HUF: tax planning

In the era of progressive taxation system, it is always advisable to distribute the income across multiple legal entities. A new pan card can save approximately 1.6Lkhs every year in taxes. Yet creating a Hindu Undivided Family (HUF), is one of the least talked about topic in India’s financial advisers.

How it saves tax:

  1. HUF becomes a separate legal entity. Hence it is eligible for rebates that is enjoyed at lower tax rate. Making the first 4-5 Lakhs of income virtually tax free.
  2. Cost of set up is also negligible. (20/- for a stamp paper, 50/- to get it notarized, 107/- for the PAN card application, ~200/- per annum for the bank account, ~400/- per annum for the demat account) Remember the bank account & demat account are optional.

Process to set it up:

  1. Create an affidavit for HUF & get it notarized.
  2. Apply for PAN. It is a simple process that you can do from your home.
  3. Open a bank account (or post office)
  4. Open a demat account
  5. Buy 1.5 Lakhs of NSC or investments that are 80C eligible.
  6. Transfer your assets to HUF so that the returns on it can be reported at a lower tax slab
  7. File HUF income tax returns

Process to dissolve:

  1. The best way to dissolve the HUF is to use its assets for the family expenses. You could buy a car, pay for the maid, gardener, driver salary etc. Buy furniture, pay for the medical expenses of the Karta or coparceners etc.
  2. Although there is no restriction on HUF holding property or shares of business, try to keep the HUF hold liquid funds invested in taxable entities (like bonds & FD). This way it is easy to prevent the HUF for owning too much funds and make periodical withdrawals to extinguish easier.
  3. As long as the karta is alive, the coparcener cannot force it to dissolve. The HUF karta (under whose name HUF is formed) has the sole discretion on its assets.

Other considerations

  1. As the name suggests, only Hindus, Buddhist, Jains & Sikhs can open a HUF.
  2. Also people from Kerela are not eligible to open the HUF.
  3. The HUF is formed at the time of marriage and all lineal ascendants & descendants automatically become members, without exception.

HUF is beneficial for you only if your non-salary income is substantial. By moving those assets & income here, you could save some taxes. Apart from tax saving, there is little to be gained from this instrument.

The first kick

A friend of mine is expecting her first kid and I happened to be around when she witnessed the first movement of the unborn baby. She was filled with pure euphoria of motherhood and wanted to share the moment with me. I felt awkward and politely declined to touch her belly. By this time, her hormones had also normalized and my reaction made her self-conscious and led to a very long awkward silence.

An innocent kid would have not only participated in this event but would have amplified the significance. I, as an adult, only dampened the moment. It was my own inhibitions & thought process that denied me the pleasure of witnessing this wonder of nature. The first movement of the kid is a moment of pure joy where the mother realizes for the first time that a living breathing individual is being incubated in her belly. It’s like an exclusive unveiling of a premier show months before its actual release.

Why have we killed the innocence in us? We have placed innumerable artificial barriers, constraints, conditions and traditions that rarely we are able to enjoy a moment without inhibitions. The stress in our life is building up because of the 100s of man-made filters that block our joy but amplify our misery. All being said, I still don’t know how I would react if I could time-travel back.

Cost of mimicking NIFTY?

S&P 500 has as the name suggest 500 stocks. It makes it pretty difficult for a retail investor to create a portfolio, unless they have 10s of millions of dollars. As a result, investors have gone via ETF route to help them replicate the returns of the index. The market is quite efficient and the cost involved is also low (management fee of 4-20 basis points) compared to what is charged by mutual funds in India.
In India, if I invested the 15 Lakhs in Nifty, I could replicate the portfolio within 2.5% error (the cost of the management fees). Added advantage being that I get NIFTY total returns (benefit of dividends, stock repurchase, rights, one time offers etc.) which is not shown by fund managers when they show the fund performance against the benchmark. I am surprised why not many individuals are still going through mutual funds & not direct.
There are 100s of papers pointing to the fact that “In an efficient market, portfolio managers cannot beat the market (once compensated for the management fees)”. If you also subscribe to this theory, the chart below from the 10th July closing price might give you some tips. Please note this was constructed when market was at an all-time high. If a 10% correction happens, your money can buy you more stocks and help reduce tracking error further.

