Monthly Archives: December 2015

Thursday Trivia – Simple illustrative example to understand meaning of “Mutual fund Investments are subject to Market risk”

Significant risk.

An existing or prospective mutual fund investor may not remember the name of the scheme he has invested into.  But surely would remember the disclaimer declared in every communication “Mutual fund investments are Subject to Market Risk”.

So this leads us to a question, what exactly is market risk? Market risk impacts you in all areas of life right from your job to something as regular as buying groceries.

Wikipedia defines Market risk as

“Market risk is the risk of losses in positions arising from movements in market prices.”

Market risk, also referred to as systematic risk, involves factors that affect the overall economy or securities markets.  It is the risk that when an overall market will decline, it will bring down the value of an individual investment in a company regardless of that company’s growth, revenues, earnings, management, and capital structure.

So let’s understand it with this simple example and see how exposed we are to it’s impact.

When you decide to buy a car, it is usually to fulfill a need of reaching your destination within a stipulated time period.  Just the same way, as you make an investment, it is associated with a future goal which needs to be serviced as and when it comes up.

As you start to look out for a new car, there will be lot of factors to consider like price, engine capacity, mileage sitting capacity etc.  Apart from these you will also consider the safety features like air bags, ABS etc.  According to your specific requirement and your own travel pattern you will choose a car which is best suited for your needs.  Similarly, while approaching an investment decision, factors like return on investments, safety of capital, interest rates, liquidity, etc. will also be looked upon for reaching the desired goal of the investor.

But whichever car you choose you will be subjected to certain risk of road travel (read Market Risk), which is independent of the car itself.  These risks like bad road conditions, unfavorable weather, heavy traffic, etc. will impact your travel and your plans to reach your destinations.  If these events occur you may have to tackle it by taking a detour, waiting for some time or may be choose even a different mode of transport.

This is exactly what happens when an event pertaining to market risk occurs and as an investor you are subjected to risks like inflation, fluctuation in interest rates, fluctuations in foreign exchange, geo political risks, war etc.  These are big forces and will impact the overall market; it has nothing to with the specific investment vehicle that you choose, like mutual fund or equity investments all other investments are actually subject to market risk, be it the investments which are perceived to be safest like real estate or gold, will react to change in macro conditions.

If you look at things more closely and from another perspective, we are subject to market risk all the time.  If you are an employee you may choose a great employer to work with, but again change in market condition may result in change of your job profile and appraisals.  It might be nothing specific related to you or your company, it is just what happens in market impacts everyone including you.

Conclusion:

Looking only from an investment point of view, we can easily infer that all the investments are subject to certain kind of risk.  As you understand more about these risks it will help you in taking more informed decisions.  As far as market risk is concerned it is unavoidable and one of the most useful way of tackling it by having a right asset allocation strategy and rebalancing it periodically.

 

Thursday Trivia- Super simple explanation of Fed rate

Santa Banta discussing Fed Rate

Santa: I have been hearing a lot about Fed Rate hike recently. What is this Fed Rate? Why is there a hike now? How was it before? What impact it will have on us?

Banta: Too many questions. Let’s go one by one.

Santa: Ok, then tell me what is Fed Rate?

Banta: In US (like in other countries) banks lend to and borrow from other banks as and when there is an excess cash reserve or there is a need for money. The rate at which one bank lend money to the other bank (for a very short term) is known as Fed Rate.

Santa: But such rate must be depending on demand and supply. How can this be influenced or controlled then?

Banta: Good question. The Fed (equivalent of our RBI) can influence this inter-banking overnight lending rate by buying or selling government securities.

If the Fed wants the federal funds rate (or Fed Rate) to decrease, then it buys government securities from a group of banks. As a result, those banks end up holding fewer government securities and more cash reserves, which they then lend out to other banks. That increase in the supply of available reserves causes the federal funds rate (or Fed Rate) to decrease.

