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Podcast #22: How Budget 2020 impacts the way you save and invest


On today’s show, Deepak Shenoy (CEO) and Aditya Jaiswal discuss the impact of the union budget on our savings and investments- would you be better off moving on to the new tax regime? how does the budget impact your mutual funds (dividend options)? Does this budget makes dividend reinvestment options redundant? Are the Arb fund dividend reinvestment plans dead?


(The transcript has been sourced from a premium transcription provider. Yet, it may contain inaccuracies.)

Deepak: Hi and welcome to the Capitalmind podcast. Ladies and gentlemen, we have for you a quick analysis today on the budget. The budget, which was last weekend, on February 1st, 2020. It was a Saturday and a lot of crazy things happened. And today, with Aditya, we go through some of the finer points of the budget. So welcome to the show and hi, Aditya.

Aditya: Hi, Deepak. Thanks a lot. Again, it’s a pleasure being here. Deepak, as you know that the budget gave us a new tax regime. So you have an option of paying tax at the existing slabs or you could move to the new tax regime where there are no exemptions but the tax rates are lower and slab rates are new. So I was reading your live tweet during the budget hours. So initially you were of the opinion that the new tax regime wouldn’t help most of the people, but then you changed your mind. I would want to know what made you change your mind?

Deepak: So you know, if you look at what we’re talking about in terms of slab differences, there are six new slabs, four old slabs, surcharge slabs remain the same. So it was not possible at the time when we got the speech, about what would actually be the impact. It just seemed like, “Oh, we’re going to get some tweaking.”

Aditya: Correct.

Deepak: But then, if you think about it a little bit more, and then you say, okay, there are lots of people for whom the exemptions are actually being used only to save tax. So they’re not actually using the exemptions to build. So for instance, the retired people, they use the 80C investment to build long-term retirement savings. But if you’re already retired, why do you need to build more retirement savings? Because, it doesn’t make any sense. So instead, you would actually use a … You could use the cashflow and pay the same amount of tax if you use the new regime.

Deepak: But it turns out that for a lot of people, the new regime is actually going to allow you to pay lesser tax, even if you don’t consider the 80C reductions and all that. Look at the deductions people get. You’ll get an HRA. The housing rent allowance has a Chapter 6 taxation impact where it is the lower amount of the rent you actually pay versus the HRA you receive. And you know, there are three factors.

Deepak: Now, this makes sense for a salaried person who remains on rent, but if you’re a person who owns his own house, then you won’t get the deduction. Now there’s also another deduction for housing loan interest. Not principal. Principal is in a different place, but interest. Now, if you’ve got housing loan interest, then yes, you could use that and therefore it would be better to stay in the current regime now because you have a choice between this one and the new one. Now, if you think about what this does is if you have a housing loan interest, it makes sense to stay, most likely.

Deepak: If you have 80C reductions, which are natural, some of it is natural. You see, if you’re working in a salary job, many times you get PF cut from a salary. That’s part of your deductions. It adds up to an 80C deduction. If you have kids who are of school going age, like me, you are paying their school fees. Those fees are deductible under 80C. So you’re naturally going to want to take that deduction because you have to pay the school fees anyway. You may also have a housing loan in which you’re paying principal back. The principal qualifies. You may have an insurance policy, in which case the insurance policy premium qualifies. So, all of these put together add up to around 150,000 in 80Cs.

Deepak: Now you’ve got three reductions, housing loan interest, HRA and 80C reductions. You also have about Rs. 25,000 for medical insurance premium and other Rs. 50,000 as a standard deduction. Roughly 10% of your salary. And so this actually creates a bunch of deductions, which if you use all those deductions, yes, stay in the old regime, don’t use the new one. But if you’re a retired person who doesn’t have a salary, who has paid for his house, who doesn’t have an HRA because he doesn’t have a salary, who probably will not have health insurance premium because when you’re past 65, probably won’t get it even if you wanted it or it would be too expensive.

Deepak: So if you consider just the standard deduction in this 80C thing that you are forced to do and you’re earning 15 lakh rupees. At 15 lakh rupees of earning, you’re making that money through interest or dividends or whatever, that amount is actually going to be better if you don’t take any deductions, don’t invest in an 80C and just pay the tax in the new slabs. Because in the new slabs you will be Rs 15,000 rupees less. Where our calculations say for 15 lakhs, you will pay 210,000 if you used the deductions and paid tax in the old regime, versus you will pay only 195,000 if you didn’t use any deductions at all. So at 15 lakhs, it starts to make sense to, even for a retired person, to use the new regime.

