Published blog Details

Posted by: Uma Shashikant and Arti Anand Bhargava on Sun, Jul 13th, 2014

How Do Tax Proposals in Budget-2014 Affect Debt Fund and FMP Investors?

1.    How does the budget impact the investors in debt mutual funds?

       There are three things proposed in the budget that are negative for investors in debt funds.

a. Investors have to hold a debt fund for 36 months, to get any benefit of long-term capital gain (LTCG).  Currently this number is 12 months. (Effective date 1 April 2014)

b. The choice of paying taxes at 10% without indexation on LTCG is no longer available. LTCG from non-equity oriented funds would be taxed at 20% tax after indexation. (Effective date  1 April 2014)

c. Dividends distributed by mutual funds are subject to dividend distribution tax (DDT). This will now be paid on the gross basis and not on net amount of dividend paid. (Effective date 1 Oct 2014)

 

2.     How are FMPs likely to be impacted?

FMPs  with tenure less than 36 months, redeemed after April 1, 2014, will no longer be eligible for indexation benefits, or lower long-term capital gains tax.  The redemption proceeds will be subject at tax at the marginal rate of tax of the investor (nil, 10%, 20% or 30% as the case may be, plus surcharge and cess).

 

3.    What will happen to the return on existing FMPs that mature after 1st April 2014, but do not have a tenure of 36 months?

The effective post tax return to such investors will be lower. The FMP will be as good or bad as a bank deposit.

 

Debt_MF_Budget 2014_pic1

 

An investor who bought this FMP in March 2014, hoping to get 9.98% return, will now earn 7% post tax.

 

4.     How do FMPs and debt funds compare with bank deposits now?

For tenures less than 36 months, FMPs, debt funds and bank deposits are not different in terms of tax benefit. They may differ in terms of return. A debt fund may earn capital gains, but may be subject to expenses and loads. A bank deposit will only earn interest income, and may be subject to TDS.

For tenures longer than 36 months debt funds and FMPs may look better than bank deposits of the same tenure, because they will be able to offer indexed capital gains, which bank deposits do not offer.

 

5.     Should one redeem the debt funds and FMPs?

Any gains from redemption before 36 months of holding will be subject to STCG tax. Since FMPs are closed end funds, a mid-course change in tax aspect makes it tough for investors to act.  FMPs are listed and can be sold only on stock exchanges. The price an investor may get will depend on liquidity in the markets, and if everyone tries to sell, the price is likely to fall further. 

In the case of a debt fund that is open-ended, investors holding for a period of 36 months or more, are still eligible for indexation benefits. Pre-mature sale will increase the tax liability, unless the investor is an entity that is exempt from taxes.

 

6.     How does a bond compare with debt funds now?

A listed bond including a zero coupon bond, will continue to enjoy the benefit of being regarded as a long-term capital asset after a holding period of 12 months.  A listed bond with a tenure over 1 year but less than 3 years, will get a better post-tax return compared to a debt fund or FMP.  Longer tenure bonds (36 months or more) are no different from debt funds in terms of tax benefits.

 

7.    Will the new rules apply only for debt funds and FMPs bought after the effective date of 1 April 2014?

The new rules change the taxability of capital gains that accrue after the effective date of 1 April 2014.   Capital gains accrue on sale, not purchase. Therefore any debt fund or FMP, bought after 1 April 2011 and sold before the expiry of 36 months from the purchase date, will be subject to STCG tax under the new regime.

 

8.     Will the STCG apply only for FMPs and debt funds that are redeemed within 36 months?

The new STCG rules will apply for redemption, switch, systematic transfer, or systematic withdrawal from any non-equity fund before completing 36 months of holding period. Since all funds that invest less than 65% money in equities are treated as non-equity funds for taxation, the change will also impact gold funds, international funds, fund of funds, and other non-equity oriented funds such as MIPs.

