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Mutual Fund FMPs with Zero Tax



Inflation reduces tax liability on debt fund gains from investments of over 3 years to just 0.5%Experts are of the view that FMPs coming up for maturity can be rolled over if an investor does not have any cash requirements in the near future

 

Investors in short-term debt funds may be ruing the changes in tax rules but long-term investors have plenty to smile about.


They are still eligible for a tax bonanza, thanks to the indexation benefit available on investments of more than three years. If you invested in a three-year fixed-maturity plan (FMP) in 2011 and earned a return of 9.5%, you will have to pay a paltry tax of 0.56% on the gains.

 


High inflation in the past few years has reduced the tax payable on gains from debt funds to almost nil.


No tax is payable even if the debt fund you bought in 2009 has earned 10% returns.

Till now, gains from investments in debt funds were treated as long term capital gains if the investment was held for more than a year.


After the budget increased the minimum holding period from one year to three years, short-term FMPs of one-two years virtually vanished from the market.

But fund houses have now replaced them with three-year FMPs.


At least eight three-year FMPs are currently on offer and sources reveal more are in the pipeline.

Though illiquid, these schemes are more tax-efficient than fixed deposits. The interest on fixed deposits is fully taxable. It is added to the income of the investor and taxed as normal income. For those with a taxable income of more than ` . 10 lakh a year, the tax is 30%. In stark comparison, the effective tax on gains from a three-year FMP is 0.56%. The budget killed one-two year FMPs but three-year FMPs still have a significant tax advantage over fixed deposits.

Though FMPs can give higher post-tax returns, they don't score very well on the liquidity front.


They are closed-end schemes and the fund house is not under any obligation to redeem the units before the maturity date. the maturity date.


However, mutual funds do offer a small exit window to investors who want to redeem before maturity. FMPs are listed on the stocks exchanges and one can sell investments to any one willing to buy them.

But this exit route is only a theoretical possibility. In reality, there are hardly any FMPs traded on the exchanges. According to Value Research, in 2013, only eight of the 700 FMPs available in the market were traded on the BSE on 20 days. This year has been better but the volumes rarely cross a few hundred FMP transactions a day . The scanty trading is not the only problem. The price offered by buyers is usually lower than the NAV of the scheme. If you need the money urgently , you will have to take a loss and sell at a discount. So, be ready to hold for the full term when you invest in an FMP. Several fund houses such as HDFC Mutual Fund, ICICI Prudential Mutual Fund, Reliance Mutual Fund, IDFC Mutual Fund, among others, are rolling over their one-year, one-day fixed maturity plans (FMPs) that are coming up for maturity. It will help investors ward off the increased tax proposed in the Budget. The finance minister has proposed to hike tax on long term capital gains in all non-equity schemes to 20% from 10% and the holding period to 36 months from 12 months in the Budget. HDFC Mutual Fund has rolled over its HDFC FMP Series 26, maturing in July 2014, by 763 days to August 2016. Other mutual funds are likely to follow suit.

Experts ask investors to consider rolling over these FMPs if they don't have any cash requirement in the next two years, as they feel interest rates are headed lower in the coming months. With the State Bank of India cutting interest rates on deposits by 50 basis points across maturities, it is a matter of time before interest rates head down. It makes sense for investors to roll over their FMPs and lock-in their funds at these high rates

If the FMP was meant to meet a specific goal, which is less than two years away, do not rollover. FMPs Still Score on Taxation

Investment experts say individuals who have opted for the growth option can consider the rollover of their FMPs. If you have invested in the dividend payout option, it may not make much sense to rollover. Since a dividend distribution tax (DDT) has already been paid, there will be no further tax benefits. Investors who do not have any liquidity requirements could consider rolling over their FMPs, as they will get the benefit of indexation, thereby reducing their tax liability. Triple indexation benefit may even reduce the tax liability to zero.

If you rollover your FMP beyond three years, your income will be subject to long-term capital gains tax at 20% or with indexation, whichever is lower. By using the indexation method to calculate tax, you shall be eligible for triple indexation benefits. Using this method, your tax liability may be negligible or even nil.

However, experts say investors must keep in mind their cash flow needs and the purpose for which the investment was made in the FMP before taking a final decision.

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