THE ECONOMIC TIMES, MUMBAI
Reverse swing
5 Sep, 2007, 0002 hrs IST,
By: Suresh S
Notwithstanding reports that reverse mortgage payments will be considered a
‘loan’ and not an ‘income’ for income-tax calculation, this newly introduced class
of housing finance is unlikely to be a runaway success. Embedded in the structure
of a reverse mortgage is a time bomb. The longer the borrower survives the louder the
bomb will tick. If the borrower outlives the tenure of the loan, the bomb could even explode.
Though reverse mortgage appears to offer prima-facie a sense of financial independence
to the elders, it is likely to carry to create future baggage and crush them down with
financial problems, all at an age when they wish to put their feet up and live in peace.
Reverse mortgage is the scheme of providing money to a house owner against the security
of the house. It is intended for senior citizens, aged 60 or more, with a maximum loan
tenure of 15 years. The loan need not be repaid until the term is completed.
If the senior citizen dies before the term, the lender would sell the house and recover the loan.
The surplus of sale proceeds after extinguishing the loan would be passed onto the heirs. If the
senior citizen survives the term, the entire outstanding would be treated as a corpus and interest
alone would accumulate until the death of the owner.
The first issue concerns end-use. What happens when the money so borrowed is used
up for purposes other than what it was intended? The guidelines do mention end-use as
a pre-requisite. But these are prescriptive and it would be left to individual institutions to do due diligence.
The concept of repayment itself is dangerously structured. What happens when mortgagee
survives the tenure of the loan? The entire outstanding comprising principal and interest would
be treated as corpus and the interest meter starts ticking on the corpus. A loan of Rs 14.4 lakh @45%
of the present market price of Rs 32 lakhs, taken when the house owner is 62 becomes Rs 35.8 lakhs
at the end of 15 years at 12% rate of interest.
If the senior citizen survives till then and continues to stay in this house, he/ she could opt to continue
servicing the loan. The interest then for the next five years is as follows:
Snowballing effect of interest in reverse mortgage when borrower survives term. Thus at 82, the total
outstanding would be a staggering Rs 63 lakhs. If the mortgagee survives another five years, this outstanding
would become Rs 111 lakh. In terms of valuation, property valued at Rs 32 lakhs must after 25 years have
a value of at least Rs 111 lakhs otherwise the borrower is in deep trouble.
The interest paid on reverse mortgage is an expense not carrying tax advantage. It would not be allowed
under the head ‘income from house property’ since this is not a loan for construction/purchase of property.
At the same time at the time of sale, the interest cannot be added to the cost of acquisition of property for
computing capital gains. This poses an interesting question: if on the death of house owners and the property
is sold, the proceeds would be utilised to repay the principal and interest.
The amount of capital gains is likely to be very high. What happens if the net proceeds remaining after repaying
principal and interest is inadequate to pay capital gains tax?
Finally, there is the finer print that would add on a basket of costs — processing charges, legal opinion,
registration of mortgage, valuation at sanction and after every five years — all of which would act as an invisible
sledge hammer.
Following steps may be taken to make the facility of reverse mortgage workable:
End use of loan should be monitored. An explicit clause preventing use of loan to support wards’ personal requirements
or businesses to be introduced.
Interest paid on reverse mortgage should be explicitly allowed under ‘income from house property’ to give tax
advantage to the borrower.
Insurance of credit default such as in the US should be made mandatory. A small part of the loan amount may be
parked in unit linked insurance schemes so that the premia paid will keep appreciating and at the same time in the
eventuality of death, the sum assured will likely make good any deficit.
Instead of merely capping loan amount as a percentage of value, total outstanding including interest should be capped
if the borrowers survive the term of loan. The borrower must undertake to pay the difference from his other sources.
A pool account may be operated by NHB or any agency promoted for this purpose which will meet short recoveries
either due to outstanding overtaking the value of property or, due to value of property falling. Counselling to be mandatory
could be free as in the US and should be done by advisors carrying NHB certificates.