Deepak: And like this, there are lots of categories. People who are young, but who’ve paid for the house already completely and who have no HRA because they’re staying in the same house they’ve bought. So those people again get benefited. Non-working members of a family who have interest income or dividend income, they will make benefit of this new policy. Young people who are just starting to work and therefore don’t have a lot of the other-

Aditya: Below five lakhs.

Deepak:… Well, below five lakhs anyway you don’t pay any tax. But say you’re earning about 10 lakh rupees and now out of that 10 lakh, you’re going to have to pay 150,000. So 15% of your salary, you actually have to pay just in order to save tax. Maybe the new regime will actually help you saying, listen, forget all the deductions. They don’t make a lot of sense to you. Let’s just go with the new one. The reason I changed over was once the calculation started, we built a spreadsheet and I think we’ve mentioned in one of the posts as well-

Aditya: Correct.

Deepak: So you could go to the spreadsheet and put your values and see what’s happening for you, for your particular case. Now there is a point that says, okay, it may be true this year but may not be true next year. So you can shift; you can shift back. Except if you have business income, in which case you can shift one way into the new regime, but you can’t shift back from the new regime to the old regime. If you have business income. So the way to ensure that you can bring it back is to not have business income.

Aditya: And Deepak, what happens, for example, take my case. So I have a salary income, plus I invest in markets, so I incur capital gains. So for me, it works out to be a salaried income plus gains from business and profession. Because, when you do trading, you have to report it under a PGBP. So for me, what if after two years, suppose I don’t invest in the market at all for one year? So on that year, I’ll be having just a salary income, but say next year, I have salary income and income from business and profession as well. So can I keep switching from one to the other?

Deepak: Yeah, the rule actually says you can switch if you don’t have business income in that year. But once you have business income and you’ve claimed this exemption, then you can’t go back. So I think the rules will change because this is one year. Next year, the rules could change again.

Aditya: But clearly, Deepak, on one aspect where this really fails is simplicity. How is this going to make my life simple-

Deepak: It’s not.

Aditya: This makes it complex, actually.

Deepak: It’s horrible, and it’s very good for people who are CAs and advisors. And in all probability, they are also using Excel sheets and trying to figure out what is the correct thing. And it’s complicated also because, see, till next February, you probably don’t even know whether you should be using the old or the new regime because your tax calculations, your this, that … So in February, you’re going to be like, “Oh my God, I should go back to the old regime. So I’ll go by the 80C. I’ll put it in this one short 150,000 into say some ELSS tax-saving mutual fund.” Which is like a bad way because you should technically invest in these things on a monthly basis or something like that, which will give you a better return.

Deepak: But having said that, it’s a good thing because people are sometimes forced to buy these products and they kind of live with the consequences of them. So if you have a really bad product, and for you it doesn’t make sense to kind of stay in the old regime, you should consider stopping paying those crazy insurance premiums and just go with the new regime. And perhaps it will stop you from buying those mis-sold products in the future as well. So it’s definitely not simple, the new tax system. It’s very, very complex.

Deepak: But I think the idea is eventually they will remove all the exemptions and there will only be one tax regime, which is no exemptions, flat tax. Which is great because I don’t think we should promote one kind of investing versus another kind of investing. People invest in equity funds today, not in ELSS mode. Most of the investing happens in regular mode or indirect mode, but not in the tax saving products. So you don’t need to encourage people to save into equity investment schemes anyway. And what kind of a time period is three years? It’s not retirement kind of time frame.

If I were to create a real thing, I would say create a retirement account. We created a post about this, called MERA. Create a My Empowered Retirement Account. Create this account as a demat account linked with a bank account. A special bank account where you can’t withdraw money whenever you like because any money that goes into that bank account is now tax-exempt, let’s say up to 10 to 12% of your income. And you can take that money and invest it in any instrument that can be demated. So you can buy a stock, you can buy bonds, you can buy insurance policies. All of these can be demated. You can buy many of these deposits as well, which can be demated.

Deepak: So the idea is to buy any of these products and then when those products earn interest or give interest on anything, there is no tax. So the interest accumulates, you can reinvest it, you can keep it in the bank, you will not get any interest if it stays in the bank. This is a special account, but you can invest in anything you want. So you can invest in the stock market, in ETFs. So you do that while it is exempt and it’s going in, the interest is exempt while it is being earned or the gains are earned. You can buy and sell stocks, but just say buy and sell stocks. Then take the money out when you’re retiring.

