Author: root

Taxpayer Charter: Why execution matters

Personal Finance

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The Centre recently unveiled a new Taxpayer Charter, listing out an income taxpayer’s rights and obligations.

The UK and Australia have similar charters in place.

This move comes a year after the Centre abolished the Tax Ombudsman institution that was established nearly a decade ago. The Charter is trying to address this gap in a way. It addresses only income taxpayers, while the ombudsman scheme was available for both direct and indirect taxpayers. The Charter emphasises that the Income Tax (I-T) Department trusts the taxpayers upfront.

However, there are no new elements in the charter as such because the rights and obligations are already part of the Income Tax Act, 1962.

Global experience

Australia and the UK have strived to codify their tax charters into an institutional philosophy on how revenue-collecting agencies deal with taxpayers. There are frequent reviews of implementation of their charters based on the experience of taxpayers. In India, there has been no such information yet, except the one page that enumerates rights and obligations of a taxpayer.

It doesn’t stem from any legal provision in the I-T Act either. The announcement of the charter seems to be an attempt to tone down the adversarial approach that the I-T Department has taken in the past with some taxpayers.

The charter seems to dovetail the new faceless assessment and appeal scheme that the Centre has unveiled.

Here, the assessment proceedings have been de-linked from the taxpayer’s location, and will be distributed to income-tax officials across the country in a randomised manner.

There is not enough clarity as to whether all cases will be taken up through this faceless assessment and appeal scheme, or how documents that are needed for assessment proceedings will be allowed to be shared with the assessing officer or at the level of commissioner appeals.

Execution is key

The Taxpayer Charter seems to have resurrected the complaint mechanism that was earlier available through the ombudsman scheme.

Taxpayers who are unhappy or perceive the handling of their assessment proceedings to be contrary to the Taxpayer Charter can approach the Principal Chief Commissioner of Income Tax of their respective zones.

How this will work in an environment where assessments are distributed across the country to income-tax officials is still not clear. One will have to wait for more details.

One reason the Taxpayer Charter might not work well in the current environment is the practice of assigning steep revenue targets to income-tax officials.

Only if the I-T Act, its rules and the Central Board of Direct Taxes’ regulations make complying with the charter mandatory, can there be any meaningful change in the experience of an income taxpayer.

It needs to be seen whether this new charter changes the income taxpayer’s experience while dealing with officials while undergoing scrutiny assessments.

It also needs to be seen whether the charter evolves into a more robust grievance redressal mechanism. The current mechanism available through the Income Tax Department’s return e-filing portal and ASK centres allows grievances such as non-processing of returns, not receiving refunds, return rectification pending with assessing officer and correction of incorrect outstanding demand.

It will be interesting to see how the charter evolves these processes to make the interaction of Income Tax Department with taxpayers easier, especially in cases involving alleged harassment.

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All you need to know about Gold Monetisation Scheme

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Intending to mobilise gold held by households and institutions in the country, to facilitate its use for productive purposes, and to reduce the country’s reliance on gold imports, the government started the Gold Monetisation Scheme (GMS) in 2015.

In this scheme, one can deposit the gold idling at home with the bank and earn interest on it. Depositing the gold now when the yellow metal is trading at elevated levels would earn you higher income as interest is calculated on the value of gold on the date of deposit.

But remember, under the gold monetisation scheme, the gold you deposit will not be returned to you in the same form you deposited. Say, if you deposit the gold in jewellery form, you will be given back the gold in the form of gold bars or coins or the rupee value of the gold at the end of the tenure.

Here, we look at some of the key aspects of the scheme.

How does it work?

Under GMS, gold is accepted in the form of raw gold. All deposits under the scheme shall be made at the authorised collection and purity testing centres (CPTCs). In the case of large depositors, a bank branch may depute an official to accompany the customer to the CPTC.

After assaying the gold, the CPTC will issue the depositor a receipt showing the standard gold of 995 fineness on behalf of the bank. The gold deposit (say, in the form of ornaments) will be cleaned of its dirt, studs, etc and will be tested to see the quantity equivalence of 995 fineness gold. In case of ornaments, the weight in terms of equivalence of 995 fineness gold will be lower than that of the actual ornament as the latter usually has lower fineness gold.

The depositor shall produce the receipt issued by the CPTC to the bank branch, either in person or through the post.

