I am sure you would have read about the proposals in the Union Budget – 2014, presented by the Finance Minister Mr. Arun Jaitley which includes a tax exemption limit increase by 50,000/-, increase in 80C investment limit from 1 to 1.5 lakhs, increase in loss of house property exemption from 1.5 to 2 lakhs and so on. While there has been a slew of good measures from the FM, the proposal to tax the Debt MFs by 20% and increase the Long Term Capital Gains duration from 1 year to 3 years has dealt a severe blow to the Debt Fund investors in Mutual Funds.
FMPs (Fixed Maturity Plans) has been a big hit with investors as they offer indexation benefits for over 1 year of investment. While an investment in Bank FDs would give about 9% return for a year, the taxes of 10, 20 and 30% used to eat into the post-tax returns of Bank FDs depending on the tax bracket of the individual, thereby giving only a post-tax return of 8.1%, 7.2% and 6.7% respectively. This is where FMPs were scoring high as they enjoyed indexation benefit for investments over a year and the post-tax returns of FMPs were in the range of 9 to 10% approx.
Now, with the new proposal all investors who have invested in FMP tenures less than 3 years would be affected. Many of the investors including me have parked money in FMPs based on the indexation benefits that FMPs offered and now if we are asked to pay tax based on our marginal tax rate (10, 20 or 30% as the case may be), we would be hit big time. This proposal is not just for FMPs but for all Debt MFs thereby taking the sheen out of Debt MF investments.
Will investors wait for 3 years parking their money in Debt instruments? Typically, only the short term money gets parked in Debt MFs and now this move will trigger a massive change to the approach towards debt investing. We recommend investors to move out of equity when they approach a financial goal or event and park them in debt MFs. If investors are taxed based on their tax bracket similar to the way it happens in Bank FDs, Postal Deposits and Corporate Deposits, why would investors look at Debt MFs?
This proposal is expected to impact 35% of the MF Assets or over 3.5 lakh crores (FMPs comprise 1.74 lakh crores of this) of investments. I heard from Fund houses that they would be making a representation to the Finance Minister as it will hit the MF industry, big time. But this proposal has been mooted by the Banks which lobbied big time as Band FDs were at a disadvantage to Debt MFs. The voice of Banks is definitely greater than the AMCs and hence this proposal is likely to be passed in the Finance bill. There is a possibility of some minor tinkering though.
What is the FMs answer to the Investors who have invested in Debt MFs and FMPs based on the taxation at that point in time? Ie. Indexation benefit for over a year of investment. Does it not sound like one more Retro tax proposal???
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Blog #PenguWIN 1005 – Draconian Proposal from Mr. Jaitley, Budget 2014
I was also very surprised by this move. Now that you have written about Big banks lobbying to get FD’s back into favor, it becomes clear. I think this was a very retrograde step.
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