Tax planning and months of February and March

Sanjana and Sanjay were out on a stroll early wintry Thursday morning of February in Mumbai, which generally is a rarity for this city.

“What a pleasant weather today is!” Sanjana noticed and asked, “Let’s go outdoors during the weekend and enjoy the nature. What say, Sanjay?

“It’s a good idea and weather is also perfect for a day’s outing. But I have some important personal work to do and shall not be able to join you.” Sanjay replied.

“Oh! You and your so called important personal work!” Sanjana exclaimed, “You always have your excuses ready for everything!”

“No Sanjana”, Sanjay replied in a bit serious mood, “it’s already February and I need to do my tax related investments and planning for the year.  I need to submit the documents to my employer in next few days.

“I don't get any time to do this during weekdays and need to complete it during the coming weekend.  We shall plan for outing some other day, Sanjana.”

“You are not yet through with your tax related investments, Sanjay?” Sanjana quizzed, “I never expected you to be lazy in such matters.”

Irked by Sanjana’s question, Sanjay responded “Now where laziness comes in this? Last quarter of the year is meant for tax related investments and planning and I am bang on time.  Only issue is it is not possible for me to do it during weekdays and hence I am doing it during my off time.”

“That’s the problem with all you guys.” visibly upset Sanjana said, “You start your tax planning activities in the month of February or worst in March.  You wait till the end of the year and then start lamenting about it!”

Clueless Sanjay questioned, “Can you please elaborate on this?”

“I don’t want to ruin your pleasant Thursday morning.” Sanjana replied, “But still it is important for you and all others who start their tax related activities late to understand.

“Tax planning should not get started during the end of the year, but should be carried out right at the outset of the year.  By this what I mean is it should be carried out in the months of April or May.”

Still not convinced, Sanjay ask her to explain this further.

“Listen, whatever activities you are planning to do right now - like investments in PPF or tax savings mutual funds, insurance premium, etc - can take place anytime.

“Infact I do all these things in the month of April itself so I need not worry about my tax investments in the month of February or March.   Now all I need to do is take a print out and submit the proof to my employer.  That’s all!”

“That’s all?” Sanjay said, “How is this possible?  If there is a way to do all this earlier during the year, I am all ears.  Tell me how I can do that.”

“It’s simple.” Sanjana started explaining, “All you need to do is plan and start early.  Let’s say you are planning to invest Rs. 1 lac in PPF during the year.  All you need to do is give your bank standing instructions to transfer Rs. 10,000 p.m. from your savings account to your PPF account.  Similarly for mutual fund investment, you can start a SIP and invest during the year in ELSS scheme.  You can structure all your investments in a similar fashion.”

“This is interesting and very much practical.  I never thought about it in this way.” said Sanjay.

“As regards home loan and interest deductions, EMI on home loan is paid monthly so you need not do anything about it.  Same applies in case you pay rent periodically to your landlord.  You can also plan purchasing your insurance policies such that the premium is due early during the year so that is also taken care of.  Have I missed out anything?” asked Sanjana.

“You have covered almost everything.  For things like medical bills, etc. these gets accumulated during the year as and when the expense incurs.  All I need to do is keep record of these things and bingo I am free for you during the weekend for outing!” exclaimed Sanjay.

“Yes” said pleased Sanjana, “This is not only the most effective way, but also helps you to plan your investments quite early during the year.  This time I absolve you from the outing but next year I don’t want you to blubber about the same thing again!” winked Sanjana.

How are you planning your tax investments?  Do share your experiences and thoughts with other readers in the comment section.

Debt Mutual Funds and Tax Implications – Recent changes in tax rates

Earlier Bachhat had written about how one can use ultra-short term debt funds to maximize post tax returns.  The article spoke about investing in dividend reinvestment plan of such funds, since dividend are effectively taxed at lower rate than short term capital gain rates and hence such funds are tax effective.

The tax rates on debt mutual funds were revised earlier during this year and hence the said article is not relevant in the current scenario.  Based on the revised tax rates, we have tried to analyse and tabulate which type of option (growth or dividend) should be chosen for investment in debt mutual funds.

Revised tax rates on debt fund

For an individual investor, short term capital gains in a debt mutual fund is taxable at tax slab under which such individual falls.  Long term capital gains are taxable @ 20% with indexation benefit and 10% without indexation benefit.  Surcharge @ 10% for taxable income of more than Rs. 1 crore and cess @ 4% shall apply additionally.

