Infrastructure Bonds

Section 80CCF of Income Tax Act ,1961 as inserted by Finance Act,2010 w.e.f 1-4-2011 says:

Deduction in respect of subscription to long-term infrastructure bonds.

In computing the total income of an assessee, being an individual or a Hindu undivided family, there shall be deducted, the whole of the amount, to the extent such amount does not exceed twenty thousand rupees, paid or deposited, during the previous year relevant to the assessment year beginning on the 1st day of April, 2011, as subscription to long-term infrastructure bonds as may, for the purposes of this section, be notified by the Central Government.

Description:

The investment market in India is flooded with a range of products like Life insurance policies, NSE and PPF, it really becomes very difficult for the individual to decide on the product that yields the maximum benefits. But most of the people already have tax saving investments to their credit and they want to further invest in products that will exempt them from paying heavy amounts as tax and also yield returns in the form of interest. And in this Scenario, Infrastructure bonds are the latest introduction in the field of investment. An important thing to be kept in mind is that no two people have the same needs and requirements. Hence people should invest according to their requirements.

There are a number of companies that offer infrastructure bonds like IFCI, LIC SBI, IDFC and L&T Infra. However the concept of investing in bonds is still at a nascent stage in the country. People still are not very well aware of the product and think twice before making such an investment.

Here is a brief analysis on this product-

There are four parameters on which we will analyze investment option:

1. Actual tax saving

2. Return on Investment

3. Opportunity Cost

4. Effect of Inflation

Assumptions:

1. Lock In period of 3 yrs

2.  Rate of return is 5.5% per annum

3. Inflation rate 8%

Tax Groups:

Tax group 1: Taxable income Rs. 1.6-5 lakhs

Tax group 2: Taxable income Rs. 5-8 lakhs

Tax group 3: Taxable income above Rs. 8 lakhs

Parameter 1: Actual tax saving

Actual tax saved on the investment; so for an individual having 10% tax slab the tax saved by him is Rs.2,000 (10% of Rs 20,000 = Rs 2,000)

Parameter 2: Return on Investment

At the end of Lock in period of 3 years, on an investment of Rs 20,000 the interest earned would be Rs. 3,484. Total return on 3 year lock in period is Rs 25,485 (Rs 20,000+3,484+2,000).

Parameter 3: Opportunity Cost

If Rs 20,000 had been invested in other tax saving instruments like ELSS Mutual Funds which also comes under 3 yrs lock in period which gives a return of 15% (which is very reasonable considering that the benchmark Sensex and many mutual funds have given comparatively higher returns on a long period) the effective return will be Rs 27, 376 (Rs 20000-2000=Rs 18000 invested @15% per annum for 3 yrs).

Parameter 4: Effect of Inflation

The minimum amount required to counter the inflation at the end of 3 yrs is Rs 25,194 at 8%

                Thus, it is clear that for a person in tax group 1, the benefit is of Rs 291 (25485-25194) whereas the benefit out of paying the tax and investing the balance in any decent instrument would be Rs 2,182.

So it is clear from the above analysis that if you are looking for getting tax benefit for an investment locked in for 3 yrs in Infrastructure Bonds then people who fall in tax group1 should not invest in Infrastructure Bonds. If you are in the tax group2 then think of only upto 3 yrs period investing in Infrastructure Bonds to remain neutral and people in the tax group3 are highly benefited from Infrastructure Bonds and can invest for long term.

Points to remember:

• Infrastructure Bonds do not offer any protection against high inflation since the rate of interest they offer is pre-determined.
• Against the pledging of the infrastructure Bonds with a bank, one can borrow money from banks. The amount depends on the market value of the bond and the credit quality of the instrument. 
• Moreover, it should be noted that although Infrastructure Bonds are considered to be safe, there is no assurance of getting the full investment back.

Interest Income is Taxable:

The interest income from infrastructure bond is taxable. The interest will be added to investors taxable income. This means even though the investment in these bonds is exempt from tax (maximum Rs 20,000). interest income is not. Thus investment under section 80CCF is advisable only after the investor has completely exhausted Rs One Lakh investment under section 80C.

The proposed DTC has left infrastructure bonds out of the ambit of tax-saving investment avenues. 

 

Dividend Stripping Transaction

As per the text of Income Tax Act, 1961,

Section 94(7) says, Where -

(a) any person buys or acquires any securities or unit within a period of three months prior to the record date;

(b) such person sells or transfers—

(i) such securities within a period of three months after such date; or

(ii) such unit within a period of nine months after such date;

(c) the dividend or income on such securities or unit received or receivable by such person is exempt,

then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable to tax.

In simple terms,

Dividend stripping refers to transacting in shares or securities linked to shares of a company on which dividend is payable. Typically, a dividend stripping transaction involves the following steps:

1. Purchase of securities/ units linked to shares of a company on which dividend is payable, at a price, say INR 100

2. Holding on the investment in the above securities/ securities linked to shares of a company and enjoying the benefit of dividend distributed on such investment, say INR 10.

3. Sale of the securities/ units linked to shares of a company at a lower price, say INR 85. This fall in price of the shares/ units linked to shares of a company is largely attributable to the dividend payout.

A dividend stripping transaction is particularly lucrative for a taxpayer since by virtue of section 10(33) of the ITA, dividend distributed by a company is not taxable in the hands of its shareholders. Further, the taxpayer may claim a carry forward or set off of the loss arising from selling the shares/ units linked to shares of a company at a lower price. Interestingly, section 94(7) of the ITA provides that only so much of loss is available for set-off or carry forward, which exceeds the amount of dividend earned on the shares/ units linked to shares of a company. In effect, in the above example the taxpayer would have incurred a loss of INR 15 by virtue of sale and purchase of the shares (100-85 = 15), however by virtue of section 94(7), only INR 5 (15 – 10 = 5) would be available as loss for set of and carry forward purposes.

In its recent ruling of CIT, Mumbai v. M/s Walfort Share and Stock Brokers Pvt. Ltd., the Supreme Court of India has held that losses arising from the purchase and transfer of units of a mutual fund, on which dividends have been freshly paid (also known as ‘dividend stripping’), are genuine.

The above analyzed ruling is noteworthy for two reasons. Firstly, the Supreme Court of India upheld the validity of dividend stripping transactions, as permissible affair under tax laws. Secondly, this ruling is yet another recognition of the distinction between tax avoidance and tax planning. The Supreme Court has reiterated that tax planning is perfectly valid, since it is within the four corners of law.

It is important to note that the Indian government is planning to introduce the Direct Tax Code (“DTC”) from April 2012. The DTC proposes to introduce a General Anti Avoidance Rule (“GAAR”), which could empower tax authorities to re-characterize a transaction entered into by a taxpayer and the income there from. The GAAR provisions are proposed to override the other provisions of the DTC. Currently tax planning is considered as legal. However, it remains to be seen how GAAR would impact tax planning by taxpayers, including in cases of dividend stripping.