The Union budget has outlined some major changes in the way the taxation is treated in relation to debt and debt-oriented mutual funds. At present, these MFs have relatively enjoyed better post-tax returns thanks to their differential treatment with that of the bank Fixed Deposits (FD). The tax treatment was not as interest earned but on capital gains taxation with long-term benefit i.e. investment of one year and above was payable at 10 per cent without indexation or 20 per cent with indexation.

This feature made for an attractive and productive alternative to the FD especially with the investors of the higher tax bracket. But, as per the new provisions, the long term capital gains (CG) would be treated only for investments of 36 months or above and the tax treatment will be flat 20 per cent with indexation benefit, similar to that of the Real Estate CG tax. This has negated the arbitrage they enjoyed against the FD and put them on par with regards to taxation.

The other change though marginal is the treatment of Dividend Distribution Tax (DDT) for the debt MF. Earlier, it was 28.33 per cent on net dividend paid and now it’s considered on the gross basis, which cuts down the dividend by about 10 per cent.

How does one transgress this area of investment to their advantage, here’s a quick take.

Liquid/Liquid Plus/Ultra Short term funds: As the name suggests these are for very short term requirements and ideally less than a year. The tax laws remain same and if the investment is for a few days to few months then one can continue to invest in these. These are also called ‘parking’ funds. The effective returns might still beat the term deposits, though performance of these funds is dependent on the liquidity in the system.

Short term funds: This category involves in funds between six months and one year horizon. If the horizon is for one year and a little above, then one is better off not investing in these as the tax treatment has negated any gains it earlier had.

Fixed Maturity Plans: These are the funds that were grossly hit. They also have tenures beyond 3 years and up to 5 years. The double-indexation in the LTCG effect usually made them attractive in the shorter periods i.e. less than 2 years against the FD but would now fall off in favor of the FD. If a less than 3year horizon is the case, then better invest in a FD.

Income/Gilt Funds: With the G-Sec exposure in these funds, these are ideally suited for longer term and so the taxation effect wouldn’t completely take sheen off them. But, any speculation and opportunist investment now doesn’t find merit in these funds.

Dynamic Bond Funds: These are duration funds with short, medium and longer tenure debt instruments and are used to counter any volatility in the interest rates. Now, with the interest rates tend to move southward, albeit at a much slower rate, these funds would be ideal to exploit the current situation. The best way is to pick a fund with higher average maturity to maximise the advantage.

Monthly Income Funds: These have a bit of exposure to equity and offer that bit of excitement the returns. These were used as one of the retirement options with Systematic Withdrawal Plan (SWP) over a year of investment but now with the tweak in taxation, it’s stands less disadvantaged.

(The writer is a practicing financial planner; he can be contacted at [email protected])