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Posted by: Uma Shashikant on Mon, Jul 28th, 2014

Debt Funds and FMPs - What Happens Now?

The Finance Bill (2) 2014-15 was passed by the Lok Sabha on July 25, 2014.  Once the Rajya Sabha passes it, and it receives Presidential assent, it will be notified as an Act.  There has been an amendment that impacts mutual fund investors. Non-equity oriented mutual funds, which were redeemed in the period April 1 to July 10, 2014 will be eligible for tax concessions available before the budget was announced.

 

Interpretation

1. All redemptions, STP, SWP and switches made from FMPs, debt funds, MIPs, gold funds and ETFs and international funds, before July 10, 2014 will enjoy the benefits that existed earlier. The holding period to classify gains as long term will be 12 months, and taxation at 10% before indexation will be available for these transactions

 

2. Any of the transactions as above, made after July 10, 2014 will be subject to the new rules. The holding period for treatment as long-term capital gains will be 36 months. These will be taxed at 20% after indexation. Any gains for holding periods less than that will be treated as short term capital gains, and taxed at the marginal rate applicable to the investor.

 

Implications

1. Capital gains accrue on sale of an asset. Therefore the new rules will apply at the time of redemption of units. There is no concession on purchases made before July 10, 2014. FMPs with maturity less then 3 years and non-equity oriented funds irrespective of when they were bought, will be subject to the new rules if they are sold within 3 years, after July 10, 2014.

 

2. Mutual fund investors can approve changes to the fundamental attributes of a scheme. Mutual funds are now sending investors such consent letters, to extend the maturity of shorter term FMPs to a period of 36 months plus 1 day.  Investors who do not sign and return such consent letters, will receive the redemption of units on the original maturity date.

 

3. Investors can consent to a change in scheme features such as applicability of exit load, extension of maturity date, or change in the type of fund from closed end to open ended.

 

4. Investors whose marginal rate of tax is nil are not impacted by this change. Retired investors whose income falls below the exempt limit for taxation, have a marginal rate of taxation of ‘nil’.  Therefore such investors are free to redeem, switch or continue with their SWP or STP as before.

 

5. Investors who have set up SWP or STP from their debt mutual funds will be impacted, but not as much as feared. Each withdrawal will be subject to tax, based on the first-in-first-out principle. Until the time difference between the investment and withdrawal is more than 36 months, they will be subject to short-term capital gains tax.  But SWP or STP or redemption from a growth option will include capital and income (recall that NAV represents both). Therefore the impact will be far lesser than the tax impact on interest from bank deposit.  See the example below:

 

Debt-funds_and_FMPs

 

This difference is because the entire bank interest earned is treated as interest income, but a large part of redemption of the mutual fund is treated as withdrawal of capital invested. Only the gain is subject to tax in a mutual fund, whereas the entire interest income from a bank deposit is subject to tax.  Unless the investor redeems the entire amount invested, as may be the case in an FMP, the tax treatment as capital gains (short or long) will work in favour of investments in mutual funds. 

 

What should investors do?

1. If invested in FMPs, which are maturing after July 10, consenting for extension of maturity by two years will save taxes, provided the investor does not need the money immediately.


2. If invested in open-ended debt funds or MIPs, continuing with STP or SWP for purposes of regular income, or switching to equity scheme will attract taxes. The tax impact however, will not be too high.

 

To read FAQs on Debt funds and FMPs illustrating the impact of the budget provisions, read this blog.

monil daru on Mon, Aug 4th, 2014 9:03:19 am

what about in case of 10% tax slab & secondly who earned only 15000/- penson only..every calculation is considered with 30% tax slab ?? why its so & not either with zero tax or 10% or 20%?? give me all these 3 types of calculation against bank FD. THANKING YOU

atin khanna on Fri, Aug 1st, 2014 9:30:01 am

any new rule which governemnet make should be applicable with immidiate effect it should not take in account the transaction done prior to the annoucement. Such move typically shakes investors confidence which will prevent any long term investments by investors.

srinivasan on Fri, Aug 1st, 2014 6:12:23 am

timely and good illustration for amateur investors

Ajit Purohit on Thu, Jul 31st, 2014 12:57:17 pm

Most IFAs & investors should make a note of it,& invest accordingly in debt funds.

Sashi Sekhar Saha on Wed, Jul 30th, 2014 10:18:01 am

Instead of making the redemption criteria effecting 10th July, they should have made the investment criteria effective 10th july. In smaller locations where the investor had just started understanding debt funds along with indexation benefits will again be going back to the banking system.Ideally, the policy should be Investments made before 10th July should enjoy the existing benefits and the new rule should have been applicable for investments done on or after 10th July.

HARSH CHATURVEDI on Tue, Jul 29th, 2014 3:08:58 pm

very well illustrated, most of the investors are not aware of this & probably IFAs too are unaware of the minimal impact of taxation.

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