Answering Readers’ Questions (# 2) – Starting a Consultancy in India

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The following question was asked by a reader in the comment section of the post: Residential Status of Returning Indians.

Q: Is there a difference or advantage in operating as an Individual or setup a firm in trying to work from India for a US client? I assume as a consultant, I could claim tax deductions on travel and such. Would business setting enable tax deductions on rent if operating from home? BTW, any recommendation of folks who can advice me either in US/India regarding this would be appreciated.

As the query requires an exhaustive response, I thought it prudent to write a separate and detailed post so that other upcoming / budding entrepreneurs can also benefit from the advice.

How to Start a Consultancy Business in India: Regulatory and Other Issues
An individual planning to start his own consultancy in India, would like to have the answers for the following questions:

Q1: Can I simultaneously start my own business / consultancy while working as an employee?

Q2: Which is better from tax point of view: salaried employee vs. working as a consultant?

Q3: If I start a consultancy, then what are the legal formalities?

Q4: If working as a consultant, whether to open a sole proprietorship firm or work under individual’s name?

Q5: If I open a sole proprietorship, whether any registration is required for it?

Q6: How can I be sure that the name I’m going to use, say, “ABC Consultants” is unique and there is no other business or profession is being operated under the same name? What if in future I become famous and someone else copies my firm name?

Q7: What is the status of sole proprietorship under Income Tax Act, 1961? Do I need to apply for a separate PAN card for sole proprietorship? Do I need to file two returns, one in the individual capacity and other for proprietorship firm? What are the tax deductions allowed in running my own business or consultancy? How does it make a difference in the taxation if I run the run the business / profession from home?

Q8: What are the TDS implications?

Q9: Whether any other tax is applicable such as service tax? If yes, then is there any exemption limit below which I’m not liable for service tax? What about service tax registration? Is it required irrespective of the exemption limit or only if my billing exceeds certain minimum threshold? Do I require registration before starting the service or can I apply afterwards? What is the rate service of service tax applicable for FY 2009-10?

Q10: Whether a separate bank account is required for banking purposes?

Q11: What if I render services to a foreign client?

Q12: What if I start a sole proprietorship and later on in future (to expand the business) decide to convert it into partnership / company?

In a nutshell, the reader wants to know how to start a consultancy business in India?


Working as an Employee vs. Consultant: Income tax Implications
Location of Clients: In deciding whether to work as an employee or as a consultant, it is immaterial whether you work for a US client or Indian client.

However, if you work for US clients you also need to take into account US tax laws and DTAA between India and US.

Tax on Salary vs. Professional Income: As a consultant your income is taxed under the head “Income from business or profession” and accordingly you’re entitled for all the genuine expenses incurred for purpose of running your professional practice such as travelling, rent (even if working from home), depreciation (on car, computer etc) printing and stationary, telephone etc.

On the other hand, if you work as an employee, your entire salary doesn’t get taxed. You’re entitled for various exemptions and deductions such as HRA (for rent paid), transport allowance, medical reimbursement, LTA etc.

TDS: If you are a salaried employee, the entire tax on your salary gets deducted at source as per section 192 of the IT Act. But, if you’re working as a consultant, TDS @ 10% is deducted under section 194J (TDS on professional or technical services).

Non-Tax Consideration: As a consultant you can work for many clients but as an employee you can only work for one employer. Why? There are no statutory restrictions on engaging yourself in any other activity / trade while simultaneously working as an employee. However, usually as per the terms and conditions of employment contract (appointment letter), employees are barred from undertaking any business, profession or vocation directly or indirectly without prior permission of the employer.


Starting or opening a Sole Proprietorship Firm
Meaning: A sole proprietorship firm (also called proprietorship) is a form of business entity (other forms are partnership firms and Companies registered under Companies Act, 1956) owned and operated by an individual. It is the oldest, cheapest, simplest and most common form of business organization.

Registration: In India, a sole proprietorship firm has no legal existence separate from its owner. Therefore, there is no requirement of registration.

However, you might require registration under other regulatory authorities. For example, if you’re a professional, say, practicing as a CA, you require registration with ICAI; if selling mutual funds, registration is required with AMFI; if selling insurance need to have license from IRDA; if into import / export of goods or services, IEC (Import Export Code) is required.

Tax Status: From tax point of view, it is immaterial whether you run consultancy in your name or open a proprietorship firm. Unlike a partnership firm, which has a separate status than the partners running it and is accordingly a separate tax entity for tax purposes, the sole proprietorship firm and the sole proprietor are the same and there is only one tax assessment in the name of individual. Therefore, only one tax return is to be filed in the name of individual.

