Financial Instruments and

their taxation.
 What is a Financial Instrument?

• Financial instruments are contracts for monetary assets that

can be purchased, traded, created, modified, or settled for.
In terms of contracts, there is a contractual obligation
between involved parties during a financial instrument
transaction.
 Financial Investment Options
• Short Term Investing
1. Savings Bank Account - Use only for short-term (less than 30 days) surpluses
Often the first banking product people use, savings accounts offer low interest (4%-5% p.a.), making them only
marginally better than safe deposit lockers.
Interest generated on a savings bank account is tax-free up to ₹10,000, under section 80TTA of the Income Tax Act. It
makes an account with a balance of less than ₹10,000 a tax-free savings account. The additional interest on the
savings account will be taxable if the interest earned from these sources exceeds ₹10,000’.
2. Money Market Funds (also known as liquid funds)- Money market funds are a specialized form of mutual
funds that invest in extremely short-term fixed income instruments. Unlike most mutual funds, money market funds are
primarily oriented towards protecting your capital and then, aim to maximize returns.
• Short term capital gains:
If an investor sells or redeems the units of a liquid fund after a holding period of up to 3 years, he or she is deemed
to have earned short‐term capital gains. This is taxed at the income tax slab rate applicable to the investor.
• Long term Capital Gains Tax:
If a liquid fund is redeemed/sold after being held for more than 3 years, the capital gain is treated as a long-term
capital gain, and the investor gets the benefit of "indexation." This means that the purchase price is increased to
adjust for inflation (using an index provided by the Government) before calculating the capital gain. Long term capital
gains are currently taxed at a rate of 20%.
3. Bank Fixed Deposit (Bank FDs) - Also referred to as term deposits, this product would be offered by all banks.
Minimum investment period for bank FDs is 30 days.
The ideal investment time for bank FDs is 6 to 12 months as normally interest on bank less than 6 months bank
FDs is likely to be lower than money market fund returns.
Interest earned on fixed deposits is taxable and depends on different IT slabs. In case tax deduction is zero but still
interest gets deducted, a refund can be claimed. The TDS applicable on the interest is deducted by the bank at the
rate of 10%. The interest amount that you earn your Fixed Deposits is taxable.

• Long Term Investing

• Post Office Savings Schemes (POSS) : POSS are popular because they typically yield a higher return than
bank FDs. The monthly income plan could suit you if you are a retired individual or have regular income needs.

Besides the low (Government) risk, the fact that there is no tax deducted at source (TDS) in a POSS is amongst
the key attractive features.
 The interest earned is taxable according to the income tax bracket in which your taxable income falls . Most of the
Post Office Saving Schemes provide tax rebate under Section 80C of the Income Tax Act on the amount that the
investor deposits. Some schemes such as SCSS, Sukanya Samriddhi Yojana, PPF, etc. as well provide the tax
exemption over the interest earned amount.
• Public Provident Fund (PPF):PPF is a very attractive fixed income investment option for small investors
primarily because of 7.1% tax free returns.
As per PPF rules provisions, any kind of money received from PPF account is completely tax exempt. It can be
withdrawn money amount, PPF maturity amount or PPF account closure amount. However, PPF money received
before five years by premature closure or withdrawal is taxed as income.

•  Bonds and Debentures:Bonds are debt financial instruments issued by large corporations, financial
institutions and government agencies that are backed up by collaterals or physical assets. Debentures are debt
financial instruments issued by private companies, but any collaterals or physical assets do not back them up.

Type of Asset Capital Gains Tax Rate

Listed Bonds & Debentures Short Term Capital Gains Slab Rate

Listed Bonds & Debentures Long Term Capital Gains 10% without Indexation

Unlisted Bonds & Debentures Short Term Capital Gains Slab Rate

Unlisted Bonds & Debentures Long Term Capital Gains 20% without Indexation
• Mutual Funds: A mutual fund is a type of financial vehicle made up of a pool of money collected from many
investors to invest in securities like stocks, bonds, money market instruments, and other assets.

