July 2014

Latest Cost of Inflation Index March 2014 & Double indexation benefits.

Latest Cost of Inflation Index March 2014 , Double indexation benefits, Short term debt, 30% tax bracket, Investing strategies, year end tax planning

Cost of Inflation Index upto FY 2013-14. (The year mentioned is financial year(FY) 

The cost of inflation index is useful for income-tax assesses in the computation of tax on long-term capital gains (for indexation purposes). In the previous two years, the cost inflation index rose 10 per cent and 12.5 per cent, respectively.

A cost inflation index helps reduce the inflationary gains, thereby reducing the long-term capital gains tax payout for the taxpayer. Currently, the income-tax law allows long-term capital gains to be computed after adjusting for inflation (Debt Mutual Funds, FMP’s, Real Estate Gains etc.) .

The cost of acquisition as well as the cost of improvement is adjusted for inflation between the date of purchase and date of sale (through the cost inflation index) before the long-term capital gain is ascertained.

Assume, if the investor invested Rs 1,00,000 in the growth option on March 30, 2012 and redeemed the investment on April 2, 2013 for Rs 1,10,000 

The investment happened in financial year 2011-12, for which the government has declared cost inflation index of 785.

The investor redeemed the investment in financial year in 2013-14, for which the cost inflation index is 939.

The capital gains is Rs. 110,000 minus Rs. 100,000 i.e. Rs. 10,000.

The holding period is 367 days, which is more than 1 year. Therefore, it is a long term capital gain.

The maximum tax the investor has to bear is 10% (plus surcharge plus education cess) on the capital gain of Rs. 10,000. Thus, the maximum tax payable would be Rs. 1,000 (plus surcharge plus education cess).

Investor can benefit from indexation. The indexed cost of acquisition is Rs. 100,000 X 939 ÷ 785 i.e. Rs. 119,618 . This is higher than the selling price of Rs. 110,000. Thus, the investor ends up with a long term capital loss of Rs. 9,618. So no tax payable and also this can be set off against long term capital gains, as discussed in the next section.

Another point to note is that although the investor held the investment for slightly more than a year, the investor gets the benefit of indexation for two years viz. 2011-12 and 2012-13. Hence the name “double indexation” for such structures.

Mutual funds tend to come out with fixed maturity plans (FMP’s) towards the end of every financial year to help them benefit from such double indexation. Even short term debt is a good investment towards the financial year end, as they too offer the same benefits. 

Largely investors are unaware about this benefit. This benefit can and should be taken by investors who are in 30% tax bracket as they get the maximum benefit. So, invest in wither FMP’s or Short term Debt (Holding period > 1 yr) towards the end of a financial year, and sell towards the beginning of a financial year and take advantage of   double indexation tax benefit for virtually tax free capital gains. Money saved is indeed Money earned.

Be Money Savvy and invest smart. Happy Investing. 

July 2013

Why RBI has hiked the Base Rate on Jul 15 & Implications

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Reserve Bank Of India (RBI) announced several measures day before yesterday late evening to tighten liquidity in the system and arrest depreciation of rupee.  Why RBI wants to tighten liquidity and why the urgency.

RBI had tightened liquidity to support rupee during Asian crisis:

Historically, During the Asian crises of 1997-98, the RBI raised its benchmark interest rate by three percentage points in one go to 8%, in order to attract capital from foreign investors. The RBI had raised the bank rate and cash reserve ratio of banks too. This had sucked out liquidity, and interest rates had skyrocketed. This checked the run on the rupee.

The reason for this move and its impact:

Liquidity had eased considerably in June and that had brought the overnight rates (also CP, CD) rates below the Repo rate. With these measures, RBI will be able to raise the effective short term interest rate considerably without hiking the policy rate. (more…)

June 2013

Increase in Dividend Distribution Tax from June 01 2013 in Debt Mutual Funds – Impact

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In the FY14 Budget the Finance Minister has proposed to increase the Dividend Distribution Tax (DDT) on Debt Mutual Funds (other than liquid and money market funds on which the DDT was already 25%) from 12.5% to 25% (plus surcharge and cess) for individuals and HUFs. The hike is proposed to provide uniform taxation for all types of funds other than equity oriented mutual funds in the Mutual Fund Industry.
This amendment will take effect from 1st June, 2013.

Classification of Funds: As far as tax implications on Indian mutual funds are concerned, they are classified as three parts as ‘Equity oriented Funds’, ‘Liquid and money market Funds’ and ‘Debt Funds other than Liquid Funds’.

In ‘Equity Oriented Funds’, the categories coming under are Equity Diversified, Equity Sector, Hybrid – Equity Oriented (more than 65% equity) and Arbitrage Funds.

Liquid Funds and Liquid ETF are coming under ‘Liquid Funds’ while Ultra Short Term Funds, Floating Rate Funds, Short Term Income, Dynamic Income, Income Funds, Gilt Funds, Fund of Funds, Hybrid – Debt Oriented (less than 65% equity), MIP, FMPs are coming under ‘Debt Funds other than Liquid Funds’.,

Summary of Changes proposed :

Classification of Debt funds , Short term taxation , dividend distribution tax DDT, Effective yield


Tax on distributed income:Given the tax provision on the distributed income, fund houses pay taxes on the dividend distributed to the investors. Fund houses deduct DDT from the Dividend. So the dividends are tax free in the hands of investors.
Existing tax structure on DDT:As per the existing structure, there is no tax levied on the dividend distributed by Equity oriented mutual fund schemes for any investors. But, Liquid and money market Funds are liable to pay the DDT of 25% (plus surcharge and cess) for retail investors while the funds other than Liquid and money market funds are liable to pay DDT of 12.5% (plus surcharge and cess).

For institutions and corporates, DDT on Equity funds is nil while 30% (plus surcharge and cess) in case of the dividends from the investments in Liquid Funds and debt funds other than Liquid funds.

Proposed Structure: From June 01, 2013 onwards, retail investors who invest in all debt funds (other than equity funds) are liable to pay DDT of 25% (plus surcharge and cess) on the dividend income. The DDT for corporate investors has been kept unchanged at 30% (plus surcharge and cess).
Increase in Surcharge: Further, the surcharge on Dividend Distribution Tax for all mutual fund schemes has gone up from 5% to 10%.
Impact: This move will make dividend options in Debt Mutual Funds unattractive for retail investors. Because the net post tax return in the hands of the investors from dividend plans would be lower as the DDT charged on the debt funds has been increased from 12.5% to 25% (plus surcharge and cess). Meanwhile, the Growth options in the Debt Mutual Funds will become attractive for retail investors who redeem the investments after a year, taking advantage of long term capital gains.

Capital Gain: Since the DDT is applicable for Dividend plans, Capital Gains tax is applicable to Growth plans. The gains from the debt mutual scheme (growth option) are taxed depending on the period the investments in the mutual funds are kept. If the debt mutual fund units are redeemed after a year, then the gains thereon are liable to Long Term Capital Gain tax while the proceeds from the investments which redeemed before one year are taxed as Short Term Capital Gain. For long term capital gains in debt funds, the investor has to pay the tax @ lesser of 10% without indexation or 20% with indexation; (plus education cess). Short Term Capital Gain is taxed as per the normal slab of the investors. (more…)