Stamp duty on mutual funds to apply from 1 July: what it means for you

The stamp duty will be imposed at a rate of 0.005% on the purchase or switch-in amount. Apart from this, stamp duty will also be imposed on the transfer of mutual fund units such as transfers between demat accounts at 0.015%. Due to its design, the stamp duty is likely to have the most impact on short holding periods of 90 days or less.

The implementation of the stamp duty was initially slated for January but was postponed first to April and then to July. The stamp duty will apply to all kinds of mutual fund purchases, including lump sum, SIP, STP and dividend reinvestment.

For dividend reinvestment, it will be imposed on the dividend amount minus tax deducted at source (TDS). For purchase, it will be imposed on the purchase amount less any other charge such as a transaction charge, a note released by ICICI Prudential AMC explained.

For example, assume your purchase amount is ₹1 lakh and the transaction charge is ₹100 making the net purchase cost ₹1,00,100. The stamp duty will be imposed on ₹1 lakh and not on ₹1,00,100. At 0.005% it will come to ₹5.

As the stamp duty will be auto deducted by the registrar and transfer agent (RTA) of the mutual fund when you buy units, you don't have to pay it separately. You will get fewer units in the mutual fund due to the deduction. For example, instead of 100 units, you may end up with 99.998 units due to the stamp duty deduction.

Since the duty is imposed on purchase and not redemption, it is akin to an entry load, a note from B&K Securities pointed out. Entry loads on mutual funds were abolished by the Securities and Exchange Board of India (Sebi) in 2009.

“Investors with a short indicative time horizon of 30 days or less will get impacted more because stamp duty charge is being charged as a one-time charge," the ICICI Prudential AMC note added.

B&K Securities laid out an example of stamp duty impact in its research note. Assuming a return of 3.5% on liquid funds, the note showed the return falling to 3.24% for a seven-day holding period. However, for a 30-day holding period, the post stamp duty return comes to 3.44%. For a 90-day holding period it comes to 3.48%, mere two basis points lower than the pre-stamp duty return.

The impact is greater for overnight funds, which are held for very short periods of time. An illustration put out by B&K Securities assuming a 2.70% pre-stamp duty return on such funds saw it falling to 0.87% if the money is held for a single day. For a seven-day period, however, 2.70% fell to 2.44%. Overnight funds have an assets under management (AUM) of ₹86,664 crores while liquid funds have an AUM of ₹5.07 lakh crore as of 25 June, the note added.

Let us look at this impact with a more detailed example. If you invest ₹1 lakh in a debt fund and the annualized return is 5%, you will make ₹5,000 over the course of the year and ₹416 over one month (ignoring compounding to keep things simple). The stamp duty ( ₹5) looks big compared to the month’s return of ₹416. However if you hold the same fund for three months, you make ₹1,248. In this case the stamp duty ( ₹5 again) is a smaller share of the return. This impact gets smaller and smaller the longer you hold the fund.

Retail investors generally invest in liquid funds rather than overnight funds. "The stamp duty impact will be negligible for any holding period more than a month. So apart from your immediate monthly expenses, the case for mutual funds is not affected," said Amol Joshi, founder, Plan Rupee Investment Services.

Viral Bhatt, founder, Money Mantra concurred. However, he added that investors should not frequently churn their portfolios, since fresh purchases attract stamp duty each time. He also advised investors against choosing the dividend reinvestment option.

The Union Budget 2019 made dividends fully taxable at slab rate leading to deduction of Tax Deducted at Source (TDS) on dividend reinvestment on each dividend reinvested. The stamp duty becomes another reason why this option is unattractive, he added.