(The author is director, DMS Financial Services Pvt
Ltd)
BUSINESS LINE (THE HINDU) 14th APRIL, ‘07
Woes of TDS rate hike
Suresh S.
An unfair burden on profitable firms
The proposed TDS increase for professional fees from 5 per cent to 10 per cent in the recent Budget is a retrograde step,
which may worsen the cash-flows of firms rendering professional services, especially those that are cash-strapped or in turnaround mode.
The TDS hike will affect different firms differently. For instance, for a professional services firm running a highly
profitable service, with no tax planning to speak of, the impact would be only marginal. However, the TDS unfairly
burdens even the profitable firm as compared to advance tax. Say, on April 30, the firm receives payment for work completed in early April.
The firm will receive only 90 per cent of the contract value as 10 per cent TDS is deducted upfront. If there were no
TDS provisions, the firm would pay advance tax only in September (non-corporate).
A rate of 10 per cent for TDS means the tax component on the profits expected is Rs 10 on a contract of Rs 100.
At a tax rate of 30 per cent, that translates into a net profit margin of 33.33 per cent. In how many businesses is the
profitability so high that the tax applied on such profits works out to 10? Further, TDS is on the gross amount billed, inclusive
of service tax and education cess. Hence, effectively, the firm's gross billing approximates to Rs 112.36 and the TDS becomes
Rs 11.24.
The cash-flow implications for a marginally profitable enterprise or one that is currently running at a deficit can easily
be imagined. To this extent, TDS provisions pose a serious threat to a firm's cash-flows.
Effect on Cash-flow
The timing difference between tax withheld from service payments and advance tax dues might not be a serious issue if the
self-assessment and consequent advance tax that would have been paid match the recoveries by way of TDS. But when
cumulatively TDS starts exceeding the advance tax components, the firm's cash-flow takes a beating. In most cases the only
recourse is to await the income-tax refund.
Till the refund is obtained, the firm incurs interest cost on the incremental amount paid as TDS, which would be non-existent
had there been no TDS provisions.
The shoe pinches hard for four categories: i) Unprofitable professional firms, ii) Professional firms that, though not loss-making
now, are yet to come out of the red iii) moderately profitable firms receiving sizeable portion of the contract value as advance
from customers, and iv) firms whose businesses exhibit intra-year volatility.
The TDS provisions would hit them as their real tax liability would be either zero or very low, in contrast to the amount of tax
deducted. The cash-flow impact could translate into external borrowings which, in turn, lead to high interest expenses and
reduced profits. Being firms with marginal profitability, they may not even enjoy significant credit limits from banks.
There are provisions in the tax laws that provide for an application to the tax authorities for deduction at lower rates or nil deduction
for loss-making units, but in practice they do not work. The decision is `at the discretion of the Officer', effectively meaning that no
Officer would stick his neck out to grant a reduced rate.
The process could also be time-consuming, defeating the spirit of granting a reduction. Besides, the logistics of securing such
relief is also beyond the scope of most self-employed professionals managing a modest services operation.
The increase in TDS from 5 per cent to 10 per cent is thus uncalled for. When the Government has vested in itself the right to
appropriate corporate profits through the medium of advance tax, there is no rationale in enhancing the TDS.
The conscious focus of the Government may be to target firms that do not disclose incomes and, therefore, do not pay tax.
The TDS route may indirectly force these firms to pay tax. Chances are these firms may be ready to even forego the TDS amount
rather than become income-tax assessees. But the tactics applied to such units can never warrant making a generalisation.
Why tinker with TDS?
Advance tax collections are at an all-time high and the Department is overshooting its target of Rs 2,10,000 crore in 2006-07.
The Government's Ways and Means position is luxurious. Enjoying tax revenues much in advance of the year-end has already
become an integral part of the taxation structure. Why tinker with TDS rates then? This is a step that may even impact entrepreneurship
in the medium term.