When you take the money out, instantly it is taxed. It’s added to your taxable income. That is the way a retirement account should work. That should be the only exemption. Everything else is non-exempt. You want to educate your kids, do it after post-tax income. I say that even though I have kids, but I know this is going to happen in the next four or five years.

Aditya: I hope the government is listening. So that was about my savings, but let’s talk about my investments. Now the government has abolished the dividend distribution tax, instead the mutual funds will now be deducting TDS at the rate of 10% if their dividend payout is more than 5,000. So about 12% of the total AUM of open-ended mutual funds is invested under the dividend option. Okay? Which is around three lakh crore. Now, if I entered into a mutual fund with dividend option, expecting that I’ll get a regular income, but now I’ll have to pay tax, right, on their dividend received on my tax slab rate. So this is definitely going to impact my total returns over the long-term. Right?

Aditya: So my question is, how should I plan this? Like, because if I’m at a higher tax slab, and even if someone is at a lower tax slab, eventually he will move to a higher tax slab, right? So this needs to be planned. So for me, paying capital gains at 10 or 15% respectively makes more sense than to pay tax on dividends at slab rate for both equity and debt funds. And a second question is, should I be better off switching to growth option? But again, here the thing is switching is treated as a redemption so I’ll incur tax liability. So how should I plan this?

Deepak: So I think are there two kind of aspects. First is dividends by mutual funds, which are going to be taxed. You’ll get TDS at 10% at source. So it makes sense to exit those funds in this financial year and move into new funds, growth funds, even though you’ll pay a tax. You’ll not pay much of tax because if the funds are paying out their gains and dividends, then your capital is roughly the same. So in all probability, you will not have any gains, capital gains. Your gains have already come to you in the form of dividends, whether it’s equity or debt funds. So therefore you can just sell the funds now. You will have no capital gains and you can just go and buy the growth option.

Deepak: The growth option will give you growth over the long term. If you want money out of it, then do a withdrawal. So you can do a systematic withdrawal plan saying, “Every month, give me Rs. 30,000, Rs. 40,000.” It’ll automatically sell worth 40,000 and give it to you. You could do this in a mutual fund, whether it’s equity or debt. Achieve the same thing. So, that’s one part. For stocks, you can’t do anything because you can’t refuse to take a dividend. The stocks will pay you, you’ll have to take the stock dividend and you’ll have to pay tax on that anyway on your own. However, we feel that there’ll be a 10% dividend TDS, which will be deducted at source. So you can use that to offset any taxes you actually have to pay eventually. And this dividend is treated as income.

Deepak: So apparently I am early … we haven’t figured this out yet. But any of the other costs that you’ve incurred in order to invest, whether it is … Let’s say you have invested in a PMS and you paid fees to the PMS, a custodian charge, a certain set of charges which are actually not included in capital gains calculations, are not allowed to be offset for capital gains calculations, can be offered for income calculations.

Aditya: Oh, that’s interesting.

Deepak: So you may be able to offset some of this with the other. We’ll have get some more detailed inputs from the tax people here, but that might actually help you in terms of saying, “What deductions I couldn’t claim in an earlier tax regime because dividends were not taxed, now I can claim them against the dividends.” So, at some level, this might give some respite.

Aditya: Okay. And what about the dividend reinvestment options? Because I believe those are redundant now because if I opt for a dividend reinvestment option, even though I do not receive it, but the fact that dividends will incur, I’ll have to pay tax. A I correct?

Deepak: Yes. In fact, not only that, what happens is the tax is left to you. So they’ll deduct 10% TDS and only reinvest the rest. So the TDS will be, if you get Rs. 100 dividend, only Rs. 90 will be reinvested. This has a problem because you now how to take the 10 rupees, claim it and declare Rs. 100 dividend income in your tax return in the end of the year. Luckily, I think they will report this against your PAN so you may actually be able to get it from your 26AS or whatever they call an annual financial statement, which will probably be released from July of this year, which will allow you to see all your deductions at one shot, the same way 26AS was allowed.

Aditya: Amazing.

Deepak: So this means that dividend reinvestment plans are a complete no-no. You need to go into growth. And what you need to do here is take the dividend reinvestment plans which are … Unfortunately, many of them are forced on you. There are liquid ETFs in the market. These are, by nature, only dividend reinvestment products. They pay dividend every day and whenever you collect enough dividend to buy another unit, they automatically buy another unit. This will result in a lot of pain. Because if you have a few … Let’s say somebody who’s rich, who’s got a couple of crores sitting in a liquid ETF which he’s using as margin, at the end of the year, he may have earned five or six lakhs as dividend, of which only about 50, 60,000 is paid as tax and the rest of the money is reinvested.

