Understand the taxation on various products and benefit from them

There are advertisements these days for FDs, advertising 12-13% returns. But these are misleading as they just calculate the yield for the tenure of the investment and divide it by the tenure. For instance, if the yield is 10.75%pa for a five year deposit, the cumulative yield for the 5 year period is 66.62%. Dividing this by the tenure ( 5 years ) , one gets 13.32% as the annual return. But this is not correct and the annual return as we have seen in the beginning, is only 10.75%pa. But, people get misled by these numbers all the time. Also, these yields are just pre-tax returns. Now, if one calculates post tax returns, it will be even less impressive. For a person in the highest tax bracket ( 30.9% ), a 10.75% annual return turns out to be just 7.43%. That is not very impressive, is it? It obviously isn’t, with inflation itself hovering between 9-10%. One is actually getting a negative real return, this way. It would be better if this haircut called tax is not there, would’nt it? Unfortunately, it is going to be there. Is there a way out? There is, but not in FDs. In case of investments in Mutual Funds, the gains from the investment are taxed in a different manner. For investments upto 12 months, gains from them are treated Short-term and beyond that, gains made are treated as Long-term gains. In case of Equity oriented funds ( funds investing atleast 65% of the assets in indian equity ), the tax on short-term capital gains are at 15%. This is irrespective of one’s tax slab. Tax on long-term capital gains for Equity-oriented funds is nil, currently. For debt funds, the Short-term capital gains is taxed at one’s income tax slab and long-term capital gains are taxed at 10% without indexation and 20% with indexation. In case of dividends that are paid out, there is a dividend distribution tax, which is applicable. It is 13.51% for individuals, for most debt funds. This is paid by the fund house, but the investor is indirectly bearing the same. The amount coming into the hands of the investor is hence tax-free. This would be useful in cases where the investment is for less than 12 months and the investor is in the 20-30% tax slabs. The Long-term capital gains tax of 10% without indexation or 20% with indexation is applicable only for financial assets. For other assets, the gains are treated as long-term only after a period of 36 months. In case of property, gold or other assets, the tax on long-term gains are 20% with indexation. For this reason, Gold ETF would be a good bet ( instead of Gold ), as the capital gains are treated as long-term after 12 months. The tax treatment for long-term capital gains are like debt mutual funds. There are several other advantages of investing through ETFs like low transaction charges, no storage, no worry about purity etc. This has hence become very popular and Gold ETFs have been mopping very good sums in the recent months. It is important for an investor to hence understand where they are investing and the tax treatment for that instrument. This simple knowledge will assist them to maximize their post-tax returns and enable them not to fall for any advertising gimmicks offering 12 & 13% returns. Article by Suresh Sadagopan ; Published in moneycontrol.com on 30/11/2011