GST for 10th Grader (Part -1)

“On 4^th August GST was all over the news. All the news channels were discussing this historic tax reform that will be effective from 1^st April 2017. There were many articles, videos that were floating all around to confuse me and I thought, it’s high time I discuss this with you to understand what GST is! All I know is GST stands for “Goods and Services Tax” and it will simplify tax structure in India. Beyond this, I want you to explain everything from scratch”, said Apruva.

There are major 2 types of Taxes 

1. Direct Tax

 2. Indirect Tax

Direct Tax – This is tax levied on the Individual’s or Corporate’s Income. For Individual different tax slabs are applicable where the rules for the Corporates are different. The Tax is collected directly from the entity on whom it is imposed. 

Indirect Tax – This tax is collected on sales/manufacturing of Goods (Tangible Items) or Services (Intangible Items). Indirect taxes are called so because they are collected indirectly from consumers by the government through intermediaries, who are the first payers of the tax to the government.

GST will replace majority of Indirect taxes with a Uniform Tax. There are many types of indirect taxes but for the simplicity of understanding lets discuss the below 4 major ones because of which there is a need to have GST.

Sr no	Originally Known as	Changed to	Revenue Source for
1	Sales Tax	VAT	State Government
2	Excise Duty	CENVAT	Central Government
3	Inter State Central Sales Tax	-	Central Government but given to State producing the Goods
4	Service Tax	-	Central Government

Need for GST (Cascading Tax Effect)

The primary need for GST is to avoid the cascading tax effect. Let’s understand what does this mean. We will learn about the indirect taxes, why some of them were changed and why the changes were not enough to address the core issue.

Sales Tax (Which is now changed to VAT)

Sales Tax was levied on the sales of Goods collected by State Government and levied every time a good is sold. Different state can charge different tax rates. For simplicity let’s assume it to be 10%.

Imagine a typical supply chain model of Cars. Cars are produced in a Factory, sold to distributors/dealers which then sell them to consumers. Let’s say the manufacturer sets the price as ₹ 3, 00,000. When it is sold to distributor in the same state, government would levy 10% tax on it i.e. ₹ 30,000. This amount will be passed on to distributor and so the total cost for him is ₹ 3, 30,000. When the distributor would sell it to consumers, he will add his profit margin. Let’s say he decides profit to be 50,000 so the selling price of the car is 3, 80,000. Again 10% tax is applicable on this which makes the price of Car, ₹4, 18, 000 (3, 80,000+38,000) which is paid by consumer.

Now let’s break this 38,000 that consumer had to pay as taxà 30,000 + 3,000 + 5,000. If you observe carefully values of 30,000 (10% of 3, 00,000) and 5,000 (10% of 50,000) can be easily explainable. But where did this 3,000 come from?? This is tax on tax (10% of 30,000). This was the major pain point which would make the end cost that consumer had to pay higher. So VAT was introduced.

In VAT Input and Output Credit was introduced. Input credit is the one that is calculated when good is purchased. Output credit is the one that is calculated when the good is sold. The total Tax payable by the entity is “Output Credit- Input Credit.

Let’s understand this again with the same example, when the distributor purchased item for 3,30,000 , he had paid 30,000 as tax which he will received as Input Credit. The valued added by him (his profit) was 50,000. The tax consumer has to pay now is on price of 3, 50,000 (3, 00,000+50,000) which comes out be 35,000.So the total tax for consumer which was 38,000 (30,000 + 3,000 + 5,000) is now only 35,000 (30,000 + 5,000). So consumer will get the car at 3, 85, 000 (3, 50,000+35,000) Vs 4, 18,000 earlier.

Though state government will receive less tax, this will help lower tax and will boost the consumer demand and more cars will be sold. From the distributor point of view he collected 35,000 from consumer which is his output credit but has 30,000 as input credit so now he has to pay the difference (output- input à35,000- 30,000) 5,000 as additional tax to government.

