Tag: fixed income

How InvIT, REIT income is taxed

Personal Finance

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Over the last few years, infrastructure investment trusts (InvITs) and real estate investment trusts (REITs) have emerged as a popular investment option for those who want a regular income flow and are comfortable with taking on some risk.

The soaring equity market valuations and dwindling fixed income returns have only added to their appeal. With the government laying out a roadmap for monetisation of infrastructure assets, InvITs are expected to gain further ground.

An InvIT/ REIT pools money from investors (unitholders) to invest in a portfolio of income-generating infrastructure assets (80 per cent in operational assets) via subsidiaries (SPVs). REITs invest in real estate projects and InvITs in infrastructure assets, such as power transmission or road projects. The unitholders receive a regular payout, at least once every six months. Also, as units of publicly issued InvITs/REITs trade like shares on the exchanges, they offer an opportunity for capital appreciation.

Investors, however, need to wade through their complex taxation. The income of an InvIT/ REIT is passed on to unitholders in the form in which it’s received and is taxed as such.

Distributable surplus

An InvIT/ REIT receives cash flows from its project SPVs in the form of: a) dividends in return for the stake held b) interest and c) principal repayment on loans extended to them. Any other income at the InvIT/ REIT level such as capital gains from assets sold and not re-invested, and return on surplus cash invested, too, gets added to this.

Apart from this, if a REIT holds any real estate asset directly and not via an SPV, then the income flows to it in the form of rent (and not interest and dividend) and gets added as such.

All expenses incurred at the InvIT/ REIT level are deducted from the total cash inflow to arrive at the net distributable surplus (NDS). Unitholders must be paid at least 90 per cent of the NDS. A break-up of the components of the distribution is usually available on the websites/ presentations of the respective InvIT/ REIT.

Tax treatment

Distribution: The interest component of the NDS is taxed at your income tax slab rate. The dividend, too, is taxed at your slab rate if the project SPVs of the InvIT/ REIT have opted for the new concessional tax regime under section 115BAA of the IT Act. The dividend is tax-exempt if the project SPVs have not opted for the concessional tax.

Also as Hemal Mehta, Partner, Deloitte India, explains, before the interest and dividend are paid out, a 10 per cent withholding tax (for resident investors) is deducted by the InvIT/ REIT, against which the investor can claim credit.

The loan repayment component represents return of capital and is not subject to tax. Any other income at the InvIT/ REIT level such as capital gains on any asset sold or interest on fixed deposits which is passed on to the unitholders, too, is tax-exempt in their hands.

Powergrid InvIT, India Grid Trust and IRB InvIT Fund are the three publicly listed InvITs open to retail investors.

IRB InvIT Fund has distributed ₹41.30 per unit (₹30 as interest and ₹11.30 as return of capital) since its listing in May 2017 until March 31, 2021. Since most of the trust’s SPVs are loss-making (PAT level), there have been no dividends.

In case of India Grid Trust, almost all the distributions since its listing in June 2017 have been in the form of interest income. As of June 2021, India Grid Trust had opted for concessional tax for all except one of its SPVs. Any future distributions in the form of dividends will, therefore, be taxed accordingly.

Powergrid InvIT, which listed recently has not yet made any distributions. Four of the InvIT’s five project SPVs have opted for concessional tax.

In the REIT space, you have Embassy Office Parks REIT, Mindspace Business Parks REIT and Brookfield India Real Estate Trust, all publicly listed.

In the June 2021 quarter, they distributed ₹5.64, ₹4.60 and ₹6 per unit, respectively of which 80 per cent, 92 per cent and 24 per cent was tax-free in the hands of the investors.

Capital gains: If a unitholder sells his/her InvIT/ REIT units after holding them for up to 36 months, the short-term capital gains are taxed at 15 per cent (plus applicable surcharge and cess) without indexation benefit.

If the units are sold after being held for over 36 months, long-term capital gains (exceeding ₹1 lakh a year including from all equity investments) are taxed at 10 per cent (plus applicable surcharge and cess) without indexation benefit.

These rates are applicable to all REITs (which have to be mandatorily listed) and the listed InvITs.

