Tax benefits give an edge to debt funds to beat inflation

Tax benefits give an edge to debt funds to beat inflation

Fixed Deposits (FDs) are the most popular investment tool in India. This is because traditional investors find it easier to park their excess money lying in bank accounts on FDs as they rely on banks. In addition, many investors are unfamiliar with the concept of mutual funds. However, the credit section of MFs offers a wider option for short-term parking and can be used as an alternative to investing in bank FDs.

Accidents

Debt settlement is considered an asset. There are significant risks associated with those investments. Also, such funds do not fluctuate as equity funds, as debt finance positions may not contain equities, but contain debt instruments that have a predefined maturity period and return from maturity or predetermined dividends/dividends income.

Therefore, theoretically, debt financing is significantly higher compared to bank FDs as interest rates remain fixed on FDs throughout the investment period. As a result, FDs have a constant growth rate.

While FD bank returns have been adjusted and there is a fixed maturity rate, with fixed maturity instruments in its portfolio, the return to the credit fund can also be quite stable and predictable.

However, since the debt instruments present in the portfolio of the loan portfolio may be traded in secondary markets, the Net Asset Value (NAV) of this fund may fluctuate and offer higher or lower returns than the revenues generated by fixed instruments in the portfolio.

Consequence of Inflation

Since key pricing rates are used to control inflation by policymakers, the Repo rate, Reverse rate repo, and the full interest rates on deposit and lending should vary with the inflation rate.

Therefore, the interest rate charged on FDs with an annual return or CAGR on the debt fund should be close to the inflation rate.

However, if the inflation rate exceeds the interest rate regime, the money invested in FDs will drain its purchasing power, i.e. real return to FD will turn out to be bad. Therefore, FDs are considered ineffective.

On the other hand, the debt may have an impact on inflation, as fixed recovery instruments can be traded in secondary markets. In addition, indexation profits are available when calculating long-term interest rate (LTCG) on credit, which makes that inflation effective.

Taxes

Interest in FDs is taxable. Senior citizen investors, however, are subject to interest up to Rs 50,000 per financial year. As interest on FDs is charged without correcting inflation, it makes the actual return on FDs even worse. Since debt is treated as a capital asset, capital gains tax applies to those funds.

If the credit fund units are sold before the expiration of 3 years from the date of the investment, the gain/loss is recognized as a gain/loss for the short term. Those gains/losses are offset against the investor's gross income, so the tax effect on short-term gains will be equal to that of interest on FDs. In addition, older people will not be deprived of temporary benefits.

However, if credit fund units are sold after 3 years from the date of the investment, the indexation benefit will be realized. As a result, the value of the investment will be adjusted against the inflation rate at the time of investment using the inflation index for the investment year and for the sale/redemption year to reach the investment value for the year of investment/redemption.

The adjusted inflation rate will be deducted from the sale/redemption value to calculate the long-term profit/loss. In the event of any profits, the investor must pay a 20% income tax on it. Since the indexation profit takes into account the effect of inflation, the amount of tax paid becomes much lower than the comparable profit on FDs. Therefore, with an investment period of more than 3 years, higher tax profits allow credit financiers to beat inflation compared to FDs.