Excise Duty (Which is now changed to CENVAT)

Similar problem existed for excise duty as well which is levied on the manufacturing of the goods by central government. To manufacture car, company has to manufacture tyres, engine, Seats etc. and needs to assemble the same. Each time a good was manufactured, company had to pay excise duty causing cascading of the taxes. This was removed through CENVAT where similar credit system was used.

Service Tax

Now in order to sell his car manufacturer will have to do advertisement on which service tax is applicable. Manufacturer often needs to talk to distributor, there will be service tax on telephone/mobile bills. Take help of external consultants which will again mean paying service tax on the services provided them etc. So for the service tax paid by the manufacturer for selling his car, does he get input credit, “NO”! So the cascading of tax will continue, this will be added as cost while deciding the price to be sold to distributor and end consumer will have to pay more.

Inter State Central Sales Tax (CST)

When the goods are sold from one state to another CST is applicable which is actually revenue of center but is given to state where the goods are manufactured. In our case when Manufacturer in Maharashtra sells it to distributor of Madhya Pradesh he will have to pay CST. Let’s assume it to be 2%. So 2% of 3, 00,000 i.e. 6,000 will be paid by distributor in Madhya Pradesh. Does the distributor get any Input Credit for CST paid, “NO”! The cascading effect continues and it will be treated as cost which consumers will have to pay.

So though part of the cascading of tax is removed in current system there is still some amount of cascading that is existed in the system, primarily because we treat “Goods” different from “Services” and Interstate sell of goods which GST plans to address.

We discussed need of GST here. We will discuss how GST will solve this problem when we meet next time”. Did not want to confuse Apurva too much.

The ZIKA (“TIPS”y Virus) of Stock Market

“I was listening to one of the business news channels the other day where the experts were discussing as to which stock to buy and which stock to sell”, said Apurva. We had met after a long time to discuss on stock markets. We had discussed about what are stocks and reason for their existence, things to know before one starts investing in stock market, the trade life cycle and different approaches to investing. Apurva had all geared up to get her hands dirty and wanted to invest in stock market actually.

“So why would these experts give their views to everyone just like that , I mean if they know how a stock would perform assuming that they have done fundamental or technical analysis or both why would not they go ahead and do it for their personal benefit, why would they give such important information to all ?”, Apurva looked confused.

“Every expert would tell you that his advice to you is nothing but just an opinion and you need use your own intellectual ability before you take any decision”, I started explaining her. It is not possible that these experts would have information which is material and non-public and even if they do they cannot disclose it under the insider trading norms. It is just that they help you put information into prospects which is meaningful and logical to help you take decision. But it is equally true that the information which is public is already figured into the stock price to a larger extend the moment it becomes public.

At times, these experts from unaccountable sources and Tip providers can also give you wrong advice deliberately to influence the stock price. It is true that for any stock, majority of the ownership is with promoters and institutional investors and retail investors have limited influence to put significant pressure on stock prices but it certainly help set a trend and creates a market sentiment. For example if an institutional investor want to buy significant chunk in particular stock, they would like to create an environment so that they get the stock at cheapest price possible.

For simplicity consider the following example. If an institutional investor wants to buy 10 million stocks of a Company “A” for which they have positive outlook, which is currently at 100. But it is interesting as to how they will go about it. They would not buy all 10 million stocks together. They would first buy 2 million stocks. But they would not get all 2 million stocks at 100 because as they buy these stock these would make demand stronger and the stock price would increase. Let’s say they manage to buy the stock at average of 103 with current price increasing to 105. Now the real game starts. Through these unaccountable sources and tip providers, sell sentiment is created for this stock which puts downward pressure on stock. It is logical to think that this will put the institutional investors at loss.

But reality is different, these institutional investors start selling their stocks. As they sell the stocks it puts downward pressure, the retail investors get anxious and start selling their stocks as well. Institutional investors manage to sell the stock at the average price of 98 which gets them loss of 10 million but the damage is already done. The stock price of stock reaches 92. They can also create the similar impact in the market by selling the Stock Future or Put Option at higher price. It means they do not need to hold stocks to create artificial selling pressure.Always remember that the impact on downward trend is more than the upward trend as the retail investors are risk averse and have biased towards falling price. Now that the price is at 92 the institutional investor would buy 10 million stocks which would be average around 97 making stock price around 102. Had they gone for buying 10 million stocks when stock price was 100 their average would have been 106 vs 97 which is what they got eventually saving 90 million. If we subtract the 10 million loss, this saved them 80 million. The figures in this case are hypothetical for simplicity but this is how it works!

