Mutual Funds Taxation 2

8/3/2019 Mutual Funds Taxation 2

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MUTUAL FUNDS and

TAX IMPLICATIONS

MUTUAL FUNDS and

TAX IMPLICATIONS


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FINANCIAL MARKETS

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HSBC , Goldman

sachs,JP Morgan

ICICI ,HDFC


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FINANCIAL MARKETS

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MONEY MARKET INSTRUMENTS

TREASURY BILL- GOVT : mature in one year or less, they are sold at a discount of the par value to create

a positive yield to maturity. T-Bills are commonly

issued with maturity dates of 28 days, 91 days, 182

days , and 364 days .

COMMERCIAL PAPER : commercial paperis

an promissory note with a fixed maturity of 1 to 270

days. Commercial Paper is issued (sold) bylarge banks and companies to get money to meet short

term debt obligations (for example, payroll),

ASSET-BACKED SECURITY : is a security whose value and income payments arederived from and collateralized (or "backed") by a specified pool of underlying assets

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Industry profile

The mutual fund industry in India started in 1963 with the formation ofUnit Trust of India, at the initiative of the Government of India and

Reserve Bank. The history of mutual funds in India can be broadly

divided into four distinct phases.

First Phase 1964-87: Unit Trust of India (UTI).

Second Phase 1987-1993 (Entry of Public Sector Funds).

Third Phase 1993-2003 (Entry of Private Sector Funds).

Fourth Phase since February 2003


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Introduction

What is a Mutual Fund ?

Why invest in Mutual Fund?

Types of Mutual Funds

Tax Issues

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What is a Mutual Fund?

A mutual fund is a trust that pools the savings ofseveral investors and then invests these into

different kinds of securities (shares, debentures,

money market instruments, or a combination of

these) in keeping with a pre-stated investmentobjective.

The income thus generated and the capital

appreciation is distributed among mutual fundunit holders in proportion to the number of units

held by them.

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STURCTURE

SPONSORS : Sponsor is basically thepromoter of the fund.

ASSEST MANAGEMENT COMPANY : A set of

Financial professionals who manage the fund

TRUSTEES : Professionals who supervise the

activities of AMC.

CUSTODIAN :A custodian keeps safe custody

of Investments

TRANSFER AGENTS : Interfaces with

customers , issues a funds units e .g CAMS

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Working of Mutual Fund

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Net Asset Value of a fund

NAV is the total market value of all the assets,including cash, held by the fund, after deducting

its liabilities.

The per unit NAV represents the market value of

one unit of the mutual fund.

It is the price at which investors can buy or

redeem the mutual funds units.

The per unit NAV is computed by dividing the

total value of all the assets of the mutual fund,

less any liabilities, by the number of units

outstanding.14


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Benefits of investing in Mutual funds

DiversificationDiversification involves holding a wide variety of

investments in a portfolio so as to mitigate risks.

Mutual funds usually spread investments acrossvarious industries and asset classes, constrained

only by the stated investment objective.

Thus, by investing in mutual fund, you can avail

of the benefits of diversification and assetallocation, without investing the large amount of

money that would be required to create an

individual portfolio.

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Professional Management

Mutual funds employ experienced and skilled

professionals, who conduct investment research,

and analyse the performance and prospects ofvarious instruments before selecting a particular

investment.

Thus, by investing in mutual funds, you can avail

of the services of professional fund managers,which would otherwise be costly for an individual

investor.

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Liquidity

In an open-ended scheme, unit holders can

redeem their units from the fund house anytime,

by paying a small fee called an exit load, in somecases.

Even with close-ended schemes, one can sell

the units on a stock exchange at the prevailing

market price. Besides, some close-ended andinterval schemes allow direct repurchase of units

at NAV related prices from time to time.

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Flexibility

Mutual funds offer a variety of plans, such as

regular investment, regular withdrawal and

dividend reinvestment plans. Depending uponones preferences and convenience, one can

invest or withdraw funds, accordingly.

