FMP: Taxation and FD Comparison

by Manshu on April 19, 2011

in Mutual Funds

FMP (Fixed Maturity Plans) are the biggest category of mutual funds in India, and when this topic was suggested – my first thought was why did it take so long for it to appear here.

FMP: Close Ended Mutual Funds

FMPs are close ended mutual funds and have gained in popularity due to their relatively secure nature and tax advantage when compared with a FD (fixed deposit).

They are close ended so you can only invest in them during the NFO, and redeem them only on maturity.

They are relatively safe but like other mutual funds – their returns are not guaranteed (or even the principal), and unlike a bank fixed deposit where you know how much interest you will earn – you don’t know how much your FMP will return. You can get an idea based on how other funds have performed, but the fund itself doesn’t tell you much you will earn.

FMP Taxation

Fund companies normally issue a lot of FMPs that are slightly over a year – like 368 days, 370 days etc. so that it enjoys the benefit of lower long term capital gain taxation.

Under the current regime – you can even take advantage of double indexation benefit for calculating long term capital gains if a FMP is issued such that it is issued in say March 2011, and redeemed in April 2012: 13 months in all but they are spread over 2 financial years.

I understand that this will be stopped with the DTC (Direct Tax Code), and since we’re already past March – it’s something that you can’t benefit from right now.

However, if you’re in the top tax bracket – FMP taxation still works out better for you when compared with a fixed deposit.

In a FMP you pay long term capital gains gains at either a rate of 10% without indexation or 20% with indexation (whichever is lower) which is better than interest on fixed deposit that’s taxed at your tax bracket which is upwards of 30% if you’re in the top bracket.

Hemant has written a detailed post about FMP vs Fixed Deposits where he’s shown numbers as well, so you can look at his post to see how the calculation works out.

FMP or FDs

It’s the tax advantage that tips the scales in favor of FMP, and people who are in the highest tax bracket can advantage from it. However, there are no free lunches and what you gain in taxes you could end up by way of lower return since a FMP can’t indicate how much return you’re likely to get, and you may end up getting stuck with a lemon.

You could compare past performance and do all that jazz, but there’s still a chance that the one FMP you chose to invest in performed worse than the others – so appreciate that risk while investing in them.

Here are some other differences between FMPs and FDs.

FMP vs FD

FMP vs FD

 

FMP NAVs and Asset Composition

Fund companies declare the NAV of their respective FMPs, and you can find these NAVs on their website, and they also declare half yearly results which has a list of the assets they own. This may not make much sense to regular investors though because they are usually names of banks with the CDs they own, and unless you’re very well versed with the bank bond market you can’t really tell one from the other.

Bottomline

In my opinion – people in the lower tax brackets are probably better off sticking with safer instruments like high interest rate fixed deposits, or Post Office Monthly Income Schemes that generate a decent return and offer peace of mind as well, but other folks who stand to gain more can definitely explore this option.

 

{ 34 comments… read them below or add one }

Vijay April 19, 2011 at 11:42 pm

Hi Manshu,
You may also wish to add on the Growth (Cumulative) Vs Dividend Option in FMPs. What i have understood is that if the tenure of the FMP is more than one year, it might be better to go for the Growth Option and if less than a year, dividend option might be appropriate. Do let me know what you feel about it.

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Manshu April 20, 2011 at 11:24 am

Hi Vijay – that’s a good point. Since the DDT is lower than short term capital gains it makes more sense to go for a dividend option in the less than 1 year time – frame.

Whether you should opt for a FMP in such a time frame or not is another question in itself, and I think that will make a good topic for a future post.

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Vijay April 24, 2011 at 6:05 am

True!!! Thanks!

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raj April 20, 2011 at 5:06 am

Hi,

Where can we find the indexation value? Is there any GOI website from where we can get that value?

Thanks

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Manshu April 20, 2011 at 11:16 am
Sandriano April 20, 2011 at 8:35 pm

Hi Manshu,

Is a Capital Protection Oriented Fund comparable with an FMP?

Regards,
Sandeep

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Manshu April 21, 2011 at 6:51 am

I’ll have to look at the particular fund to say if it is or isn’t Sandeep. I’ve not looked at them closely enough to answer you right away. Is any release coming out that you’re interested in?