As per an independent study conducted, Indian stock investors had more than 60% chance of making profit in the last five years assuming that they chose their stocks randomly. In a survey it was found that more than 90% retail investors had lost their money during the same period. Most of these investors had taken tips or professional help from one or multiple sources. As per the study if we remove extremely good and bad performers in stock market over the past 5 years index shares have given annualized 25% return.

This works like a virus and below are vaccines that will help you stay away from diseases  

1. Chances of making profit in the stock market improves drastically if you just avoid tips from unaccountable sources.
2. Average profit made by stocks is always higher than average loss made by them. Hence, dividing the money across multiple stocks will increase the chance of overall profit.
3. Restricting your investment within Top 500 stocks improves chance of making profit as well as rate of return. If you do not like to review your stocks periodically then it is better to restrict yourself to index stocks.
4. A random year may give very bad return in the stock market. Always enter the market with a long term perspective.

“Oh this Tips(y) virus is very dangerous and thank you for giving me these vaccines at early stage of investment journey”, said Apurva and we concluded our discussion for that day.

Source: Independent study was conducted by Bazar Analysis Research.

Please refer to the highlights of the Study and other stats at

http://www.safetrade.in/ ( Safetrade is India's first robo advisor for equity market)

Decoding Union Budget Jargons

“The Budget prepared by Finance Minister is no different than what budget your mother prepares monthly for the house, Budget in simple term relates to future planning. It is a very tough task for the finance minister to plan for the entire year’s receipts that the government will generate and expenditure the government would incur so as to have growth oriented, healthy economy.

“The budget is full of Jargon with terms such as fiscal deficit, revenue deficit, planned expenditure, unplanned expenditure, revenue expenditure/receipts, capital expenditure/receipts etc.

Let us try to understand these jargons. As any budget would have, national budget also have 2 parts to it, Income and Expenditure. let us look at them one by one.

Revenue Expenditure

Revenue expenditure is for the normal running of the government's department and various services, interest charged on debt incurred by government, subsidies etc.

Capital Expenditure

Expenditure incurred to acquire, build assets, infrastructure or to upgrade existing infrastructure facilities.

Unplanned Expenditure

Unplanned Expenditure correspond to amount allocated for expenses required for activities other than one present as part of 5 year central plan.Non-plan revenue expenditure is accounted for by subsidies, and wage and salary payments to government employees, pensions, police, and economic services in various sectors, other general services such as tax collection, social services, and grants to foreign governments.Non Plan revenue expenditure also includes interest payments on the previous debt. These debt arises because India has been running fiscal deficit traditionally.

Planned Expenditure

Earlier India had a planning commission, which is now replaced by NITI (National Institute of Transforming India) Aayog which lays down the 5 year central plan for India. The planned expenditure allocation both in revenue as well as capital sector corresponds to amount allocated to implement various schemes detailed in the plan. The planned expenditure also corresponds to grant/assistance to state and union territories.

Revenue Receipts

Revenue receipts corresponds total tax and non-tax receipts collected by the central government.

Tax Receipt

Tax receipts can be income based which is known as direct tax or additional amount to be paid for availing a particular set of services at predefined rate known as indirect tax.

Direct tax are for Individual as well for the corporate. In last budget the finance minister had proposed to reduce the corporate tax from 30% to 25% over next four years by discontinuing the exemption present earlier which used to reduce 30% tax to effective 23%. 

Indirect Tax corresponds to different set of taxes such as excise duty, custom duty, service tax, value added tax etc. The indirect tax structure is very complex and government has announced all the different indirect taxes with a single tax known as Goods and Service Tax GST which is yet to be implemented..

Non Tax Receipt 
                              

Apart from Tax receipt, government can also generate revenues through means such as auctioning of Telecom Spectrum, Coal Mine Blocks etc.

