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Taxation on Bank deposits and Debt Mutual Funds

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Understanding taxation among debt funds and Bank deposits is very important as it becomes one of the parameter of selection among these.

Tax rates FY 2011-2012

Description

Debt Funds

Bank deposits

Profit booked within One year of Investment

As per Income Tax slabs

As per Income Tax slabs

Profit booked after one year of Investment

10% without Indexation or 20% with Indexation

As per Income Tax slabs

Whichever is lower

Dividend Received

No Tax

NA

Dividend distribution Tax

Liquid Schemes

25%+5%(surcharge)+3% (cess)=27.038%

NA

Debt schemes other than Liquid

12.5%+5%(Surcharge)+3% (cess) = 13.519%

NA

* in finance bill 2013-14 , Finance minister has increased the dividend distribution tax in Debt schemes other than liquid and thus are now at par with Liquid schemes which is 27.038%

Let's take an example to understand it better.

Mohan has 2 options in front of him.Either to invest Rs 1000000/- in 370 days FMP with indicative yield of 9.5% p.a or to select Bank fixed deposits with rate of 9.5% ( compounded quarterly).

Particulars

FMP (Retail Growth Option) 370 days

FMP (Retail Growth Option) 370 days

Bank Fixed deposit

Without Indexation

With Indexation

Amount invested (Rs.)

1000000.00

1000000.00

1000000.00

Assumed rate of return / interest (%)^

9.50%

9.50%

9.50%

Return / interest for first 12 months (Rs.)

95000.00

95000.00

98438.00

Return / interest for remaining 5 days (Rs.)

1301.37

1301.37

1348.47

Total return / interest for the period (Rs.)

96301.37

96301.37

99786.47

Maturity proceeds (Rs.)

1096301.37

1096301.37

1099786.47

Indexation Benefit

Not availed

Yes

No

Indexed Cost of Investments (assuming 7% rate of Inflation Index)

Not availed

1070000.00

NA

Applicable tax rate assuming highest tax bracket + 10% Surcharge + 3% Education Cess

11.33%

22.66%

33.99%

Tax liability (Rs.)

10910.95

5959.89

33917.42

Receipts net of tax (Rs.)

1085390.42

1090341.48

1065869.05

Post-tax return for investment period of 370 days (p.a.)

8.42%

8.91%

6.50%

The above calculation clearly shows that even if a person comes in lowest tax slab, then also FMP can provide better tax efficient returns after indexation.(if at all inflation is on his side). Moreover when we know that when interest rates are falling, open ended debt funds have potential to deliver better returns

Even when the requirement is to park money less than one year, then also the short term funds and ultra-short term funds prove to be very tax efficient due to less dividend distribution tax.

Happy Investing!!

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