PAN: There is no need to apply for a separate PAN card for proprietorship firm and you can quote your individual PAN wherever required in your business dealings. In other words, PAN of the proprietor will be PAN of the proprietorship firm.

Conversion: In future, if required you can convert your sole proprietorship into partnership firm or a private limited company under Companies Act, 1956.


Service Tax Implications
Registration: If you’re providing a specified taxable service and the aggregate value of the service provided by you exceeds Rs 10 lakh during the financial year, then you’re liable for service tax and also need a registration [Form no ST-1] under Service tax.

Rate: The current rate of service tax is 10.3 percent.

Location of Clients: If the taxable service is exported then no need to pay service tax by virtue of Rule 4 of Export of Service Rules 2005. But what is export of services? As per Rule 3 of Export of Service Rules, 2005, if the taxable services is provided from India and used outside India and payment is received in convertible foreign exchange, then the taxable service is considered as exported.


Banking Issues
If you’re running consultancy services or professional practice in your individual name, then there is no mandatory requirement to have a separate bank account. But it is always better to keep your personal transactions separate from business transactions as it also helps in accounting and compliance with tax matters.

On the other hand, if you’re rendering consultancy or other services under a sole proprietorship name, then it becomes necessary to have a separate bank account in the name of proprietorship firm. Why? Because your clients are going to issue cheques in the name of your proprietorship concern which can’t be deposited into your personal bank account.

Besides, as business / professional concerns are not allowed to open a savings bank account, you’ll have to open a current account. To open a business account in the name of proprietorship concern, banks usually demand a registration with any government or statutory body or a trade license (as a part of KYC norms) and if you don’t have any registrations / license, you might face problem in account opening. However, some banks allow you to submit a CA certificate. This is in fact the most troublesome part of opening a sole proprietorship firm.

But in my opinion banks are not at fault because in order to satisfy themselves about the genuineness of the sole proprietorship firm and as a safeguard against fraud, it becomes necessary for banks to require proper documentation.

Other Requirements
Website: Now a day, if you expect your clients / customers to take you seriously, it is a must to have your own website. So it is always better to buy a domain name at the beginning itself even if you would like to wait for sometime before launching your website.

Accounting & Auditing: As per section 44AB of Income Tax Act, 1961 read with Rule 6F of IT Rules, 1962 every person carrying on business or profession is required to maintain books of accounts depending upon the income and turnover / gross receipts as specified therein. In case of ‘specified professions’ the requirement is mandatory irrespective of the ‘gross receipts’.

Furthermore, according to section 44AB of IT Act, a person carrying on a profession is required to get his accounts audited if the gross receipts exceed Rs 10 lakh in a financial year.

Printing & Stationary: A letter head, visiting cards and a stamp is also required.

Trade Marks: If you want to make sure that in future nobody else makes use of your business name, brand or logo, you have to get it registered as a Trademark with Trademark Registrar under Trade Marks Act, 1999. Before registration a market survey is required to ascertain if same / similar mark is already in use in the market.

I’ve tried to ensure that the above write-up gives a comprehensive view of all the issues faced by a budding entrepreneur in starting his own consultancy business in India either in his individual name or as a sole proprietorship firm.

If anything is still missing, please write in the comment box. You can also send your queries directly to feedback [at] themoneyquest [dot] com.


Also see:
1. Why do we make Fatal Money Mistakes?
2. Answering Readers Questions: Part - 1

In a Lighter Vein: New Financial Definitions

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A person without a sense of humor is like a wagon without springs. It’s jolted by every pebble on the road.

––Henry Ward Beecher

I've bored you enough already with the technical jargon of tax laws, insurance and stock markets. What’s life without humour? Why not take a break and have some lighter stuff to read and laugh about? So this post is about some interesting and funny definitions:

New Financial Definitions…

1. Banker: A fellow who lends you his umbrella when the sun is shining and wants it back the minute it rains.__Mark Twain and Robert Frost

2. Lawyer: A learned gentlemen who rescues your estate from your enemies and keeps it for himself.__Lord Henry P. Brougham

