Save tax using indexation on FMPs
Mutual fund houses are launching FMPs that would help you get double and even triple indexation benefits.
Have you been wondering whether mutual fund houses have taken a fancy to numerology? Why would they be launching fixed maturity plans (FMPs) of 413, 373 days or even 739 days otherwise? These are nothing ways to help you save on taxes. Indexation allows you to invest for less than two financial years while claiming inflation adjustments for these two years. So, a 373-day FMP invested in March 28, 2014 and redeemed on April 5, 2015 helps inflate the cost of purchase as per inflation for two years and hence allows you to claim a higher tax benefit.
Take for instance, the HDFC Mutual Funds’ 793 FMP, wherein one invests by February 25, 2014 and the investments would mature by April 28, 2016. So technically you are keeping the money for a little over two years but getting the benefits of indexation over three years. Which is why these are typically launched during the February-March period, which marks the end of the financial year.
FMPs are low risk investments, which invest in debt and money market instruments as well as government securities. These are closed-ended schemes where one cannot redeem money before the maturity date. Though the returns cannot be promised upfront by fund houses, they can be graphed at 9.20-9.50% based on the present short-term rates.
Indexation benefits on FMPs can be claimed on investments held for more than 365 days. Indexation is nothing but adjusting the cost of asset or investments (Mutual Funds here) for inflation. This adjustment is done from the date when the investment was made; up to the period it finally matured.
So, if you invested Rs1 lakh in an FMP in February 2013, which redeemed in April 2014. So you invested in financial year 2012-13 and redeemed Rs1,10,000 in 2013-14. The inflation adjusted purchase price of Rs1 lakh becomes Rs1,10,211.3. This is higher than the actual redemption amount and hence you will not pay any taxes.
The negative returns mean capital loss of Rs211.27, which can be set off against other long-term capital gains. If one invests in the 739-day FMP then the inflation for three years is taken into account, thus increasing the capital losses, which can reduce your tax payable. Remember, that the tax rate too changes depending on whether you opt for indexation benefit. Either one pays 10.30% tax without indexation or 20.60% tax with indexation benefits.
|C||Year of Purchase||2013|
|D||Year of Redemption||2014|
|E||CII of 2012-13||852|
|F||CII of 2013-14||939|
|G||Indexed Cost of Purchase [(A x F)/E]||Rs1,10,211.3|
|Taxes (B – G)||-Rs211.27|
However, one should not ignore the other factors of investments namely the investment horizon, the performance of the fund house, the approximate yield or returns on offer etc. There is no point saving taxes if you need the money before the maturity date of your FMP.