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Cost Effective

Since mutual funds have a number of investors,

the funds transaction costs, commissions and

other fees get reduced to a considerable extent.Thus, owing to the benefits of larger scale,

mutual funds are comparatively less expensive

than direct investment in the capital markets.

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Well Regulated

Mutual funds in India are regulated and

monitored by the Securities and Exchange Board

of India (SEBI), which strives to protect theinterests of investors. Mutual funds are required

to provide investors with regular information

about their investments, in addition to other

disclosures like specific investments made by thescheme and the proportion of investment in each

asset class.

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Risk associated with Mutual Funds

Mutual funds invest in different securities whichmay be equities or bonds, depending upon the

funds objectives. Accordingly, different schemes

have different risks depending on the portfolio

composition. In general, mutual funds are subjectto the following risks

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Systemic risks

Systemic risks or market risks refer to risks thataffect the entire market and have an impact on

the entire class of assets.

The value of an investment may decline over aperiod of time because of economic changes or

other events that affect the overall market.

Systemic risks include risks related to interest

rates, inflation, exchange rates and politicalevents, etc.

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Non-systemic risks

Non-systemic risks refer to risks associated with investments in

a particular sector or industry or stock.

Sector-specific schemes invest in equities of a particular

industry or sector, owing to which they are subject to higher risks

than other diversified schemes.

For example, tax benefits to a particular sector of the economy

would affect the shares of companies belonging to that sector

and thus, affect the returns of funds investing in that sector

Other factors that have a greater impact on the performance ofa mutual fund include the skill and experience of the fund

manager and the research team, the size of the corpus,

redemption pressures, etc.

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TYPES OF MUTUAL FUNDS SCHEMES IN INDIA

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Types of Mutual Fund Schemes

Mutual funds are classified on the basis oftheir

STRUCTURE

INVESTMENT OBJECTIVE

NATURE

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BY STRUCTURE

OPEN-ENDED SCHEMESAn open-end fund is one that is available for

subscription all through the year.

These do not have a fixed maturity. Investors can conveniently buy and sell units at Net

Asset Value ("NAV") related prices.

The key feature of open-end schemes is liquidity. One can invest in such funds on any working day, during business

hours. Investors can buy or sell units of open-ended schemes directly

from the fund house at NAV related prices.

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CLOSE-ENDED SCHEMES

These schemes have a pre-specified maturityperiod.

One can invest directly in the scheme at the time

of the initial issue.

Depending on the structure of the scheme there

are two exit options available to an investor after

the initial offer period closes.

Investors can transact (buy or sell) the units ofthe scheme on the stock exchanges where they

are listed.

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The market price at the stock exchanges couldvary from the net asset value (NAV) of the

scheme on account of demand and supply

situation, expectations of unitholder and other

market factors.

Alternatively some close-ended schemes provide

an additional option of selling the units directly to

the Mutual Fund through periodic repurchase atthe schemes NAV; however one cannot buy units

and can only sell units during the liquidity

window.

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SEBI Regulations ensure that at least one of thetwo exit routes is provided to the investor.

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INTERVAL SCHEMES

Interval Schemes are that scheme, whichcombines the features of open-ended and close-

ended schemes. The units may be traded on the

stock exchange or may be open for sale or

redemption during pre-determined intervals atNAV related prices.

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BY NATURE

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Equity fund:

These funds invest a maximum part of their corpusinto equities holdings. The structure of the fund may

vary different for different schemes and the fund

managers outlook on different stocks. The Equity

Funds are sub-classified depending upon theirinvestment objective, as follows:

Diversified Equity Funds

Mid-Cap Funds

Sector Specific Funds

Tax Savings Funds (ELSS)

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Equity investments are meant for a longer timehorizon, thus Equity funds rank high on the risk-

return matrix.

