Do I have to pay tax on my chit fund investment? Read more to find out.
What is a Chit Fund?
Despite mega scams, chit funds are still a preferred investment option among people. In a chit fund, a group of people contribute towards the chit value periodically that is equal to the number of investors. An auction is held on a monthly basis wherein all the members of the scheme bid for the chit amount.
The person who bids for the lowest amount, by offering the highest discount, is awarded the bid. The value which is foregone by the winning bidder is distributed among all the members equally post deduction of foreman’s commission and the amount which is distributed to each member is called the dividend.
For Example, there are 10 people who are part of a chit fund scheme. Each of them contributes Rs. 1000 on a monthly basis. The total money collected for the month is Rs. 10,000. Out of the 10 members, 3 members A, B and C need the money. A bids for Rs. 5000, B bids for Rs. 3000 while C bids for Rs. 2000. In this scenario, C is the winner. C will get the money post deducting the organiser charges say 5% (Rs. 500). Therefore, the actual amount received by C will be Rs. 2000 - Rs. 500 = Rs. 1,500/-
The amount forgone by the winner of the auction is then distributed among the rest of the members. This is called as the dividend. The dividend is not received in cash, but is deducted from the monthly installments which the member has to pay. The member pays less than his actual installment. In the above example, the amount foregone by C is Rs. 9,500. This amount (Rs. 9,500) is divided among the rest of the members (Rs. 9,500/10 = Rs. 950). The amount won’t be paid out, but will be deducted from the monthly installments. Therefore, the contribution next month will be Rs. 50 i.e. (Rs. 1000 - Rs. 950)
Tax on Income from Chit Funds
Section 56 of the Income Tax Act states that if income of any kind is not exempt from tax but is not chargeable under any of the heads specified - salary, house property, business and capital gains - then, such income is to be included under the head income from other sources (IFOS).
The dividend income earned per month is neither tax deductible nor taxable
The overall income is subject to subject to income tax
In case of loss, the overall loss can be claimed as business loss
Eg: If a member receives Rs. 11,000 instead of Rs. 10,000, the excess of Rs. 1000 is taxable as Income. If a member receives Rs. 10,000 instead of Rs. 11,000, then Rs. 1000 can be claimed as a business loss.
Is Chit Fund Safe?
The foreman is required to register the chit company with the registrar of chits. The owner of the chit has to pay 100% of the chit value as security with the registrar of chits. If the chit is not registered with the registrar of chits, the chit fund is neither legal nor bound to pay the deposited amount of the subscribers.
The deposited amount can only be withdrawn after the said chit group closes and every subscriber is paid what is due to them.
Registration of a chit fund business can be done only by the respective state governments as per the Chit Fund Act, 1982.
Chit fund companies are more active in tier 2 cities, rural townships and areas. Though the history of chit fund schemes has seen a lot of scams, there have been a few successful chit funds also. If you are looking to invest in a chit fund, it is advisable to take all forms of caution and background checks on the chit fund company.