Tax Implications of Dividend Income

Equity Schemes

Equity Schemes are schemes, which have less than 50 per cent investments in Equity shares of domestic companies.

As far as Equity Schemes are concerned no Distribution Tax is payable on dividend. In the hands of the investors, dividend is tax-free.

Other Schemes

For schemes other than equity, in the hands of the investors, dividend is tax-free. However, Distribution Tax on dividend @ 12.81 per cent to be paid by Mutual Funds.

Tax Implications of Capital Gains

The difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset is called capital gain. If the investor sells his units and earns capital gains he is liable to pay capital gains tax.

Capital gains are of two types: Short Term and Long Term Capital Gains.

Short Term Capital Gains

The holding period of the Mutual Fund units is less than or equal to 12 months from the date of allotment of units then short term capital gains is applicable.

On Short Term capital gains no Indexation benefit is applicable.

Tax and TDS Rate (excluding surcharge)

Resident Indians and Domestic Companies

The Gain will be added to the total income of the Investor and taxed at the marginal rate of tax. No TDS.

NRIs: 30 per cent TDS from the gain.

Long Term Capital Gains

The holding period of Mutual Fund units is more than 12 months from the date of allotment of units.

On Long Term capital gains Indexation benefit is applicable.

Tax and TDS Rate (excluding surcharge)

Resident Indians and Domestic Companies

The Gain will be taxed

A) at 20 per cent with indexation benefit or

B) B) at 10 per cent without indexation benefit, whichever is lower. No TDS.

NRIs: 20 per cent TDS from the Gain

Surcharge

Resident Indians : If the Gain exceeds Rs 8.5 lakhs, surcharge is payable by investors @ 10 per cent.

Domestic Companies: Payable by the investor @ 2.5 per cent.

NRIs: If the Gain from the Fund exceeds Rs 8.5 lakhs, surcharge is deducted at source @ 2.5 per cent.

Indexation

Indexation means that the purchase price is marked up by an inflation index resulting in lower capital gains and hence lower tax.

Inflation index for the year of transfer

Inflation index =      —————————————————-

Inflation index for the year of acquisition

Mutual fund is the best investment tool for the retail investor as it offers the twin benefits of good returns and safety as compared with other avenues such as bank deposits or stock investing. Having looked at the various types of mutual funds, one has to now go about selecting a fund suiting your requirements. Choose the wrong fund and you would have been better off keeping money in a bank fixed deposit.Keep in mind the points listed below and you could at least marginalise your investment risk.

Past performance

While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. Also check out the two-year and one-year returns for consistency. How did these funds perform in the bull and bear markets of the immediate past? Tracking the performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls in a bad market.

Know your fund manager

The success of a fund to a great extent depends on the fund manager. The same fund managers manage most successful funds. Ask before investing, has the fund manager or strategy changed recently? For instance, the portfolio manager who generated the fund’s successful performance may no longer be managing the fund.

Does it suit your risk profile?

Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry loses the marketmen’s fancy. If the investor is totally risk averse he can opt for pure debt schemes with little or no risk. Most prefer the balanced schemes which invest in the equity and debt markets. Growth and pure equity plans give greater returns than pure debt plans but their risk is higher.

Read the prospectus

The prospectus says a lot about the fund. A reading of the fund’s prospectus is a must to learn about its investment strategy and the risk that it will expose you to. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.

How will the fund affect the diversification of your portfolio?

When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.

What it costs you?

A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.

Finally, don’t pick a fund simply because it has shown a spurt in value in the current rally. Ferret out information of a fund for atleast three years. The one thing to remember while investing in equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right equity mutual fund will pay off big — if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.

Three key players namely sponsor, mutual funds trust and asset management company (AMC) are involved in setting up a mutual fund. They are assisted by other indepedent administrative entities like banks, registrars, transfer agents and custodians (depository participants).

1. Professional Management: An average investor lacks the knowledge of capital market operations and does not have large resources to reap the benefits of investment. Hence, he requires the help of an expert. It, is not only expensive to ‘hire the services’ of an expert but it is more difficult to identify a real expert.

are managed by professional managers who have the requisite skills and experience to analyse the performance and and prospects of companies. They make possible an organised investment strategy, which is hardly possible for an individual investor.

2. Portfolio diversification: An investor undertakes risk if he invests all his funds in a single scrip. Mutual funds invest in a number of companies across various industries and sectors. This diversificationreduces the riskiness of the investments.

3. Reduction in transaction costs: Compared to direct investing through the funds is relatively less expensive as the benefit of economies of scale is passed on to the investors.

4. Liquidity: Often, investors cannot sell the securities held easily, while in the case of mutual funds, they can easily encash their investment by selling their units to the fund if it is an open-ended scheme or selling them on a stock exchange  if is close-ended scheme.

5. Convenience: Investing in mutual fund reduces paperwork, aves time and makes investment easy.

6. Flexibility: Mutual Funds offer a  family of schemes, and investors have the option of transferring their holdings from one scheme to the other.

7. Tax benefits: Mutual Fund investors now enjoy income-tax benefits. Dividends received from mutual funds’ debt schemes are tax exempt to the overall limit of  Rs 9,000 allowed under section 80L of the Income Tax Act.

8. Transparency: Mutual funds transparently declare their portfolio every month. Thus an investor knows where his/her money is being deployed and in case they are not happy with the portfolio they can withdraw at a short notice.

9. Stability to the stock market: Mutual funds have a large amount of funds which provide them economies of scale by which they can absorb any losses in the stock market and continue investing in the stock market. In addition, mutual funds increase liquidity in the money and capital market.

10. Equity Research: Mutual Funds can afford information and data required for investments as they have large amount of funds amount of funds and equity research teams available with them.

According to the above definition,, a mutual fund in India can raise resources through sale of units to the public. It can be set up in the form of a Trust under Indian Trust Act. The definition has been further extended by allowing mutual funds to diversify their activities in the following areas.:

• Portfolio Management Services
• Management of offshore funds
• Providing advice to offshore funds
• Management of pension or provident funds
• Management of venture capital funds
• Management of money market funds
• Management of real estate funds

One can define a Mutual Fund as a trust that pools in the savings and funds from a large number of investors who have common financial goal. Mutual funds issue units to investors, which represent equitable rights in the assets of the mutual fund.

Mutual fund by its nature is diversified i.e. its assets are invested in many different securities.

Investments in the Mutual funds may be in the form of stocks, bonds or money market securities or combination of these.

These are professionally managed on behalf of the shareholders and each investors holds a pro-rata share of the portfolio entitled to any profits when the securities are sold, but subject to any losses as well.

There are number of schemes of Mutual Fund and all of them have different character and objective.

It is the skill of the investor to keep in view the objective and then take decision where to invest

For e.g. in the wake of boom in the software sector, the Indian Mutual Fund launched various sector specific schemes that entailed only to software stocks for that period.