We all know how India has always had a massive parallel economy. According to some estimates, the so called ‘black’ money in the system amounts to almost Rs 18 lakh crore! This is out of a banked deposit base of Rs 100 lakh crore. So in other words, the unaccounted for cash amounts to almost 18 per cent of the total!! Basically the so-called black money is nothing but income on which tax hasn’t been paid. That’s all it is. Of course, a small part of it could be illegal money i.e. money earned by selling banned substances such as drugs or arms etc. However, of the total, that would not amount to a significant proportion. The vast majority of the cash is basically income on which tax hasn’t been paid. To put it differently, the only difference between black and white money is unpaid tax!
There was a time decades back when the tax rates in the economy were very high. In the early seventies for example, there were around eleven tax slabs with the highest slab hovering between 93 per cent and 98 per cent!! This right here is the genesis of India’s black money problem. An extremely usurious tax rate compelled people to under declare their income to avoid suffering the high taxes. But unfortunately, this practice was to prove to be a habit forming one. Regardless of the actual tax rate, not paying the tax and keeping the entire amount to oneself was an immediately appealing idea. So now, even when the tax rate is a very moderate 20 per cent (on capital gains) and 30 per cent (on other income), people (apparently) still avoid paying it and in the process generate black economy.
We all know that real estate transactions are rife with this problem. The ‘cash’ element of any transaction ranges from 30 per cent to even 60 per cent in some cases. Though after demonetisation, this cash component has reduced substantially, nonetheless it does exist. Basically what this does is that it under-reports the official sale price which in turn results in lower capital gain taxes. But it also has another fallout. It generates an immediate undeclared, unofficial stash of cash for the seller. We shall examine the consequence and manifestation of this cash a while later. But for now, let’s just focus on what the fact that what the seller is trying to achieve is to save 20 per cent tax on the ‘unofficial’ part. Is the effort, risk, peril and payoff worth it? Has anyone thought it through? Does the means justify the end? Is there a better more efficient way out?.
Perhaps there is. And to know what that is, we require to do a little bit of number crunching. Let’s assume for simplicity that the capital gain in a real estate transaction is Rs 100. Basically, after paying the 20 per cent tax, what the seller is left with is Rs 80. Now, if this Rs 80 is invested at say 10 per cent p.a., it would take all of 2.34 years (2 years 4 months approx.) to recover the Rs 20. In other words, Rs 80 will grow to Rs 100 in 2.34 years when the rate of return is 10 per cent p.a. After the 2.34 years have passed, any further growth in the amount is simply icing on the cake! No fear of getting caught, being penalised, or running the risk of losing all the money due to demonetisation etc. Also storing the black money is in and of itself a risky proposition. Basically, all the downside that comes along with having to deal with black money is eliminated by just waiting for 2.34 years (in this example).
Obviously, the foremost question in any reader’s mind would be that how does one earn 10 per cent per annum? Again the answer is simple and has always been right in front of us. Mutual Funds! Yes, you read that right. The simple instrument of a Mutual Fund is the answer to the black money problem. The average 5 year return of a large cap diversified mutual fund scheme is 12 per cent p.a. whereas the 10 year return has been around 15 per cent p.a. And yes – the 3 year return is (you must have guessed it already) is 10 per cent p.a. Clean, efficient and tax-free! By the way, the ‘recovery rate’ of the Rs 20 (20 per cent tax) at 15 per cent p.a. is 1.6 years ( 1 year 7 months) and at 12 per cent p.a. is around 2 years.
The immediate objection that some readers would have to this line of thinking would be that mutual funds are risky and the money runs the risk of capital erosion. For all such people, we have the following table: This is clutch of some funds with an established track record. The date in column D is randomly picked up to make up 10, 15 or 20 year periods. For example, for HDFC Midcap Opportunities Fund, the period under consideration is a 10 year plus one (where the fund has returned 19.7 per cent p.a.) whereas say for Aditya Birla Equity Hybrid ’95 Fund, the period is a 17 year plus one where it has returned around 19 per cent p.a.
What this showcases is that the so called risk in mutual funds is a theoretical one – if one holds the funds for the long-term (upwards of 10 years), the return does manifest – as it has for the various periods in the above table. That being said, this article is not about mutual funds but about how easy it is to not indulge or succumb to the lure of black money and yet conserve your capital and on top of everything, actually make money! Next week we shall examine this concept a little more in detail – we promise you, once you understand and appreciate the simplicity of the solution, you will never ever have to consider paying or receiving black money again ever in your lifetime!! The authors may be contacted at [email protected]