On submission, the bank will issue the deposit certificate and the quantity of gold will be expressed in terms of grams in the gold deposit account. Interest will then start accruing to the depositor.

The rate of interest depends on the tenure opted for by the depositor.

There are three options. One, a short-term deposit with tenure of one to three years (with a facility of rollover).

The banks are free to fix the interest rates on these deposits. The interest on these deposits will be either paid in cash or in the form of gold. For instance, currently, under its revamped GMS, SBI offers interest in the range of 0.5 per cent to 0.6 per cent per annum, and this is denominated in gold. That is, for every 100 grams of gold deposited, the depositor will earn 0.5-0.6 grams of gold per annum. Union Bank of India, as per its scheme document, has been offering 0.75 per cent on gold deposits for the short-term period. As per the document, interest accrued till maturity will be paid either in cash (based on the price of gold on redemption date) or in the form of gold, at the option of the depositor.

Two, a medium-term government deposit (MTGD) can be made for five to seven years, and three, long-term government deposit (LTGD) for 12-15 years. Unlike the short-term deposits, these deposits will not be accounted for under the bank’s liabilities in its books. The deposit under this category will be accepted by the banks on behalf of the Central Government.

The rate of interest on such deposit will be decided by the Central Government and notified by the Reserve Bank of India from time to time. As per the websites of various banks, the current interest rate offered on these deposits is 2.25 per cent per annum on medium-term deposit and 2.5 per cent on long-term deposit.

The interest on medium- and long-term deposits will be paid out in cash and not gold; it will be calculated with reference to the value of gold at the time of deposit and will accrue annually (on March 31, every year).

A depositor will have an option to receive payment of interest annually or cumulatively at maturity, in which case the interest will be compounded annually.

On maturity, the depositor can redeem the principal of a deposit either in cash — amount equivalent to the value of gold, or in gold. If the former option is selected, the quantity of gold deposited will be multiplied by the gold-INR price prevailing on the maturity date. The rate is computed considering the RBI reference rate for USD-INR, Gold’s London AM Fix rate (in US$) and the prevalent customs duty for import of gold.

Where the redemption of the deposit is in gold, an administrative charge of 0.2 per cent of the value of gold on the redemption date will be collected from the depositor.

For pre-mature withdrawals, there is a minimum lock-in period of three years for medium-term deposits, and five years for long-term deposits. Any pre-mature redemption will be made only in cash (value of gold on the date of withdrawal). In the case of pre-mature withdrawals, after the minimum lock-in period, a penalty would be charged in the form of lowering the rate of interest applicable on deposits by 0.25 -0.375 percentage points.

Note that not all banks offer the GMS scheme. RBI has allowed scheduled commercial banks to offer the scheme and it is not mandatory. Certain banks such as Bank of Baroda, Union Bank of India, State Bank of India and ICICI Bank offer GMS.

Comparison with SGBs

Since the Sovereign Gold Bond Scheme (SGB) is the closest comparable investment scheme to the GMS available in the market now, we compare SGB (having a tenure of eight years) and MTGD (medium-term gold deposit) under the GMS scheme (with tenure five to seven years) for our analysis.

While the current interest rate on SGB is 2.5 per cent, banks offer 2.25 per cent on MTGD of GMS with seven years. However, interest earned on SGBs is taxable under the Income Tax Act but the interest earned on GMS is not. Thus, the post-tax returns of the GMS could be higher.

Further, while SGBs provide an exit option from the fifth year, MTGD deposits under GMS is locked-in for 3 years but withdrawal before maturity comes with a penalty. Having said that, one can sell the SGBs anytime in the secondary market even before the fifth year, but liquidity could be an issue.

Under SGBs, one can invest up to a maximum of four kg gold (minimum is one gram) in a financial year. Under GMS, the minimum deposit at a time shall be 30 grams of gold, and there is no maximum limit.

A similarity under both the schemes is that the redemption value of the investment is linked to the market value of the gold on the date of withdrawal (assuming withdrawal under GMS is in cash). Also, the initial investment is dependant on the prevailing gold rate. Further, the interest is also calculated on the rupee value of the initial investment in both the cases.

Another similarity is that the loans may be given against collateral of investment under SGB as well as gold deposits under GMS.

Our take

GMS is not for you if you are expecting the gold to be returned in the same form you deposited (especially, in case of ornaments).