If at all TDS rates have to be increased, the move must be accompanied by all or some of the following:
i) encouraging banks to consider financing a part of the tax refund claimed as `receivables',
ii) allowing non-deduction of tax on strength of self-declaration by firms to client companies that there is no expected tax
liability at year-end, and
iii) client companies to deduct tax at the effective rate, arrived at by dividing `actual' tax paid
by the professional services firm in the last assessment year divided by its sales turnover, to be certified by a practising chartered
accountant. Thus the rate need not be rigid at 10 per cent of the contract value.
Except in the case of owner-dominated firms or firms where most skills are contributed by the owner, where the firm's net profit to
sales could be abnormally high, the proposed hike in TDS rates could slam the brakes on up and coming firms. The steps suggested
above would considerably mitigate hardship to a major segment of professionals without in any way affecting the Government coffers.
(The author is Director, DMS Financial Services Pvt
Ltd., and visiting faculty at IIMs.
He
can be reached on suresh.dms.finance@gmail.com)
THE NEW INDIAN EXPRESS, CHENNAI
Money
The bigger picture
Thursday April 20 2006 17:31 IST
published in the edition of Sunday, April 23, 2006
Can housing loans
be available at
negative rates of interest? Yes,
says Suresh S
Suresh S
Interest rates are not “negative”, but you can get the ‘‘net result’’ to be “negative” when you consider
housing loans under certain conditions after taking tax savings into account. The borrower needs
to pay the housing finance company interest on the loan as well as principal, and try to save on tax.
If these three are put together - adding interest payment to the principal repayment and deducting the
tax saved - the borrower in certain situations will end up paying in total, less than the loan amount for the
tax saved is so much it exceeds the interest on the loan. The borrower therefore in a sense does
not pay interest at all as the entire amount is offset by tax savings and even in fact saves a portion on the
principal repayment.
Ever since the Union Budget introduced Section 80 C two years ago, housing finance has become very attractive.
The interest paid for the loan is allowed under the Income Tax Act. By taking a housing loan and staying
in your own house, you can still get full tax advantage on the interest by reducing your salary income to that extent.
As per Section 24(b) of the Income Tax Act, 1961, a deduction up to Rs 1,50,000 per year towards the interest
paid on the home loan towards purchase / construction of house property can be claimed while computing
the income from house property.
Consider the case of a borrower who has just taken a housing loan of Rs 8 lakh at 8% rate of interest for an
eight-year term. In the first year, assuming that his interest is worked out at annual rests, he would be paying an
interest of Rs 64,000.
The EMI in this case is Rs 11,605 meaning the borrower is annually paying twelve times the monthly
EMI of Rs 11,605 and that amounts to Rs 1,39,260.
What is the real cost of the housing loan to the borrower? Adding up the interest paid column one gets a
figure of Rs 3,14,080. Is this the “cost”? No! To arrive at the real cost, one has to prepare the table of
cash flows taking the tax advantage and then using a discounting tool for the time-value of money.
Once that is through, the stage is set for arriving at the “real” cost. The cash flows for the borrower are
the receipt of housing loan amount as an inflow and payment of “installment net of tax saved” as cash outflows.
These cash flows are then plotted year-wise and the Internal Rate of Return is worked out to give
the “real” rate of interest for the borrower.
It can be seen that the IRR is negative. This means that the rate of interest is negative. So the borrower is not only
not paying interest to the housing finance company but also not paying principal fully. Even if you had enough
savings to afford buying a house without seeking a loan, you are advised to take the loan for it may practically be
interest-free, and your savings could be invested in fixed deposits earning interest!
But do note, such a result cannot be expected always, particularly for higher values for each of the variables.
One cannot expect a negative rate of interest at very high level of borrowing such as housing loans of
Rs 15 lakh or more, or for interest rates of 10% or more for terms of 15 years or more. Undoubtedly there will
be a significant reduction in “effective” rate of interest in all these cases but not to the extent of making it negative.
The writer is
director of DMS Financial Services Limited, Chennai
Source: blThe Hindu Business Line
5th May, ‘04
(http://www.blonnet.com/2004/05/05/stories/2004050500241100.htm)
Management control systems —
To stop `muddles' from becoming `meddles’
Suresh S
MEGA issues, pompously flashed, riding the crest of a booming market, only
to get jerked back with repeated hiccups.
