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?

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.

Finances of States owned PSEs: Power Sector

The consolidated excel sheet has been updated after cleaning and correcting the data in some places.The summary stats for Power sector are here.This post will focus on Power sector.(All numbers are approximate with less significant digits omitted)

Aggregate Data

1. This sector has a turnover of 1.9 lakh crores and employs 7.7 lakh persons. The total accumulated losses for the sector are Rs 32k crores.The turnover per employee is hence Rs 22 lakh. There is a wide variation around this figure with Orissa at the top with Rs 55lakhs in contrast to Rs 6.8 lakhs for Bihar.
2. The two industrial states of Gujarat and Maharashtra have the highest revenue at about Rs 27k crores and 20k crores respectively. Maharashtra has double the number of employees(1.16lakh) of Gujarat(56k).This is clearly reflected in their profitability with Gujarat having a profit of 628 crores(2nd highest in the country) in contrast to Maharshtra's 117 crores.
3. UP comes third with a turnover of Rs 20k crores whose manpower is not completely reported, followed by AP at Rs 18k crores.UP has the distinction of having highest losses and highest accumulated losses at about 2.6k crores and 11k crores respectively.
4. Karntaka and TamilNadu come next with revenue of about 14k crores each.While Karnatka employs 42 thousand; TamilNadu employs almost twice that(78k) .No wonder, Karnatka is making a profit of Rs 462 crores while TN is making a loss of Rs 1328 crores.
5. Further down the list, Haryana has a revenue of 13k crores with an employee base of 33k while next door Punjab earns about half that(Rs 7k crores) with more than double the number of employees (73k ). Punjab's revenue per employee of Rs 9.5 lakhs is only beaten by Bihar(Rs 6.8 lakhs) and Himachal Pradesh (Rs8.6 lakh) . But even than, their percentage losses at 8% and 1% are much less than Punjab's 23%.Hence,Electricity reforms in Punjab are inevitable; despite this.
6. The two mineral rich states of Orissa and Chhatisgarh have the highest profit margins of 19% and 10% respectively with Kerala coming a distant third at 5%.However,there is considerable scope for the latter two states to cut the flab having Revenue per employee of only Rs 17 lakhs and Rs 24 lakhs respectively in contrast to Orissa's Rs55lakhs.
   

Company level data
There are total 93 companies in power sector 14 of which have not reported any accounts.

Turnover

1. There are 46 companies with revenues of more than Rs 1kcrore aggregating to 1.77lakh crores
2. There are 32 companies with revenues of more than 2kcrore aggregating to 1.56lakh crores
3. There are 14 companies with revenues of more than 4kcrores aggregating to 1.05lakh crores
4. There are 4 companies with revenues of more than 10kcrores aggregating to 50kcrores

Profit
There are total 41 companies that are profitable earning a total of 5128crore rupees. Of these:

1. 14 companies earn more than 100crores totalling 4516crores
2. 8 companies earn more than 200crores totalling 3616crores
3. 3 companies earn more than 500crores totalling 2317crores

Losses
There are total 33 loss making companies making total losses of Rs 8044 crore.UP alone accounts for 1/3rd of these losses with Punjab and TamilNadu accounting for another 1/3rd.

1. 19 companies are making losses of more than Rs 50 crores totalling 7707 crores
2. 16 companies are making losses of more than Rs 200 crores totalling 7397 crores
3. 10 companies are making losses of more than Rs300 crores totalling 5934 crores
4. 3 companies are making losses of more than Rs3546 crores totalling 3546 crores

This short summary clearly demonstrates that some states have just too many employees and they are a serious roadblock to reforms of this sector.The 6th pay commission is only going to aggravate the situation.Just to put things in perspective,revenue per employee of private sector Tata Power Company at more than Rs1.5 crores is more than triple that of best performer of state owned Power companies. For worst performers like Punjab,Bihar and Himachal this figure is ranges from 15 to 25 times. This, simply, is not sustainable.

Finances of State owned PSEs

This excel sheet contains the last available summary financial data of each of the state owned PSE as reported by CAG of India. This is compiled are released in public intrest for wider awareness of the finances of State government owned enterprises and facilitating a cross country comparison.

Here are some interesting facts from this compilation:

• Andhra Pradesh has the highest turnover for companies owned by it at Rs 36k crores as also the highest number of employees at 2.6 lakhs.
• Gujarat has almost the same revenue as Andhra Pradesh at 33k crores but with less than half the number of employees at 1.15 lakhs.
• Maximum revenue per employee is by Gujarat but Profit per employee is highest for Orissa at Rs 3.4 lakh.Profit margin for Oriya PSE is highest at 17% probably driven mainly by Mining and its Power companies.Remember that Orissa was the first state to introduce Electricity reforms.
  