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Debt funds:

The objective of these Funds is to invest in debtpapers.

Government authorities, private companies,

banks and financial institutions are some of the

major issuers of debt papers.

By investing in debt instruments, these funds

ensure low risk and provide stable income to the

investors.

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Debt funds are further classified as:

Gilt Funds: Invest their corpus in securities

issued by Government, popularly known as

Government of India debt papers. These Funds

carry zero Default risk but are associated with

Interest Rate risk. These schemes are safer as

they invest in papers backed by Government.

Income Funds: Invest a major portion intovarious debt instruments such as bonds,

corporate debentures and Government securities.

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MIPs: Invests maximum of their total corpus in debtinstruments while they take minimum exposure in

equities. It gets benefit of both equity and debt

market. These scheme ranks slightly high on the

risk-return matrix when compared with other debtschemes.

Short Term Plans (STPs): Meant for investment

horizon for three to six months. These funds

primarily invest in short term papers like Certificate

of Deposits (CDs) and Commercial Papers (CPs).

Some portion of the corpus is also invested in

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Liquid Funds: Also known as Money MarketSchemes, These funds provides easy liquidity and

preservation of capital.

These schemes invest in short-term instruments like

Treasury Bills, inter-bank call money market, CPs

and CDs.

These funds are meant for short-term cash

management of corporate houses and are meant foran investment horizon of 1day to 3 months.

These schemes rank low on risk-return matrix and

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Balanced funds:

As the name suggest they, are a mix of both

equity and debt funds.

They invest in both equities and fixed incomesecurities, which are in line with pre-defined

investment objective of the scheme.

These schemes aim to provide investors with the

best of both the worlds. Equity part provides

growth and the debt part provides stability in

returns.

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By investment objective:

Growth Schemes : Growth Schemes are alsoknown as equity schemes. The aim of these

schemes is to provide capital appreciation over

medium to long term

Income Schemes:Income Schemes are also

known as debt schemes. The aim of these

schemes is to provide regular and steady income

to investors

Money Market Schemes: Money Market

Schemes aim to provide easy liquidity,

preservation of capital and moderate income.

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These schemes generally invest in safer, short-term instruments, such as treasury bills,

certificates of deposit, commercial paper and

inter-bank call money.

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Other schemes

Tax Saving Schemes

Index Schemes

Sector Specific Schemes

Exchange traded funds

Fixed Maturity Plans

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Tax saving schemes Such schemes are aimed at offering tax rebates to

investors under specific provisions of the Income Tax Act,

1961. For instance, investors of Equity Linked Savings

Schemes (ELSS) and Pension Schemes are applicablefor deduction u/s 88 of the Income Tax Act, 1961.

Index schemes

Such funds strive to mirror the performance of specificmarket indices, such as the BSE SENSEX, CNX Nifty, etc

which are called the base index. Investments in such

funds are made in the same stocks as the base index and

in similar proportion.

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Sector-specific schemes Such funds invest in a specific industry or sector. The

investments could be in a particular industry (Banking,

Pharmaceuticals, Infrastructure, etc) or a group of

industries, or various segments (like A Group shares).

Exchange-traded funds

Such funds are listed and traded on the stock exchange in

a similar manner as stocks. Such funds invest in a basketof stocks and aim at replicating an index (S&P CNX Nifty,

BSE Sensex) or a particular industry (banking, information

technology) or commodity (gold, crude oil, petroleum).

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Tax implications of investing in

mutual funds

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Dividends

Income received from units of a mutual fund

registered with the Securities and Exchange

Board of India is exempt in the hands of the

unit holder.

A debt-oriented mutual fund is liable to pay

income distribution tax of 12.5% and 20% on

the distribution of income to individual /Hindu Undivided Fund and other persons,

respectively.

