Budget 2014 appears to have struck a cruel blow to debt mutual fund investors and distributors. Here is the latest version of the debt mutual fund vs. fixed deposit calculator to evaluate the utility of debt mutual funds.
Update: Ramesh Mangal pointed out an error in the tool and the graphs. So I have pull out this post briefly to correct the errors. Hope they are all gone! Sorry for the inconvenience.
The finance minister in his budget speech said,
“In the case of Mutual Funds, other than equity oriented funds, the capital gains arising on transfer of units held for more than a year is taxed at a concessional rate of 10% whereas direct investments in banks and other debt instruments attract a higher rate of tax. This allows tax arbitrage opportunity. This arbitrage has hardly benefited retail investors as their percentage is very small among such Mutual Fund investors. With a view to remove this tax arbitrage, I propose to increase the rate of tax on long-term capital gains from 10 percent to 20 percent on transfer of units of such funds. I also propose to increase the period of holding in respect of such units from 12 months to 36 months for this purpose”.
Does this mean fixed deposits are better than debt mutual funds? Not quite.
The government wants to remove the tax arbitrage that now exists for debt funds.
Note: When the finance minister said, "I propose to increase the rate of tax on long-term capital gains from 10 percent to 20 percent on transfer of units of such funds", I assumed the 10% without indexation now becomes 20% without indexation and 20% with indexation.
This seems to be wrong. The 10% without indexation is no longer available. Only the 20% with indexation option is available.
This is good news. Please ignore the 'without indexation' curves (green) in the plots below.
Let us now find out which instrument is more beneficial and when. We will assume tax is paid only upon redemption for debt funds and indexation benefits are available at 20%.
Let us consider an investment of Rs. 10,000.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 30%
Here I have assumed the cost inflation index increases each year by only 5%. If it is more, the benefit will be more.
For durations above 3 years, debt mutual funds still make sense for those in the 30% slab. With indexation, the gains are higher.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 20%
Still makes sense to hold debt mutual funds since the indexation benefit still scores over FDs. Even without indexation, debt fund may do marginally better because of the 10.3% TDS by the bank.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 10%
Obviously without indexation, debt funds cannot win. Indexation will in favour of even those in the 10% slab.
Verdict:
- For those in those 30% slab, debt funds are still good instruments for any requirement above 3 years. It does not matter if indexation option is available or not.
- For those in those 20% and 10% slabs, debt funds are still good instruments for any requirement above 3 years if indexation option is available (from what I seen on the web, it is available).
- These changes will not affect those invested in international equity funds much, provided they hold on to it for more than 3 years.
But still Budget discouraged the Debt Funds. Because we usually consider debt funds for short term goals. From above examples it is clear that debt funds will have an edge only after 3-4 years (irrespective of tax slab they are into).
Yes Basu. Debt funds can still be used for all intermediate and long-term goals (as per asset allocation).
Now even me too got clarity 🙂
But still Budget discouraged the Debt Funds. Because we usually consider debt funds for short term goals. From above examples it is clear that debt funds will have an edge only after 3-4 years (irrespective of tax slab they are into).
Yes Basu. Debt funds can still be used for all intermediate and long-term goals (as per asset allocation).
Now even me too got clarity 🙂
Even for highest tax bracket...now....debt may not always be beneficial if indexatn is removed....as some banks offer higher rates for longer duration which compensates for 30% tax...in absence of indxatn...only benefit would be that the tax can be defffered upto withdrawl...
Indexation @20% is available. So that makes debt funds still suitable for long durations.
Even for highest tax bracket...now....debt may not always be beneficial if indexatn is removed....as some banks offer higher rates for longer duration which compensates for 30% tax...in absence of indxatn...only benefit would be that the tax can be defffered upto withdrawl...