 

9.     Will a dividend option work to the advantage of investors in non-equity funds?

There might be a slight advantage in opting for dividend option for a less than three years holding period, if the investor falls in the 30% bracket.  This is because dividend is subject to dividend distribution tax (DDT) at 25% for individual investors.  For investors whose tax rate is lower than 25%, growth option is better than dividend option, since their STCG will be taxed at their marginal rates of taxation. The rate of DDT is flat 25%  and hurts investors with tax rate lower than 25%. Investors in bank deposits only have to pay TDS (10%). They may also be able to claim some refunds.

 

10.   What is the effective rate of DDT now applicable on mutual funds?

Investors using the dividend option, enjoyed a lower effective DDT.  There was an arbitrage opportunity there. DDT was applied on net dividend paid out, at 28.33% effective (25% DDT+cess+surcharge). This rate will now apply on gross basis. See computation below: 

 

Debt_MF_Budget 2014_pic2

 

The above calculation takes into account 10% surcharge and 3% education cess.

Notice that DDT is now payable on the gross amount of Rs.100 and not on the actual amount paid out as dividend. In other words, almost 39% of the investor’s income would be go to the government as tax, instead of 28% earlier. This will be applicable w.e.f. from October 1, 2014.

Note: The above discussion is based on the proposals introduced in the Finance Bill, 2014 and can have amendments before it becomes an Act.

Manas Ranjan Mohanty on Mon, Jul 21st, 2014 6:23:12 pm

Dear Sir/madam.If i have invested in a 370 days fmp which is going to mature next month, shall i renew it to avoid stcg?

G Sathyam on Fri, Jul 18th, 2014 10:10:57 pm

Fin Minister should think, mf liquid funds are more flexable and attracting middle class, making interest on savings. Revert for further some more years as existing tax implication

Uma Shashikant and Arti Anand Bhargava on Fri, Jul 18th, 2014 9:12:28 am

Mr. Umesh: Investment in liquid funds are made for very short holding periods. Choosing the daily dividend option implies a DDT of 25% (effective 28.33%) for individual investors. If they choose the growth option instead, they would pay short-term capital gains depending upon their tax bracket. Those in the 30% tax bracket would pay STCG tax at that rate.

Uma Shashikant and Arti Anand Bhargava on Fri, Jul 18th, 2014 9:11:14 am

Mr. Mukund: There might be little incentive to invest in a 36-month FMP, since it is a closed-end fund. You might be better off in an open-ended debt fund, which gives the required benefit to exit whenever funds may be required. We would recommend that you wait till the Bill is passed in the Parliament and becomes a law. Please do not act on your investments in a manner that harms your interest, before the proposed changes become law.

Uma Shashikant and Arti Anand Bhargava on Wed, Jul 16th, 2014 10:12:21 pm

Mr. Gopikrishna: For tenor three years and less, there will be no difference between an FMP and bank deposit in terms of tax benefit. Such FMP investors will pay STCG tax at a lower rate (10%), or their capital gains may be exempt, as the case may be. For a bank deposit, they can claim an income tax refund or avoid TDS on the interest by submitting Form 15 (G) or Form 15 (H). For the investor falling in the 10% tax bracket, FMPs of tenor more than 3 years will work out better if 20% tax on indexed long term capital gains is lower than 10% tax on interest on bank deposits, depending on the rate of inflation. Investors who are otherwise not paying any tax might get the benefit of lower amount of LTCG on FMP held for more than 3 years, to the extent of unabsorbed basic exemption.

Uma Shashikant and Arti Anand Bhargava on Wed, Jul 16th, 2014 10:09:54 pm

Mr. Anand: The treatment of accrued interest in bonds is another matter requiring another detailed blog. But for the purposes of the current blog, if a capital gain were to accrue in a PSU or corporate bond that is listed, even if the holding period was less than 36 but more than 12 months, such gains are eligible for indexation benefits. In the case of bank deposits, yes, your observation about TDS is correct. The comments was with respect to an investor who is exempt from tax. Such an investor may be at a loss if he chooses a dividend option where DDT is not eligible for any such adjustment.