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In the case of money market mutual fundsand liquid mutual funds (as defined under

SEBI regulations), the income distribution tax

is 25% across all categories of investors

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Capital Gains

Long-term capital gains arising on thetransfer of units of an equity oriented mutual

fund is exempt from income tax, if the

Securities Transaction Tax (STT) is paid on

this transaction i.e., the transfer of such unitsshould be made through a recognised stock

exchange in India.

Equity oriented mutual fund means a fund

where the investible corpus is invested by

way of equity shares in Indian companies to

the extent of more than 65% of the total

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SHORT TERM CAPITAL GAIN

Short-term capital gains arising on such transactionsare taxable at a base rate of 15% (increased by

surcharge as applicable, education cess of 2% and

secondary and higher education cess of 1%).

If a transaction is not covered by STT, the long-termcapital gain tax rate would be 10% without indexation

or 20% with indexation, depending on which the

assessee opts for.

Short-term capital gains on such transactions are

taxable at normal rates

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Taxation

Equity

oriented

Funds

Liquid

funds/Money

Market Funds

Debt

fund/liquid

plus Funds

Short Term

Capital Gain

Tax

15%As per Income

Tax Slab

As per Income

Tax Slab

Long Term

Capital Gain

Tax

Nil

Less of 10%without

indexation or

20% with

indexation

Less of 10%without

indexation or

20% with

indexation

Dividend

DistributionTax

Nil 25%* 12.5%20.0%*

Individuals/HUFAny other

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Budget 2011 increased the dividend distribution tax (DDT) for corporate

investors to 30%, thus companies can not take advantage of the

prevailing tax arbitrage (1st June, 2011 )


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A taxable capital loss (i.e., a transaction onwhich there is a liability to pay tax if the result

were gains instead of loss) can be set-off only

against capital gains. An exempt capital loss

(i.e., a transaction which is exempt from tax if theresult were gains instead of loss) cannot be

set-off against taxable capital gains. A taxable

long-term capital loss can be set-off only against

long-term capital gains. However, a taxable short-term capital loss can be set-off against both

short-term and long-term capital gains

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Tax issues concerning Unit holders

I. Equity Oriented Funds - Tax Treatment of

Investments

A. Tax on income in respect of unitsAs per the section 10(35) of the Act, income

received by investors under the schemes of any

Mutual Fund is exempt from income tax in the

hands of the recipient unit holders.

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B. Dividend Distribution Tax:By virtue of proviso to section 115 (R) (2) of

the Act, equity oriented schemes are exempt from

income distribution tax. As per section 115T of

the Act, equity oriented fund means such fundwhere the investible funds are invested by way of

equity shares in domestic companies (as defined

under the Act) to the extent of more than sixty five

percent of the total proceeds of such fund.

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C. TDS on income of units :As per theprovisions of section 194K and section 196A of

the Act, where any income is credited or paid on

or after 1st April 2003 by a Mutual Fund, no tax is

required to be deducted at source

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D. Tax on capital gainsi) Long Term Capital Gains

As per section 10(38) of the Act, any income arising from

the transfer of a long term capital asset being a unit of an

Equity Oriented Scheme chargeable to securities

transaction tax (STT) shall not form part of total income,

therefore, exempt from Income Tax. As per section 10(38)

of the Act, equity oriented fund means a fund where the

investible funds are invested by way of equity share in

domestic companies to the extent of more than sixty fivepercent of the total proceeds of such fund and which has

been set up under a scheme of a mutual fund specified

under section 10(23D) of the Income Tax Act, 1961.

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ii) Short term capital gainsUnits held for not more than twelve month's

preceding the date of their transfer are short term

capital assets. Capital gains arising from the

transfer of short term capital assets being unit ofan equity oriented scheme which is chargeable to

STT is liable to income tax @ 15% under section

111 A and section 115 AD of the Act. The said

tax rate is increased by surcharge, if applicable.

