Securities are financial instruments that represent ownership or debt obligations. They are bought and sold in the financial markets, and they come in various forms. The different kinds of securities are:
1. Equity Securities: Equity securities represent ownership in a company, and they are commonly known as stocks or shares. The owners of these securities are entitled to a share of the company's profits, and they also have voting rights in the company's decision-making process.
2. Debt Securities: Debt securities represent a loan made by an investor to the issuer of the security. Examples of debt securities include bonds, debentures, and commercial paper. The issuer of these securities is required to pay interest to the investor at a fixed rate and return the principal amount at the maturity of the security.
3. Derivative Securities: Derivative securities derive their value from an underlying asset. Examples of derivative securities include options, futures, and swaps. These securities are used for hedging or speculation purposes.
4. Hybrid Securities: Hybrid securities combine the features of both equity and debt securities. Examples of hybrid securities include preference shares and convertible bonds.
5. Government Securities: Government securities are issued by the government to fund its activities. Examples of government securities include treasury bills, bonds, and notes.
6. Mortgage Securities: Mortgage securities are created by pooling together a group of mortgages and selling them to investors. Examples of mortgage securities include mortgage-backed securities and collateralized mortgage obligations.
In the case of Tax-Free Commercial Securities, the interest paid to the investor is exempt from tax. However, the Income Tax Act, 1961, requires the interest on Tax-Free Commercial Securities to be grossed up while computing the total income of the investor. Grossing up means adding the tax-exempt interest to the investor's taxable income and then calculating the tax liability based on the new total income. The rule regarding grossing up of interest on Tax-Free Commercial Securities is as follows:
1. Calculate the tax on the investor's taxable income without considering the tax-free interest received on the Tax-Free Commercial Securities.
2. Add the tax-free interest received on the Tax-Free Commercial Securities to the investor's taxable income.
3. Recalculate the tax on the investor's total income, including the tax-free interest received on the Tax-Free Commercial Securities.
4. Deduct the tax paid on the investor's taxable income (calculated in step 1) from the tax payable on the investor's total income (calculated in step 3).
5. The difference between the tax paid on the investor's taxable income and the tax payable on the investor's total income is the additional tax payable by the investor due to grossing up of the tax-free interest received on the Tax-Free Commercial Securities.
In conclusion, securities come in various forms, including equity securities, debt securities, derivative securities, hybrid securities, government securities, and mortgage securities. Tax-Free Commercial Securities are exempt from tax, but the interest on these securities is grossed up while computing the total income of the investor. Grossing up means adding the tax-exempt interest to the investor's taxable income and then calculating the tax liability based on the new total income. The rule regarding grossing up of interest on Tax-Free Commercial Securities is important for investors to understand to accurately calculate their tax liability.
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