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All you wanted to know about 54EC bonds

Personal Finance

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A popular option for saving long-term capital gains tax on sale of property is section 54EC bonds. Investing in these bonds can help you make gains of up to ₹50 lakh per financial year from capital gains tax. However, there is a lock-in period of five years. This used to be three years earlier. These bonds carry interest, which is currently at 5 per cent and is taxable.

While these bonds are effective in saving tax, there is another option to consider. You have two choices: (a) save long-term capital gains tax by investing in 54EC bonds and lock in your money for five years or (b) pay the tax, keep your money liquid, and invest it in avenues yielding higher than 5 per cent.

Let us compare the returns from these two options.

Assume, for instance, that there is long-term capital gains of ₹50 lakh that is taxable, after indexation benefit as applicable. A sum of ₹50 lakh invested in 54EC bonds would fetch a defined return of 5 per cent per year. This coupon/interest is taxable at, say, 30 per cent (your marginal slab rate), ignoring surcharge and cess for simplicity. Hence your return, net of tax, is approximately 3.5 per cent. As against this, if you go for option (b), you pay tax on capital gains, which is taxable at 20 per cent if we ignore surcharge and cess, for simplicity. Subsequent to paying the tax of ₹10 lakh, what remains with you for investment is ₹40 lakh. Let us now look at a few options for investing ₹40 lakh.

Tax-free PSU bonds

Since there are no fresh issuances of tax-free PSU bonds and interest rates have eased, the yields available in the secondary market are lower than earlier. For our comparison, we assume a yield (i.e. annualised return) of 4.25 per cent for investing in tax-free PSU bonds. ₹50 lakh invested in 54EC bonds, compounding at approximately 3.5 per cent per year, grows to ₹59.38 lakh after five years. ₹40 lakh, which is the net amount that remains in case of option (b), invested at 4.25 per cent tax-free, grows to ₹49.25 lakh after five years. Hence, investing in 54EC bonds at 5 per cent (pre-tax) is a better option than paying the LTCG tax and investing the remaining amount.

Bank AT1 perpetual bonds

There is a negative perception about perpetual bonds after the YES Bank fiasco. The risk factors that got highlighted after the YES Bank AT1 write-off have always existed, but came into action and hit investors. Having said that, there are front line banks such as SBI, HDFC Bank and the like that are worth investing in.

The range of yields in bank AT1 perpetual bonds is wide. We assume 7.5 per cent to strike a balance between risk (higher yield but higher risk) and reward (lower yield but lower risk). Taxation at 30 per cent means a net return of approximately 5.25 per cent. Against ₹59.38 lakh in case of 54EC bonds, ₹40 lakh invested at 5.25 per cent grows to ₹51.6 lakh after five years. Though somewhat higher than the ₹49.25 lakh from tax-free bonds, this is lower than the ₹59 lakh from 54EC, bonds making the latter a better option.

Equity

It is not fair to compare investments in bonds with equity. However, to get a perspective we will do a comparison. We will talk of the break-even rate now. Let us say, equity gives X per cent return over five years, and that is taxable at 10 per cent, which is the LTCG rate for equity for a holding period of more than one year. If ₹40 lakh invested in equity yields a return of 9.15 per cent per year pre-tax, which is 8.24 per cent net of tax per year, it grows to ₹59.4 lakh after five years. Hence the break-even rate for ₹40 lakh to outperform ₹50 lakh over five years, at 3.5 per cent net of tax, is 8.24 per cent net of tax.

Conclusion

Equity returns are non-defined and the break-even rate calculated for this asset class to outperform 54EC bonds is 8.24 per cent net of tax. It is difficult for bonds as it will be possible only for a bond with inferior credit quality against a AAA rated PSU one. Equity or a riskier bond not being a fair comparison, it is advisable to save the tax and settle for 5 per cent by investing in 54EC bonds. However, liquidity is one aspect you may keep in mind — investment in 54EC bonds is locked in for five years.

The author is a corporate trainer (debt markets) and author

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Explaining core and satellite portfolio strategy

Personal Finance

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A coffee time conversation between two colleagues leads to an interesting explainer on a portfolio construction strategy.