If you want to hold on to gold expecting further price increase but are okay with taking back the gold in another form in the future, you can consider depositing idling gold in GMS. This would earn you some interest and save storage charges of that gold (if you are paying any).

If you think that gold prices have peaked, want to monetize your idle gold and invest it more productively, it might be a better idea to sell the gold in the market and invest the proceeds in fixed income instruments such as bank deposits that give better returns than the GMS.

Suitability

The scheme is not suitable if you are expecting the gold to be returned in the same form you deposited

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New investor? Here are 3 mutual fund categories for you to invest in

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If you are a new investor seeking to make a foray into equity investing, it may be better to start the journey with equity mutual funds and not jump straight away into direct equity investing and trading. Many investors who start investing in high-risk investment avenues such as direct equities often get carried away by the rush and make mistakes which put their investments and sometimes, the journey itself, at risk. With direct equity stocks, you have to do extensive research before investing and track the investment closely, while in mutual funds, there are experts who make the investing decisions and do the tracking. These professionals understand the stock and market dynamics more closely and manage your money with measured risk. Your first brush with mutual funds carries less risk of leaving you with a bad experience than the first brush with direct equity investing.

Among the wide variety of equity-oriented funds available in the market, you can look at three categories — large-cap equity funds, equity index funds and aggressive hybrid funds — that can help you to participate in the equity market with relatively moderate risk compared with many other equity fund categories.

You can consider investing in these funds through the systematic investment plan (SIP) route that are better equipped to absorb market shocks. SIPs also help inculcate the habit of saving and building wealth for the future. The ideal investment horizon should be long-term — at least 5 years or more.

Large-cap funds

As required by the market regulator Securities and Exchange Board of India (SEBI), large-cap funds invest at least 80 per cent in companies ranked 1st-100th in terms of full market capitalisation. These funds invest in stocks that are primarily included in the Nifty 50, Nifty 100 or BSE 100 indices. These are often stocks of blue-chip companies — large well-established organisations, often in sound financial shape with relatively good earnings potential. They generally have lower volatility and are less vulnerable to adverse changes in the macroeconomic environment compared to smaller companies.

The large-cap category can weather market downturns better during bear and corrective phases compared to other equity-oriented categories such as mid-cap and multi-cap categories. On the other hand, large-cap funds tend to underperform the smaller counterparts during equity market rallies. However, they often generate better risk adjusted returns over the long run.

Axis Bluechip, Mirae Asset Large Cap and Canara Robeco Bluechip Equity are some of the top-performing schemes in the large-cap category. These funds are rated five-star by BusinessLine Portfolio Star Track MF Ratings.

 

 

Index funds

Index funds are passively managed mutual funds seeking to replicate the performance of the underlying benchmark without active management by fund managers. They imitate the portfolio of an index (say, Nifty 50) by investing in stocks that are part of the index in the same proportion as in the index. On the other hand, actively managed funds aim to outperform their benchmarks with the help of fund managers. With no active management, index funds have much lower charges (expense ratios) than actively managed funds.

Index funds are a good option for investors seeking index-linked returns. There are currently 35 index funds in the market tracking various indices. From among these, you can consider index funds tracking the Nifty 50, Nifty Next 50 and Nifty 500 indices. The Nifty 50 is one of the most traded indices in the world and the top-traded derivative index in India. The Nifty Next 50 enables you to invest in stocks that have the potential to become part of the Nifty 50 Index in the future. The Nifty 500 index covers more than 95 per cent of the listed universe on the NSE in terms of full-market capitalisation.

Index funds that have lower expense ratio and less tracking error (deviation in returns from the benchmark) are preferred. UTI Nifty Index Fund, ICICI Prudential Nifty Next 50 Index Fund and Motilal Oswal Nifty 500 index funds are good choices.

Aggressive hybrid funds

As mandated by SEBI, aggressive hybrid funds allocate 65-80 per cent of their corpus to equity investments, while the rest is invested in debt instruments. The higher allocation to equity can help deliver good returns in the long run. Debt exposure helps cap losses in market downturns. These funds are treated like equity funds for taxation purposes.

The schemes under the aggressive hybrid fund category depreciate less during market corrections and appreciate less during rallies compared with other equity-oriented categories. Lower volatility can result in superior risk-adjusted returns compared with many other equity-oriented categories over the long term.

