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Returns to Alternative
Savings Vehicle
Chapter
Slide 1Vehicles
2
Slide 13
Savings
Vehicle
Taxdeductibility
of the
investment
After-tax accumulation
per after-tax Tk. I
invested [F]
No
Annually
Ordinary
I.[1+R(1t)]n
II
No
Deferred
Ordinary
I.(1+R)n (1t)+t.I
III
No
Annually
Capital gains
IV
No
Deferred
No
Never
Exempt
I.(1+R)n
VI
Yes
Deferred
Ordinary
[I.(1t)].(1+R)n (1t)
I.[1+R(1tcg)]n
or I.(1+R)n
TaxFrequency
deductibility of taxation
of investment
Slide 14
Applicable
tax rate
Example in
the USA
No
Annually
Ordinary
II
No
Deferred
Ordinary
III
No
Annually
Capital
gains
Mutual Fund
IV
No
Deferred
Capital
gains
Foreign corporations
No
Never
Exempt
Insurance Policy
VI
Yes
Deferred
Ordinary
Pension
TaxFrequency
deductibility of taxation
of investment
Slide 15
Applicable
tax rate
Example in
Bangladesh
No
Annually
Ordinary
II
No
Deferred
Ordinary
III
No
Annually
Capital
gains
-------***
IV
No
Deferred
Capital
gains
Corporate Investment in
Shares
No
Never
Exempt
Insurance Policy
VI
Yes
Deferred
Ordinary
--------
Savings Certificate]
***Income of the mutual fund of the person issuing such mutual fund is exempted u/p 30,
Part A, 6th Sch.
Slide 16
Tax-deductibility
of investment
Frequency of
taxation
Applicable
tax rate
Example in
Bangladesh
III
No
Annually
Capital gains
------- ***
***Reduced tax rate (5%-15%) for initial 5-6 years allowed to prescribed new industries
established between 1.7.2009 to 30.6.2012 (vide SRO No. 172-Ain/Aykar/2009, dt. 1.7.2009).
[Tax Rates: 5% for first 2 years; 10% for next 2 years; 15% for next 1 year (industries in Dhaka and
Chittagong Divisions except for Rangamati, Bandarban and Khagrachari hill districts) and 5% for first 3
years; 10% for next 3 years (industries in other areas)].
Savings
Vehicle
Tax-deductibility
of investment
Frequency of
taxation
Applicable
tax rate
Example in
Bangladesh
VI
Yes
Deferred
Ordinary
--------***
*** Employers contributions towards Approved Pension Fund are tax-deductible [para 5(2), Part A, 1 st
Sch of ITO]
Income of the Fund (interest, dividend or capital gains) are exempted from tax [u/p 5(1)]
Pension received by employee is exempted u/p 8, Part A, 6 th Sch.
Slide 17
I
II
III
IV
V
VI
I = Tk. 1
R = 7%
n=1
n=5
n=10
n=20
n=40
n=100
I.[1+R(1t)]n
1.05
1.27
1.61
2.60
6.78
119.55
I.(1+R)n (1t)+t.I
1.05
1.28
1.68
3.01
10.78
607.70
I.[1+R(1tcg)]n
1.06
1.34
1.78
3.18
10.09
323.67
I.(1+R)n (1tcg)+tcg.I
1.06
1.34
1.82
3.44
12.88
737.71
I.(1+R)n
1.07
1.40
1.97
3.87
14.97
867.72
[I.(1t)].(1+R)n (1t)
1.07
1.40
1.97
3.87
14.97
867.72
or I.(1+R)n
t = 30%
tcg = 15%
I
II
III
IV
V
VI
After-tax rate of
return
t = 30%
Slide 18
I = Tk. 1
R = 7%
n=1
n=5
n=10
n=20
n=40
n=100
[F I]1/n 1
4.90
4.90
4.90
4.90
4.90
4.90
[F I]1/n 1
4.90
5.09
5.31
5.66
6.12
6.62
[F I]1/n 1
5.95
5.95
5.95
5.95
5.95
5.95
[F I]1/n 1
5.95
6.06
6.18
6.37
6.60
6.83
[F I]1/n 1
7.00
7.00
7.00
7.00
7.00
7.00
[F I]1/n 1
7.00
7.00
7.00
7.00
7.00
7.00
tcg = 15%
Slide 19
I
II
I = Tk. 1
R = 7%
t = 30%
n=1
n=5
n=10
n=20
n=40
n=100
I.[1+R(1t)]n
1.05
1.27
1.61
2.60
6.78
119.55
I.(1+R)n (1t)+t.I
1.05
1.28
1.68
3.01
10.78
607.70
tcg = 15%
Comparison:
For investment horizons of only one period (n=1), Vehicle I and
Vehicle II are equivalent.
Except for n=1, the after-tax accumulation in Vehicle II always
exceeds that in Vehicle I.
The longer the holding period, the greater the difference in
accumulation.
