Long-term FMP Investors Face Almost Zero Tax Now

August 29, 2014
1 min read

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 Rs. 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,“ said a senior fund manager.

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. 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 anyone 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.

[Source: www.economictimes.indiatimes.com]

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