sum Amount

If the customer gets a onetime cash flow, he can use that to make a lumpsum pre-payment and reduce the outstanding balance on his home loan. For example, in case of Manish, if he has maturity proceeds from a bank fixed deposit (FD) or National Saving Certificates (NSC) or insurance maturity proceeds or for that matter, any lumpsum amount available to him, he can use this amount to make a pre-payment and reduce the outstanding amount on his home loan. By making a pre-payment the customer has 2 options:

  • Reducing the loan tenure: The customer can make a lumpsum pre-payment and reduce the tenure of his home loan and keep the EMI the same. Let us see how this will work in Manish’s case. Let us assume that Manish gets a onetime cash flow of Rs 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs 5 lakhs, it will reduce his outstanding amount from Rs 24.50 lakhs to 19.50 lakhs. Manish can ask the bank to keep his EMI same at 24,043 and reduce the tenure of the loan. In such a scenario the tenure of Manish’s loan will reduce from 19 years (228 instalments) to 11 years (136 instalments). Manish’s instalments will get reduced by 92 instalments.
  • Reducing the EMI: The customer can make a lumpsum pre-payment and reduce the EMI of his home loan and keep the tenure same. Let us see how this will work in Manish’s case. Let us assume that Manish gets a onetime cash flow of Rs 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs 5 lakhs, it will reduce his outstanding amount from Rs 24.50 lakhs to 19.50 lakhs. Manish can ask the bank to reduce the EMI on the loan and keep the tenure same at 19 years. In such a scenario the EMI on Manish’s loan will reduce from Rs 24,043 to Rs 19,137 and the tenure of the loan will remain same at 19 years.

Increasing the EMI by 5%

Every individual expects his salary to increase by at least 5% or 10% every year. So the person can use this increased cash flow to lighten his loan burden. Manish can ask his bank to increase his EMI by 5% compounded every year. In such a scenario, Manish’s current EMI will increase from Rs. 24,043 to Rs. 25,245 and subsequently go on further increasing by 5% every year. In such a scenario, Manish will be able to service his loan in 130 instalments (11 years) instead of 228 instalments (19 years) and reduce 98 EMIs. Some banks do not allow the customer to increase the EMI. In such a scenario Manish can take the difference between the increased EMI (Rs 25,245) and original EMI (Rs 24,043), i.e. Rs. 1202, and put it in a monthly recurring deposit. The customer can then use this money to make lumpsum pre-payment at the end of the year. The customer can follow this practice every year till the loan gets over.

Increasing the EMI by 10%

Manish also has the option to increase his EMI by 10%. In such a scenario Manish’s current EMI will increase from Rs 24,043 to Rs 26,447 and subsequently go on further increasing by 10% every year. In such a scenario Manish will be able to repay his remaining outstanding loan amount in 8 years (100 instalments) instead of 19 years and reduce 128 EMIs. If his bank does not allow this increase in EMI, Manish can take the difference between the increased EMI (Rs 26,447) and original EMI (Rs 24,043), i.e. Rs. 2404, and put it in a monthly recurring deposit to make lumpsum pre-payment at the end of the year.

Points to Remember:

While the customer can always make a partial lumpsum pre-payment or ask the bank to increase the EMI on his loan, there are few things that he should keep in mind. These include:

  • A customer should not use money reserved for other goals like child education, marriage, retirement etc for pre-payment of home loan.
  • When a customer asks the bank to increase the EMI by 5% or 10% every year, then he should make sure that he will be able to service the increased EMI. For example, if the customer increases his EMI by 10% compounded every year, then after few years the EMI  may become substantially higher and the customer may find it difficult to service it.
  • To make the article simple to explain the article assumes that there will be no further rate hikes in future. But in case of floating rate home loans the rates may increase or decrease depending on the market direction of interest rates. Once the interest rate changes, all the above calculations will change.

Conclusion

We have seen above how customers like Manish can service their home loan in a better manner. A customer can:

  • Make a partial lumpsum pre-payment and reduce the tenure of the loan and keep the EMI same OR
  • Make a partial lumpsum pre-payment and reduce the EMI of the loan and keep the tenure of the loan same OR
  • Increase the EMI on the loan by 5% or 10% or any percentage that he is comfortable with and finish the loan before its normal schedule OR
  • Use a combination of partial lumpsum pre-payment and also increase the EMI every year by a certain percentage and finish the loan before its normal schedule.

The above mentioned all options are very flexible in nature and customers can use them depending on how comfortable they are with each of them

Maj Manish is a 30 year old officer and his family includes his wife (homemaker), 3 year old daughter, and retired parents. Manish had taken a home loan of Rs 25 lakhs one year back at 8.5% for 20 years with a monthly EMI of Rs. 21696. Apart from repaying the home loan, Manish’s other goals include planning for his daughter’s education, marriage and his own retirement. However, his entire planning is going haywire with his borrowing bank raising his Equated Monthly Instalments (EMIs) frequently ever since he has taken the loan. In one year the interest rate on Manish’s home loan has increased from 8.5% to 10%. The EMI has shot up from Rs 21,696 to Rs 24,043 and the outstanding balance is Rs 24.50 lakhs. Against the original total interest outgo of Rs 13,67,754, now the total interest outgo on the loan in the next 19 years will be Rs 17,59,484 even after paying the 1st year interest of Rs 2,08,892.

Just like Manish, lot of other people are facing the same problem due to the increase in their EMIs. So how can people like Manish tackle such situations? What are the options available to people like Manish?

