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Institute of Management

Nirma University

BBA-MBA Integrated Programme


FFM Group Assignment
Second Year BBA (4th Semester)
Section A

Topic: Taxation Of Debt Instruments

Submitted to:

Prof. Parth Rashmikant Bhatt

By:

Group Members Roll Numbers


Ninad Buch 157136
Paras Dave 157140
Punyak Satish 157145
Shrinath Mishra 157155
Vrutant Purohit 157163
Debt Instruments:

A debt instrument is a paper or electronic obligation that enables the issuing party to raise
funds by promising to repay a lender in accordance with terms of a contract. Types
of debt instruments include notes, bonds, debentures, certificates, mortgages, leases or other
agreements between a lender and a borrower. These instruments provide a way for market
participants to easily transfer the ownership of debt obligations from one party to another.

A debt instrument is legally enforceable evidence of a financial debt and the promise of
timely repayment of the principal, plus any interest. The importance of a debt instrument is
twofold. First, it makes the repayment of debt legally enforceable. Second, it increases the
transferability of the obligation, giving it increased liquidity and giving creditors a means of
trading these obligations on the market.
Debt instruments can be either long-term obligations or short-term obligations. Short-term
debt instruments, both personal and corporate, come in the form of obligations expected to be
repaid within one calendar year. Long-term debt instruments are obligations due in one year
or more, normally repaid through periodic instalment payments.

Short-Term Debt Instruments


From a personal finance perspective, short-term debt instruments come in the form of credit
card bills, payday loans, car title loans and other consumer loans that have repayment terms
of less than 12 months.

In corporate finance, short-term debt usually comes in the form of revolving lines of credit,
loans that cover networking capital needs and Treasury bills. If, for example, a corporation
looks to cover six months of rent with a loan while it tries to raise venture funding, the loan is
considered a short-term debt instrument.
Long-Term Debt Instruments:
Long-term debt instruments in personal finance are usually mortgage payments or car loans.
However, sometimes, as is the case with car loans, long-term debt instruments become short-
term instruments when the obligation is expected to be fully repaid within one year. If a
person takes out a five-year car loan, after the fourth year, the debt becomes a short-term
instrument.

For corporations, long-term debt instruments come in the form of corporate debt. This type of
debt is used to fund growth and expansion and is classified on a company's balance sheet.

Types of Debt Instruments available in India:

Bonds.

Certificates of Deposit.

Commercial Papers.

Debentures.

G - Secs (Government Securities)

National savings Certificate (NSC)


Tax on debt funds:
For such funds, short-term is a holding period of less than 36 months. Long-term holding is a
period more than 36 months. On short-term capital gains, you are taxed at your slab rate. That
is, if youre in the 20% tax bracket, you pay 20% of your capital gains as tax. If youre in the
10% tax bracket, you pay 10% tax on your capital gain.

On long-term capital gains, your tax is 20% of the gain with cost indexation benefits.
Indexation is the method by which your cost is adjusted for inflation. What this does is to
effectively reduce your absolute gain, as your cost goes up and thus reduces your taxable
profit.

Types on Taxes on Debt Instruments:

1. DDT (Dividend Distribution tax)

2. STT (Securities Transaction tax)

3. STCG (Short term capital gains)

4. LTCG (Long term capital gains)

Debt Fund held for less than 3 years is put under Short-Term Investment:

The tax on Debt Fund held for less than 3 years is calculated as per the income tax bracket for
that individual. For Example, X is an IT Executive who earns Rs.10,00,000 per annum. Per
the latest tax slabs for the year 2016-17, X falls in the tax bracket of 20%. X had invested
Rs.1,00,000 in Debt Fund from ICICI for a period of 2 years. Since this fund is held for less
than 3 years, the returns earned on this instrument will fall under short-term capital gains and
will be taxed as per the Income Tax bracket in which Sunil falls, that is 20%.

Suppose X earned a return of Rs. 10,000 on this debt fund, then per his tax bracket, he will
have to pay 20% of Rs. 10,000 as interest which comes down to Rs.2000

Debt Fund held for more than 3 years is put under Long-Term Investment:

Any interest earned on debt funds that are held for more than 3 years is counted under Long-
Term Capital Gain. The applicable taxation rate in this case is 20% with indexation plus 3%
cess which comes down to 20.90%.

