How indexation works in debt mutual funds

May 27 2014, 04:17 IST
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SummaryIf you are planning to transfer your capital asset, the relevant head of income to be referred to is ‘capital gains’. A ‘capital asset’ includes investments in stocks, mutual funds, bonds, real estate, precious metals, fine arts and other collectibles

If you are planning to transfer your capital asset, the relevant head of income to be referred to is ‘capital gains’.

A ‘capital asset’ includes investments in stocks, mutual funds, bonds, real estate, precious metals, fine arts and other collectibles. The Income Tax Act, 1967, defines capital asset as property of any kind held by a person, whether or not connected with his business or profession. However, it specifically excludes stock-in-trade, consumable stores or raw materials held for the purpose of his business or profession and personal effects.

Gains arising from the transfer of capital assets are broadly classified as long term and short term, depending on the period of holding of such assets. A long-term capital gain (LTCG) arises from the transfer of a capital asset whose period of holding is more than 36 months (12 months in case of shares or securities listed on a recognised stock exchange in India or a unit of a specified mutual fund or a zero-coupon bond). If the period of holding is less than 36 months (or 12 months, as the case may be), the gain arising from such a transfer is classified as a short-term capital gain (STCG). The tenure of investment is an important factor in arriving at the tax liability. While STCG is taxed at the normal slab rates, LTCG is taxed at beneficial rates.

To compute LTCG, the I-T Act provides a provision of indexation in certain cases. Indexation is a mechanism by which the cost of acquisition of an asset gets adjusted for inflation. Every year, revenue authorities notify the cost-inflation index (CII) for that particular year. Indexed cost of acquisition is computed by multiplying the cost of acquisition of the capital asset by the CII of the year of sale and dividing by the CII of the year of purchase. This basically increases the cost of acquisition by the inflation factor and, thereby, reduces the amount of LTCG. However, the benefit of indexation is not available in case of long-term capital assets, being bonds or debenture or LTCG arising to a non-resident from the transfer of shares or debentures of an Indian company.

Mutual funds are becoming an upcoming investment trend among the younger generation, primarily due to the ease of liquidity. Mutual funds can broadly be categorised into two categories — debt-oriented and equity oriented. Debt funds are less risky than equity funds. Investment decisions are guided

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