Sector Stock Name Weightage (%) in index Share price no of shares Actual investment Portfolio weightage
ALUMINIUM Hindalco Industries Ltd. 0.77 3726.05 3 11,178 0.75
AUTO ANCILLARIES Bosch Ltd. 0.59 662.85 13 8,617 0.58
AUTOMOBILES – 2 AND 3 WHEELERS Bajaj Auto Ltd. 1.05 2731.9 6 16,391 1.10
Hero MotoCorp Ltd. 1.33 1673 12 20,076 1.34
AUTOMOBILES – 4 WHEELERS Eicher Motors Ltd. 1 28039.9 1 28,040 1.88
Mahindra & Mahindra Ltd. 1.75 1366.5 19 25,964 1.74
Maruti Suzuki India Ltd. 2.67 7440 5 37,200 2.49
Tata Motors Ltd DVR 0.37 268.25 21 5,633 0.38
Tata Motors Ltd. 2.26 83.5 406 33,901 2.27
BANKS Axis Bank Ltd. 2.45 510.5 72 36,756 2.46
Bank of Baroda 0.42 166.5 38 6,327 0.42
HDFC Bank Ltd. 9.3 1639.95 85 139,396 9.32
ICICI Bank Ltd. 5.17 1070.4 72 77,069 5.15
IndusInd Bank Ltd. 2.06 383.6 81 31,072 2.08
Kotak Mahindra Bank Ltd. 3.23 963.35 50 48,168 3.22
State Bank of India 2.82 285.25 148 42,217 2.82
Yes Bank Ltd. 1.49 1511.2 15 22,668 1.52
CEMENT AND CEMENT PRODUCTS ACC Ltd. 0.37 1629 3 4,887 0.33
Ambuja Cements Ltd. 0.5 254.25 30 7,628 0.51
UltraTech Cement Ltd. 1.15 4145 4 16,580 1.11
CIGARETTES I T C Ltd. 7.65 291.65 394 114,910 7.69
COMPUTERS – SOFTWARE HCL Technologies Ltd. 1.35 849.5 24 20,388 1.36
Infosys Ltd. 5.19 332.9 234 77,899 5.21
Tata Consultancy Services Ltd. 3.49 447.7 117 52,381 3.50
Tech Mahindra Ltd. 0.66 383.8 26 9,979 0.67
Wipro Ltd. 0.91 268.5 51 13,694 0.92
DIVERSIFIED Hindustan Unilever Ltd. 2.14 196 164 32,144 2.15
ENGINEERING Larsen & Toubro Ltd. 3.85 1734.5 33 57,239 3.83
FINANCE – HOUSING Housing Development Finance Corporation Ltd. 7.13 1097 98 107,506 7.19
Indiabulls Housing Finance Ltd. 0.96 1560.75 9 14,047 0.94
GAS GAIL (India) Ltd. 0.65 364.4 27 9,839 0.66
MEDIA & ENTERTAINMENT Zee Entertainment Enterprises Ltd. 0.75 504.3 22 11,095 0.74
MINING Coal India Ltd. 0.88 258.55 51 13,186 0.88
Vedanta Ltd. 1.29 260.75 74 19,296 1.29
OIL EXPLORATION/PRODUCTION Oil & Natural Gas Corporation Ltd. 1.23 161.85 114 18,451 1.23
PAINTS Asian Paints Ltd. 1.38 1126.8 18 20,282 1.36
PHARMACEUTICALS Aurobindo Pharma Ltd. 0.53 711 11 7,821 0.52
Cipla Ltd. 0.78 548.75 21 11,524 0.77
Dr. Reddy’s Laboratories Ltd. 0.9 2725 5 13,625 0.91
Lupin Ltd. 0.7 1148.5 9 10,337 0.69
Sun Pharmaceutical Industries Ltd. 1.7 563 45 25,335 1.69
POWER NTPC Ltd. 1.09 160.1 102 16,330 1.09
Power Grid Corporation of India Ltd. 1.29 211.65 91 19,260 1.29
Tata Power Co. Ltd. 0.41 558.85 11 6,147 0.41
REFINERIES Bharat Petroleum Corporation Ltd. 0.92 404.5 34 13,753 0.92
Indian Oil Corporation Ltd. 1.09 955.3 17 16,240 1.09
Reliance Industries Ltd. 6.36 1489.55 64 95,331 6.38
SHIPPING Adani Ports and Special Economic Zone Ltd. 0.81 375 32 12,000 0.80
STEEL AND STEEL PRODUCTS Tata Steel Ltd. 1.02 2432.1 6 14,593 0.98
TELECOMMUNICATION – EQUIPMENT Bharti Infratel Ltd. 0.73 23832.05
TELECOMMUNICATION – SERVICES Bharti Airtel Ltd. 1.39 408.8 51 20,849 1.39
Grand Total 99.98 104914.05 3,039 1,495,244 100.00

