FMP taxation is different for growth and dividend schemes

I am a non-resident Indian (NRI) and want to invest 1 crore in fixed maturity plans (FMPs) offered by mutual funds (MFs) having a tenor of at least 91 days. I understand that short-term or long-term capital gains are deducted at the time of redemption of units in case the investor is an NRI. Also, dividend distribution tax (DDT) of 28.325% is deducted by the fund house before distributing the dividend to NRI investors. Apart from these, will I be subject to any other form of tax? Please advise.

—Ashish

When you invest in FMPs with a tenor of 91 days, you would have to choose between two options: growth or dividend scheme.

Taxation in growth schemes: If you opt for the growth scheme, the difference between your cost and the value realized on redemption will be liable to tax as short-term capital gains and the fund house would withhold tax at source on the capital gains at the applicable rate of 30.9%. There will be no further tax payable. If you do not have any other source of income in India or your other income is not significant, you may file your income-tax returns and claim the threshold exemption of 2 lakh and the benefit of lower slab rates and claim a refund.

Taxation in dividend schemes: If you opt for the dividend scheme, remember that practically the entire return on investment is by way of dividends. In such a case, the MF would pay DDT at 28.325% of the dividend declared and the dividend received by you would be tax-exempt. Note that since DDT is paid by the fund house on the actual amount of dividend paid to the unit-holder, the effective tax rate works out to 22.07%. At the time of redemption, if the amount realized is higher than the cost, the same would be liable to tax as short-term capital gains and the MF would withhold tax at source at 30.9% on the amount of gains.

There would be no further taxes levied on the FMP income, but it may be possible to claim a refund of a part of the tax deducted on short-term capital gains under certain circumstances, by filing tax returns.

You may also be able to claim any available relief under a double taxation avoidance agreement which India may have with your country of residence in respect of the capital gains.

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