When the Fed wants to increase the Fed Rate, it does the reverse open-market operation of selling government securities to the banks. As a result, those banks end up holding more government securities and less cash reserves. This decrease in the supply of available reserves causes the federal funds rate (or Fed Rate) to increase.

Santa: Ok, understood. But when and why this Fed Rate is increased or decreased?

Banta: See, when there is a change in Fed Rate (overnight inter-banking lending or borrowing rate) – cost of borrowing also changes. So if Fed Rate remains low, cost of borrowing would also remain low and vice versa. When the Fed predicts that the economy is moving toward a recession, it can boost economic activity in the short run by making borrowing less costly.

Santa: By decreasing Fed Rate, so that banks can get excess cash at lower rate.

Banta: Right. When banks get cash at lower rate, then they offer loans at lower interest rates to businesses and consumers. The cheaper credit in turn causes businesses and consumers to make more purchases, boosting sales and economic activity and putting the economy away from the recessionary trend.

Santa: So when does Fed increase the rate?

Banta: The Fed may choose to increase the federal funds rate if it predicts that the economy is heating up too much and causing prices to rise too rapidly (inflation). Increasing the cost of borrowing through the Fed Rate hike curbs demand and helps to reduce inflationary pressures in the short run.

Santa: So when was the last Fed Rate hike happened?

Banta: It happened in 2006. The US was hit by the crash in its housing market and banking sector between 2007-09. The Fed then felt that it needed prevent the economy from collapsing into a new Great Depression. One way of doing that was by cutting the cost of borrowing to rock-bottom levels i.e. by reducing Fed Rate.

Santa: So why now there is a possible hike?

Banta: One main indicator in doing that is US job market data. Unemployment rate has declined a lot and almost reached the pre-recession level. So there is an increase in hiring as well as in wages.

If at such times cost of borrowing is kept at low level, people will purchase more and there will be an increasing demand for goods and services. This will result in price rise i.e. inflation. Fed, at any moment does not want the rate of inflation to go beyond 2% rate. Inflation is already at 1.70% there.

Santa: How Fed Rate hike will affect us?

Banta: Before that let me tell you that Fed Rate is remained at near zero level for almost a decade now. Fed Rate hike, if it happens, will happen at slow rate and in phases.

Santa: I was asking you how it will affect us.

Banta: Yes. Coming to that. Few possibilities are there (Please note – I said ‘possibilities’, and not certainties).

First, rupee depreciation is likely to happen as there will be increasing demand for dollar now.

Second, Indian companies which have borrowed in dollar, will have to repay more now. This may affect their profitability and balance sheet.

Third, as US bond market rate is set to increase FIIs could take money out from emerging markets.

Santa: So that means there will be a crash in Indian stock market!

Banta: Very unlikely. Fed Rate hike will be minimum may be 0.25% to start with. Fed Rate may reach up to 2.50% by 2018 provided US job market data remains attractive and there is inflationary pressure in US consumer market. So such small hike in Fed Rate now is most likely already discounted in the market. Hence there is hardly any reason to worry now.

Remember, this is just another event. This too will pass.

 

Thursday Trivia- Debunking the Myth of Form 15G and 15H

Time and again technology has played a major factor in reducing human effort and paper work.   Lot of human efforts had been saved when filing Income Tax returns was done online.  It was cheered by both the tax payers and tax officials as the process became automated and simple.

On a similar note, there will now be an element of relief for those who have to file their Form 15G and Form 15H for ensuring non deduction of tax at source. Till now the entire process had to be done in a physical form and this caused a lot of time and effort to be spent on completing the requirements. The income tax department has now allowed for this process to be done online and this change will be able to provide some relief for the taxpayers. It does not change the whole taxation structure but will reduce the effort that has to be made on this front.

Here are some additional details related to this which needs the attention of the taxpayers.

