DO PROMISSORY NOTES NEED TO BE A FORMAL DOCUMENT?

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  • A promissory note is a tool that acts as a “promise to pay” between a lender and a borrower. The legal instrument documents the assurance of repayment by the borrower or payer to the lender or payee. It is a written and signed contract that delineates the terms of the loan repayment, and can be tailored to the needs of the two parties, including stating whether and how much interest rate will be charged and when the money will be repaid.
  • A promissory note can be unsecured or secured, with the latter requiring a collateral, usually an asset of some value, like property or gold. In case of secured notes, if the borrower defaults on the loan, they will have to surrender the collateral asset to the lender.
  • Promissory notes can be formalized, but even informal ones are considered valid contracts. A payee can file a lawsuit against the borrower in case of a default. Technically, a note written on a scrap of paper and signed by both parties involved is just as valid as one drawn up by a lawyer.
  • Indexation benefits available on debt mutual funds make them more tax efficient than FDs. One of the things that makes debt funds attractive is their tax efficiency. Long-term capital gains (LTCG) earned on debt mutual funds are eligible for indexation benefits before they are taxed. What is indexation benefit and how is it calculated?

LTCG IN DEBT FUNDS

  • Mutual funds provide returns in the form of dividends and capital gains. The dividend is paid periodically by the mutual fund to its investors from the returns earned. Capital gains are earned when mutual fund units are redeemed by the investor at a price that is higher than the purchase price. The capital gains earned are subject to tax in the hands of the investor. The rate of tax depends upon two factors— whether the capital gain was earned over a short- or long-term period, and whether it is earned from a debt- or equity oriented scheme. Gains made on investment in debt mutual funds held for more than 36 months is considered LTCG and indexation benefit is available on it.

INDEXATION

  • Indexation is the process of adjusting the purchase price of an investment for inflation. The Cost of Inflation Index (CII) is used to index the cost of acquisition of the mutual fund unit. The CII for each financial year is available on the incometaxindia.gov.in. The purchase price is multiplied by the CII for the year in which the sale is made and divided by the CII for the year in which the purchase was made. The indexed price so arrived at is used to calculate the capital gains on which LTCG tax of 20% plus surcharge of 10% plus education cess of 4% (22.88%) is applicable. If inflation has been high in the period between the purchase and sale of the investment, then the indexed cost of acquisition of the investment will go up, reducing the gains that are liable for taxation. Remember, this adjustment of purchase price is done just for calculating the tax on capital gains and it does not mean that the actual gains or profit you made will stand reduced.

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