While scheme mergers (one mutual fund scheme merging into another) is good news for the Rs7 trillion Indian mutual fund industry, it may mean that investors of schemes that get merged may need to pay capital gains tax.
Tax on gains
When a scheme gets merged into another, the first scheme ceases to exist. In such a case, units of the first scheme are redeemed, but not returned to unitholders. They are then reinvested in the scheme in which the first scheme is to be merged.
Take the case of ICICI Prudential Equity Opportunities Fund (IPEO; one of the three equity schemes) that will merge into ICICI Prudential Dynamic Plan (IPD) on 13 May 2011. IPEO’s latest net asset value (NAV) is Rs12.58. Assume that its price from hereon will remain at the same level. Now, if investors would have purchased IPEO units on, say, 10 June 2010, they would have bought units at an NAV of Rs12.01; the scheme’s NAV on that day. In other words, Rs1 lakh invested on 10 June 2010 would become Rs1.04 lakh on 13 May 2011.
Here’s what will happen on that day: Rs1.04 lakh would then be transferred to IPD at the prevailing NAV. Assuming that IPD’s NAV will remain the same as it is today (Rs110.6072), Rs1.04 lakh would buy 947 units. But before this transfer happens, the investor would have made a gain in IPEO to the tune of Rs4,764 (Rs1,04,746.04 minus Rs1 lakh). Since IPEO units are redeemed before the investor completes a year, it amounts to a short-term gain; the investor needs to pay a short-term capital gains tax of 15% (excluding cess).
What should you do?
Even though investors choose to go along with the merger and stay invested, it is still deemed as a withdrawal from one scheme (the one that will be merged) to another. In this case, the investor needs to mention his income in his tax returns and pay short-term capital gains tax, if it’s an equity fund. If your investment tenor in the merged scheme has already completed a year at the time of merger, you don’t need to pay tax as long-term capital gains in equity funds is nil. However, in case of debt schemes, the long-term capital gains are 10% without indexation or 20% with indexation.