The whole process involves the payer deducting a part of the payment and then depositing this with the government against the PAN of the person who has to receive the payment. This is considered as a tax paid by the person who would have received the payment. This ensures that a part of the transaction goes to the government and then this has to be adjusted at the time of the filing of the income tax return and the calculation of the final amount of taxes. An example of this is the interest received on a bank fixed deposit. When the interest earned during a year crosses the Rs 10,000 mark then the bank will deduct tax at source and remit the net amount to the fixed deposit holder.

There are several people who might not have any tax to be paid because the total amount that they earn is less than the amount that is taxable under the Income Tax Act. If there was no option available for these taxpayers which includes a large section of senior citizens then they would have to wait a long time till they can file their tax returns and get a refund.

The option for them is to fill in Form 15G if they are less than 60 years of age and Form 15H if they are more than 60 years of age. This will ensure that the person who has to deduct the tax will not make any deduction at the time of making the payment.

The procedure that had to be followed till now required the filling up of the form and then submitting this to the entity that had to make the deduction.  Normally 3 copies of the form had to be filled in and submitted.

  1. One copy would be returned after acknowledgement,
  2. One would be sent to the income tax department, and
  3. One would be kept with the entity making the deduction.

This involved a lot of time and effort and hence was not an easy thing to complete.

Online submission

The ability of the taxpayer to now submit these forms online means that they have been freed from the requirement of physically filling in the form and the details that are required online would be easier. Also an acknowledgement would be generated with a unique number and this would also make it easier to track in terms of what is the situation after the submission.

Earlier there were a lot of instances wherein even after submission of the forms the deduction was made and it was difficult to know where the problem was. This will now be eliminated and all that the taxpayer has to do is to ensure that they have their basic details in place which they can submit and complete this process quickly.

CBDT has made filing Form 15G and Form 15H lot simpler by putting it online. A tax payer who did not wish to deduct TDS from certain incomes is now required to file a self-declaration under Form 15G or Form 15H and submit it to the person or organization deducting tax, which is now can be done either in paper form or electronically. Earlier the same was to be submitted only in paper form.

In line with simplifying the procedure of filing for form 15G and Form 15H, both the forms have also been modified reducing the compliances

Procedure for new Form 15G and Form 15H

Under New Form 15G and Form 15H filing procedure, tax payer need to submit online and a person or organization deducting tax on receiving the same will assign a Unique Identification Number (UIN) to all self-declarations in accordance with a procedure by CBDT. Both the UIN and self-declarations details will have to be furnished by the a person or organization deducting tax in the quarterly TDS statements. In addition, a person or organization deducting tax will be required to retain Form 15G and 15H for seven years.

Online submission of form 15G and form 15H shall become effective from 1st October, 2015 and the requirement of submitting physical copy of Form 15G and 15H by the a person or organization deducting tax to the income-tax authorities has been dispensed with.

 

Category of Tax Payer Income Tax Section
Individual: Senior Citizen Sub-section (1C) of section 197A
Individual: Non-senior Citizen Sub-sections (1) and (1A) of section 197A

Online submission of Form 15G and Form 15H

The tax payer can generate and submit Form 15G/Form 15H online provided the banker created a link on their individual banks Internet Banking. Below I have given a screenshot on how you can generate and submit form 15G/form 15H online to SBI.

SBI

Detailed description of Form 15H and 15G

Form 15G and Form 15H are forms which can help a person avoid TDS in case one does not have to pay income tax at the end of the year. Form 15H is for senior citizens and form 15G is for others. The conditions under which Form 15G and 15H may be filed are similar yet with a significant difference. Each taxpayer needs to fully understand the specified conditions and ascertain whether he or she is eligible for filing the relevant form. Filing the form without being eligible to do so is illegal and will invite payment of interest on the tax payable and also a penalty.

Form 15H:- Declaration under sub-section (1C) of section 197A of the Income-tax Act, 1961, to be made by an individual who is of the age of sixty years or more claiming certain receipts without deduction of tax.

