The choice between various debt investments will change when one falls into the lower income tax bracket and this is something that needs to be given attention. The issue has importance because the net returns for the investor can rise if they make an appropriate choice. Most investors are focused on the actual returns that are generated which are actually the gross returns but the key to the process could be the tax aspect that can add a significant amount to the final return earned on it. Here is a look at the issue and how investors can make the right choice.
Lower income tax rates
There are three income tax brackets where the highest one if for those who earn income above Rs 10 lakh and the rate here is 30 per cent. There are a lot of people who are below this income bracket and this would include those who have income upto Rs 5 lakh where the rate is 10 per cent above the basic exemption limit and those with income between Rs 5-10 lakh where the rate is 20 per cent. The situation would be slightly different when it came to those who fall in the lower income bracket because the rate that they would face would come down and this can change the nature of the investment decision.
Fixed deposit interest
The interest that is earned on fixed deposits from banks and corporates is taxable and there is no marginal relief that is available on this income. What this means is that there is no limit set after which the interest income gets taxed and every rupee that is earned would be taxable. The income is considered under the head of income from other sources and this is part of the overall working of the total tax to be paid. This results in a situation wherein the income is actually added to the other taxable income and for those who fall into the lower tax brackets they will be taxable at a lower rate which makes for a relief for the individual taxpayer.
The situation gets complicated when it comes to debt oriented mutual funds because the decision of what a lower income individual will choose now depends on the nature of the income that they seek to receive. There will be a different impact as far as the dividend and capital gains is concerned and hence this needs closer attention. When it comes to the dividend then the amount received is tax free in their hands so it might seem that there is no impact that the investor is facing. This is not true because there is a dividend distribution tax that is being paid by the individual and this is adjusted in the net asset value of the fund so this becomes an indirect impact. The rate here is just over 28 per cent so while this is a slight reduction in the tax impact for someone in the highest tax bracket of 30 per cent it is actually leading to a higher cost when it comes to those in the lower income brackets.
The capital gains earned by investing in the growth option could be a useful tool in this situation if the investment is held for a period of less than 3 years which is likely for many debt oriented funds as the gains would be short term in nature. The short term capital gains are added to the income of the individual and then taxed at the applicable rates so here the rate applicable for those in the lower tax brackets will be their respective lower rates. On the other hand if the gains are long term in nature then there is a 20 per cent concessional rate applicable. On both fronts it looks better for the individual to go towards the growth option and earn capital gains when their income falls in the lower tax bracket.