Sunday, October 25, 2009

Economic return of investing in Excellence in Education

ISB Hyderabad's first class started on July 1, 2001 and it was established at a budget of Rs 200 crores and a new campus is being setup at Mohali with a budget of Rs 300 crores. ISB is scheduled to enhance its intake to 600 for the academic year 2010.Even in the current difficult economic environment, ISB had a good placement record adding an average of Rs8lakh to the existing CTC per student. Given that this was about 25% lower than the previous year owing to the recession,one can safely assume that ISB will continue to add Rs 10lakh to the existing CTC per student in perpetuity.By their very nature, the capabilities of a knowledge institution only improve with time and hence would likely add more value per student going forward.
Thus,ISB is contributing a minimum economic value of Rs 60crore(600 X 10lakh) per year.If we assume a life of 100 years(though good Institutions are known to last many centuries) for this Institution, a fixed investment of Rs 200 crore gave a return of Rs 6000 crore,an astounding 300 times. Can any venture capital fund gives this much assured return? Government of India, although did not contribute in this endeavour, by way of financing, will get Rs2000 crore as Income Tax only.What other asset class gives this much assured return?
And these are just monetary returns.The value added like executive education, manament development programs, research, conferences and incubation of startups cannot be quantified. The returns that society get from the intellectual capital added and the leadership role these invididuals will play are immeasurable.Is there any better public service other than promoting excellence in education?
ISB, here, is just a template and can be replaced with any institute of excellence be it IISc for Science, IITs for technology or AIIMS for Medicine.Despite the benefits that excellence in education entails,such endeavours continue to face delays such as this.

A related link describes GoIs intended investment in Institutes of Excellence. But this is not enough. Private sector needs to pitch in a big way. What we should have at the very least is to give 100% Income Tax exemption to any contribution to any Institute that meets the crietrion of excellence.

Monday, October 12, 2009

Bonus Shares:Whiten money,lighten tax bag

A little more details further to the previous post.As is clear from the previous post, the bonus shares do create capital loss for the purpose of tax calculation while no actual capital loss may have occur ed.This must not have been a big issue when our capital markets were small and ratio of Market Cap to GDP was low.Due to the fact that Reliance is the biggest publicly listed company in India,the government can potentially lose out on more than Rs20k crore of taxes due to the artificial capital losses generated by this bonus issue.To put things in perspective,this amount is about 20% of the total personal income tax receipts last year. If all the 30 sensex companies were to undertake the same exercise with their current free float market cap at 12 lakh crore rupees,this would create fake capital losses of 6lakh crore rupees which will be about twice the total direct tax collections made last year.Its bewildering to understand how Indian money in Swiss accounts gets so much attention while such big loopholes stare us. Ironically, the bonus issue is being greeted with great joy and welcomed as a gift and token of value creation.

That said,lets return to the alchemical world of converting black into white.Apart from the capital gains that are legitimate being set off against fake capital gains,one can create fake capital gains and set off them against fake capital losses. Some examples:
  1. Ram's friend Teja has accounted income in form of say salaries but unaccounted expenditure for example on foreign trips,luxury,art etc. Ram can transfer the black money in cash to Teja and Teja can buy Ram's land at inflated price thus creating fake capital gains.
  2. Ram can transfer the money abroad via Hawala or other routes which Teja can borrow, say through FIIs, to buy Ram's land.Also an NRI can also buy Ram's land through the transferred money.
  3. Ram's money need not be in India in the first place. It might already be resting in some Swiss account.A foreign entity can buy Ram's land using this money.
The possibilities are too many and time is ripe. In a reset world, returns on investment on white money are much more than black. The Noose is tightening on Swiss banks. Very many politicians/bureaucrats and other benign souls would be thanking Mr ambani for this opportunity.

Some friends have asked how can there be short terms gains taxed at 15%. Wont they get squared against the short term losses. The answer is that the bonus exercise may get stretched upto December.One can book the short term capital losses in this financial year,hedge for remaining months of this financial year and book short term capital gains in next financial year. Yes, there will be additional transaction costs besides those mentioned previously including stamp duty on land which is about 5% and brokerage costs involved in hedging which are relatively miniscule.

One does not know when and why this loophole arose in our taxation strucure but the earlier we get rid of this, the better.

PS: A related article in Business Standard by Kanu Doshi,a CA , explains that law was amended to plug this hole for mutual funds and not for stocks. The law in that case requires the units be either purchased 3 months prior to record date or be held for 9 months after the record date. Why cant law be amended to treat bonus shares at par with stock split for capital gains purposes?

Saturday, October 10, 2009

Bonus shares:Vehicle for whitening black money

RIL has recently announced a bonus share in the ratio of 1:1. RIL has a market cap of about 3 lakh crore rupees with 47% being held by promoters. On issue of the bonus shares, the shares will trade at about half their current price ex bonus.This Business Standard article from april 2004 explains in detail how Bonus shares can be used to create short term capital loss which can be set off against any capital gains.A relevant excerept from article from Income Tax Office,Banglore:
Loss from transfer of a short term Capital Asset can be set off against gain from transfer of any other capital asset(Long Term or Short Term) in the same year. Loss from transfer of a Long term Capital Asset can be set off against gain from transfer of any other long term Capital Asset in the same year.

If there is a net loss under the head “Capital Gains” for an assessment year, the same cannot be set off against any other head of income viz., Salaries, House Property, Business/Profession or Other Sources. It has to be separated into Short term Capital Loss(STCL) and Long Term Capital Loss (LTCL) and carried forward to next assessment year. In the next year, the STCL can be set off against any gains from transfer of any capital asset (Long term or Short term) and LTCL can be set off against gains from transfer of long term capital asset only. Any unabsorbed loss after such set off can be further carried forward to next assessment year.

Capital loss computed in an assessment year can be carried forward for eight assessment years and set off as above.

So lets say Mr Raju buys the RIL share before bonus and sell the original shares immediately after shares go ex-bonus to book short term capital loss. The bonus shares have a NIL cost of acquisition. Now, Raju can either sell the bonus shares and pay a short term capital gains tax @15% or he can hold the bonus shares for a year. He can hedge his risk by selling the RIL shares in forward market and keep on rolling for a year but there too there is cost of capital involved.Assuming he has to pay 25% as the margin money and cost of capital is 15%, the total cost will be 3.75%. Both of these options are much more attractive than standard 30% STCG for non equity capital assets held for less than 3 years.

Since the non promoter holding in RIL is worth about Rs 1.5 lakh crore rupees,there can be about Rs75,000 crore rupees of capital loss available for the taking.Since bulk of the money in country is in form of land,this is a very attractive option for bringing that on the books at its real price.And this is all perfectly legal. This loophole has existed for a long time but RIL being the largest Indian company in terms of Market capitalisation and the ratio of 1:1 probably makes it ptentially the biggest tax amnesty scheme so far.