3. Consultant: A person who borrow your watch to tell you the time and then walk off with your watch.__Robert Townsend

4. Tax payer: One who does not have to pass a civil-service exam to work for the government__Ronald Reagan

5. Economist: A person who knows more about money than the people who have it.

6. Optimist: A person who keeps the engine of his car running while his wife is shopping.

7. Miser: A person who lives poor so that he can die rich.

8. Rich Man: Nothing but a poor man with money.

9. Advertising: The art of convincing people to spend money they don’t have for something they don’t need.__Will Rogers

10. Advertisement: The most truthful part of the newspaper.__Thomas Jefferson

11. Insurance Company: Heads we win, tail you lose.

12. Life Insurance: A plan that keeps you poor all your life so that you can die rich.

13. PMS: Portfolio Mismanagement Services.

14. CEO: Chief Embezzlement Officer

15. CFO: Chief Fraud Officer

16. Budget: A method of worrying before you spend money, as well as afterwards.

17. Cash Flow: The movement your money makes as it disappears down the toilet.

18. Prices: The only thing which violates the law of gravity.

19. Inflation: Cutting money in half without damaging the paper.

20. Bull Market: A random market movement causing an investor to mistake himself for a financial genius.

21. Market Correction: The day after you buy stocks.

22. Liquidity Crunch: The state of an economy / corporate body that’s undergoing extreme dehydration.

23. Competition: When someone earns money not to make himself rich but to make his neighbor / rival less rich.

24. Capitalism: Man exploiting man, as compared with socialism, which is the reverse.

25. Old age: Age when thoughts turn from passion to pension.

Hope you enjoyed it!


Also see:

1. How to Simplify Your Life

2. First Blog Anniversary

3. Money Teaser #2

Considerations to know while Investing in Bank FDs

Photo by Jim (jaytay)

Most conventional investment option for retail investors particularly for risk-averse investors is fixed deposit (FD) of Banks. Although investing in bank FDs is the easiest among all the investment options, but before investing in bank term deposits you should well understand the considerations such as tax impact, safety, liquidity and effective returns. In the previous post, we had a look at the the taxation of interest income of FDs. This post talks about the 3 other most important considerations to be kept in mind while investing in Bank Fixed Deposits (FDs).


Investing in Bank FDs: 3 Other Most Important Considerations

1. Liquidity
Liquidity is an important consideration while making investment decisions. There can be so many reasons for breaking the FDs before the maturity date. Broadly there are two main reasons: first is an emergency need and second is to take advantage of increasing interest rates.

Though you’re allowed to break up your bank term deposits, know that premature redemption / encashment of fixed deposits (FDs) involve a cost.

Normally, banks give you an interest rate applicable for the period during which the deposit remained in force (i.e., rate of interest applicable for the shorter tenure) which is usually less than the rate of interest applicable for the original duration. For example, if you invest in a 2-yr bank FD offering 9% p.a. and after 1-yr you break the FD and the interest rate applicable for one year FD was (at the time the deposit was made), say, 8% p.a., then you’re going to lose 1% p.a. straight away.

Furthermore, most banks (with the exception of a few) also levy a penal charge for premature withdrawal of fixed deposits—usually 0.5%. So, ultimately, in the above example, you’re going to receive interest @ 7.5% p.a., instead of 9% p.a. on your bank FD.

But what if the interest rate for the period during which deposit remained with the bank is more than the contracted rate (i.e., the rate offered for the original maturity of a term deposit)?

To safeguard against such a possibility, banks usually put the clause that interest on premature withdrawal of a term deposit will be payable at the rate applicable for the period for which the deposit remained with the bank or the contracted rate, whichever is lower, less penalty as applicable.


3. Safety
Bank deposits are covered by Deposit Insurance and Credit Guarantee Corporation (DICGC) insurance up to a maximum amount of Rs 1 lakh per person per bank. Please remember limit of Rs 1 lakh includes all deposits whether held in savings account, fixed deposits account, current account or recurring deposit account.

Although bank fixed deposits offer a lower interest rate vis-à-vis company deposits, these are considered better from safety point of view because company deposits are completely unsecured.


4. Return / Yield
The return consideration is the most important consideration while making a decision for investing in Bank FDs. Here you should be concerned with post tax returns i.e., how much net amount of interest income is left to you after paying the tax.

For example, if your marginal income falls in highest tax bracket (30.9%) and you invest in a bank FD with 8% rate of interest, then your effective post-tax return from the FD will be 5.53% and if you happen to fall in middle tax bracket (20.6%), then the post-tax return would be 6.35%.

In next part, I’ll let you know some practical tips for making the most of your investment in bank fixed deposits.