  • Form 15H can be submitted only by Individual above the age of 60 years.
  • Estimated tax for the previous assessment year should be nil. That means he did not pay any tax for the previous year because his income is not coming under the taxable limit.
  • This form should be submitted to all the person or organization deducting tax to whom you advanced a loan. For example you have deposit Rs.1 lac each in three SBI bank branches than you must submit the Form 15H to each branch.
  • Submit this form before the first payment of your interest. It is not mandatory but it will avoid the TDS deduction. In case of the delay, the bank may deduct the TDS and issue TDS certificate at the end of year.
  • You need to submit form 15H to banks if interest from one branch of a bank exceeds Rs.10,000/- in a year.
  • You need to submit form 15H if interest on loan, advance, debentures, bonds or say Interest income other than interest on bank exceeds Rs.5,000/- in a year.

Form 15G:- Declaration under sub-sections (1) and (1A) of section 197A of the Income-tax Act, 1961, to be made by an individual or a person (not being a company or a firm) claiming certain receipts without deduction of tax of tax.

  • Form 15G can be submitted by Individual below the age of 60 years and Hindu Undivided family.
  • The above points are applicable to the Form 15G as well, except that the Form 15H is only for the senior citizen.
  • Form 15G should be submitted before the first payment of interest on fixed deposit.

Difference between Form 15G and Form 15H

  1. Form 15G can be submitted by individual below the Age of 60 Years while form 15H can be submitted by senior citizens i.e. individual’s above the age of 60 years.
  2. Form 15G can be submitted by Hindu undivided families but form 15H can be submitted only by Individual above the age of 60 years.
  3. The aggregate of the income from interest on securities/interest other than “interest on securities”/units/amounts referred to in clause (a) of sub-section (2) of section 80CCA received during the financial year should not exceed the basic exemption slab for Form 15G while no such condition exists for Form 15H.

To further understand these provisions, let’s take the example of Mr. Sanyam, who is 30 years old. Sanyam’s total income is Rs.3,40,000 for the financial year 2014-15 of which Rs.2,60,000 is earned by way of interest from bank deposits. Sanyam also invests Rs.1,00,000 under Section 80C and pays a medical insurance premium of Rs.15,000. Is Sanyam eligible to furnish Form 15G?

This can be ascertained by finding out if he satisfies both the above conditions.

The first condition is that Sanyam’s final tax liability should be nil. Though Sanyam’s gross income is Rs.3,40,000 lakh, on account of his Section 80C and Section 80D deductions of Rs.1,00,000 and Rs.15,000 respectively, the net income falls to Rs 2,25,000 lakh and consequently he is not liable to pay any tax. Therefore, Sanyam satisfies the first condition.

However, we find that since his interest income of Rs.2,60,000 is more than the basic exemption limit of Rs.2,50,000. Sanyam does not satisfy the second condition and hence he is not eligible to furnish Form 15G to the interest paying organization.

On the other hand Form 15H imposes just the first condition, in that, the final tax on the investor’s estimated total income computed as per the provisions of the Income Tax Act should be nil. The second condition imposed by Form 15G is not applicable in the case of Form 15H.

For example, say Mr. Nenawati, 68 years old, has a total income of Rs.3,50,000 for the financial yeat 2014-15, out of which Rs.95,000 is earned from the senior citizens saving scheme and the rest from bank deposits. He invests Rs.50,000 in PPF. Now, is he eligible to furnish Form 15H?

As pointed out earlier, all Mr. Nenawati has to do is to ascertain his final tax liability. It doesn’t matter what amount he receives from which source; this information is irrelevant for Form 15H. We find that Mr. Nenawati’s net income works out to Rs.3,0,000 (Rs.3,50,000 – Rs.50,000). As the basic exemption limit for Mr. Nenawati is also Rs.3,00,000 (on account of him being a senior citizen), his net tax liability is nil and hence he is indeed eligible to submit Form 15H.

