All about Chit Funds

 

All about Chit Funds

 

Chit Funds is a more than 1000 years old micro finance instrument used for both borrowing and saving of money at the same time.  The concept of Chit funds in Kerala came into being in the 1800's when Raja Rama Varma, ruler of former Cochin state gave a loan to a Syrian Christian trader, keeping a certain portion with himself for administrative and other expenses. Later, to manage the increasing demand for loans, he ordered a cast of lots and gave the accumulated amount to those who drew the lot on the principle of equity.  But real start of  chit fund operations was somewhere between 1830 and 1835, when the Chaldean Syrian church started Kuries under its name and issued passbooks to subscribers as evidence of enrolment.  Now Chit Funds otherwise called Kuris has become part and partial of people’s life in Kerala, especially in rural and semi-urban areas.   Chitty is simply a mechanism that combines credit and savings in a single scheme. Subscribers who bid the Chit and take the prize money are borrowers for the remaining period of the Chit. Similarly, those who are not taking the prize money before the completion of the Chit are investors. The important factor which decides a subscriber to be a saver or a borrower is the rate of discount.  This traditional savings-cum-borrowing plan is most popular in Kerala with almost 15% of households are beneficiaries of this investment plan. Moreover, it’s a means of living for women and unemployed in rural areas.

Even though the registration of Chit Funds are compulsory in Kerala and other parts of India,  but most of the chitty business in our state is conducted without proper  registration, so there is no official data available for calculating the annual turnover from this segment of business. The numbers of unregistered chit funds are may be 150-200 times than the registered ones, taking a combined yearly business of more than Rs. 30 lakh crores in India.   Unregistered Chit Funds are normally serves the financial and investment needs of the low-income households, which have been excluded from the formal financial system.  In the unorganized sector, chit funds are formed by a small group of people, generally family members, neighbors, or friends. The idea is that the people forming the chit fund are generally known to each other and have the faith that the members of the fund will not default.  Most of the people in smaller places are attracted to chit funds, because of easy availability of credit and its simplicity of operations.  In rural areas banks are not much interested in lending to poor people and poor people see chit funds as perfect way of getting a loan, though at a high cost. So we can also look at them as microfinance tools. In Kerala itself we can find thousands of chit funds run by individuals called in different names Daily Chitti, Weekly Chitti, Monthly chitti, Onam Chitti etc.  Whether it is in organized or

unorganized sector, the concept and working of chit fund are one and the same..

 

Earlier the chit businesses were localized and chit funds were operating within the jurisdiction of a small area like a village or panchayath etc.   Now the geographical jurisdiction of chit Funds has been extended to the entire state even some cases to other state also.  

 

Why people prefer Chit Funds?

The following are main reasons for Preferring Chit funds  

a)     Obtaining a loan from a financial institution or bank is not an easy task.  So it is quite natural that the common man resorted to Chits and Kuries for meeting his/her financial obligations or realization of their financial goal to a certain extent.   The process to obtain loan from banks and financial institutions are very cumbersome, needs lot of documentation, collaterals and guarantors.

b)     Though different saving and borrowing avenues are available to the people, but people still prefer chitty basically for the reason that it provides future savings in advance and also it is very convenient and easy to operate. 

c)     The concept of dual option for saving and borrowing in one instrument and the monthly dividend obtained through the sharing of discount amount with reasonable return at low risk.    

d)    The formalities to open Chit Fund Accounts are very simple.  Chit companies do not require much documentation, which is one of the advantages over banks and other financial institutions. Some of the companies, however, ask for income proof and address proof from new member but most of the cases this is not a mandatory requirement. No business or address verification is undertaken by the chit funds unless it is felt absolutely necessary.  In short the KYC (Know Your Customer) requirements are not presently applicable for Chit companies.  Most chit companies admit only members who are either connected to other existing chit members or known to the foremen personally. 

e)     Most of the chit businesses are happening in the unorganized sector without proper registration or approval, so the income from these businesses is out of the scope of Income Tax or any other applicable taxes.   As a result the actual return generated from chitty business is more attractive than bank deposits or other investments where the tax is deducted at source or the depositor is liable to disclose the income  in his/here tax returns.

Use of the Chit Price Money

 

When you wanted to take a loan from a bank you need to specify the purpose and provide necessary proof required by them, chit fund do not require the members to state the purpose to which they wanted to use the funds, it is at their liberty to use this money for the marriage of their children, buying TV, Fridge, land and residential properties, utilize for children education, buying vehicles, meeting medical expenses, settling loans which were taken from the money lenders at higher rates etc.   Small traders and businessmen subscribe largely in chit funds. Chit funds provide an opportunity for them to save their excess cash on a daily or monthly basis and, at the same time, to have access to easy finance in case of emergency or other requirement.  Banks are hesitating to provide financial assistance to individual businessmen or small entrepreneurs due to non-transparency in their operations and lack of proper record keeping.  These businessmen are highly exploited by the local money lenders charging exorbitant rate of interest for the money borrowed. Chit funds to a certain extant helps these small scale entrepreneurs to overcome their financial problems.

Chit Fund business in Kerala is governs by Kerala Chitties Act, 1975. The Kerala Cities Act was subsequently amended to include a provision which stipulates that companies can float chit schemes only amounting to 50% of the foreman’s asset, whereas in other states that adopt the Central Act, companies are allowed to float chit schemes up to ten times the foreman’s assets. The Kerala Act also imposes other stringent rules that have resulted in many companies registering themselves outside the state (primarily in Jammu and Kashmir where the Central Act does not apply). One should also note that in states which do not enact a State Chit Fund Act, the Central Act will automatically prevail.

 Income Tax Treatment

There two methods to offer the income from chit fund to income-tax a) First Method: Offer the dividend you receive from month to month to tax b) Second Method: Offer the difference between the amount you paid and the amount you received to tax if the amount received by you is greater than the amount you paid. If the amount you received is lesser than the amount you paid it is a loss

The second method can adopted only after completion of the chit. Till then the amount paid by you is treated as investment and if you bid and receive the bid money the money received by you is treated as an advance/loan in the books of account (in case if you maintain books of account)

If you contribute the chit out of the business funds for the purpose of the business the loss incurred on bidding or on closure of the chit (in case the money received is lesser than the money you paid) the said loss can be treated as business loss

A word of caution

Of late some crooked elements got involved in to this business and polluted it to the extreme. Some promoters disappeared with members’ money, and in other cases some members disappeared after accepting the money. You have to be very careful while selecting the chitty company. You can find chitty companies everywhere. When you deal with chitty companies, go for those companies promoted by reliable persons with sound track records and proper and valid registration form the concerned Government authorities. Don’t put your hard earned money based on their well-decorated offices or some attractive TV advertisements of film stars or other celebrities offering valuable gifts like luxury cars, luxury villas, foreign trips, gold coins, etc.  . People subscribe the chit fund with a hope of extraordinary return within a specified period. It is true that people have received the promised amount in certain cases. However, number of allegations relating to loss of money of the investors is also alarming and growing in numbers, people don’t have forgotten the recent chitty scam related to   Himalaya and Everest Chit Funds.  Also please note that Chitti is not a lucrative investment, if you fails to receive the money within a specified period of time, if you prolong to take your money back naturally your return will gradually come down.

 

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