Also see:

1. Bank Fixed Deposits - Interesting Interest Information
2. Impact on Continuity of a Bank FD in case of Death
3. Taxation of Interest Income from Bank FDs

Top Most Tax Myth: Taxation of Interest on Bank FDs

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In an earlier post about bank fixed deposits (FDs), I had elaborated on the known and not-so-known facts about bank interest rates and the difference between interest rate and the yield. In continuation, this post talks about taxation of FDs Interest: the top most myth associated with Bank Fixed Deposits (FDs).

A lot many people believe that tax on Bank FD interest is payable only at the time of maturity; others think that it has to be taxed on accrual / annual basis. Then there is another associated myth that if TDS is already deducted on interest income from Bank FDs, then it need not be shown in return of income (ITR). Therefore, this post is going to dig out the facts concerning taxation of interest income on bank FDs including the tax deduction at source (TDS).

Note: The ensuing discussion is regarding tax implications of interest income on bank fixed deposits of resident Indians. In other words, taxation (including TDS) of NRO (Non-resident ordinary rupee account) deposits of NRIs (Non-resident Indians) is not covered and will be discussed separately in another post.

Taxation of Interest on Bank FDs
Know that interest income from Bank fixed deposits (FDs) is fully taxable in your hands. It is included in your other income and taxed according to applicable highest tax bracket.

Interest Income on FDs: Taxation vs. TDS
Understand that TDS and taxability of interest are two separate things.

First, just because TDS has been deducted from interest income on bank FD doesn’t mean that you’re no more required to show it in your return of income.

Second, even if there is no tax deduction at source (TDS), you’ve to include the interest income in your total taxable income and pay tax on it at the maximum marginal rate applicable to you.

Regarding TDS, two points are worth noting. First, TDS on bank interest is always deducted @ 10% whereas the marginal rate of tax applicable to you may be 20% or 30%; therefore, there can be additional tax liability based on your total income. Second, even if full TDS gets deducted from any income, one has to show both the income earned as well as TDS deducted in the return of income (ITR).

However, according to section 145 of the IT Act, 1961, you’re provided an option to include the interest income for tax purposes either on cash / receipt basis or accrual basis as per the regular method of accounting employed by you. But, once a choice is made, it should be followed consistently.

Anyhow, it is better to show the interest income on accrual / annual basis because you might have to pay higher tax if you show the entire interest on FD in the year of maturity due to increase of income to next higher tax bracket.


Rate of TDS on Bank FDs
As per section 194A of IT Act, 1961, tax @ 10% (earlier 10.30%) is deducted at source if the aggregate interest payable or reinvested exceeds Rs 10,000 for all your deposits (except recurring deposits and savings account deposit) in a bank branch during a financial year. TDS is deducted every time bank pays interest during the financial year. It is also deducted on interest accrued (but not paid / credited) at the end of every financial year (i.e., 31st March).

As per the changes made by budget 2009, with effect from April 1, 2010, it will be compulsory for you to furnish your PAN to the Bank failing which the bank will deduct TDS at the rate of 20% instead of 10%.


Avoiding TDS on Bank FDs: Form G / Form H
If your income is below the taxable limit, you need to present Form 15G/15H (as per section 197A of Income Tax Act, 1961), while opening a Fixed Deposit (FD) account in a bank to avoid tax deduction at source (TDS) from your interest income. Following points are worth noting regarding self-declaration in Form 15G / 15H:

1. While Form 15H is meant for senior citizens, 15G is for any other individual.

2. Form 15G / 15H can be submitted only if the tax on your total income is nil. In other words, you can’t submit a Form 15G / 15H if you’re already a tax payer.

3. New Form 15G / 15H has to be submitted for each FY.

4. An individual who is liable to pay tax can apply in Form 13 to Assessing Officer (as per Section 197) to obtain a certificate of lower rate of tax or no tax as may be appropriate.

5. According to amendment made by Finance Act 2009, the requirement of submission of PAN is also made mandatory for those submitting declaration in Form No 15G / 15H (effective from April 1, 2010). In other words, in the absence of PAN, the 15G / 15H declaration would become invalid.

I hope this answers all your questions regarding TDS and taxation of interest on bank fixed deposits. If any doubts remain, ask in the comment box.

The next part will discuss about other considerations to know while investing in Bank FDs.