• Power companies have the highest turnover with TNEB(Tamilandu) at top with Revenues of 14.5k crores.Beverage (read liquor) sector comes 2nd led by Beverage corporations of Andhra Pradesh and Karnatka at 6.7k crore and 6.38 crore respectively. Civil supply or PDS sector comes third with Tamilnadu at 4k crores and Punjab at 3.5 crores.
• Among individual companies, maximum number of employees are employed by MSEB(Maharashtra) at 1.16 lakhs which is much higher than 77k employedby TNEB with similar revenues. Remember that distribution of power is privatised in its largest city, Mumbai.Tthe process for privatisng in some other cities is going on.
• PSEB(Punjab) is the highest loss making company with losses of 1.6k crores rupees.17 of the top 18 highest loss making companies are in Power sector with next 5 from Transport sector.
• Ironically, the top 3 profit making companies are also from Power sector with MPSEB(MP) at 1.2k crores at the top followed by ~Rs 570 crores Gridco(Orissa) and GSECL(Gujarat) ~Rs 500 crores
  
• In transport sector, most of the states are making huge losses relative to revenues and few are just breaking even not surprisingly since the total turnover of the transport sector is only Rs 16k crores. Regional integration of transport sector is urgently called for but this is unlikel to happen since Transport sector is one of the biggest employers employing about 4.7 lakh people.Considering the vital role of public transport and the number of citizens it touches directly, overhaul of the sector is urgently called for. If we assume an average ticke price per trip per person of Rs 20, an average Indian must be making at least 8 trips per year by state transport buses alone.

Just how many Millionaires are there in India?

Its better to be roughly right than precisely wrong
Since the compilation of any list of Millionaires is bound to be imprecise for a variety of reasons, chief among them being secrecy and the fluctuating valution of asset classes, i would only use rough estimates here.
We often come across new studies by esteemed sources like Forbes who claim there are 1 Lakh millionaires in India where a millionaire is defined to be one having liquid wealth of at least 1 Million dollars.As soon as these reports are published in media, commentators jump up and say there would be these many millionaires in 1 geography alone: say South Mumbai or South Delhi.
Here I have attempted to answer this question from a different angle: compiling the total liquid wealth in India.
As i understand following are the different liquid asset classes:

1. Cash:As per latest RBI figures total cash in circulation is about Rs 6 lakh crores.
2. Bank Deposits:As per RBI again, total bank deposits are about Rs 35 lakh crores.
3. Equity: As per this report in Times of India, the breakup of ownership of top 500 companies is: -23%,Government-22%,Promoters-29%,Corporates-4%,Rest-22%).These companies constitute 93% of stock market cap of India as per the same report. Since the number of promoters would be few thousands and is not a signifcant number compared to upwards of 1 lakh Millionaires, the total equity wealth avaiable to potential millionaires is about Rs 10 lakh crores
4. Bonds:As per a recent ADB report, Bonds are about 40% of GDP of which more than 50% is owned by Banks and RBI and rest by MFs,LIC,PDs etc. So a maximum 10 lakh crores is available to potential millionaires from this avenue.
5. Gold:This is by far the most democratic asset class as far as India is concerned since Indians own about 14,000 tonnes of it(source) which includes jewlery.Some people have even wilder estimates at 25,000 tonnest e.g. Taking a price of Rs 13 lakhs per kg, Gold accounts for about Rs 18 lakh crores of wealth.

The window for overseas asset ownership has recently opened and must be having modest assets. i hope no significant liquid asset class is missing here. So the potential millionaires have a total liquid wealth of about 80 lakh crores available to them. If one attributes this entire wealth equally distributed among millionaires we can have 16 lakh millionaires in India.But that would leave about 120 crore Indians penniless.Randomly assuming an average wealth of 2 million dollars for all millionaires and attributing half of the nation's significant liquid wealth to them (randomly again) gives us a more plausible maximum number of 5 lakh millionaires in India.

Judges Conference: Review of important developments in Indian Legal framework

Here are some important developments in Indian Legal framework taken from background reading to Chief Justices'conference.Thanks to Nick for posting this.

• New Civil cases in High Courts have increased from 2.5 million in 2002 to 3 million in 2009 despite a disposal rate of 1 million per year.Criminal cases have increased from 5.3 lakhs to 7.7 lakhs with disposal rate of 4.9 lakhs.Of the total cases, 0.9 million are pending with High Court of UP.


• In subordinate courts,civil cases increased from 7.2 million to 7.5 million with a disposal rate of 3.8 million per year while criminal cases increased from 15.1 million to 18.8 million with a disposal rate of 11.5 million. Of the total cases,5 million are pending with UP courts.


• Indications are that number of cases filed will only increase with time.
If we are to remove the pendency we need to boost the output of our legal framework by 100%. Filling existing vacancies alone will boost the disposal by 50% at High court level and 25% at subordinate court level.

• In India more than half the amount spent on judiciary is raised from judiciary and the total expenditure on judiciary is hardly 0.2%, whereas it is 1.2% in Singapore, 1.4% in USA and 4.3% in UK.