Fund type Short-term capital gains Long-term capital gains

Equity funds 15% + cess + surcharge Up to Rs 1 lakh a year is tax-exempt. Any

gains above Rs 1 lakh are taxed at 10% +
cess + surcharge

Debt funds Taxed at the investor’s income tax slab rate 20% + cess + surcharge

Hybrid equity-oriented funds 15% + cess + surcharge Up to Rs 1 lakh a year is tax-exempt. Any
gains above Rs 1 lakh are taxed at 10% +
cess + surcharge

Hybrid debt-oriented funds Taxed at the investor’s income tax slab rate 20% + cess + surcharge
• Life Insurance Policies: Life insurance premiums, depending upon the policy selected, include the costs of -

1) death-benefit coverage

2) built-in investment returns (average 8.0% to 9.5% post-tax)

3) significant overheads, including commissions.

Taxation :  the death benefit that your nominees/beneficiaries receive upon your demise is completely free from
tax

• Equity Share : There are two ways in which you can invest in equities-
1. through the secondary market (by buying shares that are listed on the stock exchanges)
2. through the primary market (by applying for shares that are offered to the public)s.

Taxation : Post these shares becoming, long term assets, whenever you sell them you will be liable to tax at 10% on
the LTCG exceeding Rs 1 lakh, if you sell your shares post 31 March 2018. However, LTCG made up till 31
January 2018 will not be affected. Only the gains made after that date will be taxed. STCG would be charged at
15%.
 PMS Taxation
• Since under a PMS, investments are held directly in the investor’s name (and not via a trust like in a
MF or AIF), the tax liability for the PMS investor is the same as the investor directly buying or selling
shares/securities in his own name .
• Equity Capital Gains: 15% (ST – less than 1 year holding) / 10% (LT – greater than 1 year
holding … 1 lakh exemption)
• Non-equity Capital Gains: added to income (ST – less than 3 year holding) / 20% with
indexation (LT – greater than 3 year holding)
• Equity Dividend Income: added to income
• Interest Income: added to income
 AIF Taxation

AIF Classification
• Alternate Investment Funds (AIFs) are categorized as follows:
• Category I (CAT 1): Funds that invest in start-up or early-stage ventures. This extends to
social ventures or SMEs or infrastructure or other sectors or areas which the government or
regulators consider as socially or economically desirable.
• Category II (CAT 2): Funds that do not fall under CAT 1 and CAT 3, do not undertake
leverage or borrowing.
• Category III (CAT 3): Funds that employ diverse trading strategies. They use leverage
through listed and unlisted derivatives and buy stocks or other allowed assets
• Taxation of Cat 1 & 2 AIF’s (Non-trust structures)
Cat 1 & Cat 2 AIF’s are considered as pass-through vehicles for a taxation
perspective. Any capital gains from the AIF are taxed directly in the hands of the
investor
• Taxation of Cat 3 AIF’s (Non-trust structures)
Cat-3 AIF’s are NOT pass-through vehicles, and Cat 3 AIF’s are taxed at the AIF
level itself. The taxation rate depends on the type of income:
• Business Income / Non-equity ST Capital Gains / Dividend
Income: 30%
• ST Equity Capital Gains: 15%
• LT Equity Capital Gains: 10%
• LT Non-equity Capital Gains: 20% with indexation
 Capital Gain Tax on Sale of Property

• If you are planning to sell your property, you’ll have to pay capital gain tax on the profit earned
after considering the inflation and indexed cost of acquisition. However, there are several ways
to save on the capital gain tax on sale of property .
• If you sell your land / house / property within 36 months (3 years) of acquiring it, it’s considered
to be a short term capital gain. If you sell it after 36 months (3 years) it’s considered to be a
long term capital gain. This differentiation between short and long term capital gains is
important because both of these are treated differently in terms of taxation. The tax rates and
tax benefits which are applicable on the reinvestment of these two types of gains vary.
• Long term Capital Gains on sale of real estate are taxed at 20%, plus a cess of 3%, if the sale
fulfils certain conditions.
• If you sell a property that was gifted to you, or that you have inherited, you will still be liable to
pay capital gains tax on it. The cost of purchase here is calculated on the basis of the cost to
the previous owner, indexed to the year of purchase.
How to Save on Capital Gains Tax while Selling your Property?

• The capital gains are used to purchase or construct another house.

• The new house is purchased one year before or two years after the sale of the old
house.
• The new house is constructed within 3 years after the sale of the old house.
• Only one additional house property is purchased / constructed.
• The property being bought / developed is within India’s national borders.
• You don’t sell the new house for 3 years after taking possession of it.
• If the cost of the new property is lesser than the sale amount, the exemption then
only applies proportionately. The remaining money can be re-invested under Section
54EC in under 6 months. (Rural Electrification Corporation and NHAI (the National Highways Authority
of India).