Capital Receipt

Non Debt Capital Receipts

Capital receipts consists of Non Debt receipts which corresponds to recovery of loan by the Center to State governments & Union Territories and proceeds or by diluting part of (selling off) its stake in public sector companies.

Borrowing

The other part of capital receipts are required to fund the fiscal deficit. This is done by raising of loans the market by means of Bonds, government borrowings from the RBI (raises inflation) & other parties, and loans received from foreign governments.

Deficits

Fiscal Deficit

Fiscal deficit is total expected outflow (Revenue+ Capital Expenditure) minus total expected inflow (Total Non-debt Capital Receipt + Revenue Receipt for the center). It is important to note that the revenue receipt include those of the center only and revenue receipts for the states are not included. States would include these revenue receipts in their state budget.

It is also important to know that fiscal deficit is different than the Revenue deficit.

Revenue Deficit

Revenue deficit refers to the excess of revenue expenditure over revenue receipts and does not include capital expenditure and non-debt capital receipts.

Primary Deficit

Primary Deficit = Fiscal Deficit – Interest Payment on the loan raised due to previous deficits.

Primary deficit indicates the absolute deficit in the financial generate devoid the impact of the loans raised for funding fiscal deficits of the previous years.

Current Account Deficit

Current account deficit as we already know corresponds to different between imports and exports.

All the deficits i.e. current account deficit, revenue deficit and fiscal deficit are calculated as % of GDP ( Gross Domestic Product ). It is calculated as the total amount of goods and services produced in the country.

Hope this will help you to decode the Union Budget Finance Minister will present on 29th Feb 2016 for Financial Year 2016-17..

YOU don’t have to invest in stocks to invest in stocks (PMS/MF Basics)

Portfolio Management Service and Mutual Fund

“So we discussed about how to start investment in stock market through fundamental and technical analysis last time”, said Apurva, we started continuing our discussion where we had stopped last time.

“So fundamental and technical analysis are two important approaches for stock investment but it would be very difficult for a novice investor to understand the art and apply these approaches. where can I learn this art?” asked Apurva.

“Well it is true that it will take lot of time for anyone to learn it and it will only come through experience and academic knowledge. But does that mean one has to wait to perfect the art before they start investing in Stock Market? Certainly not. There are many who thought that they had perfected the art and invested their hard earnt money directly into stock markets and burnt their fingers”, I explained her.

“So what’s the way out”, asked curious Apurva. “Well you don’t have to invest in stocks to invest in stocks”, I knew this would confuse her as soon as I said it. “Huh!! What does this mean?” confusion was clear on the face of Apurva. “Don’t worry!! Let me Explain”.

So suppose your mom is going to get late tonight and you are hungry. What do you do, would you give it a try cooking Dal Rice, Roti-Sabji by yourself. “No, I cannot cook. Actually I know all the ingredients required for cooking the normal dinner, but I do not know the proportion of each ingredient that goes into making the dishes. I would not risk cooking today, I will rather order it from the restaurant nearby and pay up the bill”, said Apurva.

Exactly!!! You want to eat but cannot cook it yourself so you take help from the restaurant chef, order the food and pay up for his services.Similarly you can invest but not necessarily by investing yourself. “I kind of get you now, but can you explain it in more detail”. Of course, she now knew the concept but wanted to know how exactly one can do it. “There are two ways you can do this either through Portfolio Management Services or through Mutual Funds” I continued explaining her.

Portfolio Management Service (PMS)

So like our restaurant chef who is expert at making dishes, in Portfolio Management Services there are experts who are very experienced and knowledgeable people who use combination of fundamental analysis, technical analysis, technology, rules to guide you to invest the market. There are different type of such portfolio management services predominantly classified into 2 categories Discretionary & Non -Discretionary.

1.      Discretionary Portfolio Management  Services

In Discretionary Portfolio Management Services (PMS) you give your money to the expert and he will do the rest. He will buy/sell stocks based on his expertise. The ownership of the stock is with you but the execution part is done by the expert. The expert will not take your permission every time he executes a trade. You will certainly have access to view the securities you own and also will have access to several reports indicating your return on investments and overall exposure. In turn the expert will charge you fix amount of fees for his services and sometimes even part of the profit that you earn.

