Fixed maturity plan (FMP) is a great option for conservative investors who seek safety of their capital with decent returns. They have a fixed tenure. Returns are not guaranteed upfront, but can be closely predicted with the interest rate movements. Popularity of FMP’s has grown multi-fold ever since the interest rates began moving upwards.
Tax benefit of FMP is what differentiates it from its peers. Though there are other financial products which offer safety of capital, FMP has gained prominence as a good post-tax returns generating product. Let’s see what kind of tax benefits an FMP has in store for you.
This is the first type of tax benefit that you get by buying an FMP. It is known as indexation benefit. This benefit is not specifically given to FMP. It gets this benefit by being a part of debt funds category. Hence, all types of debt funds such as liquid funds, short term debt funds, FMP’s, etc enjoy this indexation tax benefit.
You do not get any benefits when you buy an FMP. However, if you hold it for more than 1 year and then sell it, there will be tax of 10% flat or 20% with indexation, whichever is lesser. Let’s have a look at how this works. Suppose you invest Rs. 1 lakh in an FMP of 13 months tenure. After 13 months, it has grown to Rs. 1,12,000 i.e. it has given returns of 12% p.a or Rs. 12,000. 10% flat tax on the returns would be 1200. As we know, there will be another option of 20% tax with indexation. First, indexed cost of acquisition needs to be calculated for this. The formula for this is:
Purchase price * (CII for sale year) / (CII for purchase year)
Note: CII refers to cost inflation index which is declared every year.
If you take the sale year as 2013-14 and purchase year as 2012-13 for the above example, Indexed cost of acquisition becomes 1,00,000 * (939/852) i.e. 1,10,211. Hence, returns generated would be difference of Rs. 1,12,000 and indexed cost i.e. Rs. 1,10,211 i.e. Rs. 1788. 20% tax on this would be Rs. 357.
Since this value is lesser than 10% flat tax, it would be considered for taxation. You can clearly see a huge difference in savings by using indexation benefit. At times, higher inflation could even make your tax liability nil.
Let’s see how taxation works if the same amount is invested in a fixed deposit which yields the same return i.e. Rs. 12,000 after 13 months. If you are in the highest tax bracket, there will be 30% tax on the returns, which brings the total tax amount to Rs. 3,600. This is how FMP’s are tax efficient compare to FD’s and similar products.
This is another benefit you can avail by purchasing FMP’s. Suppose you buy an FMP of 13 month tenure in March of FY 2013-14. The maturity of the product will be in April FY 2014-15. By doing this, you are skipping one year and selling it in the next financial year. It means you are spreading your tax liability over two financial years. Moreover, there are enough chances that cost inflation index increases due to higher inflation. This will also lower your total tax liability.