SATISH JEURKAR on Wed, Jul 16th, 2014 12:36:58 pm

Thanks for giving clarity. Will it be correct to say that though the effective rate is 28.33%,as the % of investors income paid as DDT is 39.52%,even for the 30% slab the growth option is better than the dividend option.

Kirtidhwaj Rana on Wed, Jul 16th, 2014 10:17:49 am

Dear Sir/Madam, My investor is invested 10Lakhs on Treasury Advantage fund on 26 Jan 2013 with Dividend reivest, i request you to please sugest me what we do.Can invetestor continue for 2 years with same position & get the lognt erm benifit or we have to switich in Growth option

umesh on Tue, Jul 15th, 2014 9:53:30 pm

resp madam is the growth option better than ddr for liq/ultrashort funds for investors in 30% tax bracket please guide thanks umesh

MUKUND DEO on Tue, Jul 15th, 2014 6:00:06 pm

Presently I am holding FMP having maturity period of one month with option to renew with dividend on maturity date,if I renew for next 36 months what will be my tax liability? Pl let me know.

Future Vista on Tue, Jul 15th, 2014 2:31:22 pm

Thanks for giving clarity on the taxation after the proposal introduced in the Finance Bill 2014. As always CIEL helps the IFA community and investors more clearly and precisely. Thanks

vijay on Tue, Jul 15th, 2014 1:49:45 pm

Thanks for clarifing on LTCG N STCG for FMPs N Debt funds.

Uma Shashikant and Arti Anand Bhargava on Tue, Jul 15th, 2014 1:04:07 pm

Mr. Sudhir: Changes in LTCG regulations will be effective retrospectively and do adversely impact all the FMPs maturing after April 1, 2014, which would have otherwise benefited from indexation/double indexation! Having said that, in order to protect the interest of investors, the government may revise the effective date, probably announce a post-budget date, before it is passed as an Act in the Parliament.

Uma Shashikant and Arti Anand Bhargava on Tue, Jul 15th, 2014 12:57:09 pm

Mr. Suresh: All non-equity oriented funds (that hold less than 65% equity) fall under the purview of the changes in tax regulations outlined in the blog. This includes Gold ETFs.

Uma Shashikant and Arti Anand Bhargava on Tue, Jul 15th, 2014 12:55:42 pm

Mr. Joseph Kurian: The Finance Bill makes the LTCG proposal applicable from Assessment Year 2015-16, which translates into Financial Year 2014-15, beginning April 1, 2014. This is currently a Bill and may undergo amendments before it is passed as an Act in the Parliament. The blog clarifies that LTCG rules for listed bonds remain unchanged.

Vishram on Tue, Jul 15th, 2014 11:40:08 am

Good and informative.The basis changes have been correctly putforth.

v v anand on Tue, Jul 15th, 2014 11:01:38 am

This article gives the clarity we've all been searching for! A couple of points on specific observations: (a)"A listed bond with a tenure over 1 year but less than 3 years, will get a better post-tax return compared to a debt fund or FMP.". This assumes that, capital gains will be there in bonds,held for between 12 m. and 36m. However, coupon on bond is interest , and is taxable . Theoretically, there can be capital gains on bonds if rates fall, but while this happens with govt securities, it happens less with corporate bonds. Pl clarify if I err. (b) " Investors in bank deposits only have to pay TDS (10%). They may also be able to claim some refunds." Depositors have to pay tax at their marginal rate after taking credit for the TDS. TDS does not limit their tax liability to 10%. Would also be obliged for your clarification on what refunds you envisage

E M SIVASANKARAN on Tue, Jul 15th, 2014 10:44:36 am

WELL DONE .THANKS FOR BRINGING CLARITY ON THE SUBJECT.

BALU D on Tue, Jul 15th, 2014 10:31:49 am

VERY USEFUL MESSAGE. BUT AFFECT THE DEBT PRODUT SALE.

Uma Shashikant and Arti Anand Bhargava on Tue, Jul 15th, 2014 9:43:15 am

Mr.Rakesh Kapoor: Capital gains will be computed on first-in-first-our basis on the redemption date.

