These products from Mutual Funds allow you to lock-in lumpsum amounts for a definite term. Although you do not know for sure how much you will be earning, one can be rest assured that a slice of bond market with certain maturities would normally generate a particular rate of return. one can make out the expected yield curve by studying the prior period yield curve allowing for changes expected. Even if you are not knowledgable investor, it is made easier by govt freeing small savings rate and the rate on post office savings deposits.
You get FMPs for any period, be it 1 month, 2 month, etc.. to 370 days, 390 days and even more.
LTCG Tax and FMPs
The CII is used to calculate what’s called the indexed cost of acquisition and this number bumps up the original price to match inflation.
The way you calculate the indexed cost of acquisition is by using the following formula:
Original purchase price x ( Index value in the current year / Index value in the original year)In the case of FMPs, the original purchase price is nothing but the money you invested.
Let’s say you bought a FMP of a maturity of 370 days with Rs. 1 lakh in FY 2010 – 11 and sold it in FY 2011 – 12. To calculate the indexed cost of acquisition you will input the numbers in the above formula and get the new indexed value.
1,00,000 x (711 / 632) = 1,12,500
Let’s say after 370 days – the FMP rose to Rs. 1,12,500 which means it gained 12.5% in just over a year. To calculate the capital gains – you will need to subtract the indexed cost of acquisition with the selling price.
In this example both are the same so you won’t end up paying any tax.
There are a couple of things to keep in mind about this – indexation only works for long term capital gains which accrue after you have held the FMP for a year, so that’s why you see a lot of FMPs that have a maturity period of slightly over 365 days.
Secondly, what Direct Tax Code eliminates is the double indexation benefit of FMPs which meant that you could buy something in March 2010 and sell it in April 2012 and make it span across two financial years. The DTC won’t allow this, but as far as I know FMPs will still be tax efficient when compared with fixed deposits because of the way indexation works.
FMPs and FDs
Both are fixed income alternatives but FDs come with pre-determined rate of return while the FMPs come with market based rate of return that is revealed at the end of the term.
The interest is taxed according to your tax slab in the FDs but LTCG advantages are available to your FMPs
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