SBI Equity Hybrid, Canara Robeco Equity Hybrid and ICICI Pru Equity & Debt are some of the better performing funds under the aggressive hybrid category.

While the equity portion of these funds is often managed with multi-cap approach, the debt portion is deployed in fixed income instruments with varying maturities, depending on the interest-rate movement in the economy.

Safer start

It’s safer to start equity investing with mutual funds that are managed by investment professionals than with direct equity investing that involves investing and tracking on one’s own. There is a higher risk of burning your fingers in the latter.

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Experts say that tax charter is old wine in new bottle

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Last week, the Centre announced a new Taxpayer Charter that lists out an income taxpayer’s rights and obligations. Other countries like UK and Australia also have similar taxpayer charters that spell out the rights and obligations of taxpayers.

“What the Taxpayer Charter is trying to do is to emphasise that the tax department trusts the taxpayers,” says Sandeep Jhunjhunwala, Partner at Nangia Andersen LLP. “That is what it is basically meant to do. There does not seem to be anything new in this. Most of the elements have been spoken of in the past by the previous finance ministers.”

Australia and UK have strived to codify their tax charters into an institutional philosophy on how their revenue collecting agencies deal with taxpayers. There are frequent reviews of the implementation of their taxpayer charter by these countries.

In India’s case, there has been no such announcement yet other than a one-page enumerating rights and obligations of a taxpayer, nor does it stem from any legal provision in the Income Tax Act, 1962. The announcement of the charter seems to be an attempt to tone down the adversarial approach that the Income Tax Department has taken in the past with taxpayers. How this works with the new faceless assessment and appeal scheme has to be seen.

“There is a statement (in the charter) to treat the taxpayers as honest,” says Saraswathi Kasturirangan, Partner at Deloitte India. “I can quote this, if I feel that the queries that are being raised (by Income Tax officials) are vindictive and not a positive approach.”

Revenue targets

A lawyer, who represents the Income Tax Department in court cases, said revenue targets for income tax officials will deter any meaningful change to the taxpayer’s experience in their dealings with the department.

Saraswathi Kasturirangan of Deloitte India feels that compliance with the Taxpayer Charter is something the Income Tax Department should expect from its officers to make sure that it is adhered to, along with stiff revenue targets.

The practice of high revenue targets has already been flagged by the Comptroller and Auditor General in a 2018 report on the Income Tax Department. This has led to the value of disputed tax demand cases touching nearly ₹10-lakh crore.

“What the government is doing is to make a clear statement of intent,” adds Jhunjhunwala of Nangia. “However, on the ground, it needs to be seen if officers are still driven by revenue targets”.

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Financial Planning – How a single parent can meet her goals

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Nirmala, aged 37, single parent to two daughters aged 9 and 7, wanted to plan for her financial goals. Her monthly income was ₹1.4 lakh and expenses were ₹60,000 including travel and medical needs. She owns an apartment in South Chennai valued at ₹80 lakh. Nirmala began working since the last two years and has limited financial resources. Her goals were the usual ones, and she wanted to reach these comfortably without exposing the capital to risks in the long term. That said, she was willing to invest in large-cap equities for long-term goals such as retirement and wealth creation.

Goals, assets, risk profile

Nirmala

wanted to prioritise the following goals. She first wanted to set up an emergency fund of ₹7.2 lakh and also get health insurance for herself and daughters. Next, she intended to build a fund of ₹10 lakh each, at current cost, to be gifted to her daughters when they would turn 24. Nirmala also wanted to purchase gold worth ₹50,000 every year till her retirement. An annual retreat trip for ₹60,000 per annum was on her wish-list too. For the long-term, Nirmala wanted to set up a fund to provide for her retired life from 60 years of age, at a current cost of ₹30,000 per month, and also wanted to create a surplus fund at current cost of ₹50 lakh at her retirement in addition to the retirement corpus.

Nirmala’s asset position was as follows. Her EPF balance was ₹3 lakh with annual contribution of ₹1.6 lakh, and her PPF balance was ₹1.5 lakh with annual contribution of ₹1.5 lakh. She had cash in hand of ₹10 lakh, gold worth ₹20 lakh, a house valued at ₹80 lakh and a car worth ₹6 lakh.