Vina: Did you hear about Meena making windfall gains through her smallcase investments? Makes me want to try my hand at it too. I felt exactly the same way when cryptos rallied last year. I think it is some kind of FOMO playing out!

Tina: Relax Vina. It is not like she has got the Midas touch when it comes to investing. You can also up your game by venturing into other asset classes. But be mindful of the risk you undertake. I hope you know that every asset class that promises you superior returns comes attached with equally superior risks too.

Vina: Agreed! But isn’t there a way out. I mean, what is one to do if one wants to generate better than market returns, and at the same time contain the risks.

Tina: Have you heard of the Core – Satellite portfolio strategy? It is a strategy that aims to optimise costs, taxes and risks in the overall portfolio while aiming to maximize returns. May be this approach could help you address your FOMO.

Vina: I assume, the core is the main portfolio. But, what is the satellite portfolio? Does it keep revolving around the core? Like the Moon around planet Earth?

Tina: No Vina. This strategy works as follows. The core portfolio is made up of funds or other investments that aim at acheiving one’s financial goals — be it through debt instruments (sovereign or otherwise), funds (ETFs or index funds) and other assets that essentially help cut down on costs and volatility in the long run. For longer tenure portfolios, gold can also form part of the core portfolio. The smaller satellite portfolio is one where you can try your hand at actively-managed riskier assets for alpha generation. One can also use his / her satellite portfolio for saving taxes by investing in equity-linked savings schemes or ELSS. Depending upon one’s goals and the risk associated with the stock picks, direct equity investments can either be part of your core or satellite portfolio.

Vina: Why two portfolios? How does that help?

Tina: While the core helps in generating the minimumreturn required to meet one’s goals according to one’s risk appetite, the satellite portfolio adds extra spice to these returns. This is definitely better than burning one’s fingers by investing the entire corpus in risky assets, all in the name of seeking alpha.

Vina: Fair point. What is the ratio in which I should split my portfolio into core and satellite, then?

Tina: While there is no one size fits all approach, most experts advise a 70-80 per cent allocation to the core portfolio. The ideal ratio depends on the type of assets added to your satellite portfolio and the amount of risk they would add to your overall portfolio. The idea is to earn the minimum return to meet your financial goals through your core portfolio investments. One’s satellite investments can range from credit risk funds to thematic or international mutual funds to direct investments in equity. Some also prefer to add alternate investments such as REITs/InvITs, PMS, private equity (including pre-IPOs) and even cryptos to their satellite portfolio. Whatever the asset class(/es) you choose, the losses if any, should not eat away too much into your overall portfolio return.

Vina: Right. Simply put, this strategy seems like a fair way in which one can try to get the best of both worlds, superior returns with a cap on the downside risk.

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What is inflation-adjusted return – The Hindu BusinessLine

Personal Finance

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A phone call between two friends leads to a talk about inflation-adjusted returns.

Akhila: What are you up to, Karthik?

Karthik: I was planning to buy a television set for ₹50,000. But I later changed my mind to save and invest that amount to buy a better version next year.

Akhila: I hope inflation doesn’t eat into your returns.

Karthik: What do you mean?

Akhila: A few economists expect inflation to rise going ahead. If that happens, your inflation-adjusted returns can be low or even negative.

Karthik: Can you explain that?

Akhila: If you invest that ₹50,000 at four per cent p.a. in a fixed-income instrument, your investment will be worth ₹52,000 by year-end. Say, the average inflation over the next one year is six per cent and the price of the TV set which you decided not to buy, becomes ₹53,000. Let alone buying a better version, your investment amount won’t be sufficient to buy even the current model.

Karthik: Ouch!

Akhila: Inflation-adjusted returns, also called real returns takes into account the inflation rate while calculating the return on an investment.

Karthik: How do I calculate real returns?

Akhila: You can simply subtract the rate of inflation from the return on your investment. In the above example, the real return on your investment would be -2 per cent. That is, 4 per cent return minus the inflation rate of 6 per cent.

Karthik: That’s pretty simple.

Akhila: The above formula gives an approximate rate of real return. To be precise, you can use the formula — ((1+return)/(1+inflation rate)) – 1.