Penalty in filing a wrong form

Any person making a false statement in the declaration shall be liable to prosecution under section 277 of the Income-tax Act, 1961, and on conviction be punishable:

  1. in case where tax sought to be evaded exceeds one lakh rupees, with rigorous imprisonment which shall not be less than six months but which may extend up to seven years with fine;
  2. in any other case, with rigorous imprisonment which shall not be less than three months but which may extend up to three years and with fine.

Myths and Facts about Form 15G and Form 15H

Myth Fact
Anybody who wishes to avoid tax deduction can make use of Form 15G/15H Only persons with income below taxable limits and Nil Tax liability can only make use of this form.
Once declaration is given in Form 15G/Form 15H, there is no need to declare this income in return of Income. Irrespective of the fact whether the Form is used or not, the respective income should be compulsorily declared in return of income.
Once declaration is given in Form 15G/Form 15H, there is no need to pay tax on the same. As per the provisions, only persons with NIL tax liability only can give these forms. But if there is a tax liability, they have to necessarily pay the requisite tax. On the other hand, by payment of tax they run the risk of giving a wrong declaration. Hence before giving Form 15G/15H, please be doubly careful.
Form 15G  15H are submitted only to the banks/Financial Institutions/Payer. This is partly correct. The person who receives the Form 15G/15H is required to submit one copy of the Form to the Commissioner of Income-tax . Hence the information is passed on the Income-tax department and the Income-tax Department can make further enquiries on the same.
Submission of Form 15G/15H once is sufficient. No. These forms shall be submitted every Financial year at the beginning of the Financial year.
It is enough that irrespective of the fact that deposits are held in different branches, a single Form is sufficient. No. These forms should be submitted to each and every branch where you hold the deposits. For example, if you hold deposits in 3 different branches of State Bank of India, this declaration shall be given for each branch separately.
Since my Income is below taxable limits and tax is NIL , I do not have to submit the PAN details with the declaration No. Every person giving declaration using Form 15G/15H shall compulsorily provide the PAN details along with the declaration irrespective of their Income/Tax status. Otherwise tax will be deducted @ 20% on the Interest.
Form 15G/15H can be used for not deducting TDS for all types of payments (viz.,) Contract payments, Professional fees, rent etc. These forms can be used only for payments in the nature of Interest of Securities, Dividend, and Interest other than Interest on Securities (Bank/Company Deposits), NSS Interest on Units. For other types of payments, these forms cannot be used.

(References : bssridhar.com, PIB & Incometaxindia.gov.in)

 

Thursday Trivia- Cut down on expenses

People resolve to increase savings and cutting down on expenses is the first logical step to do that.  But the problem is most people don’t know where to start. They feel guilty of every money spent and may end up abstaining some wishes or even some necessity. Read on for some food for thought to see what steps can be taken to cut down on expenses

 

First and foremost the most important thing to do is to start maintaining your budget. Nothing can give you more clarity and accuracy as to how your money is being spent. Some people do it a traditional way of maintaining it on paper or an excel sheet. There are also loads of apps which can help you do this. Lot of these apps pulls data from your bank login or even text messages sent by bank to you, reducing the manual work considerably.

 

Secondly the most logical step is to group your expenses according to the nature of the expense. Here are the four grouping structure

  • Fixed and Mandatory
    • EMI, Insurance premium, Society maintenance, salaries, school fees
  • Variable and Mandatory
    • Utility bills, groceries, fuel
  • Fixed and Voluntary
    • Gym,
  • Variable and voluntary
    • Entertainment, vacations, gadgets, gifts

Grouping the expenses in the above mentioned categories helps you determine where to start. It’s very easy and desirable to start cutting expenses from the last category. After categorisation you can also compare which grid you are spending the most. There is no thumb rule as to what should be the ideal spread but if you are looking to cut down expense you should be spending the least in the fourth category.

 

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