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iii) Securities Transaction Tax (STT)

As per Chapter VII of Finance (No. 2) Act, 2004 relating to Securities

Transaction Tax (STT), with effect from June 01, 2006, the STT is

payable by the seller at the rate of 0.25% on the sale of unit of an

equity oriented scheme to the Mutual Fund. The STT is collected by

the Mutual Fund at source.

With effect from 01st April 2008: the deduction under section 88E of

the Act has been discontinued, and

the amount of STT paid by the assessee during the year in respect of

taxable securities transactions entered into in the course of business

will be allowed as deduction under section 36 of the Act subject tothe condition that such income from taxable securities transactions is

included in the income computed under the head Profits and Gains

of business or profession.

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80C benefits through ELSS: Under the current tax laws,you can get an annual income tax benefit of up to Rs.

1Lakh if you invest in Equity Linked Savings Schemes,

ELSS. However, the minimum term for these schemes is

3 years and you cannot withdraw your money before that

time

*The education cess of 3% shall be levied on all investors.

*Short Term Capital Gain Tax indicated above is inclusive

of education cess

**Dividend Distribution Taxes indicated above are

inclusive of additional surcharge and cess.

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EXCHANGE TRADED FUNDS (ETFS)

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A security that tracks an index, acommodity or a basket of assets like

an index fund, but trades like a stock

on an exchange.

ETFs experience price changes

throughout the day as they are bought

and sold.

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Exchange Traded Funds (ETFs) represent abasket of securities that is traded on an

exchange, similar to a stock.

Hence, unlike conventional mutual funds, ETFs

are listed on a recognised stock exchange and

their units are directly traded on stock exchange

during the trading hours.

In ETFs, since the trading is largely done overstock exchange, there is minimal interaction

between investors and the fund house.

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ETFs are either actively or passively managed.Actively managed ETFs try to outperform the

benchmark index, whereas passively-managed

ETFs attempt to replicate the performance of a

designated benchmark index.

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Difference Between ETF and Conventional Mutual


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Difference Between ETF and Conventional Mutual

Funds

Mutual funds are traded through fund housewhere as in an ETF, transactions are done

through a broker as buying and selling is done on

the stock exchange.

In conventional mutual funds units can be bought

and redeemed only at the relevant NAV, which is

declared only once at the end of the day.

ETFs can be bought and sold at any time duringmarket hours like a stock.

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ETFs safeguard the interests of long-terminvestors. This is because ETFs are traded on

exchange and fund managers do have to keep

cash in hand in order to meet redemption

pressures

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What Are ETFs?: Creation Process

Investor

Brokerage

account

Cash

ETF

Shares Securities

ETF Authorized

ParticipantsCapital Markets

Creation Units Basket of Securities

ETF Fund Advisor

Cash


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FIXED MATURITY PLANS

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FMPs, as they are popularly known, are theequivalent of a fixed deposit in a bank, with a

caveat.

The maturity amount of a fixed deposit in a bank

is 'guaranteed', but only 'indicated' in the FMP ofa mutual fund.

The regulator does not allow fund companies to

guarantee returns, and hence the 'indicatedreturns' in FMPs.

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Typically, the fund house fixes a 'target amount'for a scheme, which it ties up informally with

borrowers before the scheme opens. Since the

fund house knows the interest rate that it will earn

on its investments, it can provide 'indicativereturns' to investors.

FMPs are debt schemes, where the corpus is

invested in fixed-income securities. The tenure

can be of different maturities, from one month to

three years.

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They are closed-ended in nature, which meansthat once the NFO (new fund offer) closes, the

scheme cannot accept any further investment.

These FMP NFOs are generally open for 2 to 3

days and are marketed to corporate and highnet-worth individuals. Nevertheless, the minimum

investment is usually Rs 5,000 and so a retail

investor can comfortably invest too

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FMPs usually invest in certificate of deposits ,

commercial papers , money market instruments,corporate bonds and sometimes even in bank

fixed deposits.

