Mutual Funds

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A small guide to mutual funds

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Get the tax
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mutual

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Get the tax edge with

Mutual Funds

Contents
2
Why equities ................................................................................................... 4
Importance of post-tax returns in accumulating wealth.............................. 4
Tax benefits while investing in mutual funds ............................................... 6
Income received dividends and growth . ....................................................... 8
Dividend distribution tax .............................................................................. 9
Capital gains ................................................................................................ 10
Capital losses ............................................................................................... 11
Tax advantage over other competitive investments . ................................ 12
Strategies ..................................................................................................... 12
Applicable tax rates: Investments in mutual fund schemes . .................... 14
For retirees: Tax-efficient SWP option ....................................................... 15
Conclusion ................................................................................................... 16

Role of mutual funds in meeting long-term goals ........................................













Project Editor Sunil Dhawan
Copy Editor Lakshmi Krishnakumar
Assistant Art Director Anil Panwar
Copyright © Outlook Publishing (India) Private Limited, New Delhi.
All Rights Reserved
No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or means electronic, mechanical,
photocopying, recording or otherwise, without prior permission of Outlook Publishing (India) Private Limited.
Printed and published by Vinodkumar Madhavan Panicker on behalf of Outlook Publishing (India) Pvt. Ltd
Editor: Udayan Ray. Published from Outlook Money, AB 5, 3rd Floor, Safdarjung Enclave, New Delhi-29
Outlook Money does not accept responsibility for any investment decision taken by readers on the basis of information provided herein.
The objective is to keep readers better informed and help them decide for themselves.

december 2013

1

Mutual
Funds and
Taxation
ROLE OF MUTUAL FUNDS IN
MEETING LONG TERM GOALS

M

ost of us have a plan in mind to carve
out a safe and secure future for ourselves
and for our family members. But, do we
know what is the right way to go about
it or the right approach towards achieving our financial
goals. Mutual funds (MF) becomes more relevant in this
context. A MF is a financial product that pools money
of different individuals and invest on their behalf into
various assets such as equity, debt or gold. Based on
one’s financial goal or risk appetite, there are several MF
schemes to choose from. Few startling features that they
offer are simplicity, affordability, professional management, diversification along with liquidity.

2

Get the tax edge with

Mutual Funds

3

Securing your financial goals may
long term. The veracity of using equity
not be an easy process by itself. It calls to meet long-term goals have been
for a clear picture of your financial
proven time and again. Studies done
goals, number of years left to achieve
in the past have always suggested that
them and the amount you wish to
equity has delivered higher inflationsave. Also, important is the product or adjusted return than any other
a mix of products you will need to save asset class over the longer horizon.
money in creating that wealth for you. The underlying message is the time
Rather than investing directly into the horizon —the longer you remain
invested in equities better the return.
stockmarket you could choose to participate in the equity markets through The advantage comes from the power
of compounding because the
MFs. Equity MFs have the poearlier you start, the lontential to deliver returns
SECURING
ger time for your money
in order to create wealth
YOUR
to grow. If you start
in the long run. For
FINANCIAL GOALS
saving early, even in
any long-term goal be
CALLS FOR A CLEAR
small amounts, it will
it children’s financial
PICTURE OF THE
help build a sizeable
needs like education,
NUMBER OF YEARS
savings portfolio.
marriage or buying
LEFT TO ACHIEVE
Keep
investing regua house or planning
THEM AND THE
larly
and
keep investretirement, MFs offer
AMOUNT TO
ing
the
returns
too. Your
choices for all. Ideally, if
SAVE
earnings, too, will fetch
one’s financial goal is ten
years away, equity MFs could
you returns.
be the right choice of investment.

