What are Chit Funds And How Do They Work?

How to Start A Chit Funds Business?

Microfinance institutions are sometimes referred to as chit funds. These are also recognised as Chitty, chit, and other similar instruments. It's important to note that India has over 10,000 chit funds registered with the government. Chit funds usually have two active positions or designations among them. Member and delegate are two examples of such positions or designations. A chit fund arrangement demands that a certain sum of money is invested daily by various members. The money is repaid to the customers with interests after a given period. Chit funds aid with the accumulation of small savings from a large number of people, culminating in a large total.

What are exactly Chit Funds?

“A chit fund is a form of revolving investment arrangement in which various people, such as friends, relatives, neighbors, and family members, choose to contribute a certain amount of money over a certain period.”

Chit Fund Business Model:

A chit fund organisation’s activity is based on the following business model: to start a chit fund business, locating prospective participants, enrolling members in a chit, gathering donations, holding chit auctions, circulating money, and keeping books. Chit fund firms raise profits by collecting a set percentage of the overall donation from participants as a charge for administering the chit fund scheme.

Types of Chit Funds:

1. Set up

This is the first step, which entails the chit fund business launching a specific chit fund scheme and enrolling participants.

2. Contribution of Chits

The founders of the chit fund shall donate their part of the revenue at this stage. Based on the value and conditions of the chit fund system, this may be done regularly, monthly, or quarterly.

3. Auction of Chits

The chit fund company holds a chit auction after receiving the members' contributions at this stage. When there is only one participant who wishes to join in the auction, he or she is free to do so.

4. Member of the Month

If more than one participant wishes to collect the chit auction for the month, this stage will occur. In such a case, one of the above representatives is chosen at random and is given the chit.

5. Reverse Auction

If none of the participants wish to collect the entire chit auction for the month, this stage occurs. After that, a reverse auction is held, with the lowest bidder receiving the taker.

Registration for the Chit Fund Business

Although being a type of non-banking financial firm, the registration of chit fund businesses is excluded from registering with the Reserve Bank of India, as is the standard. This is because, unlike other NBFCs, chit funds are controlled by their regulators rather than the RBI. The best way to file a chit fund is for its sponsors to form a private limited company. This entity should be established to run a chit fund firm.

After following these steps, the registration of chit fund business shall apply to the State Chit Fund Registrar for registration under section 4 of the Act. The firm will only act as a chit fund after this registration has been issued.

To start a Chit Fund business, you'll need the following documents

The papers needed to launch the chit fund company would be those belonging to the directors and the company's registered office.

The following directors' records would be required:

• Details of the PAN Card
• Evidence of identification (Voter ID card, passport, Aadhar card, driving license)
• Proof of address (Latest bank statement, electricity bill, mobile bill, telephone bill)
• Photograph of passport dimensions

The following documentation will be needed for the registered office:

• Latest Electricity Bill
• Rental arrangement (if the premises is rented)
• Letter of authorisation from the owner Sale deed (in case the property is owned)

Chit Funds Are Taxable

Chit fund revenue is neither taxable or deductible, although there is a grey area. Although chit funds are becoming more common, the taxability of the profits they generate remains a grey area. The common consensus is that interest from chit funds is not taxable.

If the member chooses to report the money collected from the chit fund in question as a loss, all dividends obtained from chit funds must be reported as revenue gain in the person's tax filings. The salary would be taxed in compliance with the terms of the Income Tax Act, 1961 in this respect if it is shown as such.

The Advantages of a Chit Fund

The chit fund scheme comes with a host of built-in benefits for its owners. User-friendly programs, tax-free profits, quick mobility, no intermittent expenditure hikes, absence of latent costs, exit opportunities with negligible charges, and so on are only a few examples.

The below is a more detailed list of the advantages of chit funds:

• Chit funds may be used by their participants as a borrowing tool as well as an investment vehicle. If a participant runs short of funds, they will take money from the chit fund.
• The interest rates are usually set by the members themselves after they have reached a collective agreement. The interest rates for each auction are different.
• The money lent by a participant during a time in need is essentially deducted from his or her potential donations.
• Unlike banks and NBFCs, which require tangible securities as a condition of withdrawal, chit funds allow members to withdraw money based on personal sureties. As a result, chit funds' borrowing process is less static than that of other institutions.

The Chit Fund Process

The below is a list of the steps involved in setting up a chit fund:

• Chit funds have several participants who pay a fixed amount at regular intervals for the length of the chit fund scheme, as defined by the chit fund company.
• The money raised at each interval is then auctioned off to all of the chit fund members. The auction is organised by the chit fund corporation, and all participants can bid on the total amount of money raised, also known as the pot.
• To demand the capital, the bidder must give up some of it during the bidding process. The earned money is awarded to the bidder who can give up the most money, up to a maximum of 30% of the pot.
• Following the auction, the winning bidder is obligated to reimburse the remaining instalments for the duration of the chit fund system.

The Reserve Bank of India will advise state governments on regulatory issues such as establishing regulations or excluding certain chit funds. Simultaneously, the Securities and Exchange Board of India (SEBI), besides becoming the securities market regulator and therefore controlling collective investment schemes, has no power to control chit funds.

Conclusion

Though chit funds have received a lot of bad press and negative publicity, they can provide a positive return if invested correctly. They have the dual function of savings and a source of borrowing capital on a rainy day.

Shareholders will, however, be expected to perform thorough research on chit funds before investing to ensure that their funds are genuine and that no foul play is being perpetrated on their funds. However, this is true of most financial securities, and chit funds seem to be stable enough to invest in thanks to recent and tighter legislation.

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FAQs

Q. How are chits determined?

Ans. The Chit Amount is the amount received every month, which is calculated as 20*1000 = Rs. 20,000. When the first month's payment is paid, all subscribers are invited to submit bids. This fee is deducted from the total paid to the winning bidder.

Q. Is it worthwhile to invest in chits?

Ans. Investing in a chit fund can make you money, but it can also make you lose money. The chit fund becomes a loan if you win an offer and end up paying more than you received. The loss can be regarded as interest on the loan.

Q. Is it legal to invest in chit funds?

Ans. In India, chit funds are legal in several states and union territories. The Chit Fund Act, 1982 regulates chit fund firms in India. Although chit funds aren't financial institutions, they are not subject to the RBI's rules and regulations.