Under DTC, fixed-maturity plans may lose double-indexation benefit

One of the benefits of fixed-maturity plans (FMPs) is double indexation benefit in case it is invested during the end of the financial year.

To recap, double indexation is benefit of two years’ of indexation for calculation of long term capital gain tax even though the investment is for substantially less than two years.

For example, in case one makes an FMP investment on March 29, 2011, in a 370-day FMP, it will mature on April 2, 2012.

For calculating indexation benefit on capital gain tax, this investment will be considered to be made in fiscal 2010-11 and sold in fiscal 2012-13 and thus you will get benefit of two years of indexation.

Under the Direct Taxes Code (DTC), the situation changes a bit. The holding period of asset is important for the purpose of determining whether it will be short term or long term.

Under current tax law, holding period is difference between the selling date and buying date. If that period is more than 12 months, it is treated as long term, otherwise short term.

Under DTC, the holding period will start from the end of the fiscal in which the asset is purchased. Irrespective of whether the asset is purchase on September 1, 2010, or March 1, 2011, the holding period will start from April 1, 2011, and to consider the investment as long term, it should be sold after March 31, 2012.

Applying the above provisions of DTC in our FMP example, the holding period will start from April 1, 2011, and the indexation benefit will be available from financial year 2011-12 and not from 2010-11 as in the present case.

Hence, the investor will get indexation for one year instead of two years.
Irrespective of the above change, FMPs do not lose their attractiveness over fixed deposits.

Of course, DTC is still in draft stages and the final provisions may vary.  Further, there is no clarity on treatment for assets purchased before DTC becomes applicable.

To recap an earlier article:
The advantage of FMPs is more noticeable if we take tax aspect into consideration.  In case of FMPs for more than one year tenure, one needs to pay tax @ 10% or 20% depending on whether one chooses to have indexation.
Irrespective of the tenure of fixed deposits, the interest is treated as income from other sources and normal tax slabs applies. In case the investor is in 30% tax slab, he will be have to pay tax @ 30% on the interest generated.
Thus FMPs are more advantageous for investors in 30% tax slab looking for an investment with an horizon for more than one year.

FMPs are available in dividend and growth options. The dividend distribution tax is 16.61%.  Hence for FMP investments with less than 1 year tenure, it makes sense to opt for dividend option, since part of the income can be distributed as dividend on which 16.61% tax will be paid by the fund house and there will not be any further tax liability on investor.

Summarising the above:
a. For a person in 30% tax slab, it makes sense to invest in FMPs instead of fixed deposit (for more than one year investment horizon).

b. It makes more sense to invest in the concluding months of the financial year to take the advantage of double indexation benefits.

c. For investment horizon less than 1 year, tax impact on the gain is same for FDs and FMPs. Since dividends distributed by FMPs are taxed @ 16.61%, it may be wise to choose dividend option for FMPs less than 1 year.

The writer is a chartered accountant. He runs the blog, http://bachhat.blogspot.com/