Indexation @20% is available. So that makes debt funds still suitable for long durations.
fast insight of budget. thank you.
one may find interesting : http://qz.com/232692/the-budget-just-killed-a-massive-lucrative-segment-of-indias-mutual-fund-industry/
Thank you. Good article.
fast insight of budget. thank you.
one may find interesting : http://qz.com/232692/the-budget-just-killed-a-massive-lucrative-segment-of-indias-mutual-fund-industry/
Thank you. Good article.
Can you please explore and analyse on the bonus option, where in exit and entry will be on cost basis.
Yes I am working on this. Will post soon.
Can you please explore and analyse on the bonus option, where in exit and entry will be on cost basis.
Yes I am working on this. Will post soon.
Hi Pattu, Rightly said and always it is better to use Debt fund route for tax advantage. FM said This amendment will take effect from 1st April, 2015 and will accordingly apply, in relation to the assessment year 2015-16 and subsequent assessment years..
What is the meaning of above statement and how we can interpret the taxation. Does the statement says it is effective from 1st April 2015 means redemption after that or investment after that falls under new LTCG rules?
Interpretation is difficult and if you have any inputs appreciate it.
I think they made a mistake wrt dates and AY. Will have to wait for clarity on this.
Hi Pattu, Rightly said and always it is better to use Debt fund route for tax advantage. FM said This amendment will take effect from 1st April, 2015 and will accordingly apply, in relation to the assessment year 2015-16 and subsequent assessment years..
What is the meaning of above statement and how we can interpret the taxation. Does the statement says it is effective from 1st April 2015 means redemption after that or investment after that falls under new LTCG rules?
Interpretation is difficult and if you have any inputs appreciate it.
I think they made a mistake wrt dates and AY. Will have to wait for clarity on this.
Does it mean that for any redemption of less than 3 years, the tax liability is w.r.t. individual's tax slab straight forward?
Yes. If the unit which is redeemed is less than 3Y old, the gain has to be added to income and taxed as per slab
Does it mean that for any redemption of less than 3 years, the tax liability is w.r.t. individual's tax slab straight forward?
Yes. If the unit which is redeemed is less than 3Y old, the gain has to be added to income and taxed as per slab
Hi Pattu sir. Thanks for sharing your knowledge openly with everyone.
Considering the recent changes in the budget 2014, can we look at arbitrage funds for goals which are 1-2 years away.
http://freefincal.com/can-you-think-of-a-risk-free-and-tax-free-financial-instrument/
Yes you can. Please be aware that on a day to day basis these funds can lose some money. Returns can vary from 6-8%. Please read the scheme information document, understand the investment mandate before investing.
Hi Pattu sir. Thanks for sharing your knowledge openly with everyone.
Considering the recent changes in the budget 2014, can we look at arbitrage funds for goals which are 1-2 years away.
http://freefincal.com/can-you-think-of-a-risk-free-and-tax-free-financial-instrument/
Yes you can. Please be aware that on a day to day basis these funds can lose some money. Returns can vary from 6-8%. Please read the scheme information document, understand the investment mandate before investing.
Thank you for clarifying the new taxation of debt funds .now we cannot use debt funds for re-balancing the equity: debt ratio in one’s portfolio.
If the asset allocation changes from desired level either because of increase in equity or debt funds, rebalancing is still a good idea. Instead of annual rebalanciing one can wait for a 5% increase from desired asset allocation to rebalance. That will reduce the tax liability
Thank you for clarifying the new taxation of debt funds .now we cannot use debt funds for re-balancing the equity: debt ratio in one’s portfolio.
If the asset allocation changes from desired level either because of increase in equity or debt funds, rebalancing is still a good idea. Instead of annual rebalanciing one can wait for a 5% increase from desired asset allocation to rebalance. That will reduce the tax liability
my action item on debt MF is for october.. till that point, i guess, the matter would be clear and i can decide with much firmness... if the indexation is available, it makes sense to all (irrespective of the tax slabs)... offcourse for more than 3 years.....
thank you for the insightful post...
