The quest for higher returns is a constant pursuit for investors. This piece will compare NCDs (Non-Convertible Debentures), mutual funds, and PPFs (Public Provident Funds) solely on post-tax yields.
While the calculation may help you navigate this investment maze and determine which option you can consider per your financial goals and risk tolerance, you must also analyse each option’s unique strengths and limitations, exploring their potential for yield generation beyond tax implications.
Abhijit Roy, CEO of GoldenPi, says, “NCDs consistently outperform both PPFsand Mutual Funds, making them a preferred option for investors seeking reliable returns. Listed NCDs offer two potential income streams: interest and capital gains. Interest income from listed NCDs is fixed and added to your taxable income, subject to taxation at the prevailing tax rate. On the other hand, capital gains from listed NCDs depend on the duration of holding. If sold within 12 months, gains are treated as short-term capital gains and taxed according to the investor’s income tax bracket. However, if sold after 12 months, the profits qualify as long-term capital gains and are taxed at a reduced rate of 10% without indexation.”
Understand the maths
Non-Convertible Debentures (NCDs): Interest income from NCDs is taxed per the individual's income tax slab rates.
Let's assume the investor falls in the 30% tax bracket for this calculation.
Public Provident Fund (PPF): Interest income from PPF is tax-free and the current interest rate for PPF is around 7.1%.
Mutual Funds (MF): For debt mutual funds, short-term capital gains (STCG) and long-term capital gains (LTCG) exceeding 3 years are taxed at the individual's income tax slab rates.
Let's assume the investor has invested in a Debt Mutual Fund with an average return of 8%. Now, let's calculate the post-tax returns for each investment:
NCDs: Taking an ongoing A-rated NCD IPO, which is also senior secured in nature and is named Navi Finserv Limited, yielding 11.19% in 3 years.
Post-tax return = Interest rate * (1 - Tax rate)
Post-tax return = 11.19% * (1 - 0.3)
Post-tax return = 7.83%
PPF: The lock-in period of 15 years
The highest available return and safest PPF scheme in the current scenario is yielding 7.1%
Post-tax return = Interest rate (since PPF returns are tax-free)
Post-tax return = 7.1%
MF: Taking a Corporate Bond Fund named ICICI Prudential Corporate Bond Fund - Direct Plan-Growth yielding an average return of 6.16% in 3 years
Post-tax return = Interest rate * (1 - Tax rate)
Post-tax return = 6.16% * (1 - 0.3) [Assuming LTCG Tax Rate]
Post-tax return = 4.31%
Now, let's calculate the post-tax income for each investment of Rs 1 lakh
NCDs: Post-tax income = Investment * Post-tax return
Post-tax income = Rs 1,00,000 * 7.83%
Post-tax income = Rs 7,830
PPF
Post-tax income = Investment * Post-tax return
Post-tax income = Rs 1,00,000 * 7.1%
Post-tax income = Rs 7,100
MF
Post-tax income = Investment * Post-tax return
Post-tax income = Rs 1,00,000 * 4.31%
Post-tax income = Rs 4,310
So, for an Indian investor investing Rs 1 lakh in each instrument, the post-tax income would be:
NCDs: Rs 7,830
PPF: Rs 7,100
MF: Rs 4,310
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PPF is one of the few investment products that benefit from the triple tax exemption, also known as the exempt-exempt-exempt (EEE) classification. This means that tax breaks are provided at the time of investment, accrual, and withdrawal. Investments made during the fiscal year are eligible for a deduction of up to Rs 1.5 lakh. The tax exemption also applies to annual interest income. Third, you receive tax-free income when you withdraw the accumulated corpus at maturity, as it is also tax-free.
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“Capital gains from the sale of mutual fund units held for less than three years are classified as short-term capital gains and are taxed at the investor's applicable income tax rate. However, if held for more than three years, the gains are classified as long-term capital gains. Mutual fund taxation is primarily determined by the holding period and whether the scheme is equity or debt-oriented, with rates ranging from 10% to 15%,” said Roy.
