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Bank FDs after Budget 2014

 

Bank FDs after Budget 2014

While the Budget bats for bank FDs, investors can still find ways to benefit from debt and gold funds

 

A tax benefit of 1,300- 3,000 a month isn't huge, but the Budget proposals on individual taxation came as a huge relief as the benefit came after many years in the form of increase in the basic exemption limit to 2.5 lakh ( 3 lakh for senior citizens); increase in the 80C and public provident fund limits to 1.5 lakh and in the higher home loan interest benefit of 2 lakh.

The middle class would also heave a huge sigh of relief after the Union revenue secretary's assurance on Saturday that there would be no retrospectively in the flat 20 per cent tax on debt mutual funds.

But the doubling of the tax and the higher holding tenure for getting long- term capital gains benefits would still remain a sore point.

Now, if the investor sells the units in less than 36 months, capital gains will be added to their income and taxed as in their tax bracket, much like bank fixed deposits (FDs). There isn't any clarity on the inflation indexation benefit that investors used to get in their investments in debt instruments.

It would be unfair on debt investors if the indexation benefit is taken away." But there are many others who suggest ways out of the tricky situation. Here's how.

Tenure critical for highest tax bracket

From the tax rate point of view, investors in the highest bracket will not lose if they stay invested for three years. For, at 20 per cent, debt funds are still better than the FD tax rate of 30 per cent. However, if they take out the money before three years, they will have to pay the tax at the same rate of 30 per cent. Earlier, they benefited from the 10 per cent without indexation and 20 per cent with indexation regime.

Rate of return key for middle tax bracket

For investors in the 20 per cent tax bracket, things will be trickier. Both FDs and debt funds will be taxed in the same way, both in the short and long term. Here, the rate of return will come into play. At present, State Bank of India offers nine per cent for FDs of one year and above, whereas debt MFs have returned eight to 11 per cent. Income funds and gilt funds have suffered in the past year, returning only two to six per cent, according to data from Value Research.

If retail investors in the medium tax bracket choose good schemes, they will earn higher returns. They could, in fact, look at hybrid debt funds, which invest a little over 65 per cent in debt and the rest in equities. While their tax treatment will be like debt funds, some of them are returning a good 15- 20 per cent or even more. Investors who put money in hybrid funds will give themselves the opportunity to negative the tax impact partially due to higher returns.

Lowest tax bracket should go for fixed deposits

Investors in the lowest tax bracket ( 10 per cent) should not show any interest in debt funds, especially if the intent is to invest for more 3 years, as long- term capital gains will be taxed at 20 percent. If they invest for less than 36 months, short term capital gains will be taxed at 10 percent, which is the same as in the case of fixed deposits. However, by investing in high yielding debt hybrid funds, they can get higher returns than traditional options like bank deposits and bonds.

How to still enjoy debt funds

If you are in the highest tax bracket but your spouse or family member is, say, a senior citizen getting the benefit of the higher basic exemption of 3 lakh, or 5 lakh if he/ she is over 80, and don't have any income, you could invest in their name to get tax benefits. The capital gains could even become tax- free if the amount is below their exemption limits.

Arbitrage funds emerge winners

This is one category likely to benefit from the new tax treatment. These, by their nature, are debt funds but they get the tax treatment of equity funds because they invest in equities.

Typically, if the stock price of Reliance Industries is 967 on the BSE exchange and 970 on the National Stock Exchange, the fund manager will buy the stock on BSE and sell on NSE. Similarly, if there is a price difference between the spot and futures market, again, the fund manager will take advantage of that. These funds do quite well in volatile market conditions.

Since the strategy implies buying and selling at the same time, these funds aren't risky but the returns are low at nine to 10 per cent –similar to returns from most debt schemes and bank deposits. The advantage is, there will be no tax if the investor exits after one year, as the long- term capital gains tax for equities is zero. On the other hand, if the investor exits before one year, there will be a short- term capital gains tax of 15 per cent.

If your policy is maturing after October 1, the insurer will deduct a tax at source (TDS) of two per cent from the proceeds of your life insurance policy for both unit- linked insurance plans and traditional plans. The taxation will be on the entire sum, including the sum allocated by way of bonus, provided the premium paid towards the policy is more than 10 per cent of the sum assured.

Currently, under Section 10( 10D) of the Income Tax ( I- T) Act, any sum received from a life insurer is not taxable if the premium payable is up to 10 per cent of the sum assured. Tax would be payable as on your applicable slab if the premium exceeded the 10 per cent amount. However, since there was no TDS, several assessees avoided the tax. This TDS will, however, not apply if the amount is less than 1 lakh. What this means is that if your sum assured is less than 10 times the annual premium, you will need to pay a tax on the maturity proceeds. But the death benefit in this case will continue to be tax free.

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