Is debt fund is better than a FD with 10% interest?

Last weekend I thought of doing a FD and was checking with various corporate FD and Bank FDs

What I found DHFL corporate FD for 40 months is giving 10.10% interest. But I had a mixed  experience with FDs because last time when I did FD with HDFC ltd, though I did with high interest rate of 10.50%, I got minimal return because of taxation.

This time I did not want to repeat the same mistake. So I was checking what are other avenues where post tax return for me would be better than these high interest rate FDs.

I found debt funds are better than bank FDs in long run for post-tax return.

Now question arises how? J

Before understanding we need to understand Cost Inflation Index(CII)

What is CII?

It is used for calculating long term capital gain from income tax act section 48

CBDT has notified the Cost Inflation Index (CII) for Financial Year 2014-15. Complete Notification is Given Below.

SECTION 48, EXPLANATION (v) OF THE INCOME-TAX ACT, 1961 - CAPITAL GAINS - COMPUTATION OF - NOTIFIED COST INFLATION INDEX FOR FINANCIAL YEAR 2014-15

NOTIFICATION NO. 31/2014 [F. NO. 142/3/2014-TPL], DATED 11-6-2014

In exercise of the powers conferred by clause (v) of the Explanation to section 48 of the Income-tax Act, 1961 (42 of 1961), the Central Government hereby makes the following amendment in the notification of the Government of India in the Ministry of Finance (Department of Revenue), Central Board of Direct Taxes published in the Gazette of India, Extraordinary, vide number S.O. 709(E), dated the 20th August, 1998, namely:--2. In the said notification, in the Table, after serial number 33 and the entries relating thereto, the following serial number and entries shall be inserted, namely:--

Sl. No.             Financial Year                  Cost Inflation Index

(1)                         (2)                                       (3)

"34                    2014-15                               1024"

Cost Inflation is required to calculate Long term capital gain under Income Tax Act. Long Term Capital Gains is computed as below: -

LTCG = Full value of consideration received or accruing - (indexed cost of acquisition + indexed cost of improvement + cost of transfer)

Where,

Indexed cost of acquisition =Cost of acquisition x CII of year of transfer /CII of year of acquisition

Indexed cost of improvement =Cost of improvement x CII of year of transfer /CII of year of improvement

CII = Cost Inflation Index (Please see chart given below)

Tax liability on LTCG to be taken at 20%.

If total income other than LTCG is less than zero slabs, LTCG over the zero slabs only attracts tax at 20%.

 Cost inflation Index for Financial Year 1981-82 to 2014-15 is given below for your ready reference.

FINANCIALYEAR	COST INFLATION INDEX
2014-15	1024
2013-14	939
2012-13	852
2011-12	785
2010-2011	711
2009-2010	632
2008-2009	582
2007-2008	551
2006-2007	519
2005-2006	497
2004-2005	480
2003-2004	463
2002-2003	447
2001-2002	426
2000-2001	406
1999-2000	389
1998-1999	351
1997-1998	331
1996-1997	305
1995-1996	281
1994-1995	259
1993-1994	244
1992-1993	223
1991-1992	199
1990-1991	182
1989-1990	172
1988-1989	161
1987-1988	150
1986-1987	140
1985-1986	133
1984-1985	125
1983-1984	116
1982-1983	109
1981-1982	100

If you do not understand the above big explanation don’t worry, let me simplify in layman’s language.

The FDs whatever we get, at the end of each year compounding happened after TDS deduction. However in case of debt fund each year TDS will not be deducted. However at the end of the 3^rd year if you withdraw, you can pay income tax in either of below 2 ways:

·         Directly 10% on tax without indexation

·         Give TAX after indexation calculation

Suppose you made a deposit of 1lakh in both 10% FD and in debt fund:

	Suppose you did a Bank FD with 10 % Interest			Suppose you bought a debt fund mutual fund whose return is 10%
Year	Interest earned	TDS deducted	Money left after TDS deduction that year	Interest earned	TDS deducted	Money left after TDS deduction that   year
2012-13	10,000	1000	109,000	10,000	0	110,000
2013-14	10,900	1090	118,810	11,000	0	121,000
2014-15	11,881	1188	129,503	12,100	0	133,100

Without indexation if you pay tax you need to pay tax (133100 - 110000)*(10/100) = 2310

With indexation the tax amount would be as below:

Indexed purchase price = Original purchase price * (CII for 2014-15 / CII for 2012-13)

 My Indexed Purchase Cost of 1lakh is: 1,00,000*(1024/852)= Rs1,20,188/-

My total indexed interest/Profit would be :Sale Price – Indexed Purchase Price= 1,33,100 – 1,20,188 = Rs12,912/-

I need to pay tax: 12,912*20%= Rs2582/-

In this case my tax without indexation is better, hence I will go ahead and pay tax without indexation.

So my net Return on FD would be: 133100 – 2310 =Rs1, 30,790 which is more than bank FD.

Since I am inside 10% tax slab, so my FD return was 129503.If suppose my tax slab is in 20% , then I need to pay additional tax post TDS deduction .

So looking at these factors debt fund returns are better than guaranteed FDs.

However few pointers I would like to put here:

·         If you are retired and you do not come under taxation slab then FD would be better.

·         If you really do not want the money for 3-4 years then debt fund is better. Else if you withdraw before 3 years then short term capital gain will apply and you will lose more.

·         Debt fund returns are not guaranteed like FDs. However statistically good rated debt funds will give you handsome return.

So you can calculate tax using both ways and then choose the one which is lower. J

Indexation gives a lot of benefit as one can have a virtually tax fee income if invested for a longer duration during days of high inflation.

NOTE: This blog has been written with a lot of care. The author is not a CA. If any error found please let me know. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. The author does not accept any liability whatsoever arising from the use of any of the above contents