Single Indexation For Fixed Maturity Plans (FMPs) Under Direct Tax Code

Indexation Benefits of Fixed Maturity Plans

In one of my previous articles I had discussed about Fixed Maturity Plans (FMPs). In this article I will discuss Indexation of Fixed Maturity Plans under current Income Tax Act as well as under the proposed Direct Tax Code. The major selling point of fixed maturity plans is the tax benefit it offers in the form of Double Indexation under the Income Tax Act of 1961. This benefit is only applicable when the investor has opted for the growth option, as in the growth option, the return is treated as capital gains.

Long Term Capital Gains And Benefits From Indexation

Return from a Fixed Maturity Plan having duration is greater than one year, is treated as Long Term Capital Gain. The investor computes his tax liability both with indexation and without indexation and pays the lesser of the two. With indexation the tax rate is 20% plus surcharge) and without indexation it is 10% plus surcharge.

If an investor invests in a Fixed Maturity Plan having a duration of 370 days or more, then his investment matures in the 3rd financial year from the year of this investment. For example, if  he had invested in a FMP on March 29, 2011 (FY 2010-2011). His investment would have matured on April 2, 2012 which is (FY 2012-2013). So the investment spanned across 3 financial years ie. FY 2010-2011(purchased), FY 2011-2012(held) and FY 2012-2013(sold). His return in this case would be treated as Long Term Capital Gain. He would have to calculate his return both without indexation and with indexation and pay the lower of the two as tax.

The Reason Behind Indexation

Indexation takes into account the fact that inflation reduces the value of an assets. Hence the investor is allowed to bring the cost of the asset at par with prevailing market prices. This is done by multiplying the cost of the asset with a inflation factor called Cost Inflation Index. In India, Cost Inflation Index is notified every year by Central Board of Direct Taxes (C.B.D.T).

How is Indexation Done For FMPs

Calculation of inflated adjusted cost of a Fixed Maturity Plan is as follows

Inflated Cost of Asset = Cost of Asset x ( Cost Inflation Index of the Year of Maturity/Cost Inflation Index of the Year of Purchase )

Double Indexation Benefits under Current Income Tax Laws

So in the example we discussed above, the investor gets the benefit of indexation for two years, first for the year of purchase is  FY 2010-2011 and second for year of maturity is FY 2012-2013, though the duration of the Fixed Maturity Plan is only on 370 days which is 5 days more than a year. This is called the ‘Double Indexation Benefit’.

Direct Tax Code and FMPs

Direct Tax Code which is supposed to be implemented from April 1, 2013 will do away with this Double Indexation Benefit.

Under DTC, an investor in a FMP will only get the benefit of Single Indexation and not double indexation. The denominator will become the CII of the financial year following the year of purchase of the FMP.

This table** will give you a better understanding.

Bank Fixed Deposit FMP (Under Income Tax Act) Double IndexationFMP (Under DTC) Single Indexation
Investment DateMarch 29, 2011 March 29, 2011March 29, 2011
F.Y. of Investment2010-2011 2010-20112010-2011
Maturity DateApril 02, 2012 April 02, 2012April 02, 2012
F.Y. of Maturity2012-2013 2012-20132012-2013
Investment [a]Rs. 100,000.00Rs. 100,000.00Rs. 100,000.00
Maturity AmountRs. 109,123.00Rs. 109,123.00Rs. 109,123.00
CII for FY 2010-2011 [b]Not Applicable711711
CII for FY 2011-2012 [c]Not Applicable785785
CII for FY 2012-2013 [d]*Not Applicable832832
Indexed Cost of FMP [a* d/b]Rs. 117,019.00
Indexed Cost of FMP [a* d/c]Rs. 105,988.00
GainRs. 9,123.00Rs. (7,896.00)Rs. 3,135.00
Tax PayableRs 2,819.01 (@ 30.9%)Nil Rs 645.81 (@20.6%)

* CII number for FY 2012-2013 has not yet been releases by the C.B.D.T. It has been calculated by taking inflation at 6%.
** This Table is for illustration purpose only

We can see that due to double indexation, the the investor does not have to pay any tax as his indexed cost of the FMP is more than the maturity value and hence is treated as Long Term Capital Loss. The investor can offset this Long Term Capital Loss with other Long Term Capital Gains. So it now evident why Double Indexation Benefit is a major selling point for FMPs.

Even with Single Indexation benefit, FMPs will remain attractive investment instrument for High Networth Individuals when compared with bank fixed deposits.

To know more about Fixed Maturity Plans, click here.

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