Don’t make taxes your investment yardstick

A Friday a couple of weeks ago saw the taxation rules completely change for debt mutual funds. This change did away with the long-term capital gains benefit that debt funds enjoyed until now. This change comes after several others in the recent Budget that changed the tax impact for different financial products.

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For example, a hitherto tax-free portion of REITs and InVITs distribution has been brought into the tax net, high-value insurance policies will no longer be tax-exempt, interest on EPF contributions over a threshold is no longer tax-free, and so on.

At the same time, the government is also nudging taxpayers into opting for the new tax regime. The new regime, unlike the old regime, offers no deductions on specific investments such as ELSS, EPF, and so on.

Now, one can debate over the whys and wherefores of these developments. But meanwhile, it’s important to be cognisant of what these developments indicate.

Unsuitable decisions

With tax rules on different products changing for a wide variety of reasons, there is no long-term certainty. Therefore, deciding on which investments to make for the long term using taxes alone can lead you into making unsuitable investment decisions or miss out on good ones.

For example, consider the new tax rules for debt mutual funds that remove the long-term indexation benefits. With equity-oriented funds still enjoying advantageous taxation, you may be pushed into loading up on these instead. More, you may be met with sales pitches to invest in hybrid funds such as balanced advantage funds for their higher returns, relatively lower risk compared to pure equity funds, and look — better taxation!

But these funds aren’t direct substitutes for debt funds and are much more volatile. Altering your asset allocation to skew towards equity simply because of the heavier tax impact in debt options such as deposits, bonds or debt funds would make your investments far riskier and so less suitable for you.

It is true that tax treatment changes the return profile of an investment. However, it does not remove its viability. For example, bank fixed deposits haven’t really been tax-efficient – but they are still worth investing in given their safety, and are especially useful for purposes such as maintaining an emergency fund.

Similarly, while the NPS may not enjoy the same level of tax breaks in the new regime compared with the old, it still makes for a good retirement vehicle.

Therefore, as far as taxation on different products goes, be prepared for changes and avoid making investments only for the sake of tax advantages. Evaluate your investment choices primarily on the nature of that investment, its suitability for your portfolio, and what your portfolio needs.

• Also read: Investors rush to debt MFs before tax advantage vanishes

No handholding

The deductions allowed under the old tax regime were intended to incentivise long-term savings and investments, among others.

With the nudge towards the new tax regime, the indication is that the government will not handhold you into saving by doing away with investment-driven deductions. It is up to each individual to make prudent choices for their own finances and investments.

For many of you, more than one investment decision would have been made simply because of the tax deduction available — such as a poor returning money-back policy, or buying a second house merely for home loan deductions.

From a financial product manufacturer’s side, some products were aimed simply at addressing the tax breaks, not considering whether they were even suitable as a sound investment. All of this can change if tax deductions are phased out.

So, what does this mean? As mentioned above, evaluating investments based on their own merit becomes important. The performance will start mattering more, and the individual benefits of each investment will show up in a sharper perspective in the absence of tax sops.

Manufacturers will also no longer take guise under tax deduction in the face of poor returns! You will think twice about investing in more insurance policies and incurring heavy EMIs where it is not necessary.

• Also read: Tax query: Taxation implications on property inheritance, share and sale

For example, instead of locking large premiums in unsuitable insurance policies or large EMIs, you could deploy into equity markets through mutual funds (even just index funds or ETFs) or stocks. You could enhance life coverage through term insurance, or get a better health insurance plan. You could diversify away from just provident funds into government or corporate bonds or the RBI Floating Rate bonds.

Ultimately, while taxes play an important role, don’t set this as the primary reason for your investment choices.

(The writer is co-founder, PrimeInvestor.in)

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