Budget 2014-Debt Mutual Funds Taxation

There was huge cry and discussion going on in all platforms of planners that Budget 2014 will impact Debt Fund investors or FMP investors. I tried to wait till I get clarity from all angel to write on the same. Now some clear picture is emerging, so thought to share with you all.

Do you know how big is Debt Mutual Fund Industry in India? Please have a look at below chart which explains the % of AUM spread across asset classes (AMFI data as on 30th June 2014). This shows the impact these tax changes will have on this industry.

Mutual Fund AUM as on 30th June 2014

Mainly there are three changes which were introduced in Budget 2014 and they are as follow.

1) Holding Period

Before budget holding period for Long Term Capital Gain (LTCG) for Debt funds was 1 Year. So if you withdraw within a year then it is considered as Short Term Capital Gain (STCG) and more than a year then it is treated as Long Term Capital Gain (LTCG).

But now this changed to 3 years. Means according to current taxation rules, holding period less than 3 years is considered as STCG and more than 3 years is LTCG.

2) Indexation Benefit

Earlier if your holding period was more than 1 year then you have option to pay tax either flat at 10% OR with indexation at 20%. Now according to current rule you need to pay tax for LTCG with indexation at 20%.

Let us take an example of how above said change affect investors.  Suppose you are investing Rs.100 in Bank FDs and Debt Funds for 1 yr and return on Bank FD and Debt Fund is 10%. How the change will impact?

Budget 2014-Debt Fund Taxation

You notice that there is no change in Bank FDs and Debt Funds if your time period is less than three years. Also notice the post tax return difference existed earlier. That is the reason Debt Funds were heaven for highest tax bracket individuals and companies to park their short term funds. But after this budget such opportunity lost :)

Note-Effective date of these changes is yet a confusing. Because few claiming it to be from 1st April 2014, few after budget date and few claiming it to be from next year.

As debt fund returns are not guaranteed compare to Bank FDs, now we may notice flow of funds from these debt funds to Bank FDs in near future.

Funds that affected with these new changes-

  • Debt Funds
  • Gold Funds
  • Fund of Funds
  • Non equity Infra Funds
  • FMP
  • Any fund whose equity exposure is less than 65%

3) Dividend Distribution Tax (DDT) Method

Dividend distribution tax is something which mutual fund companies used to pay but not investors. So in investors hand it is tax free and will continue as usual. Rate of DDT was not changed and it will continue as usual at 25%+10% Surchage+3% education cess. But due to change in method calculating the tax, investors will receive less dividend than earlier. Let us take an example on this.

Suppose mutual fund company have Rs.100 as distributable  income. Then let us see how the calculation method changes and how it impact effective dividend distribution tax from below excel prepared by Mr.Pattu

You notice that earlier if distributable income is Rs.100 and mutual fund company planned to distribute Rs.80 then the tax will be only on Rs.80 but not on whole Rs.100. But now onward it is on Rs.100 with this effective dividend distribution tax raised from existing 20% to 25% (excluding surcharge and cess). Hence from now onward there is no meaning for “Effective Dividend Distribution Tax”. Because both DDT and EDDT are equal i.e at 25%

But individuals who fall at 30% tax bracket still have advantage of dividend option. Because on Bank FDs they need to pay the tax at 30% where as in case of dividend option of debt mutual funds they paying 28.325% (including surcharge and cess).

So what is total impact on you as an investor of Debt Funds?

From now onward anything less than 3 years investment will be good if you go for Bank FDs. But if you have time horizon of more than 3 years then debt funds still hold edge irrespective of your tax slab.  For a detailed comparison on Bank FDs and Debt Fund you can view Mr.Pattu’s post.

What about Direct Bond Investments?

Any listed bond including zero coupon bonds will enjoy the old capital gain rules. Means holding period less than year is treated as STCG and more than year is LTCG.

Share & Comment

Comments

  1. Hasmukh Gohel says

    Dear Basavaraj,

    I need your guidance for comparing two medium term accrual funds.

    Fund A YTM 9.87% Av Maturity 4.14 Yrs, Modified duration 3.01 years last six month’s yield 12.79%

    Fund B YTM 10.79%, AV maturity 2.66 Yrs, Modified duration 2.4 years, last six month’s yield 11.41%

    Which fund is better?

  2. Vishwa says

    Hi Basavaraj,

    I need your advice on investing in FMP. My mother is 70 and is a pensioner and is looking for investing some amount in Bank FDs. But I was suggesting her to invest in FMP instead of Bank FDs. Could you please suggest whether she should invest in Bank FD or FMP and which one would give higher returns for a tenure of 3 or more than 3 years ?

    Thanks,
    Vishwa

    • says

      Vishwa-FMPs are cyclical to interest rate fluctuation. So no one can predict it exactly. Also if her taxation is currently zero and she will not come under 20% or 30% tax bracket then I will suggest to go for FDs. Also considering her age (I hope she depends on this money), I will suggest to go for FD rather than FMP. As I am not much aware of her profile so I can restrict my suggestions to generic.

  3. Unmesh Bagwe says

    Hi Basavaraj,

    Firstly i want to say ‘ YOU ROCK ‘, suggest you to start Financial Investment Consultant Company :)

    my Question for you is

    I have surplus amount of Rs 2 Lakhs to Invest for about 15 Years what would you recommend between my options?

    1) Debt Fund or Double your FD in 7 and half Years or Lump Sump Amount in Mutual Fund ?

    I am a moderate risk taker, i am already investing in PPF & SIP as well.