Also see:

1. Bank FDs - Interesting Interest Information
2. Investing in Bank FDs - 3 Other Considerations
3. Impact on Continuity of an FD in case of Death

Life Insurance Term Plans: Lesser-Known Facts

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In my earlier post: ‘the most amazing fact about life insurance’, I advised you to go for term plans.

In continuation, this post will shed light on some lesser known details about term plans which will enable you to make a wiser decision concerning one of the most important choice in your life.

Term Insurance Policies: Lesser Known Facts

1. Why are Term plans considered as the best way to insure life?
The term insurance is designed for protection of your family. It is the best form of life insurance because the one and only purpose of life insurance is to ensure your family’s financial protection, should something unfortunate happens to you. With the death of the breadwinner of the family, an income stream also dies and proceeds from term insurance policy can replace that lost income.

Accordingly, term Plans provides you with high coverage at a very low cost. For further details, read: ‘Most amazing fact about life insurance’.

2. Why pure risk insurance plans are called term plans?
Interesting question! They are called term plans because these are offered only for a ‘definite duration / term’. But why these can’t be offered for the whole life? The purpose of insurance is to offer protection against an uncertainty. But as you know the only thing which is certain in this uncertain world is death and taxes. So, life insurance contracts offering pure life covers for the entire life (where there will be certainty of the insurance company paying up) would be an unviable / losing proposition for the insurance company.

3. Why do the insurance companies and the agents hesitate to sell term plans?
Another good question! Life Insurance Companies, like other businesses want to make a fast buck. Their self-interest (making money) comes before customer interest. Now, as investments cum insurance plans are more profitable than pure risk products, these are displayed on front shelves and advertised with a high pitch. On the other hand, Term Plans are like secret cappuccino well hidden from your eyes.

Similarly, insurance agent motto is to make hay while the sun shines (To hell with customers!) as commission earned on the insurance cum investment products is a lot higher than commission on term plans.

4. But aren’t the people intelligent enough to know which insurance policy is most suitable for them?
Actually, in this era of high decibel marketing, people get easily distracted by the high sales pitches of life insurance companies which are hell-bent on selling investments disguised as insurance.

Furthermore, most of the people think that life insurance products are only meant for tax saving and investment, which makes the job of insurance companies a lot easier. I could never understand why the government encourages people to park their money in life insurance by offering tax incentives; the only plausible reason can be to safeguard the interest of Life Insurance Corporation of India (LIC), the behemoth created by the Government of India.

The third reason is deep rooted notion that something should be received back on maturity. And on top of it, nobody wants to think of a premature death let alone planning for it. (Maut aaye mere dushan ko).

So, although life insurance is actually meant for ‘death benefits’ but people buy it for ‘living benefits’.

I’ve written this post in an attempt to make you realize that the harm caused to our financial health by life insurance industry (due to mis-selling) is similar to the harm being caused to our physical health by the processed and packaged food industry.

I hope that after reading this post at least some of you might become wise enough to understand the insurance pitfalls and start buying life insurance for the purpose of insurance only.

I’ll be covering a lot more information about term plans (including term plan FAQs and tips to remember while buying a term plan) in forthcoming posts.

Meanwhile, if you’re still not convinced about the importance of term plans as part of your financial plan, do write in the comment box.

Also see:

1. Direct Tax Code: Encouragement to mis-selling of Life Insurance

2. Understanding Life Insurance: Ask Yourself a Few Questions

3. Term Plans: FAQs

New Direct Tax Code: Income Tax Slab Rates

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The draft Direct Taxes Code (DTC) Bill, 2OO9 will become applicable from April 1, 2011, if enacted.

Under Section 2(2) read with first schedule of the Direct Taxes Code (DTC), 2009 the new tax rates and slabs applicable to individual tax payers from the financial year (FY) 2011-12 are as follows:


New Direct Tax Code: Income Tax Slabs / Rates from FY 2011-12


New IT Slabs/ Rates for Resident Senior Citizens (FY 2011-12 onwards):

Up to Rs 2,40,000-----------------> No tax / exempt
2,40,001 to 10,00,000------------> 10%
10,00,001 to 25,00,000-----------> 20%
Above 25,00,000------------------> 30%


New IT Slabs / Rates for Resident Women (below the age of 65 years) (FY 2011-12 onwards)

Up to Rs 1,90,000-----------------> No tax / exempt
190,001 to 10,00,000-------------> 10%
10,00,001 to 25,00,000-----------> 20%
Above 25,00,000------------------> 30%


New IT Slabs / Rates for Other Individuals (FY 2011-12 onwards):

Up to Rs 1,60,000-----------------> No tax / exempt
160,001 to 10,00,000------------->10%
10,00,001 to 25,00,000----------->20%
Above 25,00,000------------------> 30%


Unlike the current IT Act, 1961, under new tax code (DTC) there is no special / concessional rate of tax on short term capital gains and long term capital gains. The only income which doesn’t form part of the ordinary income as per above IT slabs is winnings from lotteries, races, card games, gambling, betting etc. It is taxed separately at special tax rate of 30%.