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Manikaran singal June 12, 2012 at 9:37 am

CPO funds are designed in such a way so as to give capital protection to investors by keeping maximum amount in debt and the balance in equity. The Return on investment is dependent on the performance of equity only.
Say for e.g 3 years CPs in market are yielding 9% , so in 3 years CPO 77% corpus will be invested in debt, which will becom Rs 100 on maturity and remaining 23% in equity which will help in generating returns. If equity market performs then you will gain otherwise you will get your capital back.
These products are similar to FMPs only in terms of taxation as these are treated as debt funds only but in terms of features these are different in nature.

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Manshu June 12, 2012 at 5:04 pm

Thanks Manikaran, doesn’t sound too exciting to me…any example of such a product that comes to your mind? Thanks.

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Khan Ejaz July 30, 2011 at 2:58 pm

if there is cumulative FMP if Yes then tell me in details as soon as possible plzzzzzzz
Thanks

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Vikas December 4, 2011 at 1:59 pm

I am struggling to find one place to see all open FMPs. Can anyone suggest a website which lists all open FMPs.

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Manshu December 5, 2011 at 7:40 pm

That’s a good question, I’m afraid I don’t know of a website that does this, but I agree it’s a useful thing to have. I’ll see if it is practical for me to create a page like that. Let’s see.

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Manikaran singal June 10, 2012 at 8:09 pm
Ranga March 2, 2012 at 8:13 pm

The top 10 closed FMPs on ValueResearch as of date show an average return of about 10.25% roughly. Given the 10% taxation without indexation, the effective return after tax is 9.22% roughly. Also, it looks like many fund houses like HDFC, DSP etc. that issue FMPs also charge an expense ratio of 2.25%. Simplistically calculated, this would cut down on the total return and give an effective rate of 6.97%.

Am I missing something in the calculation above? If not, even for a high tax bracket individual, isnt the effective rate of return after taxes much more comparable to FDs after taxes (assuming 9.5% this would be about 6.67%)?

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Ranga March 4, 2012 at 1:54 pm

After reading up more, it seems like almost all funds specify an estimated expense of 2.25% (the maximum a debt fund can be) but in practice the funds’ expense ratios vary. For instance, even within DSP’s FMPs & FTPs, in latest published stats (http://www.dspblackrock.com/PDFs/Scheme%20Expense%20Ratios/Current_Expense_Ratio_2022012.pdf), the ratios dont seem to go beyond 1%. Which does make FMPs a good proposition even including expenses. Thanks.

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Jitendra P.S.Solanki March 3, 2012 at 10:56 am

Ranga,

The benefit of indexation and lower tax on dividend makes FMP an attractive proposition.

As far as expenses are concerned, it gets reduced as the securities are held till maturity and there in no pressure on FM to redeem in between.

When you are investing for above 1 year then indexation benefit reduces your taxability. For lesser time horizon dividend will reduce taxability.Hence, in either case you are yielding higher then FDs if do a comparison .

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ankm83 June 10, 2012 at 11:43 pm

Are FMPs totally illiquid? What if i wish to redeem before maturity?

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Manikaran singal June 11, 2012 at 5:03 pm

u can’t withdraw it before maturity.

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ankurm83 June 11, 2012 at 5:22 pm

Dont FMPs trade on stock exchange? Although on practical basis, liquidity on exchange is low. Any idea of yield advantage (in bps) of FMPs over Ultra short term funds? UST funds can be easily redeemed

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Manikaran singal June 12, 2012 at 9:24 am

No, FMPs don’t trade on stock exchange. It is not a bond with specified rate of interest. It is a combination of different papers where yield itself is not disclosed. You can only have an idea by asking the portfolio and find out the prevailing rate of those papers in market.
Ultra short term funds and FMPs are both completely different product. If you want to take advantage of current high rates and also want to avoid the volatility, you should go for FMPs. UST funds are only for parking of short term money. Whenever the interest rates in market starts falling, the yield on UST funds will also starts falling due to portfolio of very short term papers.

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ankurm83 June 12, 2012 at 9:35 am

If they dont trade on stock exchange, what is this then?