For dividend distributed, dividend distribution tax is applicable.  Earlier there was difference in dividend distribution tax rates between liquid / money market funds and other debt funds.  Now this difference has been eliminated and now dividend distribution tax on all debt funds shall be 25% (effective tax rate of 28.325% including surcharge and cess).

Growth or Dividend Option

One can maximize his returns from debt funds by choosing the correct option which has least tax implication.  Things to be considered before choosing a plan are:

1. Time period for investment
2. Tax bracket under which an individual falls
3. Need for regular income

Based on the above three criteria, the best option to choose from is as below:

When regular income is required

Since dividend distribution tax rate (28.325%) is higher than the effective tax rate for investors falling under 10% or 20% tax slab, it is beneficial for them to opt for growth option in case they are looking for investment horizon of less than 1 year and choose systematic withdrawal plan wherein a fixed amount shall be redeemed and paid to the investor at periodic interval.  SWP shall provide source of regular income to them.  However before opting for SWP under growth option, one needs to check out for exit load and commence SWP only after the exit load period. 

For individuals falling under 30% tax slab and in need of regular income, the tax benefit between dividend and growth option is minimal with dividend option slightly beneficial than the growth option.

For investment horizon of more than 1 year, it is beneficial for all investors looking for regular income to choose systematic withdrawal plan under the growth option.

When regular income is not required

For investors not looking for regular income, growth option is best irrespective of investment horizon.  However, there can be marginal tax benefit for investors falling under 30% tax slab by choosing dividend reinvestment option for investment horizon of less than 1 year.

Bachhat’s take

By increasing the dividend distribution tax rate, the tax advantage of dividend option which was available till late year has been eliminated, save for investors falling under 30% tax slab.  If an investor decides to invest in a debt mutual fund, he needs to take into consideration above aspects to increase his post-tax returns.  However one needs to keep in mind that the above analysis is relevant only till the tax rates are kept constant.  In case of any revision in tax rates (which may happen at the earliest in 2014 budget), the above may not hold true. 

Mutual Fund Tax Ready Reckoner for year 2013-2014

Continuing the initiative taken last year to provide a one stop solutions for tax implications on mutual fund investments, Bachhat has updated its mutual fund tax ready reckoner for the year 2013-2014.  

As you all are aware, mutual fund investors need to take into account plethora of tax rates to understand post tax returns.  Bachhat's mutual fund tax ready reckoner is an attempt to simplify and help mutual fund investors to determine the tax impact on their mutual fund investments.

You can view the ready reckoner by clicking on this link.  The link also provide rates for the last financial year (i.e. 2012-2013).

Whether labeling makes it easier to invest in mutual funds?

Continuing with various regulatory changes in mutual fund space, SEBI earlier during this week mandated mutual funds to label their offerings.  The purpose of labeling is to address the issue of mis-selling by enabling investors an easy understanding of the kind of mutual fund scheme they are investing in and its suitability to them.

Changes suggested

With effect from 1^st July 2013, all mutual fund companies shall label their schemes on the following parameters:

1.  Nature of scheme: whether the scheme is to create wealth or to provide regular income and its time horizon - whether short, medium or long term.

2.  Investment objective: All schemes shall describe its objective in a single sentence along with whether it is an equity, debt or hybrid product.

3.  Riskiness of investments: which shall categorized the risk attached to return of principal amount.  To achieve this, SEBI has suggested colour codes as below:

·       Blue             – Principal at low risk

·       Yellow         – Principal at medium risk

·       Brown          – Principal at high risk

4.  Further all schemes shall have a disclaimer that if the investors are not clear about the suitability of the products, they should consult their financial advisers.

All key documents (such is Key Information Memorandum, Scheme Information Documents, etc) as well as scheme advertisements should prominently disclosed the above labels.

For example, Fixed Maturity Plan shall come with the below mentioned labeling.

Whether it actually simplifies the investment process for investors?

Though the intention of SEBI is good, one needs to see whether this simplifies the investment process for the investors.  It is difficult to categorize the investments based on risk.  One single rule cannot be applied everywhere. 

Are all debt schemes low risk investments?  For eg:  FMPs, in general, may have low risk of principal amount getting reduced but it depends on the kind of company the mutual fund scheme has invested in.  If the investment is in low quality / rated company, the actual risk coding should not be blue but yellow or may be brown in case of investment in junk papers. 

Nevertheless, this is a good attempt by SEBI to simplify mutual fund investing for investors.  These labels can be used as an initial screener to short list the schemes one wants to invest in, followed by more scheme specific evaluation.

