Tax efficiency over Fixed Deposits make FMPs a better choice

»EXAMPLE: Have a look at the following table. It is assumed that both, the Bank FD as well as the FMP yield the same rate of interest i.e. 10.25% p.a.

An investment of Rs. 1 lakh is made in an FMP of 91 days and 366 days. The corresponding figures for the Bank FD appear alongside.

FMP – 91 days v/s Fixed Deposit LONG-TERM FMP OF 366 DAYS
Dividend Option – Individuals Dividend Option – Corporate Fixed Deposit FMP- TAX @20% WITH INDEXATION FMP- TAX @10% WITHOUT INDEXATION Fixed Deposit
A Investment Amount 100,000 100,000 100,000 100,000 100,000 100,000
B Post Expense Indicative Yield 10.25% 10.25% 10.25% 10.25% 10.25% 10.25%
C Maturity Value 102,555 102,555 102,555 110,250 110,250 110,250
D Gain = C-A 2,555 2,555 2,555 10,250 10,250 10,250
E Inflation Rate For Indexation 14.16% 22.66% 33.99% 5% N.A
F Cost after inflation 317 472 869 105,000 N.A
G Capital Gain = C-F & C-A 2,239 2,083 1,687 5,250 10,250  
H Tax Rate 9.29% 8.62% 6.94% 20.00% 10.00% 33.99%
I Tax 1,050 1,025 3,484
J Post Tax Gains = C-I 9,200 9,225 6,766
K Post Tax Annualised Returns = 9.20% 9.23% 6.94%

Tax Advantage of FMP over FD

• Interest income from FDs is added to the investors income and is taxable at the applicable tax slab for that investor. Interest from FDs is categorized as ˜Income from other sources under Income Tax laws.
• In the case of FMPs, tax implication depends on the investment option Dividend or Growth.
• In the Dividend option, investors have to bear dividend distribution tax, whereas in the Growth option returns earned are treated as capital gains (short-term or long-term depending on tenure of investment).
• Thus, due to indexation benefit, FMPs end up becoming more tax efficient than a FD. Indexation lowers tax liability.

Capital Gain Tax?

• Short Term Capital Gain is taxed at rate of taxation.
• Long Term Capital Gain is taxed at 10% (without Indexation) or 20% (with indexation).

Dividend Distribution Tax?

• 14.16 % for individuals & HUF
• 22.66 % for institutions

»For Dividend option: Dividend paid to investors is TAX FREE under Income Tax but attracts Dividend Distribution Tax (12.5%). The responsibility of deduction of DDT(Dividend Distribution Tax) is that of Mutual Fund while distributing the dividend. So the credit you get in your account as fund dividend is net of DDT and you need not to pay any further tax on it.

»For Growth option Long Term Capital Gain Tax for >365 days schemes TDS will be deducted @ 20%
Short Term Capital Gain Tax for <365 days schemes TDS will be deducted @ 30%

»Double indexation benefit FMPs also offer double indexation benefit, which comes into play when the scheme purchase is made in one financial year and the maturity of the scheme is after two financial years. Indexation (for tax purposes) allows returns generated on FMPs to be adjusted for inflation so that investors are taxed only on the real returns.

For instance, if a 13-month FMP is launched in March 2010 i.e. FY09-10, it will mature in April 2011 i.e. FY11-12. While the investment is made in FY09-10, the redemption takes place in FY11-12. Thus, by investing in FMPs with maturity of a little over a year, the purchase and sale years are spread over two financial years, called double indexation, which effectively reduces one’s tax liability.
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