The reason for this 2% error: Bharti Infratel (not a fancy stock but still has a high stock price) making it hard to incorporate in the portfolio. Also Tata Motors & Tata Motor DVR are two separate scripts. If you choose one of the two, your tracking error can be further reduced.

If you plan to replicate this strategy, I would advise that systematic monthly investment would be more sound that one shot (bullet) investment. NSE categorizes stocks in 23 categories. However if you are starting with a monthly plan, get the basics sectors right in the first 6 month (Banking 24%, O&G 15%, Technology 14%, Auto 11% & Tobacco 5.8%) then start adding the minor industries over the next 12 months. Second year onwards diversify in the main industries and gain exposure in the second & third weights of the main industries. Like that if you systematically buy exposure in 1-2 companies every month, you can reduce your tracking error & yet able to mimic the stock index returns within a 2% range. A ghost trading in which you track your portfolio performance to a SIP on your favorite mutual fund or Index might give you a nice bearing on the efficacy of your strategy.

Please note I am a passive investor. I trade only 1-2 times in a quarter. This strategy will involve trading one day in a month to rebalance.

Home loan for tax savings? Think twice

Real estate to me is a lifestyle consumption good and not an investment category. Hence my opinions on home loans also differ a lot. Please note that this article is directed for white collar salaried professionals who are taking loan as a tax planning tool and not as a financing tool.

My reasons for not taking home loan:

  1. 80C is an overused tax saving tool. Its limits are ridiculously low and after netting your PF, insurance etc. most white-collared professionals have no limit left to leverage through home loan repayments.
  2. INR 1.5Lakhs interest subsidy on home loans: This makes sense if you are in the market for a 15-18Lakh loan. However, if your house is going to cost 1CR+ (cost of a 3BHK in a decent locality by a reputed builder), then your loan will be 70Lakhs plus, making the interest subsidy insignificant. Also for anybody paying more than 12-13k a month on house rent, would realize that they end up being a net tax loser because of house ownership.
  3. HRA: Your tax planner rarely talks about it and very few people understand that house ownership makes them ineligible for HRA benefit. (House rent allowance is good 40-50% of one’s basic pay). If you don’t take a loan, you don’t have to worry about loan eligibility, you can have a dependent own your house and claim HRA.
  4. Interest spread (only applicable if you have enough capital to finance the house purchase): SBI Home loans is at 8.75% (https://www.sbi.co.in/portal/web/interest-rates/home-loans-interest-rates ) while the FD rate are 6.75% pre-tax (https://www.sbi.co.in/portal/web/interest-rates/domestic-term-deposits-below-one-crore ) Mind you that only partial amount of your loan is tax free but all of your interest income is fully taxed. Hence this 2% of interest rate actually increases once you do the tax math. Also this spread will eat away any tax savings that you had envisioned.
  5. Essentially you need earn about 12.5%+ if you pay the taxes, pay off the loan and make a profit from this financial engineering. Don’t you think it is quiet steep? If you invested in stock market (directly or through mutual funds), you save on the taxes. But it is a sound investment only if you understand the risk & perils of borrowing to fund your stock market portfolio.
  6. The 8.75% sticker price of home loans is also not without caveats. It forces you to take an insurance policy, increases the cost of paperwork, filing/administrative trouble etc. all that needs to be accounted for. The stamp duty (esp. in NCR) varies if the wife, husband or both own the property. This saving is foregone if the bank loan is availed.
  7. Also do keep in mind that the tax benefit of house ownership can be availed only for two times in one’s lifetime. So if you repay the loan fast, you have squandered away this opportunity. Also remember that certain tax advantages cannot be availed till the property construction is complete.
  8. Couples often end up with joint ownership of property when they avail home loans because of eligibility & better interest rate reasons. This has a hidden cost because the next property purchase either one of them does will end up costing them with a deemed rental income tax. If the property was owned by only one of the couple, then the third property would have the deemed rental income.