What do you feel about the labeling of mutual funds?  Will this simplify your mutual fund selection process?  Do share your comments with us.

Ultra short term debt funds - Pepping up your post tax returns

Sanjay was busy on the phone since last five minutes.  Sanjana sat across the table at a neighbourhood coffee day shop where both of them agreed to meet in the evening.  Finally, when Sanjay disconnected his phone, Sanjana asked him whom he was speaking for so long? 

Sanjay saw the curious eyes of Sanjana and offering a smile said, “My relationship manager from XYZ Bank.  She was offering me advice on managing my money.”

“Oh good.  So now you are a special customer of your bank and have a dedicated relationship manager?” quizzed Sanjana.

“Yeah.  I became their special customer since I started maintaining an average balance of Rs. 2,00,000 in my savings bank account and fixed deposits.  And I shall continue to be, till the time the average balance is maintained.” answered visibly delighted Sanjay.

“So to have a privilege of relationship manager, you maintain a balance of Rs. 2,00,000 in your bank account!! You are happy to forgo the return on your money for this privilege?” questioned Sanjana.

Sanjay was quick to reply, “No, who says I am not earning return.  My savings account gives me 4% and bulk of the money is in fixed deposits, which earns me anywhere between 7% to 10% per annum.  You see my money has been effectively employed for providing returns plus special customer benefits.”

“The returns you are mentioning are absolute returns.  Have you ever thought about post tax returns?  If I am not wrong you are in 20% tax rate bracket, right?” to which Sanjay nodded.  Sanjana continued, “Even if I consider the fixed deposit giving you 10% per annum return, 20% tax would leave you with post tax return of 8%!!”

A visibly annoyed Sanjay said, “Well that’s the best return I can get for liquidity and low risk.  You only told me other day that one needs to compromise the return if he is not willing to take risk and wants liquidity.”

“That’s true” said Sanjana pleased by the fact that Sanjay still remembers what she had told him few months back when they had discussion on the risk and return trade off. “Savings accounts / fixed deposits are the best place for high liquidity and minimal risk returns.    However, why to maintain a huge balance in your savings account when there are other low risk, high liquidity alternatives available providing better returns?”

Confused Sanjay said, “I do not understand what you are saying.  Can you please elaborate?”

“Sure” Sanjana replied, “See, I am not against maintaining adequate money in savings / fixed deposits.  This is required for any unforeseen immediate requirements.  However, one can pep up the returns by investing excess portion of the money lying in savings account in debt funds which provides liquidity along with low risk and high returns.”

Suspecting no response from Sanjay, Sanjana continued. “I am referring to ultra short term debt funds offered by mutual fund companies.  These funds provide tax-efficient returns with liquidity and low risk.  I agree that these funds are not as safe as fixed deposits, but given the low maturity profile of these funds the risk of losing money is minimal.”

“Tell me more about them and especially tax-efficient returns that you mentioned” stated Sanjay eager to learn from her friend.

“These funds, earlier known as liquid plus funds, invest in short term debt papers which have maturity of more than 90 days but less than 1 year.  Barring few, they do not have any entry or exit loads and one can redeem it any time with proceeds credited to bank account by next day or at the max, day after depending on the timing of your redemption.”

“Since these funds invest in debt instruments and commercial papers of corporates, their returns are attractive even after deducting fund management expenses.  In last 12 months, good ultra short term funds managed to provide returns anywhere in excess of 10% to 9%.  However, the most important factor which tilts the pendulum in their favour is their tax treatment.

“Though any gains arising out of such investments are treated as capital gains and taxed at applicable short term or long term capital gains rate, many of these funds provides dividend option and facility to reinvest dividends.  The interesting thing is dividends are taxed at lower rates and thus it boosts post tax returns.

“Let me give you an example.  If you invest in such funds with daily dividend reinvestment option, any increase in NAV during the day is declared as dividend by the fund and gets reinvested after paying dividend distribution tax at 12.5% plus surcharge and education cess.  Since dividend is tax free, it is not taxed in the hands of investor.  Since all the gain is declared as dividend, NAV of the funds remains unchanged and there are no / insignificant capital gains tax at the time of redemption of units.” 

  

Trying to put things together, Sanjay said, “So you mean to say there is only dividend income on which fund pays the tax @ 12.5% and dividend is tax free for me.  Since this tax rate is less than the tax @ 20% which I pay on interest income from fixed deposits, even if the fund earns 10%, my post tax returns are better than post tax returns on fixed deposits.  And if one falls in highest tax slab of 30%, it is more beneficial, right?”