It is expected that individual’s tax burden will reduce substantially due to increase in exemption / deduction limit for savings from 1 lakh to 3 lakh and widening / expansion of tax slabs under the new direct tax code. Further the surcharge and education cess is also done away with.

Although prima facie it seems that new tax code will lower your tax liability but the fact is otherwise. There will be more tax outgo from salaried taxpayers pocket under the new tax regime. Put another way, your effective tax rate would see an increase as I shall discuss in more detail in subsequent posts.



Also see:

1. Income Tax Slabs / Rates for FY 2009-10
2. New Tax Code: Boost to mis-selling of Life Insurance

New Tax Code - Impact on Life Insurance Policies

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Currently more than 80% savings under section 80C goes towards life insurance. A consumer behavior survey (in January 2009) by IMRB for ICICI Prudential Life had revealed that 79% of people prefer life insurance vis-à-vis other tax saving instruments.

As already mentioned in my previous posts, the main reason behind mis-selling of life insurance policies is tax concessions and not the high commission rates (which is the secondary reason).

Let’s review how the Direct Taxes Code Bill, 2009 (New Tax Code) changes the life insurance current scenario. First, investment in life insurance policies is also covered under EET regime. Following are the relevant sections of the new tax code impacting life insurance:

New Direct Tax Code on Life Insurance Policies: Relevant Provisions
According to section 56(2)(r) of the new tax code, the scope of residuary income includes

“any amount received, or withdrawn, under any circumstances, from any account maintained with any permitted savings intermediaries, referred to in sub-section(2) of section 66, representing,-

(i) the principal amount of the savings; or

(ii) interest, dividend, bonus, capital appreciation or any other form of return on the investment, by whatever name called;”

This income u/s 56(2)(r) can be reduced by deductions allowed under section 57. As per section 57 of the new tax code following deduction is allowed while calculating income u/s 56(2)(r):

“any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, if –

(i)the premium payable for any of the years during the term of the policy does not exceed five per cent of the actual capital sum assured; and

(ii) the sum is received only upon completion of the original period of contract of the insurance or upon the death of the insured;”

Further, following two paragraphs of Chapter XI (Income from Residuary Sources) of Discussion Paper on Direct Taxes Code, 2009 are also relevant:

Para 11.3: The scope of gross residuary income include, inter alia, the redemption or withdrawal of the principal amount from any investment that is eligible for deduction in computing the total income. However, withdrawals/ redemptions from provident funds and pure life insurance policies will not be included under this head.

Para 11.5: Any sum received under Life Insurance Policy, including any bonus, shall be exempt from income tax, provided it is a pure life insurance policy. In order to achieve this objective, the Code provides that deduction will be allowed in respect of any sum received under a Life Insurance Policy, including any bonus, only if the premium payable for any of the years during the term of the policy does not exceed 5 percent of the capital sum assured. Consequently, in all other cases, the sum received under the policy, including any bonus, will be included under this head and taxed accordingly.

Review / Analysis: Impact of New Direct Tax Code on mis-selling of Life Insurance
Apparently, Mr. Draftsman thought that by making it mandatory to have insurance coverage of at least 20 times the premium paid, only pure term policies will be covered under tax exemption.

I think the Draftsman are blissfully ignorant of the working of the life insurance business. Why? Because the new tax code contains so many flaws:

1. First, there is neither any maturity value nor any bonus in case of a pure life insurance policy. Let me inform the draftsman that amount spent on buying a pure life insurance cover is an expense (just like tuition fees) and not an investment. The amount of life cover is payable only to the nominee in case of unfortunate death of the insured during the policy term.

2. By paying premium equivalent to 5 per cent of sum assured, one can get a life policy with a sum assured which is 20 times the premium paid. But what’s wrong with this? It means that the life insurance coverage is too low and major portion of premium is going towards investment. For buying a pure life insurance cover, you don’t need to pay such a high premium. For example, a 40 year old male can buy a Rs. 10 lakh level term plan from SBI Life Insurance (SBI Life Shield) for a period of 25 years by paying an annual premium of Rs 6,648 which means that insurance cover is 150 times the premium paid or, in other words, premium is just 0.66% of the sum assured.

