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Debt Funds - Hike in long-term capital gains
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Hike in long-term capital gains, tax on non-equity funds to 20 percent and extending the holding period to three years will be a damper for debt funds
THE Budget comes as a mixed bag of blessings and disappointments for mutual fund investors. While the increase in tax exemption limit under Section 80C of the Income Tax Act will benefit equity fund investors, the changes in tax structure on debt funds may prove to be a drag on their finances. Here's how the maiden Budget presented by Finance Minister Arun Jaitley will affect the mutual fund investors.
DEBT FUNDS The individuals who invested in short-term debt funds and fixed maturity plans (FMPs) to earn better post-tax returns will have to pay more taxes now. The finance minister has proposed a hike in the long-term capital gains tax on debt mutual funds from 10 percent to 20 percent and has extended the holding period to 36 months from 12 months. Experts believe even gold fund investors will be affected by the proposal.
People in the higher tax bracket, who preferred mutual funds because of the 30 percent tax implication on the interest earned from bank fixed deposits, will be the worst hit. This makes investments in debt schemes, including FMPs, for less than 36 months, unattractive. The changes proposed in dividend distribution taxes (DDT) would also hurt debt investors.
The DDT was on the net dividend distributed. Now it will be based on the gross dividend distributed. She says investors will be taxed higher at 33.99 percent (including surcharge and cess) from 25.36 percent earlier. Investors should not, however, give up on debt funds entirely because of the new tax proposal.
Due to high inflation, even if you invest in debt funds with a three-year horizon, using the indexation method, your post-tax returns could be higher than those offered by bank fixed deposits.
Some experts feel investors should take a look at arbitrage funds as they can offer better post-tax returns. Arbitrage funds, as the name suggests, look for an arbitrage opportunity among different markets. They are treated as equity funds for taxation purposes, that is, investments held for over one year will not attract taxes. Investors with no risk appetite and an investment horizon between one and three years can consider investing in arbitrage funds.
ELSS The Budget proposal to increase the investment limit under Section 80C is good news for fans of tax-saving mutual fund schemes. The finance minister has raised the exemption limit from `1 lakh to `1.5 lakh under the Section, thereby , enhancing the tax-saving ability of small investors.
Effectively, it means that you can now enjoy a further `50,000 deduction on your total taxable income if you invest an equivalent amount in eligible Section 80C instruments. Individuals earning up to `4 lakh and making an investment of `1.5 lakh under Section 80C will be out of the tax net. The earlier limit was considered too low for investors to actually make optimum use of the available options.
For most individuals, the mandatory contributions towards Provident Fund and premiums towards life insurance policies ate up a chunk of the `1 lakh limit. Earlier, many investors had no reason to save further. However, the revised limit now provides more headroom for them to consider good investment avenues. Experts insist that the revised limit should be used to allocate more towards equities. your compulsory savings towards PF and insurance, investors should now make use of this enhanced limit to take exposure to a different asset class, such as equities."
A tax-saving equity fund or equity-linked savings scheme (ELSS), which falls under the Section 80C umbrella, is the best option to deploy the surplus savings. Investors should make the most of the additional investments of `50,000 allowed under Section 80C by picking up the right schemes. Not only will it help in saving tax, but also provide more scope for wealth creation over the long term. Besides, with a lock-in period of just three years, these products come with a shorter maturity period than most traditional savings instruments, including the Public Provident Fund, National Savings Certificates and tax-saving FDs. Says Rajesh Kothari, managing director, It is better to invest in equity for the long term compared with fixed income, both from the perspective of liquidity and tax saving.
RGESS Apart from ELSS, first-time equity investors looking to save taxes, in addition to Section 80C, can consider investing in the Rajiv Gandhi Equity Savings Scheme (RGESS). If you exhaust the `1.5 lakh limit, you can claim a further deduction of `25,000 on your taxable income by investing in it. Many investment experts were expecting the new government to give it a quiet burial, but nothing of the sort happened. RGESS continues to be intact and first-time investors can continue to invest and claim tax benefits. Those with a gross annual income of `12 lakh or less can invest up to `50,000 under Section 80CCG in the scheme every year, and claim tax benefits for a period of three years.
Investors have the option of buying stocks from the BSE-100, NSE CNX 100, Maharatnas or Navratnas or ETFs specified under the scheme. Experts say investors must avail of the entire `1.5 lakh limit under Section 80C and opt for ELSS if they want equity exposure. If you are inclined to save more tax, consider opting for RGESS, preferably through designated mutual funds and not through direct investment in shares.
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