The share market intermediaries, coming out of an unduly long hibernation,
find themselves unable to shake off the sleep. In all these, one casualty
is certain — investor confidence.
An analysis of the nature of slippages occurring point to the absence of
good management control systems within the market intermediaries such as
registrars and merchant bankers.
A good management control system identifies critical variables, sets up
standards for performance, enables measurement of actuals and assesses
the reasons for deviations and suggests framework for remedial action.
In the ONGC episode, the basis of allotment was not tied to the actual
allotment of shares. High net worth individuals were treated on a par with
retail investors who were promised 100 per cent allotment. As a result,
some HNI investors received full allotment to their surprise and, by the
same token, some did not get any.
The heat really turned on when the HNIs who were "over-allotted"
started selling their shares. Appalled by the slip, MCS pulled the plug
by alerting exchanges not to trade in the shares, and the market reacted
the only way it would: With shock.
Share prices plummeted to a low of Rs 780 and recovered only when it was
understood that the real dimensions were not as bad as was projected.
The panic, in retrospect, was totally disproportionate to the event —
the fiasco pertained only to a miniscule percentage of shares stated as
`oversold'.
An analysis of the failure points to inadequate supervisory mechanisms
and audit procedures of the registrar.
A sound management control system identifies what variables are critical
and provides at higher levels of hierarchy, a system of counter-checks.
"Errors in allotment" is one such, since small or big, the resulting
damage-control exercise can be very `expensive'.
One of the significant causes for the happening was stated to be the "largeness
of the issue". The larger the issue size, the greater the role of
planning and control systems.
Historically, the same MCS handled the Mangalore Refinery and Petrochemical
issue, one of the biggest issues till date with over 40 lakh applications,
without any problem.
The reaction of MCS was a typical knee-jerk one. It asked for a co-registrar
to the ICICI Bank issue that followed and if there be no co-registrar,
ICICI Bank should appoint another registrar.
What, one may ask, is assured by a co-registrar? Does it give a foolproof
solution to such a happening? If the error was human, could it still not
repeat?
At most, the noose would have tightened around two necks instead of one
(and a possible pitched battle between the two inter-se). Or, could it
be that two hands are better than one for such volumes? Why was this not
deliberated upon earlier?
Close on the heels of this blunder, investor confidence took another beating
when the IT Department shot off missives to high net worth individuals
asking for their source of income for the funds invested.
Whether there is protection for the small investor or not, there is certainly
harassment for the big. For a market that was bouncing back, this could
not have been more ill-timed. What differentiates `muddle' from `meddle'
is transparency. A good manage- ment control system would mitigate the
probability of occurrence of the muddle.
But, if `muddle' it does, then the speed of response is critical. Otherwise,
the muddle will start degenerating into a `meddle'. Muddles affect only
the short-term investor confidence, whereas meddles affect the long-term.
In the case of Power Trading Corporation, the listing of shares, which
was slated for March 29, was delayed thrice till April 7.
Consider this: On the first day itself, shares twice the issue size were
traded. Little wonder this delay in listing irked investors both small
and big. This is yet another pointer to inadequate management control systems.
Middlemen need to roll up their sleeves for sure.
The ONGC episode, considering the speed with which the error was detected
and depository accounts frozen, appears only a muddle. A good management
control system would have mitigated the probability of occurrence of the
muddle. Recently, merchant bankers decided to form a "core committee"
to fix definitive responsibilities for each intermediary in a public issue.
Without doubt, the committee will seek to save the skin of merchant bankers
saying that they can play the role of a coordinator and not take responsibility
for mishaps.
But, hopefully, the committee will produce a document spelling out the
checks and controls, which if given to an intermediary with a good management
control system, will give investors something to cheer about.
(The author, a director in DMS Financial Services Pvt Ltd, is a visiting
faculty at IIMs. The views are personal. He can be contacted at suresh@dms-finance.com)