Be a Smuggler or Buy Quantum Gold Fund?

Posted On Thursday, Jul 30, 2009


The Finance Minister delivered what could be a called as an "aam aadmi" budget. The stock markets were disappointed with the budget as it did not include big announcements to further the "lets buy now" sentiment.
While it was initially a "no-masala" budget for equity markets (of course, since budget day stock markets have found a lot to be happy about!), it remains a sour budget for gold investors.

Taxing gold

The finance bill doubled the import duty on gold from Rs. 100 per 10 gms to Rs. 200 per 10 gms. The rationale for the same was that these rates of import duty were fixed in 2004 and continued even though the price of gold has increased substantially. The import duty of Rs. 100 per 10 grams was applicable since 2004 when the price of gold was about Rs. 5,800 per 10 gms. The duty amounted to 1.7% of the gold price in 2004.

Since then, prices have increased by 250% to the Rs. 14,500 levels. To adjust this levy in line with the increase in the price of gold, the Finance Minister has reset the levy to Rs. 200 per 10 gms. The duty now amounts to 1.4% of the current price of gold.

Some have suggested that the increase in the levy was also to make up for the shortfall in tax collections - India’s import of gold have nearly halved this year. So, doubling of import duty will keep the government’s revenue intact.

Most of the gold consumed in India is imported from overseas. Naturally, an increase in customs duty would lead to increase in gold prices to that extent as customs duty is a pass through and gets added to derive the domestic price. This increase in duty comes at a time when the "high" price of gold (we think it could go "higher") are already pinching consumer pockets, thereby limiting their buying capacity. Gold prices rose by Rs. 100 per 10 gram in the bullion market immediately after the announcement of the increase in the tax.

Graph 1: Spread between International gold price and domestic price of gold
Spread between International gold price and domestic price of gold
Source: Quantum AMC estimates using London AM Fix, RBI Reference rate and various applicable duties and taxes for arriving at gold price in Mumbai

Impact on Investors:

The increase in the gold tax has an immediate impact on:
1) Existing investors of gold: They will benefit as the value of their gold holdings has increased by Rs. 103 per 10 grams or by Rs. 5.15 per half gram. An increase of nearly 0.7% of the current gold price;

2) Those investors who wish to buy gold: They will have to pay a higher price for the gold to the extent of increase in the duty.

With these tax changes, is the government encouraging you to be a smuggler?

This import duty adds an additional levy of 0.7% of the current market value. Adding this with other existing duties and levies, the difference in price between the internationally sourced gold and Indian domestic gold widens to nearly 3%. (see Graph 1). This means that the Indian consumer is paying 3% more than the price of gold in the international markets.

The World Gold Council has cautioned that this higher spread might lead to an increase in gold smuggling. Investors will buy gold through their other channels and not through the official banking channels. While 3% is "only" 3%, it is a lot in the extremely price sensitive Indian gold market.

Ajay Mitra, Managing Director Indian Subcontinent, World Gold Council, quoted in the press, said: "World Gold Council actively lobbied the Indian Central Bank and Ministries of Finance and Commerce in the late 1990’s to facilitate the free flow of gold into the country and in making a case for the rationalisation of import duties. The stabilisation of import duties enabled the secure development and growth of the Indian market through official channels. We hope that this higher duty rate does not add to significant trading through non-official channels."

Mr. Dharmesh Sodah, director at WGC also said "There is evidence from other key gold markets around the world that higher taxation regimes can lead to the trading of gold along non-official channels."

Will potential investors "smuggle" gold or seek other avenues of gold investment?

Indian investors can invest abroad legally upto a limit of $200,000 per annum.

Through this provision, investors can invest in global gold ETFs like GLD, IAU, and avoid this India-specific incidence of high import duty and other taxes. If an Indian was to remit USD 200,000 every year and use all of it to buy gold, in theory he would "save" USD 6,000 (about 3%) for all the gold purchased. Not bad.

And there is nothing illegal about it.
This is not "smuggling" in the true sense of the word - this is a legal avenue to buy a commodity cheaper in international markets compared to its price in the local markets.

But, will this be a wise decision?

While investors will definitely save on the duties and taxes on buying gold in India, they may pay a lot of additional charges involved in investing overseas. There are account opening charges, foreign exchange markups, money transfer charges and high brokerage costs.

Table: Estimate of charges

Account opening charges$25-50
Foreign currency Mark ups1.5 - 3%
Brokerage0.5 - 0.8%
Money Transfer (Inward / Outward)$ 10-30

Source: Industry

The above charges are pure expenses and will not be recovered even on selling the investments. These are like sunk costs.

Although the increased customs duty makes purchasing gold in India a little expensive, investors should remember that they could recover these same duties when the sell their gold investments in the future. A new gold buyer will have to pay these same taxes to the seller.

Investing in gold ETFs listed outside India could become an expensive proposition because it involves high transaction costs which are not recoverable.

Also, many gold ETFs listed outside India may not insure the gold they hold. In fact they may not hold all the gold in "physical" format in a bank vault.

In light of the above arguments and the high costs associated with investing in gold ETFs abroad, it would be a prudent decision to invest in gold ETFs like the Quantum Gold ETF.

Invest in the Quantum Gold Fund (ETF)

  • Each unit backed by physical gold and not receivables. No units are created until physical gold backing these units is received.

  • Gold backing each unit is of 0.995 purity from LBMA accredited refiners only.

  • Gold is held in secured vaults.

  • Gold is completely insured and includes terrorism insurance.

  • Gold is regularly audited and physically verified.

Don`t get worried about the small increase in duties as it will only marginally increase your buying price.
Look at the long term opportunity of investing in gold to benefit from a possible increase in the price of gold in these uncertain times.
So, don’t think about "smuggling" gold, consider buying Quantum Gold ETF instead.

Above article is authored by Quantum.

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