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Debt funds - Tax doubles and Tenure trebles
Retail investors who have been looking at debt funds for good short- term returns and tax benefits will now have to go for other options. The Union Budget has increased the rate of tax of debt funds to a flat 20 per cent. Importantly, the tenure for claiming long- term capital gains has been increased to 36 months from the existing 12 months.
Earlier, the long- term capital gains tax was 10 per cent without indexation and 20 per cent with. The Union Budget is marginally negative from the debt fund perspective. But it will also ensure that people willing to stay for three years and above will come in. The fund manager will also benefit from this because they will get money for the long term. The rise in the tax rates will bring these products on a par with fixed bank deposits in which the income is taxed on the tax bracket.
Mutual fund experts say besides the rate, the lock- in tenure increase of one to three years might have a wider impact. This is because, at present, the short- term capital gains tax ( for which the gains are added to the income of the investor and taxed as per the income- tax bracket), is applicable for investments of less than one year. Under the new regime, the investor will have to pay short- term capital gains for a period of less than three years — much like real estate investors. In other words, the tenure for availing long term capital gains tax has been trebled.
This will hurt the appetite of retail investors in short- term debt instruments. "Now investors will have to pay 10- 30 per cent ( according to the income tax bracket) if they exit the scheme in less than three years; this will hurt sentiment,
Investors will now get more interested in schemes like arbitrage funds, where the annual returns are 910 per cent, in tune with the debt fund returns. Arbitrage funds invest in equities and benefit from the price difference of shares in the cash and future market or between two exchanges. Since the buying and selling happens at the same time, these funds are ideally like debt funds because there is no risk. However, the tax treatment of these schemes is according to equity guidelines. That is, there is no tax in these schemes if you have stayed invested in these funds for over one year and 15 per cent short- term capital gains tax.
Another marginally negative move for investors is the dividend distribution tax, which has gone up by 2.47 per cent due to the new method of calculation.
Both mutual funds and stock investors will now get lower benefit. In the past, the company used to deduct dividend distribution tax at 16.9 per cent. This number will now go up to 19.4 per cent.
Both these moves will impact risk- averse investors, who prefer debt funds and dividend income, as they do not want to participate aggressively in equities. An increase in these rates will hurt these investors.
Fixed maturity plans will be worst hit, dividend pay out will decrease marginally, arbitrage funds should benefit
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