Nirmala was focused on safety of capital but understood the importance of allocating a portion of investments to equity towards her long-term goals. But she was very particular about keeping the balance money in avenues that would avoid capital erosion despite opportunities for better returns.

Review and recommendations

We advised Nirmala to keep ₹7.2 lakh in fixed deposits (from her cash balance of ₹10 lakh) towards emergency funds. She could reserve the balance ₹2.8 lakh for her career growth needs that was imperative under the present conditions. We recommended that she take medical insurance with sum insured of ₹10 lakh for herself and her daughters, in addition to the employer-provided health cover. Nirmala is a divorcee and both her daughters are staying with her. Their education and other expenses are to be managed by the father and hence, Nirmala need not opt for life insurance.

To provide for the fund gift to her daughters when they turned 24, we advised Nirmala to invest in large-cap funds. She needed to invest ₹7,800 per month for 15 years towards the gift to the first daughter and ₹7,200 per month for 17 years towards the gift to the second daughter. At an expected annualised return of 9 per cent, Nirmala should be able to build a corpus of ₹27.6 lakh and ₹31.60 lakh respectively.

Taking into account her provident fund contributions, Nirmala had to invest ₹34,000 per month towards her retirement. She needed to accumulate ₹4.48 crore to retire at the age of 60, assuming a life expectancy of 90 years. It was assumed that her expenses till retirement would increase at 7 per cent annually. After retirement, with intended moderation in lifestyle, it was assumed that her expenses would increase at 6 per cent per annum. With Nirmala particular about avoiding capital erosion, it was suggested to set an expected return of 7 per cent per annum. Though this is achievable in the current environment, an exposure of 10 per cent to equity-related investments was advised to ensure adequate returns.

We advised Nirmala to use voluntary PF contribution and NPS to manage her fixed income allocation towards retirement, and large-caps and mid-caps for equity investments. The retirement corpus with 50:50 equity and debt allocation was planned with these products. Based on her cash flow with allocated investments towards her multiple goals, it may be difficult for Nirmala to start building her surplus fund, if some money has to be kept aside for unexpected expenses. But she could increase her savings in subsequent years to build a surplus fund at current cost of ₹50 lakh that would translate to ₹2.37 crore at her retirement. The PPF, not mapped to any of her goals, could also be used towards building the surplus.

Cash flow (₹)

Monthly

Income

1,40,000

Expenses

60,000

Surplus

80,000

Annual surplus

9,60,000

Funding needs & goals:

Annual retreat trip

60,000

Gold purchase

50,000

PPF

1,50,000

Gift to Daughter 1

93,600

Gift to Daughter 2

86,400

Retirement

4,08,000

Total

8,48,000

Balance

1,12,000

After funding the goals, the balance money could be used towards building long-term surplus fund or to have a better lifestyle. The choice was Nirmala’s to decide about how to deploy the money.

Planning for the future within three years of employment, especially for a late entrant on to the employment scene, was a wise thing for Nirmala to do. By adhering to the plan, she could avoid costly errors. We advised her to seek professional help to draft a will at the earliest.

It would take four to five years for Nirmala to reach the planned asset allocation of 40:60 in equity:debt in the pre-retirement phase. We advised her to maintain a ‘behaviour journal’ during this time to study her emotions on the volatility induced by equity-oriented investments. This would help her gauge her risk tolerance better and adjust asset allocation accordingly to equity, debt and other investments.

Asset allocation is the key to a successful financial plan. “History shows you don’t know what the future brings” is a quote to be recalled while thinking of asset allocation.

The writer is a SEBI-registered investment advisor at Chamomile Investment Consultants

Mind it!

A behaviour journal can help study emotions, gauge risk tolerance, and adjust asset allocation accordingly

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Why investing via wallets in gold is fraught with risks

Personal Finance

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Are you in a rush to buy gold, given the breathtaking rally of the metal? It is understandable that as an investor hunting for returns, you don’t want to miss the bus. In this article, we make compare different modes of digital investment in gold based on safety and returns.

There are broadly three ways to invest in gold digitally — buying through mobile wallet companies such as Paytm, PhonePe or GooglePay or through digital platforms of players such as Motilal Oswal and HDFC securities; buying through mutual funds via listed gold exchange-traded funds (ETFs); and buying sovereign gold bonds (SGBs) of the RBI.

Gold ETFs

Gold ETFs are safe and transparent instruments. There are many checks and balances in place to ensure that the investor is not cheated.