ICICI Prudential Fixed Maturity Plan – Series 64: Being a close-ended fund the Scheme will not reopen for subscription. The Scheme is proposed to be listed on BSE Limited.

http://www.icicipruamc.com/download/NFO/SID-FMP64-274DaysPlanF.pdf

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ankurm83 June 12, 2012 at 9:40 am

I would be more comfortable investing in a ultra short term fund, because of high liquidity. To cover up on the lost interest, one can trade in GILT funds, which will rise with int rate fall (more than compensate due to longer residual duration) and are fully liquid (with no exit load)

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Manshu June 12, 2012 at 5:03 pm

Could you give a couple of fund names that you are familiar with for doing this Ankur? I’d like to read up their details. Thanks.

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Manshu June 12, 2012 at 5:01 pm

I can’t see an option to buy any FMP through ICICI Direct. Have you ever done this Ankur? If so, could you tell me where to look for this? Thanks.

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ankm83 June 12, 2012 at 6:00 pm

I have never bought FMP, just exploring the mechanism. I pasted a link above on ICICI Pru FMP and also Manikaran pasted below on HDFC FMP. Both these 2 links state that FMP will be listed on BSE/NSE and investor can sell these units on exchange to another investor, although trading will be very limited. Thats my precise problem with FMP, they are illiquid. I would consider them more illiquid than even a bond. Only if you are very sure that you dont need the money, it would make sense to invest in FMP. I am better off earning 0.50-1 % lower in UST/Liquid fund and keep 100% liquidity. Ofcourse it would depend upon situational profile of investor.

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Deo May 29, 2012 at 7:17 pm

@Ranga – Agree with your point. If ~2.25 % is reduced from the amount that you receive the return would diminish. In such case it doesnt seem to be as lucrative.

@Jitendra – Wouldn’t there be expense of ~2.25 % (may be slightly less) even if securities are held till end of maturity or otherwise?

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VikasG June 9, 2012 at 10:50 pm

Hi Manshu,

I bought an 2 year FMP (growth option) in Dec 2011. It matures in Dec 2013.

Since I have chosen growth option, no dividends will be declared by the AMC.

Like FDs, do I have to report the accrued interest in this FMP in my yearly tax return or would I handle the total interest after the FMP matures?

Thanks again.
-Vikas

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Manikaran singal June 10, 2012 at 8:04 pm

Vikas, FMPs don’t earn interests but gets capital gain.
So you don’t need to show the accrued interes/gain in the yearly return. But do show the calculation only on the maturity of the same, and pay tax accordingly.

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VikasG June 10, 2012 at 8:26 pm

Thanks Manikaran,

It seems that FMPs will simplify my annual tax return as well – I will have to handle the FMP taxation only in the year it matures as opposed to FDs which have to be handled every year till they mature.

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VikasG June 10, 2012 at 8:44 pm

I am having a hard time finding FMPs with duration of 3 years of more. Does anyone know if FMPs are issued with > 3 years maturity?

Essentially, I am trying to find a mutual fund which will let me lock in the high interest rates right now for, say, 10 years without the tax complexity of FDs.

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Manikaran singal June 11, 2012 at 3:58 pm
VikasG June 12, 2012 at 2:13 pm

Thanks Manikaran. This particular FMP is of 3 years and 1 month duration. Do you know of any other FMPs with 5-15 year duration?

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karuna July 5, 2012 at 4:43 pm

Sir,
You have mentined in your third paragraph that ……”They are relatively safe but like other mutual funds – their returns are not guaranteed (or even the principal),”, which means the returns of mutual funds or some mutual fuds are guaranteed…will you please kind enough to mention a few funds where the returns are guaranteed?…GILT funds????
Karuna.

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Aakash August 14, 2012 at 2:54 pm

Hi Manshu –

I learnt a lot about FMPs from your blog. Thanks! I had a few questions:

1) If the choice is between Bank FD or FMP, would FMP be still better than bank FD even during low interest rate regime? The assumption is that investment in equity is not an option and liquidity is not expected from this investment.
2) In terms of risk of capital loss, where would you put FMPs investing ~ 50% in securitised debt / asset backed security?
3) Is there a way to find out fund houses who are better at managing FMPs? Or should I just decide my investment duration and then go with what is available in that month?
4)Is the capital capital gain deducted at source for FMPs?
5) Do I get to choose if I want to get capital gains calculated with indexation when I purchase FMP units or that is something I do when I file my returns?

Thanks!
Aakash

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