Tax advantages of Fixed Maturity Plans (FMPs)

Tax Advantages of FMP^@

Fixed Maturity Plans scores high on tax advantage when they are compared to similar instruments like Fixed Deposits (FDs).  In FDs the interest earned is added to the investor’s income and taxed at individual personal income tax rate. Interest from Fixed Deposits is categorized as ‘Income from Other Sources’ under the Income Tax laws. In the case of FMP, the tax implication depends upon the investment option chosen – Dividend or Growth

Which Option Should You Choose?

1. Dividend Option: Dividends in FMPs are tax free in hands of investors. However, Mutual Fund companies have to pay a Dividend Distribution Tax (DDT) of 25% plus surcharge and cess for Individuals and HUFs (28.325%) and 30% plus surcharge and cess for others (33.99%) before distributing it to investors.
2. Growth Option: If any investor opts for Growth option, he is subject to Capital Gains Tax.
3. Short Term Capital Gains (if units are held for 12 months or less) are taxed as per the Tax Slab Rate. For Long Term Capital Gains (if units are held for more than 12 months) are taxed at 10% without indexation or 20% with indexation. The indexation benefit inflates the cost of purchase lowering long term gains tax liability, which is not the case of FDs

The length of the holding period matters, especially when one has to decide between growth and dividend options. Investors can go for the growth option if the holding period is more than a year and for the dividend option if the holding period is less than a year.

*The last 5 year simple average indexation is at 10%, hence we have assumed a 10% indexation cost for estimation.

** 1 year SBI FD rate

Double Indexation Benefits

Double indexation simply means getting the benefit of two years of indexation when the holding period for investments has been substantially less than two years.

Concept of Double Indexation

A.    If Mr. ABC had bought 10 units of mutual fund for Rs. 10,000 on 1st April 2011 and sold them for 11,000 on 1st April 2012. (Holding period- 1 year).

B.    If Mr. ABC had bought 10 units of mutual fund for Rs. 10,000 on 31st March 2011 and sold them for 11,000 on 1st April 2012. (Holding period- 1 year and 1 day)

In the two examples given above, the information is same except the year of purchase, which differs by just one day.The difference in one day changes the financial year of purchase for Mr. ABC, which changes the CII numbers to be used for indexation.

Case A: Single indexation

*Source: Central Board of Direct Taxes (CBDT)

Case B: Double Indexation

*Source: Central Board of Direct Taxes (CBDT)

Here is a small comparison between Fixed Deposits & FMP with Double Indexation Benefits: