Indians just love investing in gold. After all that has been one of the most primitive form of investment known to mankind and has been told to us for generations as an investment (along with land) which doesn’t lose its value, rather gives a consistent return over a period of time. An interesting article Golden Path of Gold highlights even further the way forward for gold. However, with this big advantage comes a big risk – security and purity of gold. Gold is amongst the most dense material known to mankind. Consider this – Gold worth approx Rs. 30 lacs (3 million INR) can be contained in 1 kilogram gold bar which will be around 2.5 times less in mass compared to the same weight of an Iron bar (and notably 80,000 times valuable than Iron). An item which is so valuable and easy to carry will obviously have the following two key risks :
1. Purity; and
People who actively invest in physical gold can very well tell how much they worry about the above two risks. In order to mitigate these risk from hitting them, they would buy gold from only reputed jewellers or banks and put their physical gold holdings in safe custody to prevent the gold from being stolen. Others would store it in their homes waiting for the day when their house may be broken into by a robber. Yet others may insure themselves from this risk by paying hefty insurance premiums. But is there a solution behind protecting your investments in gold? Luckily yes – by two main categories :
1. Invest via Gold ETFs, Gold Funds and eGold. For details, please refer to Different Options of Investing in Gold
2. If you want to invest in physical gold, then buy the gold and hand it over to a bank which is operating a Gold Deposit Scheme (GDS).
Gold Deposit Scheme (GDS)
Banks such as State Bank of India currently operates a GDS, but it hasn’t attracted enough investor attention. I won’t blame it on the scheme features but probably on the lack of sufficient publicity and investor education. GDS requires a customer to visit the participating branch of a bank to deposit their physical gold holding. This gold is melted to convert it into pure gold and eliminate any impurities. The weight of pure gold weight is used to issue gold certificate to the investor. You can choose to invest for a period of time ranging from 3-5 years. Such certificates carry an interest rate which is paid on a regular basis or at maturity. On maturity, you can choose to have your repayment in physical gold or equivalent cash. The banks use your gold to lend it to jewellery manufacturers – so basically your unproductive idle gold is circulated to become productive gold without affecting your ownership and ability to generate investment returns from gold prices.
Key features of the scheme
1. Interest rates
Generally the interest rates offered on GDS are not attractive. For example SBI offers 0.75% p.a. for 3 years deposit and 1% p.a. for 4 & 5 years deposit. There is a lock in period of 1 year and after that you have an option to prematurely terminate your deposit by paying penalty of 0.25 % to 0.5%. However, while the banks advertise it as an interest earning deposit, I would argue that interest is just a bonus on top of the primary objective – which is taking away the risk of theft without any charge !
Your gold gets converted into GDS certificate which offer a nomination facility. Customers can fill the nominee details just like any other bank deposit at the time of opening of GDS. You can read more about Nomination at Importance of Nomination.
The minimum denomination of gold which can be deposited is 500 gram. There is no maximum limit of gold which you can deposit.
4. Loan Against Deposit
Bank loans can be easily obtained against the GDS certificates. Generally banks would be able to lend up to 75% of the value of GDS certificates and hence adding to the liquidity of this deposit.
5. Transfer of GDS certificate
You can transfer the certificate to any person by registering the details with the Bank. The transferee’s details would then be endorsed on the certificate.
Procedure for Investment
- You need to visit a participating branch of the bank. It is important to note that not all banks operate GDS. I could only come across SBI operating GDS schemes. If readers are aware of other banks, I would appreciate your inputs.
- Fill an application form along with nomination detail.
- Fill an ECS form in case you need interest to be credited in your account directly.
- Fill an Inventory Form mentioning number of units of gold items / bars / coins / biscuits, their weight and purity.
- Bank shall issue a preliminary receipt against gold deposit.
- Gold shall be sent by the bank to a centralised department in Mumbai – India Government Mint, who shall melt it (to purify the gold) and then issue a report to the bank on the purity of gold. This report is generally not available for review by the customer and the results are binding on both customer and the bank.
- Gold certificate will then be issued by the bank within 90 days and sent to the customer by post. From here on, the certificate is your proof of ownership of gold.
Procedure for Redemption
- Customer has to submit Original Gold certificate after signing it. This has to be done generally one month before maturity.
- Redemption shall be either in physical gold or in cash depending upon the option chosen by the investor.
- If the payment is in form of gold, its purity will be either 99.9% or 99.5%.
- An advice will be sent to the customer.
- Customer will take the advice letter to the branch where he deposited the gold and take delivery of physical gold.
Apparently this is even encouraged by Finance ministry, i.e. avoid unproductive investment into gold and channelise unproductive gold holdings into productive usage. Hence they have provided the following tax rebates on GDS :
1. Wealth Tax – certificates issued by GDS are not classified as Wealth or in short – are exempted. So as long as your physical gold is in the form of GDS, you don’t need to pay wealth tax on them. This saves you around 1% tax on the value of your gold per year;
2. Interest on GDS is exempt from any Income Tax.
3. Capital Gain on GDS - Income tax act exempts GDS certificates from the definition of a capital asset. Hence any capital gain arising from the sale of such assets is tax free.
In short, all form of earnings from Gold held under GDS is tax free !
Beware of Jewellers Operating GDS
It is not uncommon for some jewellers operating such schemes. I would like to warn all my readers to stay away from such schemes as they are neither regulated by RBI nor by SEBI. Plus they won’t provide tax rebates as only approved GDS schemes are allowed for such rebates. You would also expose yourself to the risk of default from the jeweller who may close his shop and run away with your gold.
What is the catch ?
While sounding an extremely interesting option to deposit your gold to a bank, GDS has following catches owing to which it’s demand has not picked up massively :
1. Minimum amount of deposit
This is the most unfortunate part of the scheme. It requires a minimum 500 grams of gold in order to deposit it with a bank. In monetary terms, 500 gms would be equivalent to approx Rs. 15 lacs. That is a massive amount for a retail investor whose holding in gold is often far less than 500 grams.
2. Melting of Gold
This definitely would be a No-No for any gold owned in the form of jewellery as you would not want to destroy the craft as well as jewellery handed over to you in inheritance. If you hold physical gold coins, gold biscuits, this may be an option. However, you can never be sure if your existing gold is pure enough. Hence it is quite possible that you deposited 1000 grams of gold and after melting only 900 grams is pure gold, meaning you will loose 100 grams in this process. But this loss will always be there when you would sell your existing gold.
3. Theft risk to Credit Risk
The risk which you had to secure your physical gold gets mitigated by going through the GDS scheme. However, now you will be sitting on a credit risk of the bank not being able to pay your gold’s worth on maturity. While the chances are very remote, but still this worth a consideration if you are planning to take the route of GDS.
So what would be your take on it? If you have some good amount of gold sitting in your lockers, I would strongly suggest you to give GDS as careful and positive thought. Interest income from GDS may be ignored as being immaterial, but concentrate upon the tax benefits as well as mitigating the theft risk completely. You would save a lot on the regular security and insurance costs and it makes a lot of sense if you are accumulating gold for long term investment for future consumption.
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