Home loans are the lowest cost borrowing offered by institutions & is further sweetened by various sops by the government. Monthly EMI payments also forces a financial discipline for those who are not very strict about maintaining a monthly budget. Hence ignoring loans is not the idea of this post. It is directed to a small set of people who take a loan not because they need to, but because they think it is a smart tax planning tool. Lastly, please talk to your financial adviser (preferably one who is paid by you and not by the banks/mf to guide you)

Cost of Being Poor: Buying experience of my maid

India has the highest saving rate in the world and that probably has less to do with financial acumen of Indian poor but the sheer absence of avenues where an economically vulnerable person can get value for the money. For example my maid ended up paying 5,600/- ($87) more for a 3 door frost free refrigerator that has a 5 start BEE energy rating, then what it would have costed me.

For her it was an important purchase that reflected on her social status & allowed her to revel on the prestige & luxury that any premium white goods promise to the buyer. Her buying experience is a typical example of how this country is divided in the lines of English speaking & non-english speaking. From the price, to the financing options, service, delivery etc. everything is different & dependent on the buying behavior.

Product selection: The product was available cheaper online, but online stores does not deliver without a door number and she is living in a temporary housing where there is no door number. Being a bulky equipment, the traditional mode of delivery to workplace (homes of the person where they work) often does not work out. Also physical look & feel is important for a physical selection.

These guys are not illiterate, just that they are not educated in English medium. Hence newspapers or internet based product selection is difficult for them. However even the shopkeepers were not too keen in helping them. My maid was so much frustrated with likes of reliance digital etc. that she literally had to flash a bundle of currency to get the attention of the sales executive. Rather being courted and treated like anybody would do for someone buying a house or a car, they were shunned by the stores. Then again the deals & discounts she gets is remarkably different from what the white-collar folks can get without much effort. The store also limited her options by stating that the refrigerator came only in steel color (while white, black & red options were available online)

Financing & payment options: Most retailers have tie up with one bank or the other giving additional discounts or cash backs. White collar folks usually have multiple bank account it is free money. Even otherwise, credit cards immediately give back 0.5-1% but you need to have a card to avail this option. Also I get 30-40 days interest free loan through cards which someone paying hard currency cannot avail. Finally, in our case, we could avail a bank offer from flipkart if the payment was made through Citibank credit card saving a net of 1,500/- from the MRP. credit score based interest rates are acceptable, but it is hard for someone to build up a score if they are not in organized sector. Normally that should not matter much, but unfortunately in their case it raked up to a huge difference in the price.

Product price

The store’s best price after all discounts, haggling & negotiations was 25,000/-

The price in flipkart was 24,000/-

However the bank schemes made a lot of the difference.

1000/- was on prepaid orders was a good incentive

Additionally my credit cards reward points worth 370 bucks should be accounted for

Coupondunia gave me 644/- of cashback for online purchase (payable after 60 days)

Then I got a 40 day interest free billing holiday on my card that’s worth 250/- at 8% rate

In total the landed cost from flipkart came to 21,764/- which was 3,254/- cheaper (a significant sum for my maid)

Installation & After sales service

The whirlpool installation engineer practically forced my maid to buy a stabilizer, even though the refrigerator had an inbuilt voltage system making it redundant. Furthermore, rather than a generic 800-1,000 bucks voltage regulator, he convinced her to buy a 2,400/- stabilizer using a scare tactic etc. I have not used a stabilizer in my 6 year old refrigerator without any adverse effects, but looks like sales & service folks in Bangalore sees the economically vulnerable as cashcows that can be milked.

It reminds me of C K Prahlad’s book “fortune at the bottom of the pyramid” It talks about how the poor sections end up paying a exhorbitant price for basic commodities & service. Their limited bargaining power, ignorance of English language & lower levels of education is being used by sales persons to rob them from their savings. The products are often low quality (but not low price), packed/produced in standards that don’t justify the price, the after sales service & warranty is denied to them for the flimsiest of the reasons. The LIC insurance agents sell them policies where the returns are lower than the bank FD (even after adjusting for the term insurance premiums), the doctors use their ignorance of medical terms to empty their pockets etc.

