MUTUAL FUNDS : UNDERSTANDING CHARGES AND TAXES

MUTUAL FUNDS : UNDERSTANDING CHARGES AND TAXES

 

 

Your returns as an investor depend not only on the performance delivered by your chosen asset class but also by the taxes and expenses that you incur in the transaction. Two factors that an investor must consider before redeeming are exit loads and capital gains tax as per Income Tax Act, 1961.

 

1. Exit load: Exit Load is an amount charged by mutual fund schemes on redemption of investments before a specified period. It is charged as a percentage of the Net Asset Value (NAV) as on the date of redemption. Such exit load could range from 1% to even more. For example, let’s say a scheme charges an exit load of 1% on redemption of investment within one year. Suppose the NAV of the scheme is `100 on the date of your redemption, you will get only `99 on your units after application of exit load, if

redeemed within 1 year. Exit Load is imposed in order to discourage short term investing.

2. Taxation: All market related investment products are subject to capital gains tax owing to appreciation in their prices at the time of sale/redemption by an investor. Depending on the holding period, they are classified as long term or short term as depicted below. Long term capital gains typically enjoy lower tax than short term capital gains.

 

	SHORT TERM CAPITAL GAINS		LOND TERM CAPITAL GAINS
	PERIOD	TAX RATE	PERIOD	TAX RATE
Equity oriented mutual fund schemes	Up to 1 year	15%	More than 1 year	Nil
Other than equity oriented schemes or liquid schemes	Up to 3 years	Gains added to taxable income and taxed at applicable slab rate	More than 3 years	20% after providing indexation

 

Note: Surcharge at 12% to be levied in case of individual/ HUF unit holders where their income exceeds Rs 1 crore. Education Cess at 3% will continue to apply on tax plus surcharge. Illustration valid for domestic (resident) investor.

 

CUMULATIVE IMPACT OF EXIT LOAD & CAPITAL GAINS TAX ON RETURNS

 

(A) Equity Mutual Fund :

The following illustration shows how investors’ returns are impacted by exit load and capital gains tax. Let us take the example of Mr Niveshak who invests Rs.1 lakh in an equity mutual fund scheme. Eleven months later, let us say the investment value has increased to Rs 115,000. Mr Niveshak planned redeeming his investments considering the appreciation.

Unfortunately, returns from the Scheme reduced after calculating the impact post exit load (assuming exit load period of 1 year) and short term capital gains tax. Mr Niveshak’s investment return of 15% reduced to 11.71% owing to the impact of exit load and taxation. This loss can be minimised by holding investments for the long term and if such favourable market conditions persist. Had the investor held on to his investments for more than a year his returns would have been 15%. (Assuming no change in market condition).

 

ILLUSTRATION of Mr Niveshak’s investment gains

 

		EARLY EXIT	LONG TERM INVESTING
S.No	Category	1 year or Below	Above 1 year
A	Amount invested	1,00,000	1,00,000
B	Gross Return	15%	15%
C	Amount Before Exit Load	1,15,000	1,15,000
D	Exit Load Applicable	1%	Not Applicable
E	Amount Post Exit Load	1,13,850	1,15,000
F	STCG Rate	15.45%	Long Term – Nill
G	STCG	2,140	Not Applicable
H	Net Amount After Tax	1,11,710	1,15,000
I	Net Investment return	11.71%	15.00%

 tal gains Long term capital gains

FORMULAE : E = C x (100%-D), G = F x (E-A), H = E – G, I = (H-A)/A

 d Tax rate Period Tax rate

Short Term Capital Gains Tax rate is as per tax slab applicable for the financial year 2016. For illustrative purpose to explain the impact of exit load and capital gains tax and benefits of investing for long term. There is no assurance or guarantee of returns on investments in mutual funds. Investments in mutual funds are subject to market and various other risks and it is advisable to consult with financial advisor before investing. Securities Transaction tax has been ignored for the purpose of illustration. Illustration valid for domestic (resident) investor

Early Exit Long Term Investing

(B) Non-Equity Mutual Fund (Other than liquid schemes)

 

Let’s say Mr. Niveshak invests Rs.1 lakh in a debt mutual fund scheme. One year later, let us say the investment value has increased by 12% CAGR (Compounded annual growth rate). Mr Niveshak considered redeeming his investments owing to good returns from the Scheme. Unfortunately, returns from the Scheme reduced from 12% to 7.52% owing to the impact of exit load and taxation. This loss can be minimised by holding investments for the long term and if such favourable market conditions persist.

 

Now, if Mr Niveshak had held on to his investments for the long term (more than 3 years), he would not have incurred exit load (assuming exit load period of 15 month) and he would have paid lower capital gains tax post indexation. In addition, long term investing could be beneficial with an opportunity for increase in scheme NAV. Assuming investments held for just above 3 years and a CAGR of 12%, his Net investment return would be 11.46%.

 

ILLUSTRATION of Mr Niveshak’s investment gains

 

		EARLY EXIT	LONG TERM INVESTING
S.N	CATEGORY	SAY AFTER 12 MONTHS	SAY AFTER 3 YEARS
A	Amount Invested	1,00,000	1,00,000
	Gross return (CAGR 12%)	12.00%	40.49%
	Amount Before Exit Load	1,12,000	1,40,492
	Exit Load Applicable	1%	Not Applicable
	Amount Post Exit Load	1,10,880	1,40,492
	Tax Rate on Gains	30.90%	20% with Indexation*
	Tax Applicable	3,362	2,009
	Net Amount After Tax	1,07,518	1,38,483
	Net Return (CAGR	7.52%	11.46%

 

xit Long Term Investing

FORMULAE : E = C x (100%-D), G = F x (E-A), H = E – G, I = (H-A)/A

 

* Assuming investment in FY 11-12 and Redemption in FY 14-15

Cost Inflation Index = 785 for FY 11-12 and 1024 for FY 14-15

Indexed Cost of Capital = (1024/785)*100000 = Rs 130446

Tax on Gains = (140492-130446)*20% = Rs 2009

 

^Short Term Capital Gains Tax rate is as per tax slab applicable for the financial year 2016. This is assuming the investor falls in the highest tax slab. For illustrative purpose to explain the impact of exit load and capital gains tax and benefits of investing for long term. There is no assurance or guarantee of returns on investments in mutual funds. Investments in mutual funds are subject to market and various other risks and it is advisable to consult with financial advisor before investing. Illustration valid for domestic (resident) investor.

 

INVESTING FOR THE LONG TERM IS BENEFICIAL

Happy Investing