Depending on the tenure of the FMP, the fundmanager invests in a combination of the above-

mentioned instruments of similar maturity. Say if

the FMP is for a year, then the fund manager

invests in paper maturing in one year.The prevalent yield minus the expense ratio,

which varies from 0.25 to 1 per cent, will be the

indicative return which can be expected from the

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The expense ratio is mentioned in the offerdocument. The yield can be indicated fairly

accurately because these schemes are open only

for a short while.

The fund received is for a pre-specified tenureand the exit load from this plan is high (usually 1

per cent to 3 per cent, depending on the time of

redemption). So, the fund manager has the liberty

to deploy most of the funds mobilised under the

scheme.

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The actual return can vary slightly, if at all, fromthe indicated return. Against that, a bank fixed

deposit exactly prints the amount which is due to

you on maturity on the FD receipt. However,

FMPs do earn better returns than fixed depositsof similar tenure.

FMPs are classified under the debt scheme

category and enjoy certain tax benefits, such as:

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Dividend in the hands of the investor is tax-free.But the mutual fund has to deduct a dividend

distribution tax of 12.5 per cent in the case of

individuals and Hindu Undivided Families (HUFs),

and 20 per cent in the case of corporate.

Long-term capital gains (investment of more than

a year) enjoy indexation benefit.

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Short-term capital gains are added to the incomeof the investor and taxed as per his/her slab,

whereas the interest on a bank deposit (except

where special 80C approved) is added to the

income of the investor and taxed as per his/herslab.

The results of all these are quite dramatic.

Lets take an example of a 90-day FD yielding 8per cent, compared with an FMP yielding 8 per

cent for an individual investor in the highest tax

bracket.

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BANK FD FMP-

dividendoption

FMP - growth

option

Net yield 8% 8% 8%

Tax 30.90% - 30.90%

DDT - 12.88%Net yield 5.53% 6.97% 5.53%

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Actually, the dividend distribution tax is deducted on the gross yield.

So the return from the dividend option can be 10-20 bps higher.

But for the sake of simplicity, it is calculated here on net yield.

If the tenure of the FMP is more than a year, the growth option gives

a higher yield because of the indexation benefit.

What is indexation benefit?


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What is indexation benefit?

The finance minister has been generous enoughto recognise that inflation erodes the real value of

any investment.

So every year, he comes out with an inflation

index based on the prevailing rate of inflation.

The cost of investment is indexed by multiplying

the index of the year of maturity and divided by

the inflation index prevailing on the year ofinvestment.

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Look at the workings: Note: Cost Inflation Index for FY06-07 is 519. The

assumption is that the CII for FY07-08 is 567 and

for FY08-09 is 592.

Clearly, the post-tax return is superior for an

FMP.

If you have arrived at an indexed cost, then the

long-term capital gain is taxed at 20.6 per centand if you do not opt for the indexed cost, then

the tax is 10.3 per cent.

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Cost of inflation Index


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Cost of inflation Index

FINANCIAL YEAR COST INFLATION INDEX

2003-2004 463

2004-2005 480

2005-2006 497

2006-2007 519

2007-2008 551

2008-2009 592

2009-2010 632

2010-2011 711

2011-12 785

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Indexed Purchase

Price = Purchase Price * (CPI for

current year / CPI for year of

purchase)

Bank Fixed

Deposit 30 Month FMP


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Deposit 30 Month FMP

With Indexation

Without

Indexation

Amount of Investment (Rs.) 10000 10000 10000

Post Expenses Yield (p.a)* 8.30% 8.30% 8.30%

Tenor (in months) 30 30 30

Approx Maturity Amt 12,075 12,075 12,075

Gain 2075 2075 2075

Indexed Cost NA 11,406 NIL

Indexed Gain NA 669 NA

Tax Rate 30.9% 20.6% 10.3%

Tax 641 138 214

Post Tax Gain 1434 1937 1861

Approx Post Tax

Annualised Return 5.74% 7.75% 7.44% 86


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BONDS

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TREASURY CURVE RATES


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TREASURY CURVE RATES

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The yield curve is a description of a line thatconnects the yields on various maturities, ranging

from 3-month Treasury Bill to 30-year Treasury

Bonds

It is tool to help track and predict the overallmovement of interest rates and the near future of

the economy.