Deepak: That tax has to be either claimed back or offset and you have to declare the five or six lakhs as income, whereas right now it is not so. So liquid ETFs will get impacted, I think. Liquid funds should be used only in the growth option because now it doesn’t make any difference whether you do it in the dividend option or the growth option, for a short-term investor. But it does make a difference for a long-term investor. So you could do that. And also, I think because now there’ll be no difference between generating income, short-term income, from a fund by selling it versus taking dividends from it, it’ll make your decision-making a little bit easier eventually because either ways you’re going to earn the income.

Deepak: One way it’ll be actually as taxable income. One will be as under taxable, under capital gains. So there are two different heads and what you can offset on each head is different. Income from other sources, okay, you get a slightly different structure, you can’t offset it with capital losses. Capital losses can only be offset against capital gains. So you have a capital gain in a debt fund, you could have a capital loss in some equity product and offset the two and not pay any tax. But if you have a dividend income and a capital loss, those two can’t be offset against each other. So it’s a little complex, but a proper CA will be able to guide you on this.

Aditya: So let’s talk about Arbitrage Funds. What are going to be the implications?

Deepak: Arbitrage Funds have now recently been using the dividend reinvest or dividend payout mode. The idea here being that dividend is taxed at 10% so you get 10% tax, and then the dividend is tax-free in your hands, which can be reinvested. And these effectively give you about a 6 to 6.5% post-tax income. With dividend being taxed, a dividend reinvestment product, even an Arbitrage Fund is inefficient because it creates income in your hands. So you should use something called a growth plan. Where even those, for short-term purposes, because it’s an equity fund, you will only pay 15% tax versus if you’re in the highest tax bracket, you’re paying 30% tax on any income.

Deepak: So you should just use an Arbitrage Fund in the growth mode and withdraw money whenever you need it. So that might be the only difference for Arbitrage Funds. But the Arbitrage concept continues to remain attractive, just that these shouldn’t be used in the dividend option anymore.

Aditya: So, Deepak, let’s come out of the mutual funds and let’s talk about equity investors. Suppose I’m an equity investor, so because of this DDT, should I expect companies to go for more buybacks? Like, how do you see this panning out for companies?

Deepak: Yeah, so from a company perspective, three things, right? So if your company has a very large promoter stake and the promoters are individuals, remember individuals today pay the highest tax rate of 42.7% above five crore of income. And many of these promoters have so much shareholding that just their dividend itself will give them more than five crores per year. Which means on their dividends, they’re paying 40, 42% income tax. They will not like it. So they will say, “Listen, I will try to avoid this as much as possible.” So they may not actually declare higher dividends, as was thought about.

Deepak: Earlier, they thought … Earlier it is to be like, if I had to invest Rs. 100 dividend, I will pay government 20 and declare Rs. 80 dividend. The dividend is now not taxed in the individual’s hands, except if it’s above 10 lakhs a year. Another 10% is taxed in the individual’s hands. So even then you’re paying only 30%, so it’s fine. Now if I pay Rs. 100 dividend, 42% will go away. So instead what I will do is I will say, announce a Rs. 50 dividend and I’ll keep the rest of the money in the company. That’s one problem.

Deepak: Now consider a company with no promoters, like ICICI Bank or a number of other companies where there’s no promoter at all. There, there is no reason to believe that this 42% applies. Because also, remember that the investors in these companies are mostly mutual funds and insurance companies who don’t pay any tax. So you could give them as many dividends as you like and they will be happy because they don’t have to pay tax. It’s their investors who have to pay tax when they get out, but that’s a different kind of tax because that is a capital gains tax. It’s not a dividend tax. So effectively, anyone who’s institutionally owned will be wanting to declare higher dividends. Anyone who’s owned by a foreign promoter might want to declare higher dividends. Any promoter in a company, any high promoter holding in a company, Indian promoter holding in a company, will say, “I will use a buyback instead of using a dividend.”

Deepak: This only applies if you have less debt because you can only do one buyback a year, and it’s a complicated process. And when you do a buyback, you can’t raise more capital for another six months. So if you have capital raising plans, you shouldn’t be doing buybacks.

Aditya: Exactly.

