Debt Funds and FMPs

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Debt Funds and FMPs

 

 

The Finance Bill (2) 2014-15 was passed by the Lok Sabha on July 25, 2014. Once the Rajya Sabha passes it, and it receives Presidential assent, it will be notified as an Act. There has been an amendment that impacts mutual fund investors. Non-equity oriented mutual funds, which were redeemed in the period April 1 to July 10, 2014 will be eligible for tax concessions available before the budget was announced. Interpretation 1. All redemptions, STP, SWP and switches made from FMPs, debt funds, MIPs, gold funds and ETFs and international funds, before July 10, 2014 will enjoy the benefits that existed earlier. The holding period to classify gains as long term will be 12 months, and taxation at 10% before indexation will be available for these transactions 2. Any of the transactions as above, made after July 10, 2014 will be subject to the new rules. The holding period for treatment as long-term capital gains will be 36 months. These will be taxed at 20% after indexation. Any gains for holding periods less than that will be treated as short term capital gains, and taxed at the marginal rate applicable to the investor. Implications 1. Capital gains accrue on sale of an asset. Therefore the new rules will apply at the time of redemption of units. There is no concession on purchases made before July 10, 2014. FMPs with maturity less then 3 years and non-equity oriented funds irrespective of when they were bought, will be subject to the new rules if they are sold within 3 years, after July 10, 2014. 2. Mutual fund investors can approve changes to the fundamental attributes of a scheme. Mutual funds are now sending investors such consent letters, to extend the maturity of shorter term FMPs to a period of 36 months plus 1 day. Investors who do not sign and return such consent letters, will receive the redemption of units on the original maturity date. 3. Investors can consent to a change in scheme features such as applicability of exit load, extension of maturity date, or change in the type of fund from closed end to open ended. 4. Investors whose marginal rate of tax is nil are not impacted by this change. Retired investors whose income falls below the exempt limit for taxation, have a marginal rate of taxation of 'nil'. Therefore such investors are free to redeem, switch or continue with their SWP or STP as before. 5. Investors who have set up SWP or STP from their debt mutual funds will be impacted, but not as much as feared. Each withdrawal will be subject to tax, based on the first-in-first-out principle. Until the time difference between the investment and withdrawal is more than 36 months, they will be subject to short-term capital gains tax. But SWP or STP or redemption from a growth option will include capital and income (recall that NAV represents both). Therefore the impact will be far lesser than the tax impact on interest from bank deposit. See the example below: This difference is because the entire bank interest earned is treated as interest income, but a large part of redemption of the mutual fund is treated as withdrawal of capital invested. Only the gain is subject to tax in a mutual fund, whereas the entire interest income from a bank deposit is subject to tax. Unless the investor redeems the entire amount invested, as may be the case in an FMP, the tax treatment as capital gains (short or long) will work in favour of investments in mutual funds. What should investors do? 1. If invested in FMPs, which are maturing after July 10, consenting for extension of maturity by two years will save taxes, provided the investor does not need the money immediately. 2. If invested in open-ended debt funds or MIPs, continuing with STP or SWP for purposes of regular income, or switching to equity scheme will attract taxes. The tax impact however, will not be too high.

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