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What to keep in mind when compiling income from MFs

What to keep in mind when compiling income from MFs
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First Published: Wed, Oct 19 2011. 09 05 PM IST

Shyamal Banerjee
Shyamal Banerjee
When one is compiling data regarding one’s income for the purposes of tax return, one normally looks at all the bank transactions to ensure that all investment income is captured for income-tax returns. This can, however, sometimes be misleading as very often there could be transactions in units that do not reflect in the bank account, such as a switch-in or switch-out of units from one scheme to another of the same mutual fund or a merger of two schemes of a mutual fund, whereby one gets units of another scheme in exchange for units of the scheme which were originally acquired. At times, there is a change from the dividend reinvestment plan to the dividend payout plan of the same scheme. Do such transactions give rise to taxable income in the form of capital gains? The answer to this depends upon whether there is a transfer and whether such transfer is of units of an equity-oriented scheme that has been subjected to securities transaction tax (STT).
From dividend reinvestment to dividend payout
In the case of changeover from the dividend reinvestment option of a particular scheme of a mutual fund to the dividend payout option of the same scheme of the mutual fund, or vice-versa, what is really happening is that instead of the dividend being reinvested in the future, it will be paid out to you, or instead of being paid out to you, will be reinvested in units. The type of units remains the same and it is only the manner of payout of the dividend reinvestment of the dividend which undergoes a change. Therefore, in such a situation, there is no transfer of the units of the mutual fund scheme held by you and, accordingly, there is no liability to capital gains tax.
From one scheme to another
Shyamal Banerjee
In the case of a switch in or switch out, such transaction takes place only on the basis of the instructions that you give to the mutual fund. Effectively, you are surrendering units of the scheme that you held and acquiring units of a new scheme for the same value. Therefore, you do not pay or receive any money, but the certain number of units held by you in one scheme, are substituted by a different quantity of the units of another scheme, the total value of the units of the old scheme at the time of surrender being the same as the cost of the new units. In such a case, there is clearly a transfer of units by you of the units of the scheme surrendered while acquiring the units of the other scheme. Normally such switch-in, switch-outs are subjected to STT. If such scheme is equity oriented and the units have been held by you for more than a year, the long-term capital gains arising on such transfer would be an exempt income, but would have to be disclosed as such. In case the units have been held for less than a year, the short-term capital gains arising on such switch in or switch out would be subject to tax at 15% (plus education cess). If, however, the units are not that of an equity-oriented scheme, the capital gains would be subject to tax at the lower of 10% of the capital gains computed without indexation of cost or 20% of the capital gains computed with indexation of cost, while short-term capital gains would be chargeable to tax at the normal slab rates of tax applicable to you.
From dividend to growth option
Would it make any difference if you are switching into the growth option of a scheme from the dividend option of the same scheme or vice-versa? Normally, the net asset values (NAVs) of the growth option and the dividend option are quite different, and there is invariably a change in the number of units that you are entitled to as against the number of units that you held earlier on account of such differential NAV. Such a switch-in and switch-out, therefore, amounts to a transfer, and is normally subjected to STT. Even in such cases, you would need to consider the capital gains while computing your income as above.
Merger of two schemes
What about merger of two schemes where you get units of a scheme other than that in which you had originally invested? Normally, in such a merger, you are given an option to exit or to get units of the other scheme. It is only when you do not exercise this option to redeem that you would get the units of the other scheme. Given that fact, there is a transfer of units on which STT is charged. Of course, at times such STT may be borne by the asset management company instead of being charged to you and deducted from your unit holding. Even then this does not change the fact that the transfer of units is subject to STT and, therefore, the tax treatment would be the same as discussed above even in the case of merger of two schemes of a mutual fund.
It is, therefore, essential for you to examine your mutual fund statements for the year and not just the bank statements while preparing your tax returns to ensure that you properly disclose all the capital gains arising on your mutual fund transactions, particularly those that do not show up in your bank statement.
Gautam Nayak is a chartered accountant.
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First Published: Wed, Oct 19 2011. 09 05 PM IST