Parking Rs 10L for 1yr: Should I use an FD or an Arbitrage Fund if I am in the 30% tax bracket?

The Gist: Arbitrage funds are treated as equity for taxation so you can save a massive amount on taxes compared to a traditional FD if you are in the 30% bracket.

Let us break down the exact math using a very realistic scenario. Suppose you invest your Rs 10L in a traditional FD and it generates a 7% return. That gives you a profit of about Rs 70k for the year.

Because you are in the 30% tax bracket that entire Rs 70k is added to your income and taxed at your slab rate. Your tax liability on that FD interest would be roughly Rs 21k. Now let us look at what happens if you put that same Rs 10L into an arbitrage fund generating the exact same 7% return.

Arbitrage funds are treated as equity funds for taxation purposes. If you hold the investment for just over 1yr your profits fall under Long-Term Capital Gains or LTCG. Under current rules equity profits up to Rs 1.25L in a financial year are completely exempt from tax.

If you have no other equity gains your Rs 70k profit falls well below that limit so your tax liability is literally zero. Even if you have already exhausted your Rs 1.25L exemption through other stock investments the Rs 70k profit is only taxed at 12.5%. That comes out to roughly Rs 8750 in taxes.

By simply shifting your money from an FD to an arbitrage fund you save about Rs 12250 in taxes on a Rs 10L investment. It is an incredibly efficient way to park short-term capital without letting the taxman take a huge bite out of your yield.

Disclaimer: All information shared above are strictly for educational and informational purposes only. It should not be construed as financial or investment advice.