Karthik: Are there any savings instruments in the market that offer returns linked to inflation?

Akhila: There used to be inflation-indexed bonds but they are no longer available.

Karthik: Equities would give higher returns, right?

Akhila: Equity is said to deliver inflation-beating returns in the long-run. But remember, for the sake of earning higher inflation-adjusted returns, you should not go for investments that do not fit your risk appetite.

Karthik: What are the alternatives in the fixed income space?

Akhila: You can consider floating-rate instruments, coupon rates on which are linked to interest rate movements in the economy, which are a play of inflation as well.

Karthik: I remember reading the Simply Put column in BL Portfolio a few weeks back that talked about floating rate instruments such as Floating Rate Savings Bonds 2020, the PPF and the Sukanya Samriddhi Yojana.

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Paytm launches ‘Wealth Community’ for young investors

Banking & Finance

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Home-grown digital financial services platform Paytm has launched a new video-based wealth community called the Paytm Wealth Community.

Paytm Wealth Community is an investing community based on video, and “will enable users to attend live sessions conducted by subject matter experts across an array of wealth topics like Stocks, F&O, IPO, ETFs, Mutual Funds, Gold, Fixed Income, and Personal Finance,” the company said in an official release.

“Users will be able to learn from experts, interact with them to clarify doubts, and also chat with other users on the platform to discuss various wealth-related topics,” it said.

The community is meant to tap young users and has been designed for the needs of the “new Indian investor.”

Artificial Intelligence: Financial services industry behind the curve in meeting customer expectations

In beta mode first

“The next 100mn capital market investors in India are expected to originate from social groups and investment communities. Paytm Wealth Community intends to be the leader in helping users save, invest & trade better,” the company said.

The “intuitive” platform will offer live video content on an interactive chat platform. Creators can conduct 30 to 60-minute sessions in multiple languages like Hindi, English, Gujarati and others.

The Paytm Wealth community is owned and operated by OCL Ltd (Paytm) and is initially being offered in beta mode on the Paytm Money platform. It will be offered in beta for select users for the next two months, followed by open access for all.

A limited set of creators have been onboarded by Paytm in beta. In a bid to ensure the safety of retail investors, all creators go through a comprehensive KYC onboarding and all content is recorded/checked, the company said. Over time, users will be able to create custom discussion rooms, set up their creator accounts and chat.

Paytm Money opens new Technology Development Centre in Pune

Community calendar

Varun Sridhar, CEO of Paytm Money, said, “Paytm Money was a natural choice for the Beta launch of Paytm Wealth Community, given our direct access to the broad investment community and reach across India. The Paytm team has implemented cutting edge video & community technology ensuring the platform is seamless, and the user communication is safe and secure. We are very excited by the potential positive impact it will have on how users engage, learn and invest.”

Users who have received access to the Paytm Wealth Community can explore the community calendar, which lists out all upcoming sessions and their details on the Paytm Money app. They can also share sessions on various social media platforms. Other interested users can download or update their Paytm Money app to the latest version and follow Paytm Money on social media platforms to get access to the live session links.

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Smart ways to compound your debt investment returns

Personal Finance

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Money managers and financial advisors, when pitching financial products to you, love to cite Einstein on compounding being the eighth wonder of the world. Then, they do their best to convince you that if you want to benefit from compounding, you should be maxing out your equity investments. But if you give it a bit of thought, debt investments often turn out to be more predictable compounders of wealth for Indian investors, than equities.

Steadier compounding

In equities, your returns come in fits and starts. You may make a 30 per cent return one year, lose 15 per cent of it in the second year and gain back 10 per cent in the third year. But such zig-zag returns from stock prices don’t really make for steady compounding of your money.

So, when equity fans praise the magic of compounding, what they’re really talking about is owning great companies that manage secular profit growth, reinvest it in their business at high rates of return and thus deliver high earnings compounding, which eventually leads to stock price returns. But then very few companies manage to achieve such earnings consistency in real life. To identify them, you’ve got to be extremely skilled or very lucky.

