How Investors Benefit from Double Indexation

The lure of FMPs at this time of the year is due to this tax benefit that can be
exploited.
Priyadarshini Dembla | 26-03-14
Fixed maturity plans, or FMPs, have their charm for a certain type of investor, but there is an added
lure to them at this time of the year. Think not only indexation but double indexation. For instance,
if you invested in a 370-day plan in March 2014 which matures in April 2015, your financial
transaction would be spread over more than one financial year which gives you an added tax
benefit.
How it works
If you sell the asset after holding it for a period of 36 months, it qualifies as long-term capital gains.
In the case of stocks and mutual funds, the holding period to qualify for long-term capital gains is
just 12 months.
For non-equity mutual funds, long-term capital gain is taxed at 10% without indexation or 20% with
indexation. Simply put, indexation adjusts your investments against inflation. By resorting to the
Cost Inflation Index, or CII, indexation brings the cost of investment to the current value.
Double indexation is one step ahead. It is getting the benefit of indexation over two years by
actually staying invested for just over a year. This is what happens when the investment is made at
the end of a financial year, held through the next, and sold at the start of the third financial year,
Lets say you invested in a fixed maturity plan on March 31, 2012 and sold it on April 1, 2013. This
investment spans over 3 financial years - FY12, FY13 and FY14. Lets also assume that you earned a
return of 20% over this time period.
Amount invested: Rs 1 lakh
CII in year of purchase (2011-2012): 785
CII in year of sale (2013-2014): 939
CII for year of sale / CII for year of purchase: 1.196178
Indexed cost of acquisition (1.196178 x 1,00,000): 1,19,617.8
Taxable gains without indexation (1,20,000-1,00,000): Rs 20,000
Taxable gains with indexation (1,20,000-1,19,617): Rs 383
The above example clearly demonstrates the effect of double indexation. Indexation raised the cost
of acquisition of the asset since it was technically bought two financial years ago. This, in turn,
reduced the taxable capital gain. Of course, the return of 20% was definitely on the higher side, but
if we lowered it to, say, 10% instead of 20%, it would have resulted in a capital loss which would
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have benefited the investor all the more. Incidentally, a capital loss can be offset against long-term
capital gains anytime over the coming 8 financial years.
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