A chit fund is a type of rotating savings and credit association system practiced in Pakistan, India, Bangladesh, Sri Lanka and other Asian countries. Chit fund schemes may be organized by financial institutions, or informally among friends, relatives, or neighbours. In some variations of chit funds, the savings are for a specific purpose. Chit funds are often microfinance organizations.
Organised chit fund schemes are required to register with the Registrar of Firms, Societies and Chits. A chit fund company is a company that manages, conducts, or supervises such a chit fund, as defined in Section of the Chit Funds Act, 1982.
According to Section 2(b) of the Chit Funds Act, 1982:
“Chit means a transaction whether called chit, chit fund, chitty, kuree or by any other name by or under which a person enters into an agreement with a specified number of persons that every one of them shall subscribe a certain sum of money (or a certain quantity of grain instead) by way of periodical instalments over a definite period and that each such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount”
Though they are not required to be registered under the RBI Act, chit funds are regulated as Miscellaneous Non-Banking Companies (MNBCs). Their activities relating to soliciting deposits are governed by the Non-Banking Financial Companies and Miscellaneous Non-Banking Companies (Advertisement) Rules (1977) framed by the Government of India under Section 58A of the Companies Act 1956.
Chit funds are known by a number of names.
After the amendment of the Chit Funds Act in 2019, the following names have also been added. These are,
Features of Chit Funds
Chit funds have the following features:
How does Chit Funds work?
Let us assume, a chit fund with 12 members, operating for 12 months with a monthly member contribution of Rs.10,000.
The chit company would then collect Rs.120,000 every month and offer the amount in an auction, less the chit company fee and a discount.
Thus, every month, the members receive the chit amount at Rs. 96,000 (10% chit company fee and 10% discount).
If any one member would like to receive the auction, then he/she can receive the entire chit auction amount. If more than one person would like to receive the chit auction, then it selects the lucky member randomly. If no member wants to receive the chit auction, then if offering the chit amount without any discount at Rs.120,000 and it causes a reverse auction. The person offering the lowest amount will get the award of chit auction amount. In any case, every member of the chit receives the chit auction once, the chit discount is spread evenly amongst the members, and the chit company only earns a fee for operating the chit fund.
Although there is a law governing the chit funds but still there are a lot of ‘kitty’ and ‘committees’ who operate on the chit fund model but are not regulated. This is the unorganised sector of chit fund. They can have their own modification in the model. Be it in depositing of installments or withdrawal method, unorganized chit funds customize according to their convenience.
Then again there is an organised sector which is operated and regulated according to the law and are regulated by the Chit Funds Act, 1982. There are very few companies who operate in the organised sector such a Shriram Chit Funds.
After the Saradha Scam in 2013, many people have lost faith in the chit fund scheme. Since even after the regulations there is a huge inherent risk of defaulters and organizer’s authenticity. The Act came into force in 1982 but the scam was exposed in 2013, which clearly reflects that even with the law in place, it is not stringent or regulated enough making chit funds a highly risky affair. Nevertheless it is still popular in the southern states.
Tax on Income from Chit Funds
The dividend income earned per month is neither tax deductible nor taxable.
The overall income is taxable as income from other sources.
The overall loss can be claimed as business loss.
How to start a Chit Fund Company?
To start a chit fund business in India, it is recommended that the promoters of the chit fund company first start a Private Limited Company with the objective of operating a chit fund business. After the incorporation of a private limited company, the company can apply with the relevant Chit Fund Registrar of the State to obtain registration. A chit fund business can commence only after obtaining chit fund business registration from the relevant State Registrar.
The documents required to register a Private Limited Company is:-
Also some other notable points are:-
The procedure to register a Private Limited Company is:-
Note: Default in filing of Form INC-20A can lead to punishment. Company shall be punishable with fine which may extend to Rs. 50,000 and officer in default with a fine which may extend to Rs.1000 for every day for which such contravention continues to a maximum of Rs. 1,00,000.
Chit fund business registration can be cancelled in the following cases:-
Types of Chit Funds
Chit funds are of different kinds. These are:
Organized Chit Funds: In northern India, a common type of chit fund is where small paper chits with each member’s names are gathered in a box. When all the members come together for a monthly gathering, the person who is in charge in front of all the present members picks a chit from the box. The member so selected gets to take home the day’s collection. Afterwards, that person’s chit is removed from the box. The person who was previously selected comes to the meetings and pays his/her share, but his/her name will not be selected again.
Special Purpose Funds: Some chit funds are organized for a specific purpose. For example, Christmas gifts fund which has a very specific end date which is about a week before Christmas. Such a fund can reduce the cost and relieves the members from extra work in the busy festival season. Nowadays, such special purpose chit funds are conducted by, ladies wear shops, jewellers etc. to promote their goods.
Online Chit Funds: With the popularity of e-commerce, Chit funds are being organized online as well. Online chit funds are conducted online, and contributors can make their monthly contributions and receive the prize through online transactions including electronic funds transfer system. Each member gets his or her own online account to manage and circulate chit funds.
Registered Chit Funds: Registered chit funds are those funds which are registered with the state government under the Chit Funds Act, 1982. There are over 10,000 registered chit funds in India.
Unregistered Chit Funds: Unregistered funds are those which are not registered with any state government. They are not regulated under any law.
Chit funds companies in India are governed by various State or Central laws. Organized chit fund schemes are required to be registered with the Registrar of Firms, Societies, and Chits. The chit funds are governed according to the following laws: