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MUTUAL FUNDS and TAX IMPLICATIONS
MUTUAL FUNDS and
TAX IMPLICATIONS

COST

RETURN

FINANCIAL MARKETS

Investors

(Lenders)

COST RETURN FINANCIAL MARKETS Investors (Lenders) Financial Markets Banks Profit Borrowers ( Gov‟t Companies) HSBC ,

Financial

Markets

Banks

Profit

Borrowers

(Gov‟t

Companies)

COST RETURN FINANCIAL MARKETS Investors (Lenders) Financial Markets Banks Profit Borrowers ( Gov‟t Companies) HSBC ,

HSBC , Goldman

sachs,JP Morgan

ICICI ,HDFC

FINANCIAL MARKETS

MONEY MARKETS Short term

FINANCIAL

MARKETS

FINANCIAL MARKETS MONEY MARKETS Short term FINANCIAL MARKETS MARKETS Equity- Shares Debt- Bonds Long term

CAPITAL

MARKETS

Equity-

Shares

Debt-

Bonds Long term

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 paper is an promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is issued (sold) by large 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 are

derived from and collateralized (or "backed") by a specified pool of underlying assets

Industry profile

» The mutual fund industry in India started in 1963 with the formation of Unit 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

»Introduction »What is a Mutual Fund ? »Why invest in Mutual Fund? »Types of Mutual Funds »Tax Issues

What is a Mutual Fund?

»A mutual fund is a trust that pools the savings of several 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 investment objective.

»The income thus generated and the capital appreciation is distributed among mutual fund unit holders in proportion to the number of units held by them.

STURCTURE

»SPONSORS : Sponsor is basically the promoter 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 fund‟s units e .g CAMS

Working of Mutual Fund

Working of Mutual Fund

Structure of mutual fund

Structure of mutual fund

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 fund‟s 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.

Benefits of investing in Mutual funds

Diversification

»Diversification involves holding a wide variety of investments in a portfolio so as to mitigate risks.

»Mutual funds usually spread investments across various 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 asset allocation, without investing the large amount of money that would be required to create an individual portfolio.

Professional Management

»Mutual funds employ experienced and skilled professionals, who conduct investment research, and analyse the performance and prospects of

various 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.

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 some

cases.

» Even with close-ended schemes, one can sell the units on a stock exchange at the prevailing

market price. Besides, some close-ended and

interval schemes allow direct repurchase of units at NAV related prices from time to time.

Flexibility

»Mutual funds offer a variety of plans, such as regular investment, regular withdrawal and dividend reinvestment plans. Depending upon

one‟s preferences and convenience, one can

invest or withdraw funds, accordingly.

Cost Effective

»Since mutual funds have a number of investors, the fund‟s 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.

Well Regulated

»Mutual funds in India are regulated and monitored by the Securities and Exchange Board of India (SEBI), which strives to protect the

interests 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 the scheme and the proportion of investment in each asset class.

Risk associated with Mutual Funds

»Mutual funds invest in different securities which

may be equities or bonds, depending upon the

fund‟s objectives. Accordingly, different schemes

have different risks depending on the portfolio composition. In general, mutual funds are subject

to the following risks

Systemic risks

Systemic risks or market risks refer to risks that

affect the entire market and have an impact on

the entire class of assets.

»The value of an investment may decline over a period 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 political

events, etc.

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 of a mutual fund include the skill and experience of the fund manager and the research team, the size of the corpus, redemption pressures, etc.

TYPES OF MUTUAL FUNDS SCHEMES IN INDIA

Types of Mutual Fund Schemes

Mutual funds are classified on the basis of

their »STRUCTURE »INVESTMENT OBJECTIVE »NATURE

BY STRUCTURE

OPEN-ENDED SCHEMES

»An 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.

CLOSE-ENDED SCHEMES

»These schemes have a pre-specified maturity period.

»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 of the scheme on the stock exchanges where they

are listed.

»The market price at the stock exchanges could

vary 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 at the schemes NAV; however one cannot buy units and can only sell units during the liquidity window.

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

INTERVAL SCHEMES

»Interval Schemes are that scheme, which combines 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 at

NAV related prices.

BY NATURE

Equity fund:

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

vary different for different schemes and the fund

manager‟s outlook on different stocks. The Equity

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

»Diversified Equity Funds »Mid-Cap Funds »Sector Specific Funds »Tax Savings Funds (ELSS)

»Equity investments are meant for a longer time

horizon, thus Equity funds rank high on the risk-

return matrix.

Debt funds:

»The objective of these Funds is to invest in debt papers.

»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.

»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 into various debt instruments such as bonds, corporate debentures and Government securities.

»MIPs: Invests maximum of their total corpus in debt instruments 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 debt schemes.

»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

corporate debentures.

»Liquid Funds: Also known as Money Market Schemes, 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 for

an investment horizon of 1day to 3 months.

» These schemes rank low on risk-return matrix and are considered to be the safest amongst all

» Balanced funds:

»As the name suggest they, are a mix of both equity and debt funds.

» They invest in both equities and fixed income securities, 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.

