Sample this. If you want to participate in an initial public offering (IPO), you will be called a retail investor only if you invest up to Rs 2 lakh. At the same time, a retail investor is someone who invests up to Rs 10 lakh in a tax-free bond issuance. In the case of mutual funds, a retail investor puts in up to Rs 5 lakh in a scheme. Similarly, banks protect or insure deposit accounts for up to Rs 1 lakh.
And, when the government has proposed to secure company deposit holders, they plan to protect such investors for only up to Rs 20,000, irrespective of the type of investor.
Clearly, the definition of a retail investor is unclear across the financial services sector. So are many norms. At least, retail investors are confused about it.
Globally, there isn't much of a difference. For instance, the US' Federal Deposit Insurance Corporation insures deposit accounts for up to $250,000 for each deposit owner category. When it comes to investment in stocks, there is no such limit for retail investors.
Till sometime earlier, there were two different ages defined for senior citizens. While an individual retired from work by 60, he could get the advantage of a higher exemption limit under the Income Tax Act only after the age of 65. This was changed only in 2011.
There are many other anomalies, especially in our tax system, that can be confusing for investors.
For instance, most individual investors believe capital gains on equity investments can be tax-free only when invested in equity-linked saving schemes (ELSS), a mutual fund category. Whereas, if you book capital gains on investments in equities (both other equity fund categories and stocks) that you've held for more than a year, the gains are tax-free.
"This is why you see investors buying an ELSS scheme in the last quarter of every year, when their portfolio might not require so many of ELSS schemes," says chartered accountant and financial planner Anirudh Hatwalne. It's just that the product is a tax-saving one under Section 80C of the Income Tax Act.
Many assume paying income tax is the same as Tax Deduction at Source (TDS), says certified financial planner Suresh Sadagopan. "This is because banks do not deduct tax at source if your interest income from fixed deposits is up to or more than Rs 10,000," he says. Therefore, many make small deposit accounts across more than one bank and save on TDS. Instead of one Rs 5-lakh deposit, many make five Rs 1-lakh deposit accounts. Yet, there is an incidence of income tax liability under the head of income from other sources when you take into account all the interest incomes together.
When investors put money in tax-saving bank deposits, that have a lock-in of five years, they assume the interest earned on these deposits is also tax-exempt. This is untrue. Only the principal component or the capital invested in the deposit scheme is so exempt.
When you invest in a fund of funds, the major drawback is their tax treatment. Typically, a fund investing more than 65 per cent in equities is considered an equity fund. Long-term capital gains arising out of investment in such a fund is tax-free. However, a fund of fund investing more than 65 per cent in equity is also considered a debt fund. This means investors have to pay a long-term capital gain at 10 per cent with indexation or 20 per cent without it; else, the gains will be added to the income and taxed on the relevant slab, if held for a short term.
To avoid paying high tax on rental income, many home owners ask for a very high deposit and a comparatively lower rent. While some tenants might prefer this arrangement, it can be taxing for home owners. For instance, if you charge a rent of Rs 10,000 and the fair value of the property is Rs 80 lakh but you have taken a deposit of Rs 1.5 crore, you will get pulled up for it. Tax experts say a part of such a deposit will be treated as rental income, levied on a notional gain.
Many may know that if a second property is bought on a home loan, then there is no limit on the interest repayment that can be claimed under Section 24 of the I-T Act because a second property is considered let-out. This norm is applicable even to a first property if it is let-out. The tax benefit for repayment of interest on a home loan taken for a self-occupied property is capped at Rs 1.5 lakh a year.
Similarly, many would be aware that proceeds from the sale of a house property get indexation benefit. But the rate applicable is only at 20 per cent with indexation. Only gains from financial assets (mutual funds, shares) get the option of either 10 per cent without indexation or 20 per cent with it, whichever is lower.
Many individuals don't know that funds borrowed for renovating a house could be claimed for a tax deduction. Interest paid on a loan utilised for renovation is eligible for deduction of up to Rs 30,000, under the head of income from house property. You are entitled for the deduction if you prove the loan had been used for renovation. Here, the capital should be borrowed after April 1, 1999 but the construction should be completed within three years from the end of the year in which the capital was borrowed. The deduction of interest repayment (of up to Rs 1.5 lakh) on the home loan is allowed if the acquisition/construction is completed in three years from the close of the financial year in which the loan was taken.
Sadagopan says many small investors feel contributing to more than one Public Provident Fund (PPF) account means being liable for tax benefits of Rs 1 lakh from each of these. This is untrue. What many do is make, say, three accounts, one in his or her name and two in each of their minor children's name.
They assume they can claim for tax benefits of Rs 3 lakh; they can claim for only up to Rs 1 lakh.