With non-equity schemes qualifying for long-term capital gains after three years, FMPs have lost sheen
Fixed maturity plans (FMPs), which were a rage with retail investors till not long ago, have lost much of their sheen, primarily because of the mitigating provisions of Budget 2014.
Assets under management (AUMs) of mutual funds from this category fell for the third consecutive quarter in March 2015, shedding 5.4%, or R8,463 crore. However, the overall AUM of the industry grew for the sixth consecutive quarter to R11.89 lakh crore, Amfi data show.
After last year’s Budget, investments held in non-equity schemes qualify for long-term capital gains only after three years (36 months), up from one year. The rate of long-term capital gains tax stands at 20% with indexation. As a result, FMPs of less than three years have lost their edge over bank fixed deposits (FDs) in terms of tax benefits.
As Brijesh Damodaran — founder & managing partner, BellWether Advisors LLP — says, FMPs with duration of one year were a rage till
July 2014. “With benefits of indexation and long-term capital gain consideration, for period in excess of a year, the instrument was one of the preferred modes of investment for both retail and high net-worth clients. Also, as the period of investment and the paper to be invested in were clear, there was liquidity after one year and investors could decide whether they wanted to reinvest after redemption. These benefits are no longer there,” he says.
Fixed maturity plans are closed-ended funds and investments by fund houses are made in securities maturing on or before the maturity of the scheme. Earlier, mutual fund houses used to launch 380-day FMPs in the last week of March. After the scheme matured in April next year, investors took the double indexation benefit. However, after Budget 2014, most mutual fund houses offered an option to roll over the one-year FMP for an additional two years with the consent of investors.
Before the changes introduced by the 2014 Budget, short-term capital gains with a holding period of less than a year were taxed at a marginal rate. There was no change in this structure after the 2014 Budget.
Also, for investments over a period of one year, capital gains tax was applicable at 10% without indexation, or at 20% with indexation. However, the definition of ‘long term’ was extended to three years and the gains now taxable at 20% with indexation.
Damodaran says FMPs of one year typically did not have any interest rate risk as papers were held till maturity and there was no duration risk as the period of holding was known in advance to investors. “With indexation benefits, the yield was in double digits, which was better than the rates offered by bank fixed deposits. The double whammy of lack of liquidity and change in long-term capital gain structure made FMPs unattractive,” he says.
Bank FDs or FMPs?
The increase in long-term capital gains tax on debt-oriented mutual funds was done to bring parity with bank deposits and other MF debt instruments. In case of bank fixed deposits, the tax is paid on the interest earned every year at a marginal rate applicable to the investor. So, under the new tax structure, does it make sense to invest in a bank fixed deposit? There are two scenarios in which investments in FMPs are still beneficial compared to bank fixed deposits. One, in a falling interest rate scenario, debt funds would benefit as bond prices will increase.
Second, where the investment horizon is more than three years, the tax efficiency of debt funds would be better than bank fixed deposits.
For other cases, an investor could consider bank fixed deposits, given the guaranteed returns. The advantage bank fixed deposits have over a three-year FMP is the liquidity factor. In case of any emergency, bank fixed deposits can be liquidated, with some penalty for premature withdrawal. But FMPs cannot be liquidated as the funds are closed-ended.
Analysts say if an investor is in the 10-20% tax bracket, bank fixed deposits or corporate fixed deposits with AAA rating could be considered. However, if one doesn’t need to liquidate the investments or falls in the 30% tax bracket, a three-year FMP could be a good option.
How fmps lost their mojo
* after last year’s Budget, investments in non-equity schemes qualify for long-term capital gains only after three years (36 months), up from one year
* The rate of long-term capital gains tax now stands at 20% with indexation. As a result, FMPs of less than three years have lost their edge over bank fixed deposits in terms of tax benefits
SHOULD YOU STILL GO FOR THEM?
* In a falling interest rate scenario, debt funds would benefit as bond prices will increase. So, FMPs are still a good option for such periods
* When the investment horizon is more than three years, the tax efficiency of debt funds would be better than that of bank fixed deposits