When you take the mutual fund or index route to equities, your compounding happens at a much lower rate, depending on your timing and staying power. A rolling return analysis of the Nifty50 Total Return Index over the last 20 years tells us that there have been quite a number of occasions (13 per cent of the times) when the Indian market has delivered a less than 7 per cent CAGR to investors with a five-year holding period. Even a 10-year holding period doesn’t guarantee compounding at a high rate. Folks who bought into Nifty 50 in end-2007 and held till 2017 earned less than an FD CAGR of 7 per cent from the Nifty50.

Debt instruments, in contrast, offer greater certainty of compounding. This is why, while making debt allocations towards long-term goals such as children’s education, the purchase of property or retirement, you should pay close attention to whether your interest compounds, to create wealth.

Choice of instruments

Here are ways to ensure that your debt money compounds.

While investing in fixed deposits or non-convertible debentures, choose the cumulative option as your default. If you opt for income, the interest from the deposit can land in your bank account and get spent before you know it.

Prefer instruments with compounded interest even if their interest rate is slightly lower. Today, the seven-year Government of India’s Floating Rate Savings Bond offering a 7.15 per cent interest is one of the most attractive debt options in the market. But this bond has only a payout option and no cumulative option. So, if you’re looking for a debt instrument for your long-term goals, the Public Provident Fund with its tax-free interest, despite its 15-year tenure, is a better choice (unfortunately you can invest only ₹1.5 lakh of your annual savings in it).

If you choose a regular payout debt instrument owing to its safety or high returns, open a separate bank account for your interest receipts and make it a habit to reinvest the balances frequently. This will ensure that your interest receipts compound.

When seeking compounding, do it with sovereign-backed instruments or pedigreed AAA-rated issuers and not with lower-rated entities that offer higher rates. With cumulative options of NCDs, FDs or deposits, you’re allowing the borrower to hang on to your money until maturity. It is not worth risking your principal for higher compound interest.

The manner in which your returns are taxed also affects the rate of compounding. In the case of FDs or NCDs, interest on the cumulative option is added to your income every year and taxed. But with debt mutual funds, if held beyond three years, returns are taxed as long-term capital gains with indexation.

Compounding options

If you’re seeking compound interest, post office schemes offer you the best bet in terms of safety. But then, popular options such as the 5-year time deposits, Monthly Income Account and Senior Citizens Savings Scheme offer only interest payout options and no cumulative options. 5 year plus FDs with leading banks or highly rated NBFCs offer cumulative options, but unfriendly taxation takes a bite out of your returns.

For 3-5 years, accrual debt funds (categories such as corporate bond funds, PSU & Banking Funds and short-duration funds) and Fixed Maturity Plans are good choices. Funds that rely on duration gains (gilt funds, medium duration and dynamic bond funds) behave a little like equities and are less desirable for consistent compounding. For 5 to 7-year horizons, the post office National Savings Certificates and NCDs from top-quality NBFCs make for good choices.

For horizons stretching to 10 years and beyond, the Public Provident Fund, is a great compounding option. For retirement, your EPF account is a good choice. For most investors, the National Pension System flies under the radar as a long-term debt investment. Allocating high proportions of your annual NPS contributions to the C (corporate bond) and G (government bond) options can compound your debt money at a high rate. If you want to withdraw before you turn 60, use the same choices in the NPS Tier 2 account.

While many regular income options are available on tap, cumulative options such as high-quality NCDs, tax-free bonds and FMPs come up only once in a blue moon. Rarely do these issues coincide with an upcycle in interest rates. Therefore, always hold some portion of your long-term debt money in accrual debt funds and switch the money into such options when they do crop up.

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Product review: Axis Securities’ YIELD platform

Personal Finance

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To make investing in bonds and debentures easier, Axis Securities launched a new online platform ‘YIELD’ early this month. Customers of Axis Securities can use YIELD to buy and sell bonds in the secondary market.

What it is

YIELD enables customers of Axis Securities to invest in a range of corporate bonds (rated A and above) trading in the secondary market. The bonds purchased on the platform can also be sold here.