For every unit of the instrument you buy, there is physical gold bought by the AMC (asset management company) and this is checked by a SEBI-registered custodian (for most gold ETFs, it is Deutsche Bank).

The presence of a custodian in gold ETFs of mutual funds, besides a trustee, adds a layer of safety for investors.

The custodian is responsible for safekeeping of gold, and is obliged to keep a check on gold holdings’ net inflows and outflows.

 

Further, in the case of gold ETFs, all gold is stored with an independent vaulting agency — mostly, Brink’s India — where records are maintained on a daily basis for bar number, purity certificate, gold movement, etc.

Also, unlike issuers of digital gold, the MFs issuing gold ETFs are required to give periodic disclosures on fund holdings through a fact sheet at the end of every month to SEBI. Also, there is auditing of the gold-holding of the MF by internal as we all as SEBI auditors.

Charges: For an investor, gold ETFs may work out cheaper than digital gold of mobile wallets. Investors can buy and sell gold ETFs without GST. However, note that there is a fund management cost and brokerage.

Sovereign gold bonds

SGBs score the highest on safety among the digital gold investments.

It is issued by the Reserve Bank of India (in denominations of one gram of gold and in multiples thereof) and comes with sovereign guarantee. It is available in demat form.

Further, there is an added benefit of 2.5 per cent per annum interest, that boosts returns for the investor.

Also, if you hold it till maturity, that is, eight years, there is no tax on the capital gains from gold price increase. The bonds is issued and redeemed at the market price of gold.

Charges: There is no extra cost on SGBs but for what you pay the broker (or other intermediaries) to buy the bond.

There is discount available for investors buying online at the time of the primary issue by the RBI.

Digital platforms

MMTC-PAMP — a joint venture between MMTC, a Government of India company that is into gold trading, and PAMP, a Switzerland-based gold refiner — sells gold as coins/bars in different denominations through retail outlets and also digitally. You can buy the gold of MMTC-PAMP through players including Paytm, PhonePe, Google Pay, or through stock brokers such as HDFC securities or Motilal Oswal, digitally. While the purity of gold of MMTC-PAMP is assured (it is LBMA ( London Bullion Market Association)-certified for 999.9 purity), the lack of regulation in the space poses a risk.

There is no watchdog governing this space, like the Securities Exchange Board of India that governs gold ETFs or the Reserve Bank of India that oversees sovereign gold bonds.

In September 2019, there was news of the Central government considering closing of some operations of MMTC.

MMTC-PAMP tried to calm the nerves of its investors by saying that MMTC was only a minority shareholder in the entity and that the joint venture will continue unaffected by the government’s decision.

It added that IDBI Security is its trustee and that customers’ gold is safe with it.

But this may have to be taken with a pinch of salt as there is no regulator and there is no independent auditing of the holdings.

For people wanting to buy physical gold digitally, another option is using SafeGold, which is offered through mobile wallets, including PhonePe. Again, this is an unregulated entity and risks are the same as investing through MMTC-PAMP.

Besides, the gold you buy here is a tad lower in purity — 995 fineness against 999.9 offi MMTC-PAMP gold.

The point in which SafeGold scores is that it stores gold in Brink’s India vaults unlike MMTC-PAMP, which keeps customers’ precious metal in its own vaults.

Note that while the digital platforms allow you to sell the gold in your account without having to redeem it physically, you cannot sell gold on the same day you buy it.

Also, there is a 2-3 per cent difference between the buy and sell prices because of the charges levied by the distributor/gold-issuer. Further, with MMTC-PAMP, you can keep gold only for five years, and with SafeGold, it is two years from the date of purchase.

Charges: The cost of buying gold through the digital platforms is higher. For instance, on August 12, the rate on Paytm for buying 1 gram of 24k gold was ₹5,423.32, while gold ETFs were quoting at ₹5,193/gram (the LBMA spot price). Besides, note that each time you buy/sell gold via digital platforms, you will be charged 3 per cent GST.

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Can switching home loan ease your EMI burden?

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Is your big-ticket home loan pinching you in this time of crisis? While continuing to pay your EMIs is advisable (rather than opting for the moratorium), it may be time to review your existing home loan to see if you can lower your monthly payout.

In its monetary policy last week, the Reserve Bank of India (RBI) held its key policy repo rate at 4 per cent.