So, by keeping low coverage / high premium, Mr. Draftsman is trying to ensure that even most of the ULIPs also get the tax exemption under the new tax code.

3. Furthermore, there is no such condition under section 66 of the new tax code(which replaces existing section 80C of the IT Act, 1961) which implies that at the time of making savings one is free to invest Rs 3 lakh in all kinds of life insurance policies (including Ulips, money back and endowment plans) and avail tax deduction irrespective of the extent of insurance coverage provided under the plan.

If you take a second look and dig a little deeper, you’ll find that this new tax code is only going to increase the mis-selling of life insurance policies. How?

1. If you invest in life insurance policies such as ULIPs, money back and endowment plans with a sum assured less than 20 times, you’re going to get tax deduction u/s 66. However, all the withdrawals would be taxable (irrespective of whether amount withdrawn before or after the maturity). In effect, it means that the tax status of such life insurance policies will be equivalent to PF, PPF and NPS under the new tax code.

2. If you invest in ULIPs or traditional life insurance plans, with a sum assured greater than 20 times the premium, the tax concessions will go a step further and even the maturity amount would become tax exempt. In effect, such life policies will enjoy a better tax status than NPS, PPF and PF under the new tax code.

So it’s a win-win situation for life insurance companies. Heads they win and tails you lose.

My contention is that:

If the intention of the legislature is to really provide tax benefits only on the premium paid on pure life insurance policies, the wordings of the section 57 of the new tax code can simply state “ term plans without return of premiums” instead of stating it in terms of premium paid as percentage of sum assured.

Furthermore, if the legislative intent is, in fact, to encourage life insurance companies to sell and people to buy pure life insurance plans, why treat insurance policies as a saving avenue under section 66 of Direct Taxes Code Bill, 2009.

By offering tax incentives on life insurance, legislature is causing great harm to the society and the Nation. What is the sole purpose of insurance? Is it the instrument meant for protection or savings? Combining both the elements increases complexity and opens the door for mis-selling. Besides, the customer (who is already too busy watching cricket, discussing politics, buying latest models of car/gadgets, or gossiping about someone) loses focus and it becomes a preferred instrument to invest and save tax. In the process, the core purpose of insurance gets neglected.

If the government keeps on encouraging the people (via the medium of tax incentives) to save money by investing in insurance products, then providing real life insurance to masses will remain a pipe dream.

Does anybody know that providing affordable life insurance to Indian masses is even more important than providing them with an affordable car (Is Mr. Tata listening?) or an affordable house? Just go and ask any family whose breadwinner has met an untimely death without an adequate insurance cover.

Any Comments?

Also see:

1. Most Amazing Fact about Life Insurance
2. Understanding Life Insurance
3. Revised IRDA Circular on ULIPs: What a Sham?
4. New Direct Tax Code: Income Tax Slabs

Answering Readers’ Questions (Part 1)

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From time to time I’ll try to answer some of the questions asked to me by the readers. This is first part of the series.

Continuity of FD in case of Death of a Fixed Deposit Holder
This query regarding continuity of fixed deposits of banks in case of death of a person is asked by Dr. Sudheer Prabhu (email: sudheerdr2000atyahoo.com). Here’s the question:

I am the Nominee of a Fixed Deposit held by my mother who expired recently. It’s a long term FD and locked in at a good interest rate so I don’t want to close it now. When my Mom was alive she used to give a Form 15G so that no TDS is deducted. Now that she is no more I just wanted to know how the Interest portion would be taxed. It’s a 10 Year FD with interest cumulative and delivered on Maturity. My Query is

1.If I hold on to deposit which I would like to then how would the Interest portion be taxed as the Deposit is in the sole name of my Mother & I am the nominee who would receive the proceeds upon maturity?

2. At the time of maturity is the amount totally tax free in my hands?

3. How do I avoid TDS from being deducted or can I claim refund of TDS as my Mother has expired and there is no point in deducting TDS in her name. Can I claim refund of TDS by filing returns as representative assesse of my Mother?

4. If the Interest portion is taxable in hands of receiver /Nominee then can I show the Interest proceeds in My HUF account as the amount is not earned by me.

5. Can I show it in my HUF account though the deposit continues to be in my mother’s name, and I declare the interest as received by me purely for tax purposes?

