Investing in Chit Funds: A Beginner’s Guide on how Chits work

Here is a guide for beginners on how chit funds work, how to start investing in a chit fund and what to keep in mind to
Investing in chit funds for beginners - a guide to chit funds

As per the Section 2(b) of the Chit Fund Act, 1982, a chit fund is a type of rotating savings, where different persons such as friends, relatives, neighbours and family members agree to subscribe to contribute a certain amount of money for a specified period of time. These chit fund microfinance organizations are commonly known as Chitty, Kuree, or Chit.

How Does a Chit Fund Work?

The following are the five stages of chit fund business model:

Stage 1. Set-up

The first stage involves the chit fund company launching a particular chit fund scheme, allowing people to become members of the chit.

Stage 2. Chit Contribution 

In this stage, the members contribute their share of money on a weekly, monthly or quarterly basis on the basis of the terms and conditions agreed upon with the chit fund scheme.

Stage 3. Chit Auction 

At this stage, a chit auction is announced by the chit fund company after the contributions of each member is collected. If only one member wants the auction, he/she is allowed to take the chit fund amount.

Stage 4. Lucky Member

If there is more than one member wanting to claim the chit fund value, the lucky member is randomly selected through chits.  

Stage 5. Reverse Auction

When none of the members wants to receive the monthly chit auction, a reverse auction is held, and the amount is offered to the lowest taker. 

Documents Required to start a Chit Fund

Due to the numerous scams in this sector, the RBI has heavily regulated and set up processes for approved funds to follow. Personal documents of the director as well as the registered office documents as follows are needed to start the chit fund:

Personal documents of the director needed

  • Passport size photograph
  • ID proof (Voter ID card, passport, Aadhar card, driving license)
  • PAN Card details
  • Address proof (Latest bank statement, electricity bill, mobile bill, telephone bill)

Registered office documents needed

  • Rental agreement (in case the premises is rented) and a NOC from the landlord
  • Sale deed (in case the property is owned)
  • Latest electricity bill

Tax on chit fund investments

Section 56 of the Income Tax Act states that any income if not exempted from tax but is not taxable under any of the specified categories such as business, house property, salary, and capital gains, then this income will fall in the category “income from other sources (IFOS).”

  • The dividend earned every month is neither taxable nor tax deductible.
  • But, the overall income is subject to income tax.
  • However, if there is a loss, the overall loss can be claimed as a business loss.

Let’s take an example to understand this:

  • Instead of Rs. 12,000, if the member of the chit fund receives Rs. 14,000, the excess of Rs. 2,000 is taxable as income.
  • Instead of Rs. 14,000, if the member receives Rs. 12,000, then Rs. 2,000 can be claimed as a business loss.

Regulations Imposed by RBI on Chit Fund Business

The chit fund business in India is regulated under the Chit Fund Act, 1982. Under this Act, the following regulations are imposed:

  • Chit fund businesses must be registered and regulated only by their respective State Governments.
  • The chit fund companies must register with the state’s Registrar of Chit companies, giving full particulars about the chit company.
  • Earlier, the maximum discount on the bid was restricted to 30% of the total chit amount. But now, it has been increased to 40%. For example, for a chit for Rs. 1 Lakh, the bid amount cannot be more than Rs. 40,000.
  • The Reserve Bank of India has to be furnished with the details of every chit along with the names and addresses of the members.
  • The RBI keeps a month’s chit amount of all the members until the particular chit comes to an end.

Benefits of Investing in Chit funds

The following are the benefits of investing in chit funds:

  • Allows you to save as well as borrow
  • The best tool to access money in case of financial emergencies
  • No or less paperwork
  • Gives quick access to money when in need by just paying the first instalment
  • No collateral needed
  • Can be accessed and tracked through investment research services
  • You can use the chit fund for any purpose you wish – marriage, travel, shopping, medical expenses, festivals, education, etc.
  • Get dividends comparatively higher return than the interest accrued on the money saved in various deposit schemes
  • You don’t need to reveal the reason for borrowing the chit fund money
  • The interest rate for borrowing from the chit fund is comparatively lower than other forms of borrowing

Popular Chit Fund Platform and Companies

1. The Money Club

The Money Club is India’s best AI-driven online digital chit fund platform. This safe, transparent, and secure platform allows like-minded people from all over India to save, invest or borrow online.

2. Government of Kerala Backed Chitty

Kerala State Financial Enterprises is supported by the Kerala government and it is mostly limited to the people of Kerala. This financial tool allows people to borrow as well as invest.

3. Shriram Chits

The biggest chit fund company in India, Shriram Chits, has around 6,000 chit representatives and serves various states like Maharashtra, Tamil Nadu, Andhra Pradesh, and Karnataka.

4. Mysore Sales International

Started in 2005, Mysore sales international limited, popularly known as MSIL, belongs to the Government of Karnataka foundation.

5. Margadarsi Chit Funds

Founded by Ramoji Rao of Eenadu groups in 1962, Margadarshi Chit Fund Private Limited has its presence in three different states – Andhra Pradesh, Tamil Nadu, and Karnataka. Each platform and companies mentioned above have their own set of rules before signing up. But, all these companies will need member’s KYC and bank details for registration. Although chit funds have had their share of bad press, they can provide good returns if invested correctly. Investors need to carry their due diligence before investing to rule out foul play. However, owing to the stricter rules and regulations imposed on the chit fund companies, they are a  safe option to invest in.

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Abhi is a 29 yr old Indian, on FIRE to retire by 40. He has been investing and learning Finance for the past 12 years. After completing Mechanical engineering, he started working in a multi-national Bank and grew to become an AVP. Currently with an IT MNC as a VP. He lives in Bangalore with his wife and their 1 year old daughter. In his free time, Abhi loves to game on the Xbox, watch movies, read and blog.

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