Slide 110
I
II
After-tax rate of
return
I = Tk. 1
R = 7%
n=1
n=5
n=10
n=20
n=40
n=100
[F I]1/n 1
4.90
4.90
4.90
4.90
4.90
4.90
[F I]1/n 1
4.90
5.09
5.31
5.66
6.12
6.62
(r)
t = 30%
tcg = 15%
Comparison:
All the after-tax annualized rates of return (r) are 4.9% in
Vehicle I.
But these rates increase in Vehicle II with the number of
holding periods.
In fact, in case of Vehicle II, as the number of periods becomes large,
the after-tax rate of return per period approaches the before tax rates
of return (R) of 7%.
t = 30%
Slide 111
I = Tk. 1
R = 7%
n=1
n=5
n=10
n=20
n=40
n=100
tcg = 15%
II
III
II
I.(1+R)n (1t)+t.I
1.05
1.28
1.68
3.01
10.78
607.70
I.[1+R(1tcg)]n
1.06
1.34
1.78
3.18
10.09
323.67
After-tax rate of
return (r)
4.90
5.09
5.31
5.66
6.12
6.62
III
After-tax rate of
return (r)
5.95
5.95
5.95
5.95
5.95
5.95
Slide 112
Savings Vehicle IV
(Intertemporally Constant Tax Rates)
Savings
Vehicle
After-tax accumulation
I = Tk. 1
R = 7%
t = 30%
tcg = 15%
n=1
n=5
n=10
n=20
n=40
n=100
I.[1+R(1t)]n
1.05
1.27
1.61
2.60
6.78
119.55
II
I.(1+R)n (1t)+t.I
1.05
1.28
1.68
3.01
10.78
607.70
III
I.[1+R(1tcg)]n
1.06
1.34
1.78
3.18
10.09
323.67
IV
I.(1+R)n (1tcg)+tcg.I
1.06
1.34
1.82
3.44
12.88
737.71
4.90
4.90
4.90
4.90
4.90
4.90
II
4.90
5.09
5.31
5.66
6.12
6.62
III
5.95
5.95
5.95
5.95
5.95
5.95
IV
5.95
6.06
6.18
6.37
6.60
6.83
Comparison:
Slide 113
Savings Vehicle V
(Intertemporally Constant Tax Rates)
Savings
Vehicle
After-tax accumulation
I = Tk. 1
R = 7%
t = 30%
tcg = 15%
n=1
n=5
n=10
n=20
n=40
n=100
I.[1+R(1t)]n
1.05
1.27
1.61
2.60
6.78
119.55
II
I.(1+R)n (1t)+t.I
1.05
1.28
1.68
3.01
10.78
607.70
III
I.[1+R(1tcg)]n
1.06
1.34
1.78
3.18
10.09
323.67
IV
I.(1+R)n (1tcg)+tcg.I
1.06
1.34
1.82
3.44
12.88
737.71
I.(1+R)n
1.07
1.40
1.97
3.87
14.97
867.72
4.90
4.90
4.90
4.90
4.90
4.90
II
4.90
5.09
5.31
5.66
6.12
6.62
III
5.95
5.95
5.95
5.95
5.95
5.95
IV
5.95
6.06
6.18
6.37
6.60
6.83
7.00
7.00
7.00
7.00
7.00
7.00
Comparison:
Accumulation in Vehicle V dominates that for Vehicle I through IV as long as the tcg is not 0%.
If tcg = 0, Vehicles III & IV generate exactly the same after-tax accumulations as in Vehicle V.
Slide 114
Savings Vehicle V
(Intertemporally Constant Tax Rates)
Savings
Vehicle
V
VI
After-tax accumulation
I = Tk. 1
R = 7%
t = 30%
tcg = 15%
n=1
n=5
n=10
n=20
n=40
n=100
I.(1+R)n
1.07
1.40
1.97
3.87
14.97
867.72
[I.(1t)].(1+R)n (1t)
1.07
1.40
1.97
3.87
14.97
867.72
7.00
7.00
7.00
7.00
7.00
7.00
7.00
7.00
7.00
7.00
7.00
7.00
or I.(1+R)n
V
VI
In Vehicle VI, the investment is tax-deductible; and investment earnings are tax deferred.
Comparison: When tax rates are constant over time, Vehicles V and VI are equivalent. Hence,
Accumulation in Vehicle VI dominates that for Vehicle I through IV as long as the tcg is not
0%.
If tcg = 0, Vehicles III & IV generate exactly the same after-tax accumulations as in Vehicle VI.
Slide 1Time16
For pedagogical reasons, tax rates are assumed to be known and constant
and here, this assumption is relaxed.
In particular, when tax rates are rising, Vehicle VI (pensions) become less
attractive and when tax rates are falling over time, Vehicle VI (pensions)
become more attractive.
The subscript o indicates the tax rate in the period when the contribution is
made, assumed here to be the current period, and the subscript n indicates
the tax rate in the future period n when withdrawals are made.
Slide 1Time17
Thank you.
Slide 118