A tribute to Nehru

Sometimes I wonder that we Indians have a strange way of evaluation, we judge not by his/her performance, but how his grand daughter in law or great grandson perform. More over,

  1. A person who took the reign when whole country was in chaos, communal riots were rampant, language was a burning problem, even then integrates hundreds of parts with such diversity into one country is labelled as one who ruined the country. But another person who whips up communal feelings to win election, whose party labels 69% of the population anti-national is a great leader.
  2. A leader who takes over when the country faced decades of negative growth rate and is able to achieve 3.5% sustained growth rate for full decade, (that too highest in Asia) was a failure. Another leader who takes over after a decade of 7.5% growth rate, is lucky to have crude at one third price, booming world economy and manages to bring it down to 6.1% is a maverick.
  3. A person who loved dissent so much that he made a person, who was prominent leader of Hindu Mahasabha which openly supported British during Quit India Movement, is now being labelled his murderer.

Like any great man he also had some failures. But, Kashmir was definitely a different ball game, Raja Hari Singh wanted to remain independent and India could not have used force like Hyderabad, as it was a Muslim majority state. Only when Pakistan occupied almost one third through Kabalis, he agreed to sign accession but with special status (article 370). Anyway, by hindsight we can say it could have been handled better. Sardar Patel was another titan, who did great work in merger of princely States, but whether he could be a better PM will be purely a matter of opinion. We must realize that when whole country was facing gigantic problems, which at this age we can’t visualize, only a man of grand vision, extreme tolerance was probably the best choice. If you read any book on Asian history from 1950-1960, you will find that India outperformed all other newly liberated countries, even Ceylon, Burma, Indonesia and Malaya which were far better economically to start, now we are even surprised to see the name of Burma. Unfortunately, he became a tired leader after 1960 and India never produced leaders of Nehru Patel caliber after independence.

Regarding India-china war, Genesis was Nehru like most Indians of that time had great territorial ambitions for India. We claimed Aksai Chin, which even British never had in their possession, when china built up a long road, free India came to know about it after 2 years that also through Pannikar, India’s ambassador in China. In Arunachal, McMohan line was never recognized by China. Tawang valley came into British possession only 2-3 years before our Independence, that too with lot of protest by Tibet.

Nehru failed in making army strong, but he was successful in keeping army within barracks, otherwise we might have become another Pakistan or Burma. Moreover, could India afford to spend massive amount on defense at that time?

His another blunder was Krishna Menon and Lt G BM Kaul, but didn’t Modi made so many non-performers on highly important post including Irani as education minister.

RO water purifier: Do you need it?

Mineral water was in fashion a decade ago, today De-mineralized RO water is in fashion. I can understand the need of people who live near the sea, asking for desalinated water for drinking, but why the rest of the country is going for bottled water cans and RO purifier.

There is no single WHO report that corroborates that drinking hard water has any adverse health impact (as long as you are not drinking sea water or equivalent which is manifold higher than what most borewell or piped water has). On the contrary there is a WHO mandated minimum salt (TDS requirement) that any drinking water purifier has to maintain. Even the web literature on hard water talks about its impact on soap, boilers etc. There is no impact of dissolved calcium & Magnesium on the bones, kidney stones etc. In fact, human beings need calcium either through diet or supplements to maintain their bone density.

The claims of RO treated water has lesser microbes & dissolved organic matter is also without basis. RO is designed for controlling the amount of dissolved salts only, it relies on an inbuilt traditional water purifier/filter to decontaminate the pipe water before feeding it to RO. In fact, 100% salt removal adversely impacts the taste. So the so called TDS controller actually only blends the normal (purified) water with the desalinated water to achieve desired taste/salt content. Point being if traditional purifier were so bad in decontaminating water, the whole principle of TDS controller would fail.

Domestic RO machines are expensive units costing 5-10k each and every 6-8 months the membrane needs to be replaced which costs almost ½ the unit cost itself. Even after ignoring the cost of piped water & electricity, the personal RO water cost almost the same as the commercial bottled water. Also to generate 1 glass of RO water, the filter wastes away another 3 glasses of piped water through the thin white pipe from the purifier to the drain. In a country, where ground water levels are depleting and portable water not available to 80% of the households, this seems like an expensive luxury.

There are some regions which have dissolved heavy metals, nitrates and other dissolved contaminants for which RO is the only treatment mechanism. However just using a blanket RO filtration everywhere may be foolhardy. A simple 100-300/- water purity test can prove to you that the RO marketing campaign is nothing more than a gimmick to make you spend more.