Case for redemption

Suresh Krishnamurthy

FOR investors who have income from capital gains from any source and for whom the applicable tax rate is around 30 per cent, there may be a case to exit immediately.

Redeeming US-64 immediately will lead to booking higher losses. The loss so booked will save tax at the rate of 30 per cent. For example, for one who invested in June 2000 at Rs 14, the losses would be around Rs 12,000 for 3,000 units. Set off against capital gains from other sources, it could save tax of up to Rs 3,600.

If the tax saved along with the redemption proceeds is reinvested, it is highly probable that the returns would be more than those got by holding US-64 until May 2003 and booking a loss then. However, care must be taken to reinvest the proceeds in schemes that offer government guarantees to mimic the US-64 option available till May 2003.

In contrast, if the investor redeems the units in May 2003, the loss booked will be lower as the repurchase price is higher at Rs 12. If the loss booked is lower, the tax saved will also be less.

Of course, the cost inflation index will be higher in May 2003. This index helps inflate the costs of assets and reduces capital gains. A higher cost inflation index can lead to booking higher tax losses which might compensate for the rise in repurchase price. However, the tax saved now by redeeming US-64 and booking losses is likely to grow at a rate higher than the rise in inflation. This ensures that booking losses now would be a better proposition.

There is, however, a caveat. If investors have considerable capital losses now, the value of some more losses would be reduced. In such a case, they may be better off postponing redemption to a more favourable time period.

For investors who do not have capital gains, this strategy is not applicable. This is because the losses booked would not provide any reduction in taxes to be paid. There is perhaps a case for such investors to petition the Government to allow them to set off the losses against their income from other sources, such as salary or house property.