FMPs and why
As March approaches, investors are presented with another enticing mutual fund scheme in the realm of tax-efficient investments, beyond just equity-linked saving schemes. Fixed Maturity Plans (FMPs) come into focus during this period, and numerous options are currently available, with tenures ranging from three months to a year. FMPs are closed-end debt schemes tailored to specific tenures, primarily investing in debt securities that align with the scheme's maturity date. These schemes tend to be most popular in March when short-term interest rates are typically high. However, due to persistent increases in short-term rates over the past nine months, driven by tight liquidity in the banking system, FMPs have gained particular appeal.
The tight liquidity scenario arises when the demand for money surpasses its supply. This is partly attributed to the stretched credit-deposit ratio of banks, indicating that they are lending a significant portion of their deposits, resulting in a strain on liquidity. In response, short-term rates have risen. The Reserve Bank of India (RBI) has long encouraged banks to mobilize more deposits to address this issue, as evident from RBI statistics showing higher credit growth compared to deposit growth. To attract more deposits, banks have been raising deposit rates and consistently issuing certificates of deposit (CDs), short-term scrips, primarily during the latter half of 2010.
With FMPs predominantly investing in CDs and commercial papers (CP), these funds tend to benefit when interest rates are high. Though indicative yields for FMPs were banned by the Securities and Exchange Board of India in January 2009, they can still potentially offer returns ranging from 9.25% to 9.50% over a year at current market levels. As such, FMPs are considered to outperform bank deposits on an after-tax basis for those in the highest tax bracket.
However, choosing the right FMP at the appropriate time can be challenging, as most FMPs have brief windows for redemption. It's advisable to stay in touch with your agent for updates and closely monitor New Fund Offers (NFOs) through platforms like www.valueresearchonline.com.
When it comes to taxation, FMPs are taxed similarly to other bond funds. If held for at least a year, you'll pay tax at a rate of 10.30% without indexation or 20.60% with indexation. In contrast, interest on bank fixed deposits is taxed according to your income tax rates. For tenures exceeding a year, the "growth" option is recommended, while for shorter tenures, the dividend plan is more suitable.
A tax-saving strategy involves selecting the indexation option, especially for FMPs launched toward the end of March with a tenure slightly exceeding a year, covering two accounting years. With rising inflation, the cost price of your FMP can be inflated to reduce tax liability. However, this strategy may be affected by the proposed Direct Taxes Code (DTC), set to come into effect on April 1, 2012, which could impact the availability of double indexation for FMPs maturing in the DTC regime.
In summary, while FMPs present an attractive investment option, it's essential to consider the timing of your investment and the potential impact of the DTC on tax-saving strategies.
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Best regards, Dilshad.