Mutual Funds

Budget and MFs

K. Venkatasubramanian | Updated on March 09, 2013

Steep increase in tax rates ondividends is disappointing news.— V.V. Krishnan

The Budget has an important set of measures in making mutual fund investments attractive. A significant reduction in securities transaction tax (STT) on equity mutual funds, expanding scope of investments in the case of provident funds and pension schemes are key announcements that would make investments more enticing for retail investors.

But the sore point is the increase in dividend distribution tax on all debt and liquid funds, which would hurt cash flows for investors looking for periodic payouts.

Making MFs attractive

The STT has been reduced to nil (from 0.1 per cent) while purchasing equity mutual funds. In the case of sale of units, the proposed rate is 0.001 per cent (from 0.1 per cent). With entry loads also done away with, the cost of transaction at the time of investment gets reduced substantially for all genres of investors. To peg a number to such cost savings, for an investor who makes a purchase and sale of equity mutual fund units totalling Rs 1 lakh, there is a potential saving of Rs 250.

The other very important announcement is the widening of the mandate in investments for pension funds and PF trusts to include debt mutual funds, exchange traded funds (ETFs) and asset-backed securities.

Currently, pension funds such as the NPS are allowed to invest only in the Sensex and Nifty index funds and largely Government securities. They would now be able to benefit from newer investment avenues by investing in the broader market through ETFs tracking indices such as the CNX 500 or BSE 500. ETFs also tend to have very low tracking errors and lower costs compared with pure index funds.

Investment in debt mutual funds and asset-backed securities may help these pension funds and PF trusts to generate returns that are marginally higher than or at least equal to inflation rates even on a post-tax basis. For example, in 2012, the best performing debt mutual funds could generate 12-14 per cent returns. So those in the higher tax brackets too could find investments attractive.

Making dividends costlier

But the Budget was not without irritants. The disappointing announcement for mutual fund investors is a steep increase in the tax rates on dividends distributed by fund houses. The rate has been doubled from 12.5 per cent to 25 per cent for all (non-equity) schemes that declare a dividend.

Currently dividends from only liquid funds are charged 25 per cent. Now, all debt funds such as gilt, dynamic bond funds and monthly income plans have to pay 25 per cent. This tax is, of course, charged in the hands of the fund house which deducts the amount and pays the rest as dividends.

Investors who are in lower tax bracket and who do not require steady cash flows in the form of dividends, especially from MIPs, can opt for the growth option instead of the dividend choice.

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Published on March 02, 2013

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