Also see – Mutual Fund Tax Reckoner

“Absolutely,” said a happy Sanjana realizing how easy it is to explain to Sanjay, "Tax benefit varies according to one's tax slab.  For persons paying 30% tax, the benefit is the highest."

“But if they are tax efficient, why just ultra short term debt funds which invests in debt papers with maturity of more than 90 days.  I can also invest in funds which invest in debt papers with maturity of less than 90 days.  I am sure there must be such funds in the market.” It was now Sanjay’s turn to question Sanjana.

“Correct.  There are funds which invest in debt papers with maturity of less than 90 days – those are call liquid funds.  However, they are not tax efficient, since dividend distribution tax on dividend distributed is 25% plus surcharge and education cess.  Thus on post tax return basis, they are at disadvantage as against ultra short term debt funds.”, Sanjana clarified.

“Okay.  I understood.  Ultra short term debt funds provide high post tax returns if one opts for dividend reinvestment option and they are liquid investments, but slightly riskier than bank fixed deposits.  However one can pep up their returns by investing surplus funds in them.”

“Bingo.”  Sanjana nodded, as Sanjay’s mobile rang again. 

Disconnecting the call,  Sanjay smiled and said, ‘Who now needs a relationship manager if one has such a good friend providing free financial advice!!’ sipping his cappuccino crowned with choclate sauce.

Have you ever invested in Ultra Short Term Debt funds?  Share your views on them with us.

Mutual Fund Tax Reckoner

Subsequent to yesterday's blog post on tax impact of mutual fund investments in the hands of individuals, Bachhat has created a separate page on its website to provide complete overview of tax implications on mutual fund investments for all categories of investors.  The page provides tax implications for financial year 2012-13 and shall be updated each year.

The reckoner is shared below for reference.

Mutual Fund Tax Reckoner FY 2012-13



For full screen view of above tax reckoner, click here.


Do let us know your views and suggestions on the above reckoner.

Mutual Fund Investors: Know taxes impacting your returns

Mutual fund investors need to take in to account plethora of tax rates to understand the post tax returns.  In addition to separate rates for short term and long term capital gains, the rates varies amongst equity, debt and liquid funds.  Then one needs to take in to account dividend distribution tax (DDT) on dividends received.  Again it varies based on whether dividend is from equity fund or debt fund or liquid fund.  Further one also needs to factor in securities transaction tax (STT) to calculate correct post tax returns.  For liquid and debt funds, the effective tax rate can have a significant bearing on the overall returns on the investment.    

To help you to guide through this maze of tax rates, Bachhat has tried to list down the applicable rates for resident individual investors, HUFs as well as non-resident individual investors for the financial year 2012-13.

Capital Gains Tax 

Capital gains tax arises when one redeems the mutual fund.  If mutual fund units are sold within one year from the date of its purchase, the gain is treated as short term in nature.  Otherwise it is considered as long term in nature.  

The tax rates on sale of mutual fund investments for resident individuals, HUFs and non-resident individuals are as under:

Nature of Capital Gains	Equity Funds*	Other Funds
Short Term	15.45% (15% + 3% education cess)	I.T. rate applicable for slab + 3% education cess
Long Term	no tax	20% with indexation (10% without indexation) + 3% education cess)
Securities Transaction Tax	0.25% of sale value	not applicable

*Equity funds are the funds where more than 65% of the scheme AUM is invested in equity securities of domestic companies.

Gains for non-resident individuals are subject to tax deduction at source (TDS) as follows:

Type of funds	TDS Rate
Equity Funds	15.45% for short term cap gains, NIL for long term cap gains
Other Funds	30.90% for short term cap gains and 20.6% for long term cap gains after providing for indexation benefit

Dividend Distribution Tax (DDT)

This is the tax paid by the mutual fund companies at the time of payment of dividend to investors.  Since the amount is paid from the corpus of the fund, it leads to reduction in net asset value of the fund.  The DDT rate for resident individuals ,  HUFs and non-resident individuals is the same.

Type of Mutual Funds	DDT Rate
Equity Funds	no tax
Liquid Funds / Money Market Mutual Funds	25% + 5% surcharge + 3% education cess (effective tax rate of 27.0375%)
Any other mutual funds	12.5% + 5% surcharge + 3% education cess (effective tax rate of 13.51875%)

One need to take in to account the above tax impact while deciding on mutual fund investments and comparing it with other investment alternatives.

