Tax planning is one of
the most important aspects of financial planning. Before making any investment
decision you should know final outcome post tax. Just to remind you long back
there were two RBI bonds available in the market; one is 6.5% tax free and
another one 8% taxable. Because of tax advantage in first option there was a
huge inflow in tax free option as to a person in 30% tax bracket was getting
additional 0.90% compared to taxable 8% option (net 5.60%). Government had to
withdraw the tax free bonds after they realize that smart money is heavily
coming in tax free option and government is losing on income tax revenue. You
can’t afford to ignore tax planning even you are in lowest tax bracket.
The budget of 2014 made
debt funds long term after a period of 3 years instead of previous clause of 1
year. This single amendment changed the entire investment pattern in debt funds
and FMPs. We had floods of 1 year FMPs in the market prior to this amendment and
also sizable amount came in MIP funds (Monthly Income Plans) due to its tax
advantage. The advantage in FMPS and MIP funds had a blow after the change in
long term definition of other than equity funds. This advantage has gone now
and again the sizable amount has moved to bank fixed deposits which attract tax
liability. So is there any other option available to save tax. The answer is
yes.
After debt funds are
made long term after 3 years, a new category of investment has arrived in the
market in the name of equity income fund. J P Morgan and ICICI prudential Mutual Funds are
the first to launch this investment option in the market. The equity income
funds are similar to MIP funds but these new funds are treated as equity funds
for tax purpose. The fund is classified as equity fund if it invests 65% of the
fund in equity category and for income tax purpose the fund will be treated long
term after a period of one year. So what is the difference if the risk is
almost same like MIP funds? These new equity income funds invest up to 25% in
equity and up to 40% to 50% in arbitrage which are treated as equity investment
and thus classify as equity oriented fund for income tax purpose. The equity
income fund invests balance in debt products like government and corporate bonds
or money market instruments.
The arbitrage means
buying in cash market and selling the same quantity in future and option
market. So if any fund does arbitrage means there is no equity risk as the
equity position is hedged in f & o segment. This arbitrage will give you
debt kind of return depending on the premium available on the stock. So as far
as risk is concerned it is same like hybrid aggressive debt oriented funds i.e.
MIP funds but tax treatment is like equity funds and not of debt funds. This
tax treatment gives equity income fund an edge over MIP funds and FMPs.
But surely this product
is not meant for one year time horizon even it gives tax free return after one
year. Equity investment always is risky investment and even 25% investment can
give you negative return if your time horizon is one year. The equity income
fund is suitable for those whose time horizon is 2- 3 years and can extend for
another six months if needed. The bank deposit will give around 6% return post
tax and 3 year FMP will give around 8% return but this fund can give you 2%
more if you take calculated risk. The returns in equity income funds are not
guaranteed as the funds are market linked. Investors should definitely consider
if they understand the risk involved during this 2-3 years period.
The funds
are very new and have not completed one year so past performance is not available
for comparison. Comparing this fund with aggressive MIP funds will give you
rough idea about the risk and reward. Normally I don’t recommend any fund which
has not completed 3 years time but this new category is almost same like MIP
funds so it’s easy to understand and tax treatment is added advantage. Corpus
of around Rs. 1,000 crore in less than one year period indicates that smart
money has started coming in this funds. Hope with growing demand other AMCs
will also follow the suit.
This article first appeared at indianotes.com
http://www.indianotes.com/Analysis/Equity-Income-Fund--Better-than-Fixed-DepositsFMPs/194687/6/PF
