Skip to main content

Direct Taxes Code (DTC) and its effect on Fixed Maturity Plans (FMPs)

As the Income Tax Act makes way with effect from April 1, 2012, for the Direct Taxes Code, investors should be careful of overlapping investments. Meaning, investments where the IT Act is applicable while making it, whereas it is the DTC that will apply at the time of maturity.

For example, take the currently popular Fixed Maturity Plans (FMPs) of mutual funds. The attraction of these schemes is the tax efficiency they offer over bank fixed deposits. Both bank FDs and FMPs offer a similar rate of return. While the interest on bank deposits is taxed at the normal rate, in the case of FMPs (over a year), the 10 per cent (20 per cent with indexation) capital gains tax rate applies. Consequently, on a post-tax basis, an FMP is much more advantageous.

However, there is a significant issue. If you were to invest in, say, any one year FMP available currently, the IT Act applies at the time of making the investment. However, at maturity (2012-13), the DTC would apply. And, under the DTC, the tax advantage an FMP has may not be available. Let's understand how and why.

Basically, long-term capital gains from equity shares and equity-oriented mutual funds continue to be tax-free under the DTC. However, the current system of long-term capital gain taxation of non-equity MFs (10 per cent without indexation or 20 per cent with indexation) has been discontinued under the DTC. Though indexation will apply, the resultant capital gain would be added to the other income of the taxpayer and be brought to tax at the slab rates applicable. (Note here that it is not indexation per se but only the special rate of 20 per cent after indexation that is discontinued – indexation itself continues to apply).

Also, under the DTC, there is a significant departure from the ITA with respect to the method of determining whether a non-equity asset is long-term or not. For instance, under the ITA, a financial asset has to be held for over a year to qualify as long-term. Such a holding period is calculated from the date of purchase to the date of sale. For example, if you invest in an FMP in, say, August 2011, it would qualify as a long-term asset with effect from August 2012. However, under the DTC, the asset has to be held for over one year from the end of the financial year in which it was acquired. So, taking the same example, the FMP will qualify as long-term under the DTC only if held for over one year. From March 31, 2012, it will be considered a long-term asset only if sold anytime from April 2013 onwards.

So, let's see what these provisions mean for a typical 370-day FMP on offer currently (say in August). First, since the maturity of this FMP will be in August 2012, it is the DTC provisions that would apply, not those of the IT Act. That being said, since an FMP is a nonequity asset, the current system of 10 per cent (20 per cent with indexation) will not apply and, instead, the income will be subjected to the marginal rate of tax. Even this one could have lived with, since at least the net income subjected to tax would be lower due to applicability of indexation. However, in the above example, for the FMP to qualify as a longterm asset (and, hence, be eligible for indexation), it needs to be held for over one year from the end of the financial year in which it is purchased. That is, it needs to be held till April 2013. However, the maturity of the FMP will be in August 2012 and, hence, indexation will also not be applicable. Consequently, the income from such an FMP will be taxable just like interest from a bank deposit is – to be added to your other income and taxed at slab rates. The net effect would be that, given a similar rate of interest, there would be no difference whatsoever in the posttax return from a bank deposit and an FMP!

SUMMARY

The DTC is just round the corner. It is time various stakeholders take cognizance of this and tweak their offers in a way that would be optimal for the consumer. For example, the FMP tenure could have been so adjusted that every investor would end up qualifying for indexation benefits. Many may have already invested, not knowing (and not being warned) that at the time of maturity, the tax efficiency one has been used to all these years will not be available.

Investors, on their part, would do well to appreciate that this dual law applicability at the time of entry and exit is there for not only mutual fund schemes but also a host of other investments such as insurance plans, bonds and even to payments that earn tax deductions such as home loan instalments and tuition fees. Therefore, before committing funds for the long term, take care that the investments are tax-efficient and in conformity with the provisions of the DTC, rather than the current IT Act.
 

Popular posts from this blog

Tata Mutual Fund

Being a part of the Tata group, the fund has the backing of a very trusted brand name with strong retail connect. While the current CEO has done an excellent job in leveraging the Tata brand name to AMC's advantage, it is ironic that this was just not capitalised on at the start. Incorporated in 1995, Tata Mutual Fund remained an 'also-ran' fund house for around eight years. Till March 2003, it had a little over Rs 1,000 crore in assets and 19 AMCs were ahead of it. But soon after that the equation changed. It was the fastest growing fund house in 2004 and 2005. During these two years, it aggressively launched six equity funds, two debt funds and one MIP. The fund house as of now stands at No. 8 in terms of asset size. This fund house has a lot to offer by way of choice. And, it also has a number of well performing schemes. Tata Pure Equity, Tata Equity PE and Tata Infrastructure are all good funds. It also has quite a few good debt funds. The funds of Tata AMC are known to...
Read more

UTI Mutual Fund

Even though only a few of UTI’s funds are great performers, this public sector fund house has many advantages that its rivals do not. It has a huge base of retail equity investors and a vast distribution network. As a business, it looks stronger than ever, especially in the aftermath of credit crunch. UTI is, by a large margin, the most profitable fund company in the country. This is not surprising, since managing equity funds is more profitable than debt. Its conservative approach and stable parentage is likely to make it look more attractive to investors in times to come. UTI’s big problem is the dragging performance that many of its equity funds suffer from. In recent times, the management has made a concerted effort to improve performance. However, these moves have coincided with a disastrous phase in the stock markets and that has made it impossible to judge whether the overhaul will eventually be a success. UTI’s top performers are a few index funds, some hybrid funds and its inf...
Read more

Salary planning Article

1. The salary (basic + DA) should be low. The rest should come by way of such allowances on which the employer pays FBT and you don't pay any tax thereon. 2. Interest paid on housing loan is deductible u/s 24 up to Rs 1.5 lakh (Rs 150,000) on self-occupied property and without any limit on a commercial or rented house. 3. The repayment of housing loan from specified sources is also deductible irrespective of whether the house is self-occupied or given on rent within the overall ceiling of Rs 1 lakh of Sec. 80C. 4. Where the accommodation provided to the employee is taken on lease by the employer, the perk value is the actual amount of lease rental or 20 per cent of the salary, whichever is lower. Understandably, if the house belongs to a family member who is at a low or nil tax zone the family benefits. Yes, the maximum benefit accrues when the rent is over 20 per cent of the salary. 5. A chauffeur driven motor car provided by the employer has no perk value. True, the company would...
Read more

8 Investing Strategy

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-...
Read more

Debt Funds - Check The Expiry Date

This time we give you an insight into something that most debt fund investors would be unaware of, the Average Portfolio Maturity. As we all know, debt funds invest in bonds and securities. These instruments mature over a certain period of time, which is called maturity. The maturity is the length of time till the principal amount is returned to the security-holder or bond-holder. A debt fund invests in a number of such instruments and each of these instruments would be having different maturity times. Hence, the fund calculates a weighted average maturity, which would give a fair idea of the fund's maturity period. For example, if a fund owns three bonds of 2-year (Rs 30,000), 3-year (Rs 10,000) and 5-year (Rs 20,000) maturities, its weighted average maturity would be 3.17 years. What is the big deal about average maturity then, you may ask. Well, knowing a fund's average maturity is important because it tells you how sensitive a fund is to the change in interest rates. It is ...
Read more
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now