WHY EQUITIES

For goals which are to be met over
a longer term, equities fit the bill.
Precisely because one needs to generate real returns higher to inflation.
Else, inflation eats into returns and
does not help accumulating corpus to
see you through. Whatever the risk
profile or the quantum of savings it’s
highly imperative to use equity backed
investment products to cancel the
effect of inflation especially over a
4

IMPORTANCE OF POSTTAX REAL RETURNS IN
ACCUMULATING WEALTH

A high rate of interest does not necessarily help in creating a decent corpus over the long term. This is mainly
because of the implication of tax on
the income earned and also the falling
purchasing power of money due to
inflation. From a gamut of instruments available, the choice inadvertently hinges on the aspects of safety,
liquidity and the term. Whether the

Get the tax edge with

Mutual Funds

In order to create wealth
over long term, the post-tax
return real returns assume
greater significance.

income generated is subject to tax or
not is something least talked about.
However, in order to create wealth in
the long run, the post-tax real returns
assume greater significance.
The IT Act does not treat all financial
savings uniformly, and the taxability
of contributions, accumulations and
withdrawals differ from one instrument to another. Investments in a
public provident fund (PPF) scheme,
for instance, enjoy tax savings in the
form of deductions, while the interest
escapes the tax man’s axe. The money
you get on maturity is not taxable
either. This method of taxation is
referred to as the ‘exempt-exemptexempt’ (EEE) method since all three
stages—contribution, accumulation
and withdrawals—are exempt of tax.
On the other hand, while contributions to, and accumulations in, certain
insurance products such as pension
plans are not taxable, the amounts received by way of lump sum withdrawal

or periodical pensions are taxable in
the year you receive it, i.e., pension
plans are governed by the ‘exempt-exempt-tax’ (EET) method of taxation.
For example, for a bank fixed deposit
that might give you a return of 8 per
cent the effective post-tax return for
someone paying 30.9 per cent tax
would be a figure lower than inflation—a mere 5.5 per cent.
Therefore, the question that comes
to mind is—financial planning or
tax planning? Should I be saving in
banks or in share markets or in MFs?
A proper financial planning exercise,
making full use of the tax provisions
is what everyone wants.

TAX BENEFITS WHILE
INVESTING IN MFs

Under Section 80 C of the IT Act
1961: If one invests in any of the
specified instruments, his gross total
income stands reduced by an equal
amount, subject to a maximum of `1
5

intrinsic features that differentiate it
lakh every year and tax is paid on the
from other MFs. ELSS gives tax benbalance. For someone in the highest
efit on the amount invested and hence
IT slab of 30.9 per cent, (Including
comes with a lock-in period of three
the education cess of 3 percent which
years. One can invest up to `1 lakh in
applies on tax plus surcharge) an investment of `1 lakh in one or a mix of a single or a combination of ELSSs.
There are two options to choose
Section 80C instruments reduces the
from in an ELSS—dividend and
individual’s total taxable income by
growth. One can buy units under
`30, 900. For those with income
this scheme with a miniabove `1 crore, there is a
ELSS
mum amount investsurcharge of 10 percent
has TAX
ment of `500 and in
on tax payable in adBENEFIT ON THE
multiples of `500
dition to education
AMOUNT INVESTed
thereafter. Investcess. Hence, for them
UP TO `1 lakh AND
ments can either
the tax rate is 33.99
COMES WITH
be in lump sums or
percent.
A LOCK-IN
through
the systemThe list of specified
PERIOD OF
atic
investment
plan
instruments includes
THREE YEARS
(SIP) route. Investment
equity-linked savings
In ELSS Scheme has a lockscheme (ELSS), an equityin period of 3 years .Considerbased MF scheme. As the name
goes, ELSS is a savings scheme that
ing the volatility in the stockmarkets,
it is better to invest through SIPs, save
is linked to equity. ELSS is a type of
tax and create wealth over the long
MF scheme that is formulated under
term. Typically, they are known as tax
ELSS guidelines and is similar to any
plans, and can be bought through
diversified equity MF and routes
intermediaries, such as banks, distriinvestments into the equity market.
bution houses, brokers and indiHowever, it does come with some

6

Get the tax edge with

vidual agents. One may also buy ELSS
directly from fund houses or from the
Websites of such fund houses. The
entry load in ELSS, as in any other
MF scheme, is nil. The entire investment participates in the stockmarket,
and based on the scheme’s net asset
value (NAV), units get allotted. NAV
is the applicable net value of each unit
on any particular day.
Under Section 80 CCG of IT Act.
By investing in Rajiv Gandhi Equity
Saving Scheme (RGESS), first time
retail investors with a gross total
income for the financial year with less
than or equal to `12 lakh would get
50 per cent deduction under Section
80CCG of the IT Act, 1961, on the
amount invested, provided they have
neither invested in equities or derivative instruments. For instance, if you
invest `50,000 under RGESS, the
amount eligible for tax deduction will

