The short and long of 'Capital Gains'

Capital gain is a profit that accrues on investments into capital assets such as stocks, bonds or real estate, when the sale/transfer price exceeds the purchase price. Many countries impose tax on capital gains of individuals or corporations. In India treatment of Capital gains is covered under sections 45 to 55 of IT Act, 1961.

Long Term Capital Asset (LTCA) is defined as any capital asset held by the assessee for more than 36 months immediately preceding the date of its transfer. Other assets not covered by the above definition are treated as Short term capital assets (STCA). IT Act allows special treatment for LTCA. The purchase price of a LTCA is inflated to the extent of the annual Cost of inflation index notified by the Govt., for calculation of the capital gains chargeable to tax. Certain exemptions are available with respect to LTCG, for example an assessee who has sold his property can hold the money under capital gains account scheme and use the same to buy/construct a new property within a prescribed period (upto 3 years).

Special treatment under LTCG: The under noted assets are treated as Long term capital assets if held for more than 12 months:

• Shares held in a company
• Any securities (Debentures/ Govt. securities) listed on a recognised Stock exchange
• Units of UTI/ Units of recognised Mutual Funds
• Zero Coupon Bonds

The benefit of indexation does not apply to these assets, the entire gain is exempt from tax if STT is paid on them while selling through authorised Stock exchanges. These assets thus offer the investor more tax efficient means of investment.

Treatment of Capital Loss:

1. Losses under the head “Capital gains” cannot be set off against income under other heads of income.
2. Short-term capital loss can be set off against any capital gain (whether long-term or short-term)
3. Long-term capital loss can be set off only against long-term capital gain.
4. A long-term capital loss for a case where the long-term capital gain is exempt from tax will have no value. For example, if a share is held for a year or more and then sold at a loss, there will be no tax benefit. So this loss cannot be set off against any other income.
5. If the capital loss cannot be set off against the capital gain of that particular year then it can be carried forward for the next eight years.

In the light of the above, investors are advised to take advantage of the provisions of IT Act for long term capital gains. Equities/ Mutual Fund units are preferred investment options because of the special treatment accorded to them. However, investors also need to understand the importance of short term capital gains/ losses to re balance their portfolios.

Interim Budget: Govt. in 'Sleep Mode'

The euphoria over the interim budget is over. Stand-in finance minister Pranab Mukherjee has presented a true 'vote on account' indicating that the Govt. and the Economy have gone into a sleep mode. The Govt. has admitted the grim realities facing the economy.

It is a bad omen for the economy as the revised fiscal deficit is projected to touch 6% of the GDP, against the budgetary deficit of 2.5%. If we include the off budget items like subsidies and oil bonds the figure could be as high as 7.5% of GDP. This offers enough ammunition to the rating agencies to downgrade India's sovereign rating which will raise the cost of borrowing in international markets. Govt. finances will be put under severe strain as the tax revenue is growing at a much slower pace.

To undertake the ongoing development programmes the Govt. will have to resort to massive borrowing of around Rs.45,000 crores, which is likely to put strain on the interest rates. Although inflation rate of 4% offers RBI a scope to lower rates, this may be put on hold in view of the Government's borrowing programme.

A high fiscal deficit leads to a multiplicity of problems in the long run. With a slowing economy tax receipts are likely to shrink further, whereas there is little scope for controlling Govt. expenditure. High Govt. borrowing results in reduced availability of funds for the private sector. A high fiscal deficit also leads to a high current account deficit, which leads to weakening of the currency. The foreign capital becomes dearer which is detrimental to the growth of the economy. Indian economy is in for really tough times ahead.

The Reality of Real Estate Investment

Investment in real estate is unique in many ways, yet it finds a prominent place in one's investment portfolio. The slowdown/ recession in the economy is set to take a heavy toll of the real estate sector. Owing to tighter credit and a steep decline in demand, CAPEX announcements of the sector plummeted 82% between the first and the Q3 of the current fiscal. The self owned property used for one's own occupation may not be effected by the recession because the loss, if any, in its value will only be notional, as the intention of the owner is not to sell it. However, when we invest in a second property its valuation becomes important.

The real estate sector in India is important for more than one reason. Its direct impact on the people is because it forms a part of the basic needs of human beings namely 'Roti, Kapda aur Makan', and provides direct employment to a large number of people. The sector has indirect demand implications for construction and transportation industry and sectors like steel and cement. The slowdown in real estate sector has adverse implications for the economic growth of the country. The govt. is trying its best to stimulate demand for the real estate sector.

The mantra to revive the realty sector is provision for 'Affordable Housing'. Most of the builders in the recent past had relied on upper income class, NRI's and foreigners to salvage their operations. The going was good till such time liquidity was sufficient to fuel growth, the clock has turned full circle since. Imagine, if you had purchased a small 2 bedroom house in Delhi or Mumbai for Rs.50 lacs in the recent boom, and were able to rent it out for Rs.15000 per month, the annualised return would be a paltry 3%. With the cost of Home loans in the range of 9-10% p.a., you would be losing money even if the tax breaks are taken into consideration. In a recently conducted survey it has been revealed that more than 50% of the home buyers are looking to buy a 2 BR apartment in the Rs.5-10 lac range.