But that doesn’t matter.

A look at data across banks suggests that even now there is a wide difference between the lending rates on home loans linked to MCLR (marginal cost of funds-based lending rate) and that on those benchmarked against RBI’s repo rate.

In many cases, the difference is 30-50 bps within the same bank, which amounts to a sizeable difference in interest over the tenure of the home loan.

Basics

Home loans are broadly of two types — fixed and floating. Generally, fixed-rate home loans charge a substantially higher interest rate. Hence, it may be advisable to opt for floating-rate loans, particularly in a falling-rate scenario.

Now, under floating-rate loans, lending rates change depending on the interest-rate movements in the broader economy. Earlier (from April 2016), home loans were linked to a bank-specific benchmark — MCLR.

Here, while a repo-rate cut by the RBI leads to banks lowering their MCLR, it happens with a lag and varies widely across banks.

Also, generally, home loans are benchmarked against one-year MCLR and, hence, lending rates are reset only once every year. So, even when banks cut MCLR, the benefit of it is transmitted to borrowers only when the loans are reset.

To address these issues, the RBI had mandated banks to introduce repo-linked loans from October last year. Here, if the RBI cuts the repo rate, it gets reflected on your lending rates much faster (banks have to reset their repo-based benchmark rates at least once in three months).

This is a key reason why lending rates on repo-linked home loans are much cheaper than those on MCLR-linked loans within your own bank.

Effective rates matter

While comparing rates, the final effective lending rate is what matters and not the repo-linked benchmark. This is because banks charge a spread over the repo-linked benchmark rate to arrive at the final loan rate. For instance, at SBI, the repo-linked benchmark rate (EBR) is currently at 6.65 per cent.

For a ₹30-75-lakh loan, a spread of 60 bps (for salaried borrower) is charged on it, taking the effective lending rate to 7.25 per cent. At ICICI Bank, the repo-linked rate is currently 4 per cent, over which the bank charges a 3.2 per cent spread, taking the effective lending rate to 7.2 per cent.

Hence, while comparing rates to switch, you need to look at the final loan rate, including the spread, under both repo- and MCLR-linked loans.

Next, some banks also offer special rates for good borrowers with sound credit scores. For instance, at PNB, while the spread charged over the benchmark is 50 bps in case of a borrower with credit score of 750 and above, it is higher at 75-85 bps for those with a lower score. In the case of Bank of India, you can get loan at an attractive 6.85 per cent if you have a high credit score.

Once you have noted the underlying benchmark, the spread and the concession (if any), that determine the final lending rate, the next step is to do the maths.

Tidy savings?

Your decision to switch will broadly depend on three factors — difference in lending rates, remaining tenure of loan and outstanding loan amount.

Your savings by way of interest on the entire tenure (residual) of the loan will be the highest when all three are on the upper side — a wide difference between existing and new lending rates (under repo-linked), long residual tenure of loan and huge outstanding loan amount.

The accompanying table shows that if you have a home loan outstanding of ₹55 lakh and the remaining tenure is 23 years, sizeable savings kick in when the difference in lending rates is 50 bps (or over).

In such a case, you can straightaway make the move. But if the difference in lending rates is only 10 bps, the savings shrink substantially to about ₹1 lakh over the tenure of the loan.

While this is still notable, you may still want to weigh other charges before making the switch. For instance, if you are making the switch within the same bank, you may have to pay a one-time administrative fee.

For example, Bank of India charges an additional 0.10 per cent over normal lending rate if you intend to switch over from MCLR- to repo-linked loans, according to the bank’s website.

In case you are switching between banks, there may be a processing fee involved, which could be a percentage of loan amount (can go up to 2 per cent, subject to a minimum amount). Also, amid the ongoing restrictions owing to the Covid-19 pandemic, switching between banks may be procedurally tedious.

In any case, if you have a small loan outstanding and a short tenure remaining, it may not make sense for you to switch, even if the lending rates are widely different (see table). For instance, in the case of a ₹5-lakh outstanding amount with a residual tenure of four years, the savings will be quite low.

The other factor to take into account is that given that rates have fallen sharply over the past two years, a rate hike in the next two years could pinch you more under the repo-linked loans.

This is because lending rates can move up sharply and quickly. That is all the more reason for you to avoid making the switch if you have a short tenure of loan left.

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