A normal, or positive, curve is created when long-term bonds produce higher yields than short-term

bonds.

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Investors generally seek higher rewards tocompensate for the risks involved with investing

money for longer periods of time.

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Typically, a flat curve, when long-term and short-term yields are the same, predicts economic

slowdown.

According to the Federal Reserve Bank of San

Francisco, each of the six recessions since 1970was preceded by a yield curve inversion.

That statistic, however, conveniently leaves out

the two recessions that occurred in the 1950sand 1960s, which were not predicted by an

inverted curve.

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BACK UP SLIDES

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Interbank Call Money Market


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Interbank Call Money Market

A short-term money market, which allows forlarge financial institutions, such as banks, mutual

funds and corporations to borrow and lend money

at interbank rates.

The loans in the call money market are veryshort, usually lasting no longer than a week and

are often used to help banks meet reserve

requirements.

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How is a Mutual Fund NAV Calculated?


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To calculate a Mutual Fund's Net Asset Value or NAV, the value of the total assets of themutual fund is subtracted by its liabilities, and then this amount is divided by the total

number of shares or units in the mutual fund.

Mutual Fund NAV = Total Assets - Liabilities / Total number of shares or units

The assets of a mutual fund would consist of its investments and cash. The liabilities of a

mutual fund include operating expenses.

For example, a mutual fund has assets in stocks and other investments to the value of

Rs100, 000 and liabilities worth Rs 20, 000. Assuming the mutual fund has issued 10, 000

Units, then its NAV would be:

NAV = (100, 000 - 20, 000)/ 10, 000

NAV = 80, 000 / 10, 000

NAV = Rs 8

The NAV or price per share of this mutual fund would be Rs 8.

A Mutual Fund NAV is calculated on a daily basis, after the stocks markets close for the day.

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Mutual Fund NAV after Dividend Payout


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y

A mutual fund pays out dividend to its investorswho have opted for the dividend plan. In such

cases, the NAV of the mutual fund falls according

to the amount of dividend paid.

For example, if the NAV of a mutual fund on 10

July 2010 was Rs 10 and a per unit dividend of

Rs 2 is declared and paid out, then on 11 July

2010, the NAV of the mutual fund would fall toRs8. The cash obtained by the investor can be

reinvested to buy more shares of the mutual fund

at lower value.

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Some investors who seek pure capitalappreciation may opt for an aggressive growth

fund, without dividend payments. The returns

then would be solely based on the mutual fund

NAV appreciation.

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FUND EXPENSES


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Different funds have different expense ratios.However to keep things in check, the Securities &

Exchange Board of India (SEBI) has stipulated an

upper limit that a fund can charge.

The limit stands at 2.50 per cent for equity fundsand 2.25 per cent for debt funds.

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The total expenses of the scheme excluding issue orredemption expenses, whether initially borne by themutual fund or by the asset management company, but

including the investment management and advisory fee

shall be subject to the following limits :-

(i) On the first Rs.100 crores of the average weekly net

assets 2.5%

(ii) On the next Rs.300 crores of the average weekly net

assets 2.25%

(iii) On the next Rs.300 crores of the average weekly netassets 2.0%

(iv) On the balance on the assets 1.75%

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The asset management company may charge the mutual fund with

the following expenses namely:-

(a) initial expenses of launching schemes.