The document has following suggestions:

• Of entire litigation,50-60% is due to central acts.There are 340 central laws that are adjudicated in subordinate courts.The state governments have to spend money for implementing laws formulated by Centre.Further, Article 247 allows Central government to setup additional courts for better administration of Central laws.
  While Central government may use lack of resources as an excuse it surely can simplify the Central laws and reduce filing of fresh cases.


• Whenver a new legislation is enacted that is likely to increase the workload of Courts,High courts should ask State governments to accordingly increase the strength of Judges.


• Adequate infrastructure should be provided for subordinate court buildings.Such basic facilities as regular water and electric supply are not available.Also new court complexes should be developed with proper planning.This is one recommendation that all Governments will be too happy to comply with.


• Technology: Courts should communicate with advocates/litigants through email. Already, one can file a case through internet now at nominal charges.The court documents should be scanned.Video conferencing has been a success in states that have amended CrPC to allow it.Curious to know which states have not amended it and why and why state government?Why not a constitutional amendment?


• All states should try to make optimal use of infrastrcture and setup Morning or Evening Courts. The ‘Morning Courts’ have started functioning in the State of Andhra Pradesh and they function from 7.30 A.M. to 10.30 A.M. five days a week. ‘Evening Courts’ are functional in the States of Gujarat, Delhi and TamilNadu also.


• Setting up and strengthening of vigilance cells is suggested. What is not mentioned is if any vigilance cell has found anything or action has been taken by a High court upon the cell's report.


• Alternate Dispute Resolution should be strengthened in a big way.
  In U.S.A. there are private mediation firms which employ full time mediators and possess infrastructural facilities to hold a large number of mediations. More people go to such firms rather than wait in Courts. Also, there are Court Annexed Mediation Centres, running on funds made available by the Government. There are thousands of lawyers practising exclusively as mediators. Retired Judges also act as mediators.
  There are mediators who specialize in various branches such as intellectual property, accident, commercial cases etc. and more than 90% of the cases do not go to trial
  
  Its noted that the reason ADR mechanism is virtually absent in India due to lack of human resources trained in ADRs and people who can train others in ADR.Further, its noted that Government being the biggest litigant should take the lead in promoting ADR. There are total only 147 mediation centers in India.This is a business opportunity waiting to be tapped!!Wondering what prevents this from happening.

PS: PIB Press Release, PM's speech during Joint Conference of Chief Ministers and Chief Justices, Law Minister Moily's comprehensive update on GoI's action agenda.

RBI's Branch 'Expansion' policy.

What is RBI's branch expansion policy?
As per this policy,RBI uses a list of underbanked districts (last compiled in 2001) to try and force banks to open branches in areas which apparently they are reluctant to serve.

• Even today, 378 out of 603 districts are classified as underbanked despite the fact that Indian economy has more than doubled and its structure changed significantly since the list was last prepared.As an inspector of Banking, granting licenses, RBI should be aware of the current status of Banking penetration and base its policy on that.


• Among other things,RBI defines an administrative office and controlling office as a branch and hence required to be requiring its license.


• Since demand for Banking services is huge and supply perpetually low, number of branches is the golden key to profits. Instead of relying on explicit regulatory mechanism RBI uses Branches as chocolates to be distributed among well behaved kids. One major crierion for award of branches is:
  services provided by banks to common persons, particularly in underbanked areas (districts), actual credit flow to the priority sector, pricing of products and overall efforts for promoting financial inclusion, including introduction of appropriate new products and the enhanced use of technology for delivery of banking services.
  Branch license is probably a kill all solution and instead of explicit actions RBI seems to be saying do whatever you like, I ll see you at the end of year when you come to me for getting license. Only charitable comment about this can be that RBI is plain lazy.


• RBI,busy as it is, only accepts the applications for branch licenses only once a year and owing to its benevolence,applications for underbanked districts are selected throughout the year.


• Since agriculture now constitutes 25% of our GDP, probably thats why, 25% of the branches are to be setup in rural or semi-urban areas.Even in 2001, Punjab though rural has only 1 district that is underbanked,while Maharashtra has more than half of its districts underbanked(26). So branches are proportional to economic activity; why this hang up with rural/urban?As a result, while demand for banking services increases in one segment of society, RBI is adamant not to let market cater to it.


• In case of mergers,the licence (if separate licence has been issued) ) of the merged branch (transferor branch) should be surrendered to the Regional Office concerned of RBI.Maybe RBI can learn something from TRAI here and vice versa.


• As a matter of policy, closure of even loss making branches at rural centres having a single commercial bank branch (excluding Regional Rural Bank branch) is not permitted, as closure would render the centre unbanked.
  
  Banks are permitted to close any branch in metropolitan, urban and semi-urban (not assigned responsibility under Government sponsored programme) centres without seeking prior approval from RBI.
  RBI street is one way only-->underbanked/unprofitable districts.
  

The latest policy is here. A related column on Bank Nationalisation.