Mutual Funds

be `25,000 from your taxable income.
This deduction will be over and above
the `1 lakh-limit permitted under Section 80C of the IT Act.
Unlike ELSS, or any other similar
tax-saving instruments that do not
require any demat account to get
the benefit under RGESS you will
have to open a new demat account
or designate your existing demat
account under RGESS by filling out
Form A. Even in the case of investing
in RGESS-qualified MF schemes, you
need to have a demat account because
the units you will buy are listed on the
stock exchanges. Units of Exchange
Traded Funds (ETFs) or MF schemes
with RGESS eligible securities are
eligible provided they are listed and
traded on a stock exchange and

Considering volatility in
the stockmarkets, choose
to invest in ELSS through
SIPs to save tax

7

settled through a depository mechanism. The period of holding securities
is three years for availing the benefit
under section 80 CCG in the manner provided under the guidelines of
RGESS.
start from here

INCOME RECEIVED
DIVIDENDS AND GROWTH

and the NAV will grow with time.
Hence the NAV of a growth option is
always higher than the dividend version of the same scheme.

DIVIDEND DISTRIBUTION
TAX (DDT)

According to the provisions of Section 10(35) of the Act, income received
There are two ways to receive income in respect of units of a MF is exempt
from MF schemes—as dividends or as from IT in the hands of the recipient
growth. Under the dividend option,
unit holders and no tax deducted at
when you invest in a MF and
source (TDS) will be deducted
the fund generates distribon it. While it is true that
utable surplus out of
for income received by
FOR
it, the fund manager
unit holders in the
BOTH EQUITY
may distribute such
form of dividends
AND NON-EQUITY
surplus among the
from equity funds,
SCHEMES, HOLDING
PERIOD SHOULD BE 12
Investors from time
for the debt funds,
MONTHS FOR THEM TO
to time in the form
the dividend before
BE TREATED AS LONG
of dividend. It is of
reaching unit holders
TERM CAPITAL
two types - dividend
is subject to dividend
ASSETS
payout and dividend
DDT. The dividends
declared by all the debttransfer. In the first type
oriented MFs attract DDT.
the dividend amount goes to
the investor. In the latter, the fund
All equity-oriented schemes like eqallots more units to the investor. The
uity-diversified, large-, mid-, small-cap
value of these units will be same as
equity funds, thematic and sectoral
schemes, the dividend remain tax free
the dividend amount and is based on
and are not subjected to DDT. Equitythe prevailing NAV of the scheme. As
the dividend is reinvested, the numoriented MF is a fund where the
ber of units in an investor’s portfolio
investable corpus is invested through
grows based on what the dividend
equity shares in Indian companies to
amount is.
the extent of more than 65 percent of
Under the growth option any profit
the total proceeds of the fund.
arising from the investors’ money
On non-equity oriented schemes
remains invested in the scheme. The
like debt funds, income funds, liquid
number of units will remain the same
funds, ultra short-term funds, float-

10

Get the tax edge with

ing rate funds, gilt funds, monthly
income plan (MIP) and fixed maturity
plans, the DDT stands at 28.325 per
cent. (25 per cent+ 10 per cent of surcharge + 3 per cent of cess) on income
distributed to an individual HUF and
33.99% on income distributed to any
other person. The growth option for
equity and non-equity MF schemes
are not subject to DDT anyhow.

CAPITAL GAINS

As per section 2(42A) of the IT Act,
units of the MF scheme held as a capital asset, for a period of more than
12 months immediately preceding
the date of transfer, will be treated as
long-term capital assets for the com-

Mutual Funds

putation of capital gains while for less
than 12 months they would be treated
as short-term capital assets.
The gains from the mutual scheme
are taxed depending on the investment period in MFs. If the MF units
are redeemed after a year, then the
gains thereon are liable to long-term
capital gains tax while the proceeds
from the investments which redeemed before one year are taxed as
short-term capital gains.
On debt schemes. Short-term capital
gains is taxed according to the normal
slab of investors. Short-term capital
gains are included in your gross total
income and after adjustments from
deductions gains are subjected to tax

If you suffered
short-term losses
in MF investments, it can be
set-off against any
gains in other MF
investments.