    I hate TDS so looking for Investment options in which TDS will not be Applicable.

    Thanks in Advance.

    Unmesh

  4. RP Singh says

    I bought Muthoot NCD from secondary market ICICIdirect.com and paid STT on that. In order to get LongTerm Capital Gain, Howlong I have to hold it before I sell it… 1year or 3 year?

    Can I sell in secondary market after one year and claim LTCG on equity.

  5. Madhu says

    Can you clarify the following ? If I invest Rs.one lakh in a debt / liquid mutual fund and opt for a a quarterly dividend option, I can take home the dividend tax-free as it is tax-free in the hands of the investor. If I cash out at the end of say one year, when the unit NAV is slightly less than the acquisition NAV, I will not make any capital gains and hence will not be subject to capital gains tax. For e.g. I get a dividend of Rs.6250 over a period of one year which is completely tax free. And I get out of the scheme and get Rs.99,800/= then I will not get into the capital gains ambit. Further, since the payout is quarterly it will be slightly better than the 6.25% as seen here.

    • Hasmukh Gohel says

      In case of Debt/Liquid fund dividend option, dividend distribution tax is applicable, with new budget proposal it is to the tune of>20%.
      If you need to invest for 1 year, floating rate long term is best. It will have lock-in period of 1 year. You should opt for growth direct option. 10% STCG tax will be applicable, one should go for accrual product. No major loss/gain due to change in interest rates.
      One should calculate net receipt after any taxes. And it should be more than prevailing bank FD interest by at least 1%.

  6. Ravi says

    hellow sir,

    I want to so financial planner course , I live in Mohali near chandigarh.

    I am pursing MBA DISTANCE LEARNING final semster .

    is this help me to grow up in this finance planing sector.

    • says

      Ravi-For your information degree is just your entry ticket into any profession. Post to entry what matters more is how you deal with competition, upgrading your skills and your business methodology. So never be in wrong belief that MBA or CFPs are best and highest end point of your education. Instead it is just entry. There are so many in industry who are nowhere related to finance but they took it as passion and doing wonderful change into their clients financial life.

  7. Hasmukh Gohel says

    Please explain LTCG tax in view of FM’s new directive to TAx as per latest TAX rules after 11th July 2014. I had invested in RMF FMP in March 2013 matured in April 2014.
    Originally double indexation case. Please explain latest position, will it be STCG?

  8. Ishmavel J says

    I am 24 years old, my goals are 1 need to by a house (site) with in 5 years. My earning per month is 25500.These are my investment strategy I invest 2000 monthly toward Axis Long term fund(ELSS),invest 2000 in stock market,1300 in my VPF account, invest 10000 into PPF account per annum and 50000 in FD for a year and 2000 every month in my savings account. I have taken a health insurance for my mom in Star health insurance a cover of 2 lakhs individual cover and I have a cover of 3 lakh and 10 lakh worth accident cover from my company. Please advice

    • says

      Ishmavel-Do you have insurance (pure life insurance called term insurance)? How you invest in stock market? Is it from your own research on hot tips? Is stock investment is for trading or investing?

      • Ishmavel says

        Hi,

        I do not have any life insurance or term insurance, i am a CS(intermediate) student so i am aware of stock market but not an expert,initially i invested in Stock market to get a sense of it and for learning. I also earned some profit out of it now i am focused on investing on a long run(investment purpose) i understand MF but just wanted to learn on real time basis and earn some profit as well.

        • says

          Ishmavel-If you are earning something and you have financial dependents then first priority should be towards life insurance (pure term insurance), health insurance and emergency fund. By reading your few lines, I felt you to be short term investor (less than 5 years or so) who looking for higher return. But bear in mind that equity investment is for long term.

  9. Hasmukh Gohel says

    Pl. clarify LTCG tax position after budget.
    I have made LTCL after indexation, can I carry forward?

  10. shaji unni says

    Hi Basavaraj,

    Can you just explain the tax impact for NRI’s in debt funds after the Buget 2014? Is it same as like Ordinary citizen and only TDS will be difference?. Also after the new Buget which is the best option for NR’S to park money for less than one year?.

    Thanks in advance.

    Regards
    Shaji unni

  11. Ashwary Agarwal says

    Hi Basavraj, I sincerely want to seek your advice on investments.

    I am planning for small investments which will help in future, i am already 35 yrs of age.
    Have lot of options in my mind but not sure which one to pick. I already have an LIC and one MF for HDFC bank for 3 yrs.

    I can shell 5000 odd money for my investments, need to know where to put the money in SIP or RD, which should yield better results in 3-5 yrs time.

    Please help and suggest.

    Regards
    Ashwary

  12. Sreekanth says

    Good one Basa. Investors used to take arbitrage benefit in terms of taxes on short term Debt fund investments . Now that opportunity is lost. Banks will be the major beneficiaries.
    (www.onlinefinancialplanner.in)

      • sarvesh says

        The problem is not the tax. Problem is that this tax is retrospective. Ppl putting money in 2 year FMPs did not know that it would be Short term at maturity. Else, they would have parked money for 3 years. No one has problem with tax, people have problem applying it to pre July 10 investments, for which govt should retain old definitions. This unceratainty drives ppl to HUFs, gold and real estate. Hope they dont do same with arbitrage funds next year. Ppl parking 20 lakhs for house and in 30 % bracket 2 yyrs ago in FMPs will pay 1.2-1.4 lakhs as tax as against 20,000. Ppl should not be subject to such foolish retro taxes. Please cover this aspect in article.

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