Arbitrage FoFs: Smart Tax Savings for Better Returns
By ThePip Desk
Discover how Income Plus Arbitrage Fund of Funds offer tax-efficient returns, outperforming traditional debt funds for long-term investors in higher tax brackets.
If you’re an investor looking for more tax-efficient options than traditional debt funds, especially if you hold investments for over 24 months, Income Plus Arbitrage Fund of Funds (FoFs) might be worth considering.
These FoFs strategically combine debt-oriented schemes with arbitrage-based schemes within a single mutual fund. SEBI regulations allow them to invest up to 65% in debt-oriented schemes, while the rest goes into arbitrage strategies.
Understanding How Income Plus Arbitrage FoFs Work
The debt part of these FoFs aims for stable returns through fixed-income strategies. Meanwhile, the arbitrage portion seeks to profit from price differences between the cash and futures markets, offering a transparent investment approach.
Tax Efficiency for Your Gains
The real advantage of Income Plus Arbitrage FoFs comes from their tax classification. If you hold these FoFs for up to 24 months, any capital gains you make are taxed at your regular income tax slab rate.
However, for investments held longer than 24 months, your gains are treated as long-term capital gains. These are taxed at a fixed rate of 12.5%, notably without indexation benefits. This is a key difference from debt-oriented mutual funds, where gains are always taxed at your applicable slab rate, regardless of how long you hold them.
A Practical Example: FoF vs. Debt Fund
Let’s look at a concrete scenario to see the impact. Imagine you invest ₹1 lakh over two years, expecting a 7% annual return. Both an Income Plus Arbitrage FoF and a debt fund would yield ₹14,490 in pre-tax gains.
Now, if you are in the 30% tax bracket, the Income Plus Arbitrage FoF would incur a tax of just ₹1,811 (at 12.5%). This leaves you with a post-tax gain of ₹12,679, translating to a post-tax return of 6.15%.
In contrast, the debt fund would face a tax of ₹4,347 (at 30%). This significantly reduces your post-tax gain to ₹10,143, resulting in a post-tax return of only 4.95%. You can clearly see the tax savings here.
The actual financial outcome for you can vary based on the specific scheme’s returns, your holding period, and your individual tax situation. Always consider your own circumstances when making investment decisions.