With just 3 months to go before the financial year ends (March 31), you will hear the term, ‘double indexation’ more often, especially in the context of products such as fixed maturity plans.
What is double indexation and how does it help you in reducing tax outgo? Is double indexation benefit restricted to just FMPs?
Here’s a brief article that will help you make the most of the double indexation benefit.
The income tax department allows you to bring the cost of certain assets/investments to the present value (based on inflation), while calculating your gains from sale of such investment. As part of this, all debt mutual funds (note that gain from sale of equity funds held over one year are exempt from capital gains tax) held for more than one year enjoy indexation benefits. Read our blog on how indexation works : Make use of indexation benefit for debt funds.
Investing closer to financial year end
Double indexation is nothing but investing in such a way that you invest closer to the end of a financial year and exit soon after the next financial year, to enjoy 2 years (or more) of indexation although you held it for a much shorter period. To provide an example: Let us suppose you invested in a debt fund in February 2014 and you need the money by say April 2015.
Now you would have held the fund for little over a year. But for indexation, you can claim double indexation – for year ending March 2014 and March 2015. If you exit the fund in say April or May 2016, then would you actually enjoy 3 years of indexation, although you would have held it for little over 2 years.
Simply out, investing closer to the end of a financial year and exiting immediately after the a financial year (provided it is held for not less than 1 year) would give you a longer indexation period than your holding.
And how does that help you? It helps you because you bring the cost of your holding, very close to inflation-adjusted values; and in high inflation scenarios (as was the case in the last 2-3 years), your indexed cost may be higher than the sale price. In such a case, you will have no gain and therefore no taxes. Instead, you will only have a long-term capital loss that can be adjusted against long-term capital gain.
Where can you use double indexation
As far as mutual funds are concerned, FMPs appear to be the most sought after product to avail double indexation. But do note that all debt mutual funds (and that includes gold funds and international funds) have capital gains indexation benefit if held for more than 1 year.
That means, whether you invest in liquid funds, ultra short-term or short-term funds and income or gilt funds, as long as your investments are made closer to the year end, and exits are closer to a financial year beginning, you enjoy higher indexation.
So you need not always invest in FMPs. Choose the right debt fund that suits your requirement and is a sound performer and gain the most!