Reason for rising interest rates

Since the last one year, in its monetary policy announcements, the RBI has been constantly increasing interest rates (Cash Reserve Ratio (CRR), Repo Rate and Reverse Repo Rate) in its battle against the inflation monster. All this has increased the borrowing costs for banks over a period of time. Initially banks were able to absorb the rate hikes and shield their customers against increased EMIs. But banks cannot absorb the rising costs of funds all the time. After initially resisting increasing interest rates, banks started passing the rate hikes to their customers by increasing the interest rates on floating rate loans. Since the last few months, customers have been feeling the pinch of increased rates in the form of higher EMIs on home loans, auto loans and other loans.

Pre-payment of Home Loans

Banks allow customers to pre-pay loans. Pre-payment helps the customer to reduce the outstanding amount and thereby reducing the interest burden and also finishing the loan earlier than its normal schedule. Pre-payment can be done in two ways: pre-paying a lumpsum amount at a time or increasing the EMI (5% or 10% or whatever % the customer is comfortable with). Let us explore the two options.

Pre-paying a Lump sum Amount

If the customer gets a onetime cash flow, he can use that to make a lumpsum pre-payment and reduce the outstanding balance on his home loan. For example, in case of Manish, if he has maturity proceeds from a bank fixed deposit (FD) or National Saving Certificates (NSC) or insurance maturity proceeds or for that matter, any lumpsum amount available to him, he can use this amount to make a pre-payment and reduce the outstanding amount on his home loan. By making a pre-payment the customer has 2 options:

  • Reducing the loan tenure: The customer can make a lumpsum pre-payment and reduce the tenure of his home loan and keep the EMI the same. Let us see how this will work in Manish’s case. Let us assume that Manish gets a onetime cash flow of Rs 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs 5 lakhs, it will reduce his outstanding amount from Rs 24.50 lakhs to 19.50 lakhs. Manish can ask the bank to keep his EMI same at 24,043 and reduce the tenure of the loan. In such a scenario the tenure of Manish’s loan will reduce from 19 years (228 instalments) to 11 years (136 instalments). Manish’s instalments will get reduced by 92 instalments.
  • Reducing the EMI: The customer can make a lumpsum pre-payment and reduce the EMI of his home loan and keep the tenure same. Let us see how this will work in Manish’s case. Let us assume that Manish gets a onetime cash flow of Rs 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs 5 lakhs, it will reduce his outstanding amount from Rs 24.50 lakhs to 19.50 lakhs. Manish can ask the bank to reduce the EMI on the loan and keep the tenure same at 19 years. In such a scenario the EMI on Manish’s loan will reduce from Rs 24,043 to Rs 19,137 and the tenure of the loan will remain same at 19 years.

Increasing the EMI by 5%

Every individual expects his salary to increase by at least 5% or 10% every year. So the person can use this increased cash flow to lighten his loan burden. Manish can ask his bank to increase his EMI by 5% compounded every year. In such a scenario, Manish’s current EMI will increase from Rs. 24,043 to Rs. 25,245 and subsequently go on further increasing by 5% every year. In such a scenario, Manish will be able to service his loan in 130 instalments (11 years) instead of 228 instalments (19 years) and reduce 98 EMIs. Some banks do not allow the customer to increase the EMI. In such a scenario Manish can take the difference between the increased EMI (Rs 25,245) and original EMI (Rs 24,043), i.e. Rs. 1202, and put it in a monthly recurring deposit. The customer can then use this money to make lumpsum pre-payment at the end of the year. The customer can follow this practice every year till the loan gets over.

Increasing the EMI by 10%

Manish also has the option to increase his EMI by 10%. In such a scenario Manish’s current EMI will increase from Rs 24,043 to Rs 26,447 and subsequently go on further increasing by 10% every year. In such a scenario Manish will be able to repay his remaining outstanding loan amount in 8 years (100 instalments) instead of 19 years and reduce 128 EMIs. If his bank does not allow this increase in EMI, Manish can take the difference between the increased EMI (Rs 26,447) and original EMI (Rs 24,043), i.e. Rs. 2404, and put it in a monthly recurring deposit to make lumpsum pre-payment at the end of the year.

Points to Remember:

While the customer can always make a partial lumpsum pre-payment or ask the bank to increase the EMI on his loan, there are few things that he should keep in mind. These include:

  • A customer should not use money reserved for other goals like child education, marriage, retirement etc for pre-payment of home loan.
  • When a customer asks the bank to increase the EMI by 5% or 10% every year, then he should make sure that he will be able to service the increased EMI. For example, if the customer increases his EMI by 10% compounded every year, then after few years the EMI may become substantially higher and the customer may find it difficult to service it.
  • To make the article simple to explain the article assumes that there will be no further rate hikes in future. But in case of floating rate home loans the rates may increase or decrease depending on the market direction of interest rates. Once the interest rate changes, all the above calculations will change.

Conclusion

We have seen above how customers like Manish can service their home loan in a better manner. A customer can:

Make a partial lumpsum pre-payment and reduce the tenure of the loan andü keep the EMI same OR

Make a partial lumpsum pre-payment and reduce the EMI of the loan and keepü the tenure of the loan same OR

Increase the EMI on the loan by 5% or 10% or any percentage that he isü comfortable with and finish the loan before its normal schedule OR

Use a combination of partial lumpsum pre-payment and also increase the EMIü every year by a certain percentage and finish the loan before its normal schedule.

The above mentioned all options are very flexible in nature and customers can use them depending on how comfortable they are with each of them