For example: Sunil is an employee in the IT sector. He earns a salary of Rs.15,00,000 per
annum and has invested in a debt fund of Rs.2,00,000 for 5 years. As per the latest tax norms,
his debt fund comes under the definition of long term capital gains and is eligible for a tax
deduction of 20% plus 3% cess on the returns earned.

The total outstanding tax that Sunil needs to pay on returns earned on his debt fund is
20.90%.

Securities Transaction Tax

Definition:

STT is levied on every purchase or sale of securities that are listed on the Indian stock
exchanges. This would include shares, derivatives or equity-oriented mutual funds units.
The rate of tax that is deducted is determined by the central government, and it varies with
different types of transactions and securities.

Securities transaction tax or STT was introduced in the year 2004 by the then Finance
Minister, P. Chindambaram. This tax was introduced to avoid tax evasion in case of capital
gains.
What is STT?

The most prominent point about securities transaction tax is that STT is applicable only on
share transactions made through a recognized stock exchange in the country. Off-market
share transactions are not covered under STT.

Securities on which STT is Applicable:

Securities transaction tax is levied on various types of transactions made on the domestic
stock exchanges in India. According to the Securities Contract Act, 1956, following are the
transactions covered under the same.

Shares, bonds, debentures or any such marketable security which is traded at the
stock market

Derivatives traded in the market

Units issued by any collective investment scheme to customers

Government securities that are of the nature of equity

Rights or interests in securities

Mutual funds that are based on equity trading

S.No. Type of Taxable Securities Type of Transaction Applicable STT

0.125% on total
1 Delivery-based equity shares Purchase
value

2 Equity oriented mutual funds Redemption of units 0.25%

3 Equity shares, equity mutual Purchase Nil


fund units and intra-day traded
shares

4 Derivative- sale of option Sale 0.017%

5 Derivative sale of futures Sale 0.017%

Dividend Distrtibution Tax:

Definition:

Dividend distribution tax is the tax levied by the Indian Government on companies according
to the dividend paid to a company's investors. At present the dividend distribution tax is 15%
for equity and 28.84% for AMCs, according to the Union Budget 2007, India.

The Asset Management Company deducts it from your Net Asset Value and remits it directly.
So you receive dividend net of DDT.

The DDT rate for individuals at present is 28.84% (including surcharge and cess). Do note
that as dividends are paid out from NAV, it shows the amount post such dividend pay-out or
reinvestment. Hence, the capital gains, if any, when you sell your units under this option will
seem lower. But the fact remains that you paid tax on the dividend, which is nothing but part
of your profit.

Hence, it is important for you to know whether it is suitable for you to opt for dividend option
in debt, depending on your tax profile.

Short Term Capital Gains


Definition:

Short term capital assets refer to any asset owned by a taxpayer for under than 36 months
from date of initial transfer.

What is STCG?
Short term capital gain refers to any capital gain/profit which an individual gets on sale of
short term capital assets. This includes any gain on depreciable assets.

Tax rate:

The tax applicable on short term gains is fixed by the government and comes under section
111A of the Income Tax Act. The current rate stands at 15%, minus surcharge and cess,
which are generally extra. Short term capital gains which do not fall under section 111A fall
under Normal short term capital gains and are charged taxes based on the total taxable
income of a particular individual.

If you make a gain / profit on your Debt fund (other than equity oriented schemes) that you
have held for less than 36 months (3 years), it will be treated as Short Term Capital Gain.

Example: Mr. Kumar purchased a plot in Bangalore for Rs 15,00,000 in December 2012. He
sold it in October 2013 for Rs 20,00,000. A sum of Rs 1,50,000 was invested by him in PPF
and another Rs 50,000 in NSC. What is Mr. Kumar's total taxable income and his short term
capital gains tax?

Short term gains on sale of property - Rs 20,00,000 Rs 15,00,000 = Rs 5,00,000/-

This is his gross total income.

