Look at tax structure before investing in debt products

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fe Bureau: Sep 06 2011, 03:03 IST

The downtrend in the stock market, coupled with rising interest rates, has resulted in debt instruments gaining in popularity. Of course, debt instruments vary in terms of safety, coupon rates and liquidity. Even the term ‘fixed income’ is a misnomer, as this applies only to certain investments that are held to maturity, such as fixed deposits and debentures.

Here, the primary risk is of a default. Net asset value or NAV-based options such as debt mutual funds of all hues carry market risk and hence are not ‘fixed’ in the true sense. Besides the above-mentioned differences, investors should be aware of the difference in tax treatment for various debt instruments.

Fixed deposits and corporate debentures: Interest earned on these is taxed as per the investor's income tax slab, thereby making it unattractive to investors in the highest tax bracket (30%). Besides, they also do not enjoy the benefit of being indexed to cost inflation. Hence, in the case of long-term fixed deposits or corporate debentures (maturing after one year or more), your principal amount actually loses value due to inflation. Many investors are unaware of this insidious side effect.

Government small savings schemes: Some of the popular avenues include post office monthly income schemes (POMIS), Kisan Vikas Patra (KVP), public provident fund (PPF) and National Savings Certificates (NSC). Currently, all of them are subject to administered interest rates. Hence, their popularity increases during low interest rate regimes. Here too, the tax treatment is not uniform.

Interest from KVP and interest and maturity bonus earned

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