MGS PILLAI on Tue, Jul 15th, 2014 7:39:47 am

Quite nice of you, bringing out the facts in an easily understandable way. Precise, clear and easy to undestand. Thank you.

Uma Shashikant and Arti Anand Bhargava on Mon, Jul 14th, 2014 9:48:42 pm

Mr.Singhal: Since the changes being proposed apply retrospectively, representations are being made to the Ministry by various parties. Our advice would be to ask you to wait until the Bill is passed by the parliament, after considering all the representations. Do not act in a manner that harms your interest, before the proposed changes become law. As for your systematic withdrawal from a debt fund, if you do not have any income, then it is likely that your marginal rate of tax is nil. In which case, your tax liability on such withdrawal, even if it is after a short period of investment, is also nil.

R K Agrawal on Mon, Jul 14th, 2014 8:51:57 pm

Very good clarification by way of simple question answer model. Cleared all the doubts relating to this issue.

Rakesh Kapoor on Mon, Jul 14th, 2014 8:32:44 pm

When there is SIP FOR e.g. 36 month(s) monthly deducations what will be holding applicability of holding Fund will apply to month wise contribution or not?

Atul Kamdar on Mon, Jul 14th, 2014 5:45:08 pm

A commendable job done. Have made it very simple and lucid for us to understand. Thanks.

prem singal on Mon, Jul 14th, 2014 5:09:15 pm

I do not know what is to be done with my investments in debt funds.I was advised by my financial advisor to redeem my equity funds 2 years before my retirement and invest in debt funds and get swp from the debt fund for your daily expenses and this will be tax free as I do not have any other income.Kindly inform what should be my action plan now.I am 59 years old and have no other income for my monthly expenses but for systematic withdrawal plan from my debt funds from my debt funds.

Pramod Bajaj on Mon, Jul 14th, 2014 3:08:43 pm

Very well written. The only way an investor can now soften this blow would be through a Long term capital loss of last financial year which can be carried forward. That can be used to set off the short term gain of FMPs of this year. So all those investors should make sure that do not miss the deadline of 31st July 2014 for filing the I.T return.

Sudhir on Mon, Jul 14th, 2014 12:29:44 pm

What is impact on those 367 days FMP's invested after April 2013 & getting matured for payment now ? How will they be taxed. Can some learned readers clarify ? Also what about those 13 months FMP's which were already matured during April ~June 2014. Ideally this amendment should apply for FMP"s being invested now onwards,not restrospectively. if applied retrosepctively all investors who invested on the basis of offered issue conditions during second half of 2013 stands to lose big due to treatment of redemption as STCG now !

Karthikeyan on Mon, Jul 14th, 2014 10:52:36 am

Thanks Madam. Nice & Simple Article with lots of clarity

Joseph kurian on Sun, Jul 13th, 2014 10:54:15 pm

I thought the new LTCG is getting implemented from 1st April 2015. Your report you have mentioned it is from 1st April 2014. Can you clarify the same. Also does direct bonds still continues to get LTCG and indexation benefits ?

Vijay P Kashyap on Sun, Jul 13th, 2014 8:48:15 pm

Very informative after new tax laws.

Suresh on Sun, Jul 13th, 2014 8:31:41 pm

What about Gold ETFs. What should be the holding period to be a long term capital asset now? Is it still going to have 10% without index and 20% with index benefit? please suggest

prakash on Sun, Jul 13th, 2014 7:26:02 pm

Excellent madam thank you so much for making these complicated things easier to understand

gopikrishna on Sun, Jul 13th, 2014 7:17:32 pm

Non tax payable investors and the tax payers in the bracket of 10% tax are more beneficial when invested in a Bank FD going by a present scenario of 9.00 to 9.25% quarterly compounded ROI compared to DEBT instruments and FMPs. Correct. Your comments please?

Navin Kumar on Sun, Jul 13th, 2014 6:48:25 pm

10 FAQ gives me clear understanding of the debt taxation post budget scenario.

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