11

according to your tax slab. The longterm gains are subjected to 20 per
cent tax with indexation and 10 per
cent without.
On equity schemes. For equity
shares or equity-oriented MFs, the
short-term capital gain tax rate is 15
per cent and the long-term capital
gain are tax free. According to chapter
VII of the Finance (No. 2) Act, 2004
pertaining to securities transaction
tax (STT), the STT shall be payable
by the seller at the rate of 0.001%
for delivery-based while 0.025% for
non-delivery based transactions on
the sale of a unit of an equity-oriented
fund to the MF. Long-term capital
gains arising on the transfer of units
of an ‘equity-oriented’ MF is exempt
from IT, if the STT is paid on this
transaction i.e., the transfer of such
units should be made through a recognised stock exchange in India (or such
units should be repurchased by the
relevant mutual fund).

CAPITAL LOSSES

If you have suffered short-term
capital losses in MF investments, it
can be set-off against any capital gain
in other MF investments. The shortterm capital losses resulting from the
sale of units would be available for
setting off against any capital gains
which would bring down the tax liability of the unit holder to that extent.
Further unabsorbed short-term capital losses shall be carried forward and
12

set off against the income under the
head ‘capital gain’ in any of the subsequent eight assessment years. Losses
on transfer of long-term capital assets
would be allowed to be set-off only
against gains from transfer of longterm capital assets and the remaining
long-term capital loss shall be carried
forward separately for eight assessment years to be set off only against
long-term capital gains.

TAX ADVANTAGE OVER
OTHER COMPETITIVE
INVESTMENTS

Bank deposits. MF schemes both
debt- and equity-based, provide taxefficient returns compared to other

Get the tax edge with

Mutual Funds

STRATEGIES

investments such as bank deposits.
Let’s look at someone in the highest tax slab, paying tax at the rate of
30.9 percent (For Income below `1
crore) with assuring returns from the
bank, equity or debt MF scheme of 9
per cent. The effective post-tax yield
in short-term investments (for the
redemption of within a year) is 6.22
per cent for bank fixed deposits (FD)
while it is 7.01 (please check this)
( 9% less 28.325%=6.45%) percent
for a debt fund even after adjusting
DDT. Similarly, effective post-tax
yield in long-term investments (for
the redemption of after a year) comes
to 8.07 percent under the debt MF
growth option.

Using ELSS to meet goals. Put to use
the tax benefit of ELSS to your advantage. Spread your investments in 2-3
ELSS for the sake of diversification
across market capitalisation and fund
managers. Consider the long-term
performance as against its benchmark, volatility, small-, mid- and
large-cap exposure before zeroing in
on a particular scheme. The pedigree
of the fund also plays an important
role. Don’t buy or invest in a fund
simply because its NAV is lower than
its competitors. Keep financial goals
in mind. Every ELSS adopts different stock picking strategies. Some
schemes maintain a large-cap focus
and are suitable for investors who
have a low risk profile. On the other
hand funds that have greater exposure to small- and mid-cap stocks fit
the portfolio of an investor willing to
take some risk. Ignoring this aspect
would mean a mismatch between the
fund and the investor’s profile.
If your ELSS investment made in
the past is about to mature in the
next 3-6 months, you need to decide
carefully. Once you complete three
years in an ELSS, review your investment. After all, one of your objectives
(the tax deduction) has been met.
Tax laws don’t allow a rollover for
claiming the Section 80C benefit—
they insist on fresh investments.
Hence, evaluate your “matured”
ELSS investment as a normal equity
13

Applicable Tax Rates on
Investments in Mutual Fund Schemes
Tax implication on dividend received (In the case of investors / HUF)
Dividend
Equity-oriented schemes

tax free

Other than equity-oriented schemes

tax free

Dividend Distribution Tax (payable by the scheme) from 1 June 2013
Equity-oriented schemes*

Nil

Other than equity-oriented schemes

25% + 10% surcharge +
3% cess = 28.325%

Long-term capital gains (Units held for more than 12 months)
Equity-oriented schemes*

Nil

Other than equity-oriented schemes

10% without indexation OR
20% with indexation
whichever is lower + 10%
surcharge$ + 3% cess

Without indexation

11.33%

With indexation

22.66%

Short Term Capital Gains (Units held for 12 months or less)
Equity-oriented schemes*