Thanks Viren.
my action item on debt MF is for october.. till that point, i guess, the matter would be clear and i can decide with much firmness... if the indexation is available, it makes sense to all (irrespective of the tax slabs)... offcourse for more than 3 years.....
thank you for the insightful post...
Thanks Viren.
Hi Pattu,
hi pattu
are you sure that LTCG is 20% with indexation. I think that indexation benefit is no longer available. Not sure, but that is what I gathered after reading related news and articles. Could u shed any fresh light?
Thanks,
Kuntal.
Pretty sure. Please see
http://www.hdfcsec.com/Share-Market-Research/Research-Details/MFReports/3006238
Also
http://www.ciel.co.in/blog.php?blog_view=153
Hi Pattu,
hi pattu
are you sure that LTCG is 20% with indexation. I think that indexation benefit is no longer available. Not sure, but that is what I gathered after reading related news and articles. Could u shed any fresh light?
Thanks,
Kuntal.
Pretty sure. Please see
http://www.hdfcsec.com/Share-Market-Research/Research-Details/MFReports/3006238
Also
http://www.ciel.co.in/blog.php?blog_view=153
Hi Pattu,
I wanted to ask you something. The finance minister said that the increase in the LTCG period and percentage is only for debt mutual funds right?
If I may, I have two questions?
1. I tend to buy stocks (not mutual funds), hold them for two weeks or so and then sell them. Previously I think I was paying a short term capital gain of 15%. For equities, has this now changed to 20% or ones current tax slab? Sounds to me like it is still at 15% since the finance minister said not equity based mutual funds????
2. Has the holding period for stocks also gone up to 3 years to consider them long term capital gains or stocks still remains at one year?
Regards,
Rajiv
Taxation of equity mutual funds remain unchanged. The changes are only wrt to debt mutual funds
Hi Pattu,
I wanted to ask you something. The finance minister said that the increase in the LTCG period and percentage is only for debt mutual funds right?
If I may, I have two questions?
1. I tend to buy stocks (not mutual funds), hold them for two weeks or so and then sell them. Previously I think I was paying a short term capital gain of 15%. For equities, has this now changed to 20% or ones current tax slab? Sounds to me like it is still at 15% since the finance minister said not equity based mutual funds????
2. Has the holding period for stocks also gone up to 3 years to consider them long term capital gains or stocks still remains at one year?
Regards,
Rajiv
Taxation of equity mutual funds remain unchanged. The changes are only wrt to debt mutual funds
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 uncertainty 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 retro taxes.
Agree with you Sarvesh but as a law maker it is not possible to pick and choose those who invested for 2Y and provide them exemptions. Someone or the other will able be affected by any ruling and this time it the debt fund investors. Tomorrow arbitrage funds can suffer the same fate. PPF can taxed etc.
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 uncertainty 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 retro taxes.
Agree with you Sarvesh but as a law maker it is not possible to pick and choose those who invested for 2Y and provide them exemptions. Someone or the other will able be affected by any ruling and this time it the debt fund investors. Tomorrow arbitrage funds can suffer the same fate. PPF can taxed etc.
Hello Pattu Sir,
I need a clarification. I'm investing in mutual funds for all my goals. All goals are minimum 15+ years away. But i invest only in equity funds. Now i wanted add debt funds for proper assest allocation. Can you recommend which type of debt funds i need to choose for different goals which are all 15 + years away. Also do we need to do rebalancing of portfolio for higher returns? if yes then how frequently? If we do frequent rebalancing during bull run do we loose the returns in long run? I'm currently maitaining NRI status so no tax laibility.
You are doing an excellent job sir. Just wondering how much passion you got. I have recommended this website to lot of my friends and collegues. They have all amazed to see the content in your website.
Thanks in advance.
Regards
shaji
Hi Shaji, Thank you very much.