By investment objective:

»Growth Schemes : Growth Schemes are also

known 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.

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

certificates of deposit, commercial paper and inter-bank call money.

Other schemes

»Tax Saving Schemes »Index Schemes »Sector Specific Schemes »Exchange traded funds »Fixed Maturity Plans

» 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 applicable

for deduction u/s 88 of the Income Tax Act, 1961.

Index schemes

» Such funds strive to mirror the performance of specific market 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.

» 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 basket of 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).

Tax implications of investing in mutual funds

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.

»In the case of “money market mutual funds” and “liquid mutual funds” (as defined under

SEBI regulations), the income distribution tax is 25% across all categories of investors

Capital Gains

»Long-term capital gains arising on the transfer 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 units

should 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

proceeds of the fund.

SHORT TERM CAPITAL GAIN

» Short-term capital gains arising on such transactions are 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-term capital 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

 

Equity

Liquid

Debt

 

Taxation

oriented

funds/Money

fund/liquid

Funds

Market Funds

plus Funds

Short Term Capital Gain Tax

15%

As per Income Tax Slab

As per Income Tax Slab

 

Less of 10%

Less of 10%

Long Term

without

without

Capital Gain Tax

Nil

indexation or 20% with indexation

indexation or 20% with indexation

Dividend

     

Distribution

Nil

25%*

12.5%

Individuals/HUF

Tax

20.0%*

Any other

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 )

»A taxable „capital loss‟ (i.e., a transaction on

which 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 the

result 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

»Tax issues concerning Unit holders

I. Equity Oriented Funds - Tax Treatment of Investments A. Tax on income in respect of units

As 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.

»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 fund

where 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.

»C. TDS on income of units : As per the provisions 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

»D. Tax on capital gains i) 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 five

percent 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.

»ii) Short term capital gains Units 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 of

an 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.

» 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 to

the condition that such income from taxable securities transactions is

included in the income computed under the head “Profits and Gains

of business or profession”.

»Different types of Mutual Funds attract different types of taxes.

Here is all you would want to know

about taxes applicable on Mutual Funds in India.

» 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.

EXCHANGE TRADED FUNDS (ETF‟S)

»A security that tracks an index, a commodity 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.

»Exchange Traded Funds (ETFs) represent a

basket 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 over stock exchange, there is minimal interaction between investors and the fund house.

»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.

Difference Between ETF and Conventional Mutual Funds

»Mutual funds are traded through fund house where 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 during market hours like a stock.

»As a result, ETF investors have the benefit of real time pricing and they can take advantage of intra-

day volatility

»Annual expenses charged to investors in an ETF are considerably less than the vast majority of

mutual funds.

» Most of the mutual funds have an entry or exit load varying between 2.00% and 2.25%. ETFs do not

have any such loads. Instead ETF investors have to pay a brokerage to the broker while transacting. which in most cases is not more than 0.5%.

»ETFs safeguard the interests of long-term investors. This is because ETFs are traded on

exchange and fund managers do have to keep cash in hand in order to meet redemption pressures

What Are ETFs?: Creation Process

Investor
Investor
Cash ETF Brokerage account
Cash
ETF
Brokerage
account

ETF Authorized Participants

Cash

What Are ETFs?: Creation Process Investor Cash ETF Brokerage account ETF Authorized Participants Cash Capital Markets
What Are ETFs?: Creation Process Investor Cash ETF Brokerage account ETF Authorized Participants Cash Capital Markets

Capital Markets

Shares

Creation Units

What Are ETFs?: Creation Process Investor Cash ETF Brokerage account ETF Authorized Participants Cash Capital Markets

Securities

Basket of Securities

ETF Fund Advisor

FIXED MATURITY PLANS

»FMPs, as they are popularly known, are the

equivalent 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 of

a mutual fund.

»The regulator does not allow fund companies to guarantee returns, and hence the 'indicated

returns' in FMPs.

»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 'indicative

returns' 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.

»They are closed-ended in nature, which means

that 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 high

net-worth individuals. Nevertheless, the minimum investment is usually Rs 5,000 and so a retail investor can comfortably invest too

»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 fund manager 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 FMP.

»The expense ratio is mentioned in the offer document. 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 tenure and 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.

»The actual return can vary slightly, if at all, from the 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 deposits of similar tenure.

» FMPs are classified under the debt scheme category and enjoy certain tax benefits, such as:

»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.

»Short-term capital gains are added to the income

of 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/her slab.

»The results of all these are quite dramatic.

»Let‟s take an example of a 90-day FD yielding 8 per cent, compared with an FMP yielding 8 per cent for an individual investor in the highest tax bracket.

 

BANK FD

FMP-

FMP - growth

dividend

option

option

Net yield

8%

8%

8%

Tax

30.90%

-

30.90%

DDT

-

12.88%

 

Net yield

5.53%

6.97%

5.53%

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?

»The finance minister has been generous enough

to 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 of

investment.

How does this pan out?

»Take an example of a 30-month FMP

which, if launched in Jan 2007, will mature

in June 2009.

