What should investors opt for in this scenario?
What is Fixed Deposit
What are debt mutual funds
From April 1, 2023, taxation rules for debt mutual funds changed. According to the new tax rules, indexation benefits will not be available to “specified debt mutual funds” – where equity investments do not exceed 35% of their assets under management. These mutual funds will be taxed in the same manner as bank fixed deposits.
In the case of bank FDs, interest income is fully taxable. Besides, banks also levy tax deducted at source (TDS) on the interest paid on FDs. “Suppose, if you fall under the 30% income tax bracket, you would have a tax liability of 30% on the interest paid on FDs,” explains ClearTax. Every year, the fixed deposit interest is added to the taxpayer’s income and taxed at the investor’s tax slab. Each fiscal year, a TDS of 10% is imposed on FD interest over Rs 10,000.
The remaining advantage of debt MFs is non-application of TDS
Hence, no capital gains tax will be payable during the holding period. If you continue to hold debt funds till the age of retirement, and your income tax bracket has come down to 5-10% or more, the tax liability on debt funds capital gains would be reduced accordingly. Hence, debt funds are a great option if you want to postpone your taxes.
“From 1 April, 2023 all debt investments became chargeable to tax at normal slab rate applicable to assessee instead of erstwhile status enjoyed by them @20% u/s 112. This was the primary reason why investors preferred debt investments which have gone now. This change has brought the bank FDs & Debt mutual funds at parity. Considering this change, if the investors want high volatile return and have accumulated capital gain losses for the purpose of set-off, it is advisable to invest in debt investments instead of FDs, which offer fixed rate of return, said Maneet Pal Singh, Partner, I.P. Pasricha & Co.
Though a depositor can defer offering the accrued interest to tax till the time the interest is actually credited, banks deduct TDS on accrued interest. Carrying forward the TDS credit and having it netted off in the future is a practical nightmare, more often resulting in the credit being denied in the future period,” said S Sriram, Lakshmikumaran &Sridharan attorneys.
So if one generates a return of Rs10,000/- upon an investment of Rs 1,00,000/- through debt funds, the entire amount of Rs 1,10,000/- is paid back to the investor without any deduction of TDS on return of Rs 10,000/-. whereas, in FDs, tds is deducted on the return generated, explained Sandeep Bajaj, Managing Partner, PSL Advocates & Solicitors
This means that if you have long-term capital losses from other assets, such losses cannot be set off against the short-term capital gains arising from debt mutual funds. Long-term capital losses can be set off against long-term capital gains only.
Rs 10,000/- return generated can be set off against any short term loss of upto Rs 10,000 on capital assets saving income tax on the said return.
Flexibility of Withdrawal
Charges: There are no direct costs associated with investing in fixed deposits. In the case of bonds, the cost of demat accounts need to be accounted for. Moreover, for debt mutual funds, expenditure ratios can range from 0.2% to 2.25%. It is the fee fund houses charge for handling debt funds. Therefore, regular plans are subject to higher charges.
According to Chaitali Dutta of Personal Finance Advisory, booking an FD in the following situations may be useful:
2) Senior citizens who have no other sources of income.
“With the tax arbitrage on debt funds being done away with recently, they are no longer as lucrative compared to fixed deposits as they used to be. The additional risks associated with debt funds may not be worth the incremental 50-100 bps annual return that they could potentially deliver, especially when you consider that the risks themselves are complex and beyond the understanding of most retail investors. Since both debt funds and fixed deposits are suitable for short term goals, actual effect of any potentially higher return would be limited due to the limited impact of compounding in this scenario,” said Mayank Bhatnagar, Chief Operating Officer, FinEdge.
According to CA Ruchika Bhagat, MD, Neeraj Bhagat & Co, choosing between fixed deposits and debt funds depends on various factors, including your financial goals, risk tolerance, investment horizon, and recent changes in taxation.
1. Risk and Return: Fixed deposits are relatively low-risk with fixed returns, while debt funds have varying risks and returns depending on the underlying securities. Assess your risk appetite and return expectations.
3. Tax Efficiency: While fixed deposits have taxable interest, debt funds provide indexation benefits for long-term capital gains, reducing tax liability. Consider your tax bracket and the impact of recent changes in taxation on both options.
5. Diversification: Debt funds provide diversification by investing in various fixed-income instruments. Fixed deposits, on the other hand, are concentrated in a single institution. Diversification can help reduce risk.
7. Post-tax Return: Options that give hire post return is always a better option.