Rebalancing would certainly help in lowering volatility and enhancing returns. You don't need to rebalance often. Suppose you start with 70:30 debt, and if your current allocation become 75:25 shift 5% to debt. So you wait until there is a 5% increase.
you will need at least 30-40% debt. If you use long-term gilt funds, they will suddenly produce a lot of returns when rates go down which can be shifted to equity but the losses when rates increase will also be high.
As an alternative you can choose a safe fund like banking debt funds. Which will offer steady returns.
Hello Pattu Sir,
I need a clarification. I'm investing in mutual funds for all my goals. All goals are minimum 15+ years away. But i invest only in equity funds. Now i wanted add debt funds for proper assest allocation. Can you recommend which type of debt funds i need to choose for different goals which are all 15 + years away. Also do we need to do rebalancing of portfolio for higher returns? if yes then how frequently? If we do frequent rebalancing during bull run do we loose the returns in long run? I'm currently maitaining NRI status so no tax laibility.
You are doing an excellent job sir. Just wondering how much passion you got. I have recommended this website to lot of my friends and collegues. They have all amazed to see the content in your website.
Thanks in advance.
Regards
shaji
Hi Shaji, Thank you very much.
Rebalancing would certainly help in lowering volatility and enhancing returns. You don't need to rebalance often. Suppose you start with 70:30 debt, and if your current allocation become 75:25 shift 5% to debt. So you wait until there is a 5% increase.
you will need at least 30-40% debt. If you use long-term gilt funds, they will suddenly produce a lot of returns when rates go down which can be shifted to equity but the losses when rates increase will also be high.
As an alternative you can choose a safe fund like banking debt funds. Which will offer steady returns.
It seems to have been initiated by FM unser pressure from Banks, is it not? Banks are shooting at their competiton from the safety of sitting on FM's shpoulders !But this, I am sure, is not the spirit of Modiji's vision of competiton. Modiji should reconsider this move and ask FM to drop it shortly. There are many senior citizens like me, who have invested in debytt fund. It is wrong to say it is not for retail investors. After opposing UPA's retrspective laws, it is starnage to get this from Modiji. After all, how much will be the extra revenue he is going to get by this move? Please drop it Modiji.
Not going to happen, Aravind. Once you vote a party to majority, there is not much you can do for 5Ys!
It seems to have been initiated by FM unser pressure from Banks, is it not? Banks are shooting at their competiton from the safety of sitting on FM's shpoulders !But this, I am sure, is not the spirit of Modiji's vision of competiton. Modiji should reconsider this move and ask FM to drop it shortly. There are many senior citizens like me, who have invested in debytt fund. It is wrong to say it is not for retail investors. After opposing UPA's retrspective laws, it is starnage to get this from Modiji. After all, how much will be the extra revenue he is going to get by this move? Please drop it Modiji.
thank you for your information, which is very valuble and clear
what about the taxation on NRI investment in debt fund, I had invested in debt fund on June 2013 and redeemed in 04 August, after one year period TDS deducted @ of 30%, is it correct as per new budget.
Sorry Pradeep, I am not aware of this.
Thanks for the valuable information. I understand that this a old post but your blog has become a kind of reference so people come back to it again. Just a minor point. In the graphs, for FMPs with indexation, the points representing 3 years and 4 years are connected by a smooth line. This is kind of misleading since it appears as if you get partial benefit during this period, while in reality you get full benefit for periods above 3 years (hence so many FMPs with 3 years and few days). I would expect the graph to be staggered (like a step) at the three year mark and a sudden jump in post tax returns. Normally this would't be important but since this is exploited so heavily in the market it got me confused a bit looking at the graph. Also are we allowed to pay tax on maturity for FD? If so, it could be exploited to push you tax obligations to retirement days. I had always assumed we need to pay it every year.
Hello Mr. Pattu,
I have one question.
How the tax on Debt fund will be calculated for person below taxable income (ie. Income less than 2.5L ) ? As far I understand, Tax on Debt fund is calculated as as per taxable rate on STCG and 20% with indexation on LTCG.