Are you paying  30% tax on Bank FD…?

I have seen since my childhood that majority of us feel very comfortable invest in bank fixed deposit. Either you educated or illiterate most of us assume that bank FD is safest and the best instrument for investment.  If you are in 20% or 30% tax bracket, you have to pay tax according to your tax slab on your earned interest income from FD. There are many fixed maturity plans (FMPs) available which are safe compare with equity market investment and you can also save a huge amount of tax or many times pay nil tax. When you invest in debt funds and hold it more than one year you have two choices to pay the long term capital gain. Either pay flat 0% on capital gain or pay 20% using indexation method. Let us take a simple example for better understanding.

Bank FD investment:

Mr A has deposited Rs 1 lakh in bank FD for  one year and earn interest Rs 9,000 at the rate of 9%. If Mr A is in 30% tax slab then the tax liability is Rs 2700. In means after post tax his real gain only Rs 6300. In reality, Mr A has earned after paying tax only 6.3% on his bank FD investment which even does not cover inflation also.

FMP investment:

Mr B has invested Rs 1 lakh in 365 days FMP in Feb 204. After one year Mr B would earn around 9.5%. It means Mr B would earn Rs 9,500 after one year on his Rs 1 lakh investment. Now Mr B has two options to pay the tax, either pay flat 10% on capital gain or use indexation tax benefit method and pay 20% on gain.

If calculate according to flat 10% method Mr B would pay Rs 950 tax. Before calculate tax according to indexation tax benefit, first understand about it.

What is Indexation Tax Benefit Method ?

The government of India announces a number called the cost inflation index (CII) every year. It represents the inflation movement of our country. We adjust our investment value according to this CII index. The CII for the year 2013-14 is 939 and expected CII index for 2014-5 would be 1,005 if assuming inflation 7%. The formula of obtaining the inflation adjusted value is as given below:

Inflation adjusted value = Invested Amount X (CII at the time of sale/ CII at the time of purchase)

Inflation adjusted investment value = 1,00,000 X (1,005/939) = 1,07,028

Net capital gain :  1,09,500 - 1,07,028 = 2,472

Tax Payable: 2,472 X 20% = 495

So Mr B have two choices either he can pay Rs 950 according to flat tax calculation method or pay Rs 495 according to inflation indexation method. Obviously Mr B would like to pay tax Rs 495. So the real gain after tax would be1,09,005 (1,09,500 – 495).

If Mr B uses Indexation tax method then after post tax return would be 9.05% whereas in the case of bank FD Mr A’s after tax return would be 6.3%.

For more detail and any other query related investment, you can contact me through my email.

Warm regards,

Arvind Trivedi

Certified Financial Planner

arvind.trivedi79@gmail.com

www.artofinvest.com

www.arvindtrivedicfp.blogspot.in