(b) recurring expenses including:-(i) marketing and selling expenses including agents'

commission, if any;

(ii) brokerage and transaction cost;

(iii) registrar services for transfer of units sold or redeemed;

(iv) fees and expenses of trustees;(v) audit fees;

(vi) custodian fees; and

[(vii) costs related to investor communication;

(viii) costs of fund transfer from location to location;

(ix) cost of providing account statements and dividend/redemption cheques and warrants;

(x) insurance premium paid by the fund;

(xi) winding up costs for terminating a fund or a scheme;

(xii) costs of statutory advertisements;][ (xiii) such other costs as may be approved by the Board.]

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EXIT LOAD


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Exit Load varies for different schemes and isgenerally charged as a percentage of NAV. The

Exit load normally varies between 0.25% to 2% of

the redemption value. Some mutual funds

however do not charge any exit load. Suchmutual funds are referred to as 'No Load Funds'.

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At present, my rate is 13.52% (12.5% dividenddistribution tax + 5% surcharge + 3% cess) on

income distributed by debt funds other than liquid

funds. For liquid funds, I am charged at the rate

of 27.04% (25% dividend distribution tax +surcharge and cess).

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Budget 2011 increased the dividend distribution tax (DDT)

for corporate investors to 30%, up from 25% a year back

in case of liquid funds and up from 12.5% in case of all

other debt funds.

This is a significant move as it removes the arbitrage

opportunity that companies had in parking their surplus

cash in MF schemes, especially liquid funds and ultra

short-term funds.

Since I come at a lower rate in case of MF dividends

(25% in case of, say, liquid funds) against tax charged oninterest earned from a savings bank account (where I

come at the rate of 30%), companies found it tax-efficient

to put their excess cash in MFs.

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So far as Dividend Distribution and IncomeDistribution Tax payable u/s.115O and u/s.115R

by companies and Mutual Funds is concerned

the rate of surcharge on tax is reduced from 7.5%

to 5% w.e.f. 1-4-2011.

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Section 115R:


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Particulars Existing rateNew rate

w.e.f. 1-6-2011

(i)

Income distributed to an

individual or HUF by a money

market Mutual Fund or Liquid

Fund

25% 25%

(ii)

Income distributed to any other

person by a money market

Mutual Fund or Liquid Fund

25% 30%

(iii)Income distributed to anindividual or HUF by a Debt

Fund

12.5% 12.5%

(iv)Income distributed to any other

person by a Debt Fund20% 30%

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. The only restriction is that a long-term capital losswill be available for a set-off against a long-term

capital gain only, while a short-term capital loss

can be set off either against a long-term capital

gain or a short-term capital gain.

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What Does Tax Arbitrage Mean?


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The practice of profiting from differences betweenthe way transactions are treated for tax purposes.

The complexity of tax codes often allows for

many incentives which drive individuals to

restructure their transactions in the mostadvantageous way in order to pay the least

amount of tax.

Some forms of tax arbitrage are legal whileothers are illegal.

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Securities Transaction Tax (STT)


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Securities Transaction Tax is a neat and efficient way

of computing tax on profit incurred from the sale ofsecurities, as it virtually nullifies the scope of tax

avoidance.

Securities Transaction Tax is applicable at differentrates on the value of the taxable securities

transaction.

Taxable securities transaction, payable by both the

buyer and the seller, refers to any transaction of

securities entered into in a recognized Stock

Exchange in India

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Definition of Securities


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As per section 2(h) of the Securities Contracts

(Regulation) Act, 1956 (SCRA), Securities

includes to:

Shares, scrips, stocks, bonds, debentures,

debenture stock or other marketable securities ofa like nature in or of any incorporated company or

other body corporate;

Derivative instruments (likeforwards/futures/options on indices, stocks,

commodities etc.)

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Units or any other instrument issued by any

collective investment scheme to the investors in

such schemes;

Security receipt as defined in section 2(zg) of the

Securitisation and Reconstruction of FinancialAssets and Enforcement of Security Interest Act,

2002;

Government securities;

Such other instruments as declared by the

Central Government; and Rights or interest in

securities.

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Documents

Mutual Funds Taxation 2