Today, when you buy / sell bonds through your trading account with a broker, the transaction goes through based on the volumes available on the stock exchanges. Axis Securities has empanelled large wealth management firms (that deal in bonds) on its platform. It is the inventory of bonds available for sale with these firms that is aggregated and displayed on the YIELD platform.

For each bond, YIELD shows you the face value, current price (‘minimum investment’), coupon rate, yield to maturity (‘yield’), maturity date, frequency of interest payment, among other details. You can also see whether the bond is tax-free or taxable and perpetual or not. The platform also shows you the stream of cash flows from a bond over its entire tenure. The periodic interest payments each year and the final maturity amount to be received in the end, are shown diagrammatically for each bond. YIELD also allows you to compare different bonds with each other as also with fixed deposits from a few select banks including SBI.

Suitability

While YIELD offers the prospect of better liquidity (larger volumes) that HNI bond investors may require, it may not offer any significant advantage to small retail investors who can, therefore, continue to trade with their existing brokers. YIELD gives Axis Securities’ customers access to bonds available with large wealth management firms (which is besides what is available on the exchanges) thereby providing them greater liquidity.

The platform also offers the advantage of one-time KYC (know your customer) to investors. According to Vamsi Krishna, Head- Products & Marketing, Axis Securities, once your KYC with Axis Securities is complete, all your purchases through YIELD are simply conducted based on that. You don’t require a separate KYC for bond transactions with every bond house. Existing customers of Axis Securities can use the platform at no additional cost. Note that, though, as on date, you can use YIELD to sell only those bonds that have been bought on the platform.

Furthermore, today, with the cheapest bond on the platform priced at around ₹2 lakh and many others at ₹10 lakh, per bond, the platform is not suited to the needs of small investors. Axis Securities plans to introduce bonds of smaller denominations in future. Retail investors can invest in tax-free and taxable bonds of significantly small denominations via their trading accounts with other brokerages as also with Axis Securities (outside of the YIELD platform).

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Yield to maturity – The Hindu BusinessLine

Personal Finance

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A coffee time chat between two colleagues leads to an interesting explainer on bond market jargons.

Vina: Do you think I should try my luck with the bond markets?

Tina: While stock and bond market prices are unpredictable, don’t leave your investment decisions entirely to a game of luck.

Vina: Agreed! Today while bank deposit rates are at all-time lows, I came across a bond that promises a yield to maturity of around 8.8 per cent. Interest of ₹88 on a bond with a face value of ₹1000, sounds like a great deal. Doesn’t it?

Tina: No, that’s not how it works, Vina. You are mistaking the yield to maturity for the coupon rate. The two are not the same.

Vina: Jargons again! What is the interest I will earn?

Tina: The coupon rate when multiplied by the face value of a bond, gives you the the interest income that you will earn. Yield to maturity is a totally different concept.

Vina: Enlighten me with your wisdom, will you?

Tina: When you buy a bond in the secondary market, its yield will matter more to you than the coupon rate or the interest rate that it offers on face value. Because the yield on a bond is calculated with respect to current market price – which is now the purchase price for you.

The current yield is the return you get (interest income) by purchasing a bond at its current market price. Say, a bond trades at ₹900 (face value of ₹1,000) and pays a coupon of 7 per cent per annum. Your current yield then is 7.8 per cent.

Vina: What is the YTM then?

Tina: The yield to maturity (YTM) captures the effective return that you are likely to earn on a bond if you hold it until maturity. That is, the return you get over the life of the bond after accounting for —interest payments and the maturity price of the bond versus its purchase price.

The YTM for a bond purchased at face value and held till maturity will hence be the same as its coupon rate.

Vina: Hold until maturity? The bond I was referring to has 8 years left until maturity. Too long a tenure, right?

Tina: Yes! The bond whose YTM is 8.8 per cent and has a residual maturity of eight years must be paying you a coupon of 7 per cent annually. That isn’t too high when compared to what other corporates have to offer.

Vina: So, should I now look for bonds that offer even higher YTMs?

Tina: Don’t fall prey to high yields, Vina. A high deviation from the market rate often signifies a higher level of risk. Higher YTMs are a result of a sharp drop in the current bond market price, which is most likely factoring in perceived risk of default or rating downgrades.

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