Go for systematic withdrawals from debt funds

Aug 21 2014,

 For those seeking to reduce their tax liability on redemption from debt mutual funds, Anutosh Bose, chief operating officer, LIC Nomura Mutual Fund, recommends systematic withdrawal plans (SWPs).

He says after Budget 2014-15 announced a flat 20 per cent tax on long-term 
capital gains from non-equity funds, many planned to invest in fixed deposits. "Instead, investing in bond funds or short-term funds and using SWPs can be helpful and tax-friendly. Fixed maturity plans (FMPs) are unattractive by comparison, as these have a lock-in, which will only rise with the new tax regime. Bonds and short term funds provide FMP-like returns, along with the flexibility of partial and intermittent withdrawal," he says.

SWPs are useful for those who do not need the entire money at a go. "If the investor needs a smaller amount in fixed intervals, SWP lets one withdraw a specific amount and pay tax only on the earnings or the gains portion of the withdrawn amount," Bose says.

If you invest Rs. 50 lakh in fixed deposit, you will earn 10 per cent a year. After a year, you will earn Rs. 5 lakh of interest income. If you redeem from the deposit, the entire interest income will be taxable at the slab rate. In the highest tax bracket, you will pay tax of Rs. 1.5 lakh.

By comparison, if you invest Rs. 50 lakh in a short-term fund, earn 10 per cent and use the SWP route and withdraw Rs. 5 lakh every year, you will not have to pay tax on the entire Rs. 5 lakh. "The tax will be applicable only on the capital gains part of the redeemed amount," says Vaibhav Sankla, director, H&R Block.

Say you buy each unit for Re. 1 (50,00,000 units) and plan to withdraw systematically at the end of each year. A year later, if the price of each unit is Rs. 1.1 and you sell 455,000 units (you redeem about Rs. 5 lakh), the short-term capital gains will be only Rs. 45,500 and this will be taxed at the slab rate. In the highest tax bracket, the tax will amount to Rs 13,650, says Sankla.

After three years, the long-term capital gains tax will be 20 per cent post indexation, according to the new rules. "However, after taking indexation into consideration, the long-term gains will be close to nil, as the cost-inflation index is rising at about 10 ten per cent and returns on debt funds are eight-nine per cent. So, the indexed cost of a unit worth Re 1 should become Rs. 1.3 after three years. The actual price of the units after three years will be Rs. 1.24, a small loss. Sometimes, the index value and returns are close and long-term capital gains could be zero," says Sankla.

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 Source: Business Standard

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