Example of such PMS services can be ICIC Prudential PMS: http://www.icicipruamc.com/

2.      Non-Discretionary Portfolio Management Services  

In Non-Discretionary Portfolio Management Service expert would give you advice on the things to be done. It can be with respect to the existing stock portfolio that you have or new recommendations that he may want to do. This recommendations is based on thorough analysis which includes fundamental analysis, Technical Analysis, any other rules /formula that the PMS would have arrived based on its previous experience. Such type of PMS services may or may not execute trade on behalf of you i.e. they will buy /sell security only with you permission else they cannot. The ownership of the securities in again with you. And such PMS services will mostly charge a fee for the advisory services that it provides and additional charges if it also executes trade on behalf of you.

E.g. www.safetrade.in.  Safe Trade is an Indian Portfolio Management Services Start up that received Best Finance Startup 2015 award and is also Red Herring Top 100 Asia Winner.

The PMS can also be classified based on the generic approaches as Active and Passive Portfolio management services. Active PMS providers are based on the approach that the markets are inefficient and hence it is possible to beat the average market returns by the strategy. Whereas the Passive PMS are generally believe in the principle that markets are efficient and it is possible to generate average market comparable results through their strategies.

Mutual Funds (MF)

In mutual fund there is typically a company known as “Fund” with portfolio manager managing the fund. It is similar to Discretionary Portfolio Management Services but differs from it on 2 grounds. In mutual fund you do not own the securities but you rather own units and the portfolio manager is not handling your money only but the “pool” of money from different investors hence the name “Mutual”. Let’s understand this by an example. If you have ₹ 1000 to invest, it is too small amount to invest in stock directly. Like you if there are 100 more investors.

MF portfolio manager pools the money from all, in our case it becomes ₹ 1, 00,000 and converts them into 10,000 units each of ₹ 10. So you now own 100 units. Now with ₹ 1, 00,000 that portfolio manager has got, he invests them in stock market using his expertise. Suppose he is able to get 5% return the total investment becomes ₹ 1, 05,000. And suppose he takes ₹ 1000 as the fees for his services then total investment value becomes ₹ 1, 04,000. Since there are 10,000 total units in existence, value of each unit is now ₹ 10.4 (1, 04,000/10,000). Since you own 100 such units, you can sell them and get ₹ 1040. So due to MF you could get return on investment of as low as 1000 which would have been very difficult had you wanted to invest directly by yourself.

“Oh. That’s the nice way to start investment. You do not have to directly invest in Stock market yet you can enjoy the return in the market by PMS and MF, obviously by paying fees for the expertise provided. So how to decide whether to go for PMS/MF and which one to go for?” asked Apurva. Let us not discuss everything today, we should leave some things for next discussion also. We both laughed to conclude the discussion with a promise to continue it next time.

Starting Investment in Stock Market

“We discussed different types of accounts that are required before one can start investing in the stock market, we also discussed how trade gets executed during our last discussions”, said Apurva. This time, occasion was “Bhaiya Dooj” last day of the Diwali celebrations which glorifies the brother-sister love all over in India. It was first time after two years for me, where we were celebrating this day with each other. Last two years, I was at Campus pursuing my MBA and this time it was a very special day for me to celebrate the festivals of lights at my home with my family. “So how does one go about selecting the stocks they would buy, and how do they decide whether it would be right time to sell”, asked Apurva. “If everyone knew the secret of buying and selling the stocks at the right time, then everyone would have made profit in stock market, but in fact this is not the case. Many end up making losses, in stock market. It has everything to do with the approach with which you enter stock market”, I started explaining her.

