How double indexation increases return in FMP?

Finance minister Mr P.Chidambaram in one of the award function asked the recipient of the award "What is your wish list in this year's budget" and the recipient "he din want to pay more taxes" and the recipient is none other than India richest person Mr Mukesh Ambani. In return FM commented that "India is a country where a normal person as well as the richest person does not want to pay taxes".

If Mukesh Ambani himself is more conscious about paying taxes, aam aadmi like you and me should be trying to save taxes in a judicious manner. So lets see how we can reduce taxes on Fixed Maturity Plan by double indexation.

How is the profit taxed from debt mutual funds?

Debt mutual funds have a long term capital gain tax which is taxing the interest if the investment is held for more than a year. There are two methods of taxation.

1. 10% on the interest gained without indexation.

Taxable amount = Amount Returned - Amount Invested

2. 20% on the interest gained without indexation.

In the second gain, the taxable amount is calculated by

Taxable amount = Amount Returned – (Amount Invested * Inflation Index for Redemption financial Year/ Inflation Index for Investment financial Year)

Inflation index for every year is released by the govt.

Lets understand this concept with an example.

Assuming an FMP of 15 months returning 11% and Rs 10,000 is invested. Inflation index for 2006-2007 100 and inflation index for 2007-2008 is 105 and for 2008-2009 is 111. s Tax is calculated using indexation at the rate of 20%.

Scenario 1:

Amount invested in sep 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2007-2008))

= 11000 - (10000 * 111/105)

= 11000 - 10571 = 430

Tax @ 20% = 20% of 430 = 86

Amount redeemed = 10914.

Scenario 2:

Amount invested in Mar 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2006-2007))

= 11000 - (10000 * 111/100)

= 11000 - 11100 = -100

Net Loss = 100 and hence no tax.

Amount redeemed = 11000

So in this case we have totally avoided tax.


Hence while planning an FMP investment, we should plan it in such a way that it spans two financial years to get the advantage of double indexation.