Bachhat has tried to cover all applicable tax implications for retail investors in mutual funds.  In case anything is missed out, do let me know via comments section so that the same can be incorporated.

Tracking your mutual fund investments

Source: kenteegardin, Flickr

I get many requests from friends and colleagues about how to track mutual fund investments carried out in the past and lost track of since then.  In some cases, they do not even know which mutual fund scheme they have invested in.

An investor can have investment in numerous mutual fund schemes of several mutual fund companies over a period of time.  Though one receives transaction statements and annual statements via email / post from such mutual fund companies regularly, these statements are fund specific.  In order to analysis all mutual fund investments, one needs to consolidate all such statements received.  Thus it becomes difficult to keep track of all the investments made with various mutual fund companies, their current status and calculate profit or loss on the same.

Mailback Services

Here the mailback services offered by CAMS and Karvy come handy.  These two transaction processing companies provides gamut of mailback services to enable investors to keep track of mutual fund investments.  The good thing about these services is it requires only an email id which is registered with mutual fund company.  By specifying the registered email id, one can obtain transaction details of all mutual fund schemes linked to the registered email id.  One can also track investment through PAN Number or Folio Numbers.

Services provided by CAMS:

1. Consolidated ActiveStatement / Account Statement:  By providing the registered email id, one receives the details of all the transactions link to that email id.  Consolidated ActiveStatement is interactive wherein one can click and view the transactions carried out and check portfolio composition.  One can also redeem, purchase or do any other transaction from the Statement itself by clicking on the link provided.  Consolidated Account Statement is PDF file which list down all the transactions carried out over the specified period.

2. Consolidated Portfolio Statement: This provides portfolio details about the mutual funds managed by CAMS.  It gives the cost, market value and return details.

3. Consolidated Realised Gains Statement: In case one has sold any mutual fund investment, this statement provides the details about the profit made on such investments and also calculate the capital gains on such investments.

4. Consolidated Transaction Details:  Similar to Consolidated Account Statement, however here the statement is provided in excel format to carry out analysis / reporting.

5. Single Folio Account Statement:  In case one has not registered any email id, one can obtain folio statement by specifying the folio number.

Karvy also provides similar mailback services for mutual fund managed by them.

Click here for CAMS mailback services.

Click here for Karvy mailback services.

These services are extremely useful for a mutual fund investor and one can keep track of past as well as existing mutual fund investments through these services.

Have you used any of the above mailback services till date?  Do you find these services useful?  Share your comments on these services below.

End note:  Consolidated Account Statement gives listing of all mutual fund investments irrespective of whether it is managed by CAMS or Karvy.  However, all other reports are limited to mutual fund managed by these agencies.  For eg:  CAMS site shall provide report of only those mutual funds which are managed by CAMS.  Hence one need to check which agency covers the mutual fund one has invested in and obtain the report accordingly.  The listing of mutual funds managed by CAMS and Karvy is as follows:

CAMS managed mutual funds	Karvy managed mutual funds
AIG Mutual Fund	Axis Mutual Fund
Birla Sun Life Mutual Fund	Baroda Pioneer Mutual Fund
BNP Paribas Mutual Fund	Goldman Sachs Mutual Fund
DSB Blackrock Mutual Fund	Bharti Axa Mutual Fund
Fidelity Mutual Fund	Canara Robeco Mutual Fund
HDFC Mutual Fund	Daiwa Mutual Fund
HSBC Mutual Fund	Edelweiss Mutual Fund
ICICI Prudential Mutual Fund	Franklin Templeton Mutual Fund
IDBI Mutual Fund	JM Mutual Fund
IDFC Mutual Fund	LIC Nomura Mutual Fund
IIFL Mutual Fund	Mirae Assets Mutual Fund
ING Mutual Fund	Morgan Stanley Mutual Fund
JP Morgan Mutual Fund	Motilal Oswal Mutual Fund
Kotak Mutual Fund	Peerless Mutual Fund
L&T Mutual Fund	Pramerica Mutual Fund
SBI Mutual Fund	Principal Mutual Fund
Tata Mutual Fund	Quantum Mutual Fund
Union KBC Mutual Fund	Religare Mutual Fund
	Reliance Mutual Fund
	Sahara Mutual Fund
	Tata Mutual Fund
	Tarus Mutual Fund
	UTI Mutual Fund