At first blush, term deposits score on the fact that they offer an assured return over a fixed period of time. As of today, 90-day bank deposits offer a return of around 7% p.a. while 1-year deposits yield 9% p.a. But if one takes the tax impact into account, the sheen quickly fades.

A look at the short-term debt funds over the past year indicate that the average returns are in the vicinity of 9.50% p.a. So while they are neck-and-neck in terms of returns, when the tax angle is brought into the picture, income funds emerge the winner.
Interest earned from a bank deposit is fully taxable in the hands of the tax payer. This interest is added to the individual's total income and the tax at the applicable slab comes into effect. If one takes the highest tax bracket into account, the returns fall from 9% to 6.3%. Suddenly, they don't appear lucrative at all. And when you take inflation into account, one is left with nothing.

Which brings us to the question of how debt funds are taxed. Returns on debt funds are subject to capital gains treatment. The short-term capital gain in an income fund is added to the income and taxed according to slabs. In this case, the taxation is similar to that of bank deposits, hence we recommend that you hold your investment for over a year, when long-term capital gains sets in. Long-term capital gains from debt funds (investments held for more than one year), are subject to either 10% flat capital gains tax or 20% after indexation. Taking into account the uncertain interest rate scenario, we are of the opinion that short-term debt funds are the place to park your cash in.

Below is the current list of all the short term funds in the offering from the Indian mutual Funds space and if one looks closely, then he/she is bound to notice that the average returns these funds are generating is in the range of 9-9.5%, which makes them a better and prudent choice for the risk averse investors.

Author: Debanjan Guha Thakurta, Fundsupermart.com