How to get indexation benefits

A few months back, the indexation benefit for most of the debt funds has been revoked, almost overnight. The announcement by the Union finance minister stripped the possibility of indexation benefit to those investors that have begun to invest since the current financial year. Though, it’s true, there’re pockets of investment avenues within the mutual funds (MF), still one could enjoy these benefits.

The indexation is a benefit of setting off the discounting due to the inflation ie, the investor could set-off inflation against their gains. Capital gains ie, the gains made out of the initial investment and when they’re long-term in nature ie, in debt and related investments, it is for those investments with three years and above period. At time of maturity or redemption, the realised gains in such cases are treated as long-term capital gains and they could adjust towards the inflation during that period. When considering the indexation benefit, the taxation is 20 per cent over the indexed gains.

This feature was available till the end of the last financial year and investors especially those investing in conservative funds or securities used to utilise to enjoy a higher realisation of gains, particularly when compared to those of the securities where interest income is received. So, a fixed deposit would attract a higher taxation slab on the entire interest earned over the period while a debt fund would be considered only for 20 per cent of the gains that too after inflation adjusted. This was a great saving tool for those investors exploring such conservative funds or avenues.

But, such provision is still available though, with restrictions. Funds which predominantly invest in debt securities – 65 per cent and above don’t enjoy the indexation benefit while those funds which have allocation towards equities between 35 per cent and 65 per cent could enjoy the indexation benefit. Some of the categories, of course, not all funds in these categories are multi-asset funds, balanced hybrid funds and dynamic asset allocation funds. International funds aren’t considered despite having a similar asset allocation mix as all investments done towards overseas through a fund is considered as debt category.

A fund is considered multi-asset if it allocates at least 10 per cent of its assets among at least three asset classes each. These include equity, debt, real estate (through REITs), international securities, commodities (like gold/silver) and InViTs. However, the equity allocation in these funds define the nature of fund ie, if equity is predominant then they’re clubbed together with equity hybrid funds or debt funds if predominated by debt allocation.

For investors trying to benefit from the indexation should explore funds which have equity allocation between 35 and 65 per cent, would only qualify. Also, if one is purely scouting these funds to gain advantage of taxation should keep an eye on the allocation to other assets to check if such allocation is within their risk profile. One can’t be blind to that in exploring to gain more from taxation alone.

Balanced funds are those hybrid fund categories that allocate their assets between debt and equity. The equity allocation ranges between 35 to 65 per cent depending upon the stance the fund manager takes and are accordingly sub-classified as conservative, balanced or aggressive. In order to gain the indexation benefit, the equity allocation should be in the range of 40 to 60 per cent of the portfolio allocation. Such allocations are not available currently, yet in the offering.

Dynamic asset allocation funds are those where there is a fluidity in the allocation between debt and equity. Technically, these funds opt for an equity allocation between 35 per cent and 65 per cent. But the current market offerings are predominantly equity in nature with a few limited options available in this category. Investors are hence required to check the investment objective of these funds, check with their distributor or advisor before investing in such funds. Conservative investors should do more homework and check for those funds restricting their equity allocation to at least 40 per cent and not exceeding 60 per cent to enjoy the indexation benefit on their long term capital gains.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])