» It will pass through three financial years - launch in 2006-2007 and maturing in 2008-

2009.

»Thus, it can have a benefit of triple-cost indexation for the purpose of calculating post-tax yield.

»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 cent and if you do not opt for the indexed cost, then the tax is 10.3 per cent.

Cost of inflation Index

FINANCIAL YEAR

COST INFLATION INDEX

2003-2004

463

2004-2005

480

2005-2006

497

2006-2007

519

2007-2008

551

   

Indexed Purchase Price = Purchase Price

2008-2009

592

2009-2010

632

purchase)

2010-2011

711

2011-12

785

* (CPI for

current year / CPI for year of

Amount of Investment (Rs.)

Post Expenses Yield (p.a)* Tenor (in months) Approx Maturity Amt

Gain

Indexed Cost

Indexed Gain Tax Rate Tax

Post Tax Gain

Approx

Post

Tax

Annualised Return

Bank

Fixed

Deposit

30 Month FMP

   

Without

With Indexation

Indexation

10000

10000

10000

8.30%

8.30%

8.30%

30

30

30

12,075

12,075

12,075

 

2075

2075

2075

NA

11,406

NIL

NA

669

NA

30.9%

20.6%

10.3%

 

641

138

214

1434

1937

1861

5.74%

7.75%

7.44%

BONDS

TREASURY CURVE RATES

TREASURY CURVE RATES

»The yield curve is a description of a line that connects 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 overall movement 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.

»Investors generally seek higher rewards to

compensate for the risks involved with investing

money for longer periods of time.

Does the current shape indicate economic

slowdown?

»In December 2005, the yield curve inverted, for the first time since 2000. This inversion brought

an unsettling feeling to many economists and

banking analysts.

»The shape of the yield curve has historically been a reasonably accurate and useful indicator of

future economic activity

»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 1970

was preceded by a yield curve inversion.

»That statistic, however, conveniently leaves out the two recessions that occurred in the 1950‟s

and 1960‟s, which were not predicted by an

inverted curve.

»BACK UP SLIDES

Interbank Call Money Market

»A short-term money market, which allows for large 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 very short, usually lasting no longer than a week and are often used to help banks meet reserve requirements.

How is a Mutual Fund NAV Calculated?

To calculate a Mutual Fund's Net Asset Value or NAV, the value of the total assets of the mutual 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.

Mutual Fund NAV after Dividend Payout

A mutual fund pays out dividend to its investors

who 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 to

Rs8. The cash obtained by the investor can be reinvested to buy more shares of the mutual fund at lower value.

»Some investors who seek pure capital appreciation may opt for an aggressive growth

fund, without dividend payments. The returns then would be solely based on the mutual fund NAV appreciation.

FUND EXPENSES

»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 funds and 2.25 per cent for debt funds.

» The total expenses of the scheme excluding issue or redemption expenses, whether initially borne by the

mutual 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 net

assets 2.0% (iv) On the balance on the assets 1.75%

» 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.]

EXIT LOAD

»Exit Load varies for different schemes and is generally 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. Such

mutual funds are referred to as 'No Load Funds'.

»At present, my rate is 13.52% (12.5% dividend distribution 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).

» 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 on interest 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.

»So far as Dividend Distribution and Income Distribution 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.

Section 115R:

(i)

(ii)

(iii)

(iv)

Section 115R: (i) (ii) (iii) (iv) Particulars Existing rate Income distributed to an individual or HUF

Particulars

Existing rate

Section 115R: (i) (ii) (iii) (iv) Particulars Existing rate Income distributed to an individual or HUF

Income distributed to an

individual or HUF by a money

market Mutual Fund or Liquid Fund

25%

Section 115R: (i) (ii) (iii) (iv) Particulars Existing rate Income distributed to an individual or HUF

Income distributed to any other

person by a money market Mutual Fund or Liquid Fund

25%

Section 115R: (i) (ii) (iii) (iv) Particulars Existing rate Income distributed to an individual or HUF

Income distributed to an individual or HUF by a Debt Fund

12.5%

Section 115R: (i) (ii) (iii) (iv) Particulars Existing rate Income distributed to an individual or HUF

Income distributed to any other person by a Debt Fund

20%

New rate w.e.f. 1-6-2011

25%

30%

12.5%

30%

. The only restriction is that a long-term capital loss

will 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.

What Does Tax Arbitrage Mean?

»The practice of profiting from differences between the 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 most

advantageous way in order to pay the least amount of tax.

»Some forms of tax arbitrage are legal while others are illegal.

Securities Transaction Tax (STT)

»Securities Transaction Tax is a neat and efficient way of computing tax on profit incurred from the sale of securities, as it virtually nullifies the scope of tax avoidance.

» Securities Transaction Tax is applicable at different rates 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

Definition of Securities

»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 of

a like nature in or of any incorporated company or other body corporate;

»Derivative instruments (like forwards/futures/options on indices, stocks, commodities etc.)

»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 Financial Assets and Enforcement of Security Interest Act,

2002;

»Government securities;

»Such other instruments as declared by the Central Government; and Rights or interest in securities.