First of all one needs to understand the difference between “Investment” and “Trading”. People often tend to use one term for the other. It is important to understand that these term are related to horizon of the buying and selling. “Investment” is often long term and “Trading” is short term. Definition of Long term and Short term varies based on the holding capacity, risk taking ability of the individual but anything less than 1 year does not qualify as Investment. Ideally experts will tell you that if you want to invest in stock market then you should give at least 2 to 3 years for your investment to realize and give you returns. For any trade which is realized before one year, i.e. if you buy a stock and sell it before one year, government levies, a short term capital gain tax which is 15% today. 

They are different categories of investors, which predominantly can be classified into Retail and Institutional investors.  Institutional investors refers to entities who are not individual. Retail investors are people like you and me who invest in stock market. But there are some retail investors who are full time into stock market, trading is meant for them. For retail investors, who do it part time to get more than average return on their hard earned savings, Investment is the only way to go.As for deciding which stocks to buy and when, there are different approaches with which one can decide as to which stock he/she would want to buy and at what time, what levels of the stocks. 

Fundamental Analysis:

Fundamental analysis is more academic way of analyzing stocks. Most of the time it works top down, i.e. from Macro Economic to Micro Economic (Specific) factors. So for India, Macro Economic Factors would include political stability of government, Governments budgetary provisions and its ability to achieve those, Growth prospects of India as country, Sectoral reforms, regulatory environment affecting those sectors, Interest Rate outlook etc.

This is not limited to India alone, in today’s world of “Global Economy” it is also important to look at the Global Economic Indicator as well, which has direct and indirect impact on Indian Stock Market. E.g. Interest rate changes in US will impact Indian Stock market as well, if china does not do economically well this will affect India Stock market because some of the companies in India may be importers of raw material from China.

Stock markets are most of the times considered as efficient, meaning current information will get adjusted in value of the stock as soon as it is public. And for retail investor like you and me it would be almost impossible to capture the impact of the information which gets incorporated in stock prices in seconds, sometimes in Nano seconds. Hence analysis these factors would mean analyzing them from futuristic point of view.

Fundamental analysis would also include analysis of the company as a whole, i.e. from Micro Economic point of view. This includes analyzing company’s Financial Statements that include, Balance Sheet Statements, Income Statements, and Cash Flow statements. It also includes analysis of the fundamentals of the company’s suppliers and customers. As we discussed already, all the information available in public domain will get incorporated in the stock price almost immediately hence we need to understand this from futuristic point of view.

E.g. For analyzing an Automobile maker, we need to check what will happen to price of Steel, has government increased/or there is a possibility of increase in import duty of steel? Steel is one of the most important raw materials hence will have a major impact on stock price. Also what will be inflation in coming future , will RBI lower interest rate so that it makes buying car easier, so that more number of cars will be sold and hence more profitability. Is a Diwali season, New Year coming up, because people in India tend to buy vehicles on auspicious days/seasons? Is US central government likely to raise interest rate which will mean that foreign investors will take away money from India putting a downward pressure on Indian Stock? How much % of stock of this automaker are held by foreign investors? There are many more factors that can be considered. It is also important to find out the weightage of these individual factors as each of the individual factors will have different impact on stock Price.

Technical Analysis

Technical analysis is different from fundamental analysis completely. As we have learnt already in stock prices that there are many factors that will determine the stock value. But these factors do not change on daily basis, but stock price does. Why is it so? This is because, in short term the stock prices are more depended on supply – demand principle. Technical analysis includes identifying different patterns in the stock movement through charts and is basis on the principle that these patterns have predictable meaning and historically this predictability has been confirmed. Hence Traders, will use the price patterns to figure out when to buy and sell the stock.

As we discussed, people like you and me should be investors rather than traders. Having said this it would be ideal to use combination of both fundamental and technical analysis. Fundamental Analysis to choose a stock from long term point of view and technical analysis to choose the exact timing. Easier said than done!! “I now know the approaches to invest in stock market, but I think I will take some time, may be years to perfect the art of fundamental and technical analysis. Does that mean, one has to wait to perfect the art before he/she can start investing? ”, asked Apurva. “Not necessarily, this is applicable only if you, yourself want to invest in stock market. But there are other means such as mutual funds, portfolio management services through which you can invest in stock market indirectly. Let’s discuss that next time”.