Same taxability for debt mutual fund and FD
The government has changed the tax laws with effect from April 1, 2023 with regard to debt mutual funds. Any purchase after April 1, 2023 will not get the benefit of special rate on long term capital gains. These will be taxed at the tax rate applicable to you.
The tax advantage available for debt mutual funds as compared to fixed deposits (FD’s) is hence no longer available for purchases after April 1, 2023.
Reasons why we prefer debt mutual funds to FD’s
We still prefer debt mutual funds as compared to FD’s for the following reasons:
- For Bank FD’s you are taking risk of that single bank whereas debt mutual funds offer diversification.
- For corporate FD’s it is inconvenient for you to invest in several different FD’s. Debt mutual funds spread this out. They are more convenient and the investment call is taken by a professional fund manager.
- FD’s have tax deducted at source (TDS) on the interest earned. Debt mutual funds have no TDS on the “growth option” (which is what we’re suggesting).
- On FD’s you have to pay tax based on your accounting method. You pay tax annually on the interest earned if you follow the accrual basis (or on a non-cumulative FD). Alternatively, you pay tax on interest upon maturity on the cash basis of accounting (and on a cumulative FD). If you don’t need the cash at the time of maturity, then the tax paid has a negative impact on returns. This is because the compounding on the amount of tax paid has been reduced. Over the long term this could have a big impact.
- For safety, you can select those categories of mutual funds that offer good safety with returns comparable to bank FD’s. Examples of these funds are Short Term Debt Funds and Banking and PSU Debt Funds.
- If you want an even higher safety to bank fixed deposits, you may opt for Gilt Mutual Funds. However, the return may be lower as compared to bank FD’s.
- Instead of corporate FD’s, you may opt for Corporate Bond Funds. These invest in bonds of companies that are above investment grade (ie rated AA+ and above by an independent rating agency). Corporate Bond Funds would have a higher return than corporate FD’s. This is due to the timing in tax payments as mentioned above.
- Gains or losses from mutual fund investment go under the head of capital gains (under tax law). Hence, these can be set-off against other capital gains and losses from other assets.
What about hybrid funds
There is another option for investors to get some debt exposure with a tax benefit that is better than FD’s. That option is to invest in the following types of hybrid funds:
| Type of Hybrid Fund | Equity Investment | Type of Fund for Tax Purpose | Taxability of Long Term Gains |
|---|---|---|---|
| Conservative Hybrid Fund | 10% – 25% | Debt Mutual Fund | Same as normal Debt Mutual Fund, ie at tax rate applicable to you |
| Balanced Hybrid Fund | 40% – 60% | Debt Mutual Fund | As applicable to Debt Mutual Funds, ie @ 20% with indexed cost |
| Aggressive Hybrid Funds | 65% – 80% | Equity Mutual Fund | As applicable to Equity Mutual Funds, ie @ 10% |
| Equity Savings Funds | 65% – 90% | Equity Mutual Fund | As applicable to Equity Mutual Funds, ie @ 10% |
We don’t prefer such funds because managing/balancing the desired debt:equity portfolio and diversification becomes difficult. Especially where a higher component of debt is required.
Such hybrid funds also have their own internal allocation to different types of equities and debt. Normal debt and equity funds that have the allocation based on their type. Hence this would require greater scrutiny and even then the allocations could change.
Hybrid Funds also tend to have a higher Total Expense Ratio as compared with normal debt and equity funds.
Hence our preference is for normal debt mutual funds. You may look at some investment in Hybrids only if your investment is large enough. This could resul in higher tax savings by moving to Hybrids.