Deductions under Section 80C to 80U Rs 2,00,000/-

Taxable Amount = Rs 5,00,000 Rs 2,00,000 = Rs 3,00,000/-


He is now inclined to pay a 15% short term capital gains tax towards this amount (minus the
cess)[this is keeping in mind his current income slab].

This means he has to pay Rs 45,000 as short term capital gains tax.

Long Term Capital Gains:

Definition:

A long-term capital gain or loss is a gain or loss from a qualifying investment owned for
longer than 36 months before it was sold. The amount of an asset sale that counts toward a
capital gain or loss is the difference between the sale value and the purchase value, or simply,
the amount of money the investor gained or lost when he sold the asset. Long-term capital
gains are assigned a lower tax rate than short-term capital gains.

Difference:

Short-term capital gains come from assets held for less than a year, while long-term gains
come from assets owned for over 36 months.

Indexation:

The adjustment of the various rates of taxation done in response to inflation and to avoid
bracket creep. Indexing is a method of tying taxes, wages or other rates to an index to
preserve the public's purchasing power during periods of inflation.

Debt Instruments:

There are various types of debt instruments available that one can find in Indian debt market.

Government Bonds
It is the Reserve Bank of India that issues Government Bonds on behalf of the Government of
India. These securities have a maturity period of 1 to 30 years. G-Secs offer fixed interest
rate, where interests are payable semi-annually. For shorter term, there are Treasury Bills or
T-Bills, which are issued by the RBI for 91 days, 182 days and 364 days.

Tax Free Bonds:


As the name suggests, interest earned from tax-free bonds is exempt from tax. In simple
terms, irrespective of the income slab one need not pay any income tax on the interest
income. Some of the public undertakings which raise funds through the issue of tax-free
bonds are IRFC, PFC, NHAI, HUDCO, REC, NTPC, and Indian Renewable Energy
Development Agency.

The tenure of the bonds is usually 10/15 or even 20 years. They are also listed on stock
exchanges to offer an exit route to investors. The bonds are tax-free, secured, redeemable and
non-convertible in nature.

Corporate Bonds

These bonds come from private corporations and are offered for an extensive range of tenures
up to 15 years. There are also some perpetual bonds. Comparing to G-Secs, corporate bonds
carry higher risks, which depend upon the corporation, the industry where the corporation is
currently operating, the current market conditions, and the rating of the corporation.
However, these bonds also give higher returns than the G-Secs.

A corporate bond is taxed through the interest earned on the bond, through capital gains or
losses earned in the early sale of the bond, and through an original issue discount. The
aggregate taxes owed on each of these components adds up to equal the total amount of taxes
owed on a corporate bond.

Debentures

A debenture is a type of debt instrument that is not secured by physical assets or collateral.
Debentures are backed only by the general credit worthiness and reputation of the issuer.
Both corporations and governments frequently issue this type of bond to secure capital. Like
other types of bonds, debentures are documented in an indenture.

T-Bills:

Bond buyers generally purchase debentures based on the belief that the bond issuer is
unlikely to default on the repayment. An example of a government debenture would be any
government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are
generally considered risk free because governments, at worst, can print off more money or
raise taxes to pay these types of debts.

Types:

At present, the Government of India issues three types of treasury bills through auctions,
namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State
Governments.

Unlike other debt instruments, cost indexation benefit is not allowed on debentures and
bonds. This is the treatment in case of long term capital gains. In case of short term capital
gains, it's just added to taxable income.

National Savings Certificates:

The National Savings Certificates offered by the Government of India is one of safest
investment tools available at all Indian post-offices. These certificates are designed for
salaried employees and businessmen, and they produce fixed income like fixed deposits. Any
individual can invest for up to 10 years under this scheme. Every year in April, the
Government of India set a fixed rate of interest for National Savings Certificates. Currently,
8.5% is applicable for NSCs bought for a 5 year term and 8.8% for a term of 10 years. These
interest rates will remain fixed for the whole term of investments. National Savings
Certificates are available at all Indian post offices; they can be purchased singly, jointly and
on behalf of minors.