6. Can I just leave the Deposit as it is for next 10 years and claim it upon maturity if I have not shown it now in my HUF returns or personal IT returns. Will there be problems later if it’s not shown now

7. Also my HUF account will not have my Mothers name in it as I opened the HUF account newly

8. Please answer all my Queries one by one in detail

It’s said TDS will continue till date of maturity if I hold on to the deposit. Can I claim a refund of the TDS by filing returns in the name of My late Mother`s behalf as anyways the income would have been non taxable in her hands

At Maturity My mothers account is not necessary as I am the nominee and the amount will be paid to me into my account.

The bank has been informed about the demise as soon as my mom passed away. Infact she by herself was a bank employee so they know very well about her demise. Bank has told me that I can hold on to the deposit till maturity that is 10 years. Just wanted to know how to avoid the TDS and the tax implications of interest earned. I know after maturity the amount is tax free in my hands. Just wanted to know whether I can claim refund of TDS every year for next ten years by filing returns in my mother’s name. That’s what one of the CA advised me. Please guide in this regard the tax implications.

I am sure I don’t want to close the deposit and even the Bank also does not ask me to do so.


Reply:
As per Banks fixed deposits terms and conditions:

“In the event of death of deposit holder in respect of which a nomination is in force, the nominee shall be entitled at any time before or after the maturity of the deposit to encash the deposit. For the aforesaid purpose the surviving nominee shall make an application to the branch manager of the bank supported by proof of death of the deposit holder.”

It implies that nominee can claim the deposit before / after the maturity as per his wish. It further implies that if the nominee continues the deposit, it will be continued in the name of deceased person and accordingly bank will continue to deduct TDS in the name of the deceased.

Accordingly, point-wise reply is as follows:

Q1. If I hold on to deposit which I would like to then how would the Interest portion be taxed as the Deposit is in the sole name of my Mother & I am the nominee who would receive the proceeds upon maturity?
Ans: The interest income (including interest accrued up to the date of her death) will be income of your mother and you’ll show it in the return of income you’re required to file on behalf of and as legal representative of your mother (u/s 159 of the IT Act). However, as pointed by you that your mother was submitting Form G, it implies that her total income was below the basic tax exemption limit applicable to women. So, there won’t be any requirement for you to file the return in the capacity of a legal representative (presuming her total income up to the date of her death is below the taxable limit).

Secondly, the interest income from the date of her death till the end of the accounting year/ maturity of the deposit will be your income (presuming she died intestate i.e., without leaving a will and you’re the only legal heir) and you’ll have to show it in your return of income in a similar manner as you show your own interest income.


Q2. At the time of maturity is the amount totally tax free in my hands?
Ans: No, the interest portion is taxable.


Q3. How do I avoid TDS from being deducted or can I claim refund of TDS as my Mother has expired and there is no point in deducting TDS in her name. Can I claim refund of TDS by filing returns as representative assesse of my Mother?
Ans: You can neither avoid TDS being deducted nor can claim refund of TDS. No, you can not claim refund of TDS by filing returns as representative assesse of your mother.


Q4. If the Interest portion is taxable in hands of receiver /nominee then can I show the Interest proceeds in My HUF account as the amount is not earned by me?
Ans: No, because it is not an ancestral property.


Q5. Can I show it in my HUF account though the deposit continues to be in my mother’s name, and I declare the interest as received by me purely for tax purposes?
Ans: No


Q6. Can I just leave the Deposit as it is for next 10 years and claim it upon maturity if I have not shown it now in my HUF returns or personal IT returns. Will there be problems later if it’s not shown now?
Ans: If you do it you will face difficulty in tax assessment because bank will deduct TDS in the name of your mother although it will be your income.


Q7. Also my HUF account will not have my Mothers name in it as I opened the HUF account newly
Ans: Incomplete question


Q8. Please answer all my Queries one by one in detail
Ans: Done


In my opinion, there are only two ways to resolve it:

1. If the bank is really interested in offering this facility of continuity of deposit, they should first endorse it in favour of nominee which I don’t think they’re going to do.

2. The only other alternative is to close the existing FD pertaining to the deceased and get a fresh FDR issued in favour of nominee / legal heir.


You can send your question to feedback@themoneyquest.com.

Also see:

1. Investing in Bank FDs - Interesting Interest Calculation

2. PPF Calculator

3. Interest Income on Bank FDs - Tax Treatment