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Indexation benefit can lower your tax liability

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Fixed maturity plans come with superior tax benefits, which are lower tax rates and the option to avail double indexation benefits when compared with bank fixed deposits. However, such advantages come at the cost of lower liquidity and higher credit risks.
The returns you get by investing in FMPs are subject to tax based on the options you select — dividend or growth. All the dividend schemes in FMPs are subject to dividend distribution tax (DDT) at 12.5% plus 5% surcharge and 3% cess, which translates to a total tax rate of 13.519%. This tax is deducted at source — dividend that you receive is tax-free in your hands.


FMPs also come with the growth option. Here again, there are two options, the short-term and the long-term. All investments in the growth option of an FMP, if redeemed within one year from the date of investment, are treated as short-term investments. Gains from such investments will be taxed at the income tax rate that is applicable to you as per your income. In case you are not sure in which tax rate slab you come under,10%,20% or 30%, it is better to consult a tax expert or a chartered accountant.


On the other hand, if you have invested in an FMP with growth option and remain invested for more that a year, your return will be treated as long-term capital gains. In such a situation, you will be paying tax at the rate of 10.3%, if you do not wish to avail of the indexation benefits. If you opt to take indexation benefits, you will be taxed at 20.6% after adjusting the principal sum for inflation. The effective tax rate in most cases will be actually lower than 10.3%.


Indexation benefits are allowed to you as an investor to neutralize the impact of inflation. Again, a tax consultant or a CA would be of help if you find it difficult to calculate indexation benefits.


As an FMP investor, it is advisable to opt for the dividend option if you invest for less than a year, since this could result in lower tax compared to the growth option, which will be treated as short-term capital gains. However, if you are investing for more than a year, growth option should be preferred.


Also, double indexation benefits will come into play when you invest in an FMP in one financial year while it matures in the third financial year. For example, you have invested in an FMP with growth option in March 2012, that is financial year 2011-12, and it matures in April 2013, that is in financial year 2013-14, you are allowed to use indexation benefits to neutralize the impact of inflation from financial years 2011-12, 2012-13 and 2013-14. This is why 14-month FMPs suddenly turn very popular in March — the last month of a financial year. However, such benefits may not hold good after the government's proposed direct tax code (DTC) comes into effect. Double indexation can be more effective in reducing your tax liability in a high-inflation phase.

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