Indexation benefit in Debt Mutual funds

Everyone are worried about taxes in Debt mutual fund and sale of land . Indexation is an efficient way of preventing draining of your returns on investments in the form of taxes. Indexation is applicable to long-term investments, which include debt fund and other asset classes. Indexation helps you in adjusting the purchase price of the investments. In this way, you will be able to lower your tax liability.

One need to understand Inflation and capital gains before understanding Indexation

Inflation is increase in the price of  product or service . It means you will be able to buy fewer things year after year as compared to what you can buy today with the same amount of money . 

Capital gains is the increase of value of investment in over a period of time . Suppose if you have purchased debt mutual fund for a NAV 10/- and after a year you sell same fund at a NAV 11/- the difference between  purchase NAV and selling NAV is your capital gain. 

In other words, a capital gain is a difference between the purchase price and the sale price of an investment. In the case of debt funds, which are long-term in nature (held for more than 36 months), capital gains are arrived after indexing the purchase price of the investment.

With the help of Indexation you can be able to lower your taxes on capital gains . Debt funds are more attracted than Fixed deposit because of Indexation benefit . 

Current cost Inflation Index

Financial Year

Cost Inflation Index (CII)

2001-02 (Base year)

100

2002-03

105

2003-04

109

2004-05

113

2005-06

117

2006-07

122

2007-08

129

2008-09

137

2009-10

148

2010-11

167

2011-12

184

2012-13

200

2013-14

220

2014-15

240

2015-16

254

2016-17

264

2017-18

272

2018-19

280

2019-20

289

2020-21

301

In case of long-term capital gains, the tax liability is computed using two methods

  • with indexation (charged at 20% plus surcharge) and
  • without indexation (charged at 10% plus surcharge)

 

For Example

  • An asset was purchased in FY 2004-05 for Rs. 2.50 lacs
  • This asset was sold in FY 2010-11 for Rs. 4.50 lacs
  • Cost Inflation Index in 2004-05 was 113
  • Cost Inflation Index in 2010-11 was 167


So Indexed cost of acquisition  

Indexed cost = (CII for the year of sale/ CII for the year of purchase) X (Cost of purchase)

250000 *167/113 = 369469/-

Selling price of an asset - Indexed cost = capital gain

4,50,000-369469 = 80531/-

Therefore ,Tax payable is 20% of 80,531 i.e., 16,106/-


With out Indexation benefit tax would be 

  • Selling Price of an asset - Indexed Cost = Capital Gains
            4,50,000-2,50,000 = 2,00,000/-

therefore tax payable is 10% of 2,00,000/- = 20,000/-

so you benefit by saving 3894/- in taxes by using Indexation calculation.

With the same formula of Indexation , we can calculate for Sale of Land . 

reach us on pcswealthadvisers@gmail.com


PCS CAPITAL were first generation entrepreneurs in financial services . It was formed with foundation stone for creating long-term wealth for the investors through various financial products like Mutual fund s , Insurance , Fixed deposits and Alternate Asset products . We help you understand your financial objectives and make appropriate plan to realise them with proper risk management. rnYou can leave your contact details for professional help in your investment journey.

Comments

  1. BharatiDecember 13, 2020 at 1:01 PM

    Thanks shekar for explanatio. Am about to call and ask you today

    ReplyDelete

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