Want a tax advantage? Fixed maturity plan is your best bet

It’s raining FMPs (fixed maturity plans) from mutual funds (MFs). It’s that time of the year when investments in FMPs give a special tax advantage, and with equity schemes doing badly in terms of investor preference, FMPs are the flavour of the season (See table below).

[caption id=“attachment_253294” align=“alignleft” width=“380” caption=“An FMP invested in in the last week of March and redeemed in April next year will face practically no tax in view of the benefit of cost indexation for two financial years.”]  [/caption]

FMPs are increasingly being preferred over bank deposits as the former offers a better post-tax yield. Having a similar risk profile, investors prefer FMPs on account of the double indexation benefit built into the instrument. Indexation is adjusting the cost of acquisition for the rise in inflation.

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An FMP invested in in the last week of March and redeemed in April next year will face practically no tax in view of the benefit of cost indexation for two financial years, even though the investment period is for just over a year. Many FMPs have a tenure of around 370 days.

[caption id=“attachment_253296” align=“alignleft” width=“548” caption=“Post the introduction of DTC, the benefit of double indexation will be withdrawn.”]  [/caption]

An added advantage in this year’s FMPs is that this might probably be the last year (assuming a direct tax code - or DTC - is launched before next fiscal) where double indexation benefit will be available. A debt-based instrument of less than one year will invite a short term capital gains tax. However, if they are held for over a year, they will attract long-term capital gains at a rate of 10 percent if no indexation benefits are taken and 20 percent if indexation benefits are taken into account.

Take for example a 370-day FMP bought on 30 March 2012. Its maturity will be 3 April 2013. Tax outgo for such an investor will be lower as compared to one who invests in a debt instrument for less than a year. In fact, if inflation rates are high and close to the expected interest rate, indexation reduces the tax outgo further.

Post the introduction of DTC, the benefit of double indexation will be withdrawn.

Moreover, with bank interest upto Rs 10,000 receiving tax-free status from next year, FMPs will face further competition from bank deposits.