15% + 10% surcharge$ +

Other than equity-oriented schemes

30%^ + 10% surcharge$ +

3% cess= 16.995%
3% cess = 33.99%
*STT will be deducted on equity-oriented schemes at the time of redemption and switch to
other schemes. Mutual funds would also pay Securities Transaction Tax wherever applicable on
the securities sold
$ Surcharge at the rate of 10% would be levied in case of individual / HUF unitholders, where
their income exceeds `1 crore
^Assuming the investor is in the highest tax bracket
For resident individual for FY 2013-14

14

Get the tax edge with

investment—your decision to stay on
or exit should be based on your perception of the market and the need
for funds. You may reinvest proceeds
in any other ELSS schemes. If there
is a need for funds, you could liquidate some or all units. Remember,
even partial units can be redeemed.
However, if no such need exists, you
may better postpone liquidation to
few more months.
Investing for less than a year. If you
are in the highest tax slab and paying
30.9 percent tax and wish to park
idle money for a short while (holding
overnight to a year), consider investing in dividend options of liquid, ultra
short-term, short-term income funds
or even debt funds. They are liable
to pay a tax of 28.325 per cent on
dividend income. On the other hand,
30.9 per cent of tax has to be paid if
growth option is chosen or even when
deposited in the bank.
Investing for more than a year. If
you are in the highest tax slab and
paying 30.9 percent tax, and wish to
park money for a long duration (more
than one year), the growth option of
liquid, ultra short-term, short-term
income funds or even debt funds can
be a better choice. Under growth option, you will have to pay long-term
capital gains tax of 10.3 per cent
without indexation or 20.6 per cent
with indexation whichever is lower
while redeeming the units anytime
after 12 months.

Mutual Funds

FOR RETIREES

Retirees need liquidity as well as
regular returns on their corpus.
Choosing liquid or debt funds over
bank deposits gives them an extra tax
advantage. After investing in liquid
or debt scheme, they may choose the
systematic withdrawal plan (SWP)
that lets them withdraw pre-decided
amounts from their investments at periodic intervals. There are two options
in an SWP—fixed withdrawals where
you specify the amounts you wish
to withdraw from your investment
on a regular basis and appreciation
withdrawal where you can withdraw
your appreciated amount. For those
in the highest tax bracket, the fixed
withdrawal option is more suitable and
15

bank deposits for interests above a
certain limit. SWP, therefore, gives
you a tax-efficient regular income
even if you choose the growth option
in these schemes.

CONCLUSION

It is imperative to take advantage of
equities to tackle inflation in the long
run. An equity MF fits the bill
as they come with a numFOR
ber of options to choose
RETIREES,
from. Volatility in the
CHOOSING
a systematic
stockmarket will help
withdrawal plan
generate wealth in
HELPS in DERIVing
the long run while tax
TAX-EFFICIENT
benefit on returns can
REGULAR
give your investment
INCOME
portfolio the muchneeded edge. Closer to
that, too, after holding on to
your goals, using debt funds to
the scheme for a year.
The tax liability in SWP is lower than manage and derisk portfolio is another
advantage one should take from MFs.
that of bank deposits. The applicable
It is the post-tax returns that
tax rate (for the investor who belongs
decides how much you end up saving
to highest tax bracket) on the income
for your goals. No point accumulating
from SWP is 10.3 per cent which is
wealth that sees its purchasing power
lower than the applicable tax rate
fall with just capital safety. Therefore,
of 30.9 per cent in Bank deposits.
take the MF route to meet your goals
Further, no TDS is applicable to SWP
and say bye to tax worries!
withdrawals, however, it applies to
Disclamier: This book is prepared for information purpose only and is not offer to sell or solicitation to buy
any Mutual Fund units/securities. This booklet has been prepared by Outlook Money. SBI Mutual Fund does
not certify or endorse any opinion mentioned herein. Further, these views are not sufficient and should not
be used for development or implementation of investment strategy. It should not be construed as investment
advice to any party. Neither SBI Mutual Fund or SBI Funds Management Pvt. Ltd. nor any person connected
with it, accepts any liability arising from the use of this information. The recipients of this information should
rely on their investigation and take their own professional advice.
Mutual Fund investments are subject market risks, read all scheme related documents carefully.

16
Source: Outlook Money

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