Deepak: So given all these restrictions, if there is a company with high cash components, like the IT companies in India, very high cash, no debt, and they want to give the cash back to shareholders, they would rather use a … instead of a dividend payout, they’ll use a payout through a buyback route. So buybacks will increase for certain set of companies. And for the others, who have foreign promoters perhaps or institutional investors, they might choose the dividend route.

Deepak: And companies with high debt, I mean like banks for instance, may actually have to pay out dividends because they can’t use the buyback route. If you have very high debt, you’re not allowed to buy back your shares. So they may actually even use the money that they get to pay back the debt instead of actually paying out dividends. These are the behavioral things that will happen over the next year. Let’s see how that works.

Aditya: Okay, so Deepak, I’m sorry I’m pulling in something which we did not intend or talk about, but it’s very tempting. So what do you think about the LIC IPO?

Deepak: It’s quite interesting because a lot of people are unhappy that the government has actually made this 80C less attractive, right? Just before? But I think that the government’s intent to eventually remove exemptions is well known. Imagine they have done the IPO and the next year they removed the exemptions. It would look so bad. Right? It would be like, “Oh God, they’ve done this IPO and now immediately they’re removing all the …” So now they’ve removed it up front and now they have said, “Listen, that’s the way it’s going to be. Do what you may.”

Deepak: And if that’s the thing, then it’s actually a good thing, that. Because LIC IPO will anyway get oversubscribed. It is such a huge institution, I don’t think the government is fearing that people will not subscribed to LIC IPO. The only thing they can say is, “Oh, will the oversubscription be 5x or 10x or 100x?” Well, all you want is a 1x oversubscription, right? And you’re probably not even selling 10% of LIC in the first shot. You might sell a smaller amount, get a SEBI exemption. So while I think 80C may not be very attractive for a lot of people, I believe that the LIC IPO will still sail through if it happens and the impact will not be so much for the government of this 80C thing. But as a company, we’ll have to see the books, because nobody knows what the books of LIC looks like, to figure out if it’s a good IPO or not. But you can imagine how big this IPO will be because everybody knows this. It’s a household name, and it’s the largest insurer in India with more than 80% market share, I think.

Aditya: So that’s it, Deepak. Thanks a lot.

Deepak: Lovely to hear all these questions, Aditya. I’m sure there will be more. We’ll just focus on the personal finance parts of the budget. There’s lots of other things that the Finance Minister talked about, about new things around. Even a Metro for Bangalore, which I know will happen by the time I die, I hope. And I also believe that there will be a lot more impetus on building relationships with foreign countries in terms of getting more capital in from there.

Deepak: Of course, we’ve increased their customs duties on a lot of things. So I’m not going to all of that. But this was the personal finance aspect of the Budget. We hope it’s cleared a lot of air and we hope you’ll have more questions. Remember though that we’ve clarified a lot of the positions on Twitter. I think one of the other aspects we haven’t mentioned right now is about NRIs. There’s a taxation for certain NRIs who keep roaming around, two, two months in every country and they classify themselves as tax citizens of no country because in no country have they stayed for more than two months. So the government has actually decided to tax them this time. And so those people who, if they’re carrying Indian passports, will actually have to pay tax in India if they are not paying taxes anywhere else. And when I say not paying taxes, I think what I really mean to say is they are not taxable citizens, taxable residents, of any other countries.

Deepak: So the Dubai and UAE residents and people of Saudi Arabia, who live in Saudi Arabia who are Indians, they don’t need to fear that their income is taxed. However, I feel a lot of people will require clarity, including Merchant Navy going seamen and seafarers and a number of other people who earlier used to stay in India only for say 120, 140, 150 days. Now where that limit has also come down to 120 days. If you stay now 120 days in India, you are a resident for Indian tax purposes. But for them, if they stay less than 120 but don’t pay tax in any other country, they will have to pay tax. So these are some of the smaller aspects of the budget. Overall, I think the budget’s been quite an interesting thing from terms of personal taxation, but it’s complicated our lives a lot more. And I hope that the next budget will try to simplify things.

Deepak: But at this time, your next year is going to be about a lot of Excel sheet based calculations. I hope altogether it all works out for all of us. So like always, @capitalmind_in on Twitter, and for our offerings. We have a stock market research service for you. We also have a place where we can actually manage your money and reduce your hassle in doing a lot of these things. And I’m @DeepakShenoy on Twitter, @AstuteAditya. You can ask us questions, tell us what you think, and keep your questions flowing in. Thanks for listening.

Aditya: Thanks a lot.


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