Double indexation benefit on FMPs
With interest rate volatility, Fixed Maturity Plans or FMPs have been a safe alternative investment option for investors seeking “almost assured yields” for a fixed time horizon, much like fixed deposits but far more tax efficient and therefore, more return efficient.
Why is there a rush towards FMPs mainly in March every year? There is a double indexation benefit that one can claim for the gains accrued on the FMP at the time of sale, by reducing the long term capital gains tax outflow.
When a capital asset like property or a mutual fund is sold, it is subject to capital gains tax. This capital gains tax is short term or long term in nature depending on the capital asset considered. For a mutual fund, the capital asset if sold after one year is considered a long term capital gain.
For computing capital gains tax for debt funds, an option of 10% flat on the gain or 20% after indexation, whichever is lower is the tax liability.
To understand what is indexation and its benefit, please read about our article on Capital Gains Tax with indexation benefit.
Double Indexation benefit means enjoying the benefit of indexation for two financial years, without actually holding the asset for the said period.
Let us assume, Mr A, purchases an FMP on 31 March 2011 for Rs 1,00,000 (Financial year considered here is 2010_2011) and the maturity of the same is due on 1 April 2012 (Financial year 2012-2013), the indexation benefits can be claimed for two financial years, by just holding the investment for one day in the new financial year!
For eg.
| Amount invested or Cost of Purchase | 1,00,000 |
| Sale amount @10% interest | 1,10,000 |
| Cost inflation index for the year of purchase 2010-2011 | 711 |
| Cost Inflation Index for the year of Sale 2012-2013 | 852 |
| Indexed Cost of Acquisition | 1,19,831 |
| Capital Gains with double indexation benefits | -9,831 |
| Capital gains without indexation | 10,000 |
| Tax liability with double indexation | 0 |
| Tax Liability without indexation benefit | 1000 |
On account of being invested for an additional day, the capital gains on account of double indexation benefit is 0, as against tax liability of Rs 1000 without indexation benefit.
Our advice, is, although investing in FMPs in march provide for this additional tax benefit, it is important to look at the tenure, quality of paper and objective of investment.
(Contributed by Dilshad Billimoria BBM, LUTCF CFPCM, Certified Financial Planner and Investment Advisor)