Key benefits of investing in NSCs:

Backed by the Government of India, the National Savings Certificates serve as the safest
means of investment and come with a lot of attractive benefits. Listed below are the benefits
offered by National Savings Certificates:
Attractive interest Rates: NSCs offer attractive rates of interest on your savings. You
can receive interest up to 8.8%.
Assured returns: Investors can receive assured returns by investing in National
Savings Certificates for 5 to 10 years.
Minimum/maximum limit of investments: You can invest as minimum as Rs.100.
However, there is no maximum limit for investment under NSCs.
Loan against NSCs: Banks allow loans against NSC certificates. Individuals can use
National Savings Certificates as collateral to get loans.
NSC Denominations: National Savings Certificates are issued in different
denominations such as Rs. 100, Rs.500, Rs.1000, Rs. 5000 and Rs.10, 000. A person is free
to purchase any number of National Savings Certificates as per his/her convenience.
NSC Certificate Transfer: The National Savings Certificates can be transferred from
one individual to another, if the certificate holder intends to transfer.

Tax Benefits:
Since the interest earned from National Savings Certificate is not paid to the account
holder/investor directly and is reinvested, a taxpayer/investor can claim for tax deduction
on the interest amount. First, they need to show the interest as income and then claim
income tax rebate on it under section 80C of the Indian Income Tax Act.
A yearly investment up to INR 1, 00,000 qualifies for income tax rebate under
National Savings Certificate.
There is no tax deducted source.

Advantages of investing in debt market

The biggest advantage of investing in Indian debt market is its assured returns. The returns
that the market offer is almost risk-free (though there is always certain amount of risks,
however the trend says that return is almost assured). Safer are the government securities. On
the other hand, there are certain amounts of risks in the corporate. However, investors can
take help from the credit rating agencies which rate those debt instruments. The interest in the
instruments may vary depending upon the ratings. Another advantage of investing in India
debt market is its high liquidity. Banks offer easy loans to the investors against government
securities.

Disadvantages:
As the returns here are risk free, those are not as high as the equities market at the same time.
So, at one hand you are getting assured returns, but on the other hand, you are getting less
return at the same time. Retail participation is also very less here, though increased recently.
There are also some issues of liquidity and price discovery as the retail debt market is not yet
quite well developed.

Learning Log:

This particular assignment which included analyzing various types of taxation


levied on the tax instruments gave us useful insights into the Indian debt
market and helped us gain much needed exposure to the various types of
taxation involving the debt instruments.
Before doing this assignment we had generalized idea about all the debt
instruments, but since this activity engaged us in reading the various articles,
blogs, research papers written by experts which helped us dived deeper into the
Indian debt market.

Post this assignment all of us are sure to have ample amount of knowledge
about the taxes which we focused on i.e. SST-Security Transaction tax, LTCG-
Long Term Capital Gain Tax, STCG- Short Term Capital Gain Tax, DDT-
Dividend distribution tax.

Since Financial management is all about forecasting, interpreting and analyzing


the data we came across various tax rates for different instruments and studied
numerous examples which helped us to gain practical exposure of the financial
markets.

After studying so vividly and extensively about taxation, debt instruments and
investment techniques it has definitely helped us in fostering the intrinsic
knowledge of financial management.

Researching about various debt instruments in India we undoubtedly gone into


the intricacies and nuances related to it.

References:

Long-Term Capital Gain Or Loss http://www.investopedia.com/terms/l/long-


term_capital_gain_loss.asp#ixzz4ZwwkNXHM
https://www.bankbazaar.com/tax/securities-transaction-tax.html
http://economictimes.indiatimes.comhttp://economictimes.indiatimes.com/your-money/what-
are-tax-free-bonds-and-how-they-work/tomorrowmakersshow/52501104.cms?
utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

http://economictimes.indiatimes.com/your-money/what-are-tax-free-bonds-and-how-they-
work/tomorrowmakersshow/52501104.cms

http://cafemutual.com/news/tutorials/107-all-you-need-to-know-about-security-transaction-
tax-in-mutual-funds

Long-Term Capital Gain Or Loss http://www.investopedia.com/terms/l/long-


term_capital_gain_loss.asp#ixzz4ZwwkNXHM

https://www.bankbazaar.com/tax/securities-transaction-tax.html

https://www.bankbazaar.com/tax/short-term-capital-gain.html