The RBI on its part has reduced the reference rate (REPO rate) by 3.5% in the past 4 months but the banks have reduced their PLR's by 0.5-1% only. The builders on their part have been shying away from offering low cost houses, because the margins are low here. This has created a huge Demand and Supply mismatch. Speculators have almost quit the real estate market, but their is no dearth of genuine buyers. According to an Assocham study “Reality check on Real Estate”, India has a housing shortage of about 19.4 million units. To lure genuine buyers to invest in real estate, prices will have to move southwards till such time the rental values catch up with the rate of return on investment. The real estate prices tend to follow a lag effect: They are likely to correct anywhere between 20-50% over the next one year before genuine buyers return to the market. The sooner this reality dawns on the Realtors the better!

Market Trends: Positive bias in short term

When markets get stuck up in trading ranges investors do face a tough time. Unfortunately, the current indecisive phase has extended too far for the comfort of investors. In such circumstances, it is desirable to change the strategy of investment. One should try to enter the markets at the lower end of the range and try to book profits/ losses towards the higher end of the range. However, long term investors should keep away from the markets.

Although the long term trend of the markets is still undecided, the third quarter results having been discounted, the markets in the short term will tend to follow the international cues and global/ domestic economic data. Global equity indices recently have shown a positive bias and India will not be an exception. But how far this rally will extend is any body's guess, so one must keep on booking partial profits/ losses in the current rally. The crucial levels to watch out for would be close to 10200 on the Sensex and 3100 on the Nifty. The market is ultimately likely to catch up with the negative news on the political/ economic front. The news flow in the run up to the general elections as well as disturbing economic data may lead to sharp corrections after the current rally has run its course.

One thing is for sure, the next down turn will offer really attractive long term investment opportunities. We may see such a bottoming out situation within the next 6-8 months. Investors must maintain enough liquidity to encash such an opportunity.

Why FMPs are out of favour?

Fixed Maturity Plans (FMPs) are debt mutual fund schemes, which had become extremely popular in the second half of year 2008 in India, and were being sold as a viable alternative to Fixed Deposit Schemes (FDs) of the banks. When equity markets were on the decline Mutual Funds kept their AUMs (Assets under management) intact by offering a slew of FMPs. Over Rs. 50000 crores was raised under various FMP schemes during 2008.

Why have FMPs become so unpopular in the recent past? Over the past two months there has not been any new scheme offering more than 3 months FMP. FMPs are no longer considered an attractive asset class by investors because of various reasons:

• Banks have been offering attractive returns on FDs


• Some good company deposit schemes are on offer (Tata Capital has launched its FCD issue offering upto 12% annualised return).


• SEBI has banned FMPs from being sold as Fixed income schemes. Recently fund houses have been banned from indicating the portfolio composition and returns from FMP.


• Pre mature withdrawal on FMPs is not allowed any more, and listing of FMPs on bourses has been made mandatory. Closed ended schemes normally trade at a discount to their NAV.


• Slowdown in the economy and the ensuing liquidity crunch reduced the creditworthiness of some companies whose debt instruments FMPs had invested, leading to erosion of investor sentiment.

It is the end of another financial product which has met with premature death because of 'mis-selling' by some Mutual funds/ Financial advisors. Investors should study the product thoroughly and take informed decisions. FMPs cannot replace Bank FDs as assured return instruments.

The importance of a 'WILL'

During his/her lifetime every individual is focused on 'Wealth creation' to fulfill his/her financial goals. But seldom do we take measures to ensure that this wealth is transferred to the next generation as per one's own 'will'. Perhaps, most of us think that making a will is a very tedious task, whereas it is not so. Most of the people would like to dispose of their property/assets according to their own wishes. Thus, there arises the need for making one’s Will.

A 'Will' is a legal document defined under the Indian Succession Act, 1925 as: 'A legal declaration of the intention of the testator (writer of the will), with respect to his property which he desires to be carried into effect after his death'. A valid will can be made by a person provided he is:

• Over 18 years of age
• Is mentally capable i.e. a person with a sound mind
• It must be made without any coercion.

It is important to note that a will can be made at any time during the life and it need not be registered. It needs to be attested by 2 or more independent witnesses (not related to the testator).

Execution of the Will: On the death of the testator, a heir of the deceased can apply for a probate, which is a copy of the will certified by the competent court. A valid will ensures the distribution of the assets of the deceased as per his wish. It is better to understand that nomination is not a replacement of a will, a nominee merely acts as a trustee for the legal heirs.

If there is no Will, the property would be dealt with as per the laws of inheritance. For Hindus, Buddhists, Jains and Sikhs the laws of inheritance have been codified in the Hindu Succession Act, 1956. For Christians the Indian Succession Act, 1925 will be applicable. Parsis have a different law of inheritance. Similarly, Muslims have their own law.

As will is a simple document (even a hand written will is acceptable), we must ensure smooth transfer of our property/assets as per our wish, by writing a 'Will'.