Using indexation to earn a guaranteed tax free profit, yet book a loss



The captioned statement may sound too good to be true, and it is only fair if you think – “there must be a catch somewhere”. Honestly, there isn’t and this concept of indexation benefit, if properly understood and implemented, is one of the most powerful tax planning tools; and if timed correctly can not only be used to make your returns on debt and debt oriented investments tax free, but also enable you to book a long term capital loss which can be offset against any other long term capital gains.

Most of us would have heard of indexation benefit being applied to investments held for more than a year which enables one to adjust the cost price of the asset to account for inflation over the holding period, while calculating the long term capital gains. (Pl see – for a detailed explanation).

This doesn’t apply to direct equity and equity oriented investments, as these are tax free anyway, if held for more than a year. And though real estate transactions also incur long term capital gains if held for more than 3 years, we will restrict this post only to debt funds and schemes.

Here is how it works, and why March is the best month to invest –

Double indexation – The investment should span three financial years – Invest in FY 1 and redeem/sell in FY 3 from the date of investing – i.e If you invest before 1 April 2014 ( FY 2013-2014) hold it for the whole of FY 2014-2015 and sell after 1 April 2015 (FY 2015-2016), you can adjust your cost for the inflation of  2 years using the corresponding CII values.

Triple indexation – The investment should span 4 financial years – invest in FY1 and sell in FY4. In the above example, if the asset is sold after 1 April 2016, it becomes eligible for triple indexation.

Investing in March – March is the month where the investment market is flooded with new fund offers of debt mutual funds and fixed maturity plans. The reason- March is the best time to invest to avail of indexation benefit. Consider the first case of double indexation – though the investment spans across three financial years, the actual period of holding, if one were to invest now in March 2013 and redeem in April 2015, is hardly 13 months, and in the case of triple indexation, it is around 24 months – which means by investing for roughly 2 years, one can adjust the inflation for 3 years!

The icing on the cake –

Not only can you earn a tax free guaranteed return (guaranteed if you invest in FMPs), if held for triple indexation benefit, where after accounting for the inflation for three years, the cost is likely to exceed the sale price, you technically book a long term capital loss which can be used to offset any other long term capital gains for the next eight years! Can it get better than this?

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