Budget 2014: FDs get attractive as long term capital gain tax on debt funds goes up to 20%

MUMBAI: Good days are clearly over for the debt investors. Individuals who used to park money in short-term debt schemes and fixed maturity plans (FMPs) to earn better posttax returns will have to pay more taxes now.

The finance minister has proposed to hike long term capital gains tax on debt mutual funds to 20per cent from 10per cent and the holding period to 36 months from 12 months. Investment experts believe that investors in gold funds will also be impacted by the new proposal.

Many individuals, especially those in the high networth category, used to prefer mutual fund schemes over bank fixed deposits as interest earned on bank FDs are taxed at rates applicable to the individual. This meant an individual in the higher tax bracket would pay 30per cent tax on interest earned from bank FDs. "This makes investments in debt schemes with an investment time frame of less than 36 months unattractive, which includes popular fixed maturity plans," says Feroze Azeez, director - private wealth management, Anand Rathi Financial Services.

Vidya Bala, head of research, fundsindia.com, says investors shouldn’t totally give up on debt funds because of the new tax proposal.

"Due to high inflation, it is likely that if you invest in debt funds with a three year horizon, using indexation method, your post tax returns could still be higher than that offered by bank fixed deposits," she says.

Some experts feel that investors should take a look at arbitrage funds as they can offer better post-tax returns.

Arbitrage funds, as the name suggests, look for the arbitrage opportunity between different markets. They are treated as equity oriented funds for taxation purpose. That means investments held over a year would not attract any taxes. "Investors with no risk appetite and with an investment horizon of between one and three years can consider investing in arbitrage funds," says Vikas Sachdeva, chief executive officer, Edelweiss Mutual Fund.

The changes proposed in dividend distribution taxes would further hurt debt investors. "DDT was on net dividend distributed while it wil l now be on gross dividend dist ributed," says Lakshmi Iyer, Chief Investment Officer (Debt) and Head of Products at Kotak Mutual Fund. She says investors will be taxed higher as the earlier effective DDT was 25.36per cent while now it will be 33.99per cent (including surcharge and cess).

The budget proposal to increase the investment limit under section 80 C is good news for fans of tax saving mutual fund schemes. The 80 C limit has been increased to Rs 1.5 lakh from Rs 1 lakh. "Investors should make the most of additional investments of Rs 50000 allowed under section 80C by picking up the right schemes," says Surajit Mishra, national head-mutual funds, Bajaj Capital. These funds can be a good wealth creation tool in addition to saving tax.

Rajiv Gandhi Equity Savings Scheme (RGESS) is available for some more time. Many investment experts were expecting the new government to give it a quite burial, but the budget was silent on it.

First time equity investors looking to save taxes in addition to Section 80C can consider investing in Rajiv Gandhi Equity Savings Scheme (RGESS).

Investors with a gross annual income of Rs 12 lakh or less can invest up to Rs 50,000 under Section 80CCG in the scheme every year, and can claim tax benefits for a period of three years. Investors have the option of buying stocks from BSE 100, NSE CNX 100, Maharatnas or Navratnas or ETFs specified under the scheme.