mutual funds and their taxation

8/14/2019 Mutual Funds and Their Taxation

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MUTUAL FUNDS AND THEIR TAXATIONDr. Somesh Kr. Shukla, Reader,

Shobhit, Research Scholar,Department of Commerce,

University of Lucknow.

INTRODUCTION

A mutual fund is a diversified portfolio of stocks, bonds and other

securities. A mutual fund is a financial intermediary that pools savings and

surplus of the community and invest it in fairly large and well diversified

portfolios of sound investments according to the investment objectives of

the investor. The biggest selling point of these mutual funds is supposed to

be professional management and the easy investment procedure. The

objective is to maximise the return to the investor who participate in equity

indirectly through mutual funds.

INVESTORS

INCOME/DIVIDEND/ PROFESSIONAL APPRECIATION MANAGER (AM

STOCK MARKET

MUTUAL FUNDS OPERATIONS: FLOW CHART

ORIGIN AND DEVELOPMENT OF MUTUAL FUNDS

The concept of mutual fund originated in England and later found its

way to United States in 1924. The credit for visualisation and advent of the

concept of mutual funds in India goes to Unit Trust of India, which was set

up by an Act of parliament namely UTI Act (1963) in 1964.The public


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sector banks1 and financial institutions2 began to establish mutual funds in

1987 which were later regulated and registered under the Securities and

Exchange Board of India Act, 1992 or regulations thereunder. The private

sector and foreign institutions were allowed to set up mutual funds in 1993.

Today there are around 34 mutual funds with approximately 500 products

classified under a dozen generic heads. The total investible funds of the

industry grew from Rs. 24 crores in 1964 to more than Rs. 1, 20,000 crores

in 2002. Here an effort is being made to study the various tax aspects

relating to mutual funds in India.

TAX BENEFITS TO MUTUAL FUNDS

Mutual funds in India have a special feature as to Income Tax

provisions. Under section 10(23D) of Income Tax Act, 1961, a mutual fund

has been conferred total tax exemption from income tax on all its income

provided it is a recognised fund. Recognised mutual fund implies that the

fund should be registered under SEBI3 (Mutual Funds) Regulations, 1992

or regulations made thereunder. Mutual funds set up by a Public sector

bank, Public financial institutions or authorised by Reserve bank of India

and subject to the conditions specified by Central Government in this

behalf shall be exempt from Income tax. Income accruing to Asset

Management Company by way of dividends or by way of capital gain is

totally exempt. This is meant to provide a much higher yield to the mutual

funds to enable them to distribute a higher return to the investors.

According to Union Budget 2002-03, Mutual Funds are also relieved

of the tax liability as the incidence of tax is shifted on to the unit holders of

UTI and other mutual funds and thus sub-clause (ii) and (iii) of clause 33

of section 10 are omitted. This position has been reversed in the Union

Budget 2003-04. Now, the mutual funds are liable to pay the income

distribution tax.


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Incomes from investments are otherwise taxable but under income

tax act, mutual funds are treated as pass through entities since they invest

funds of public and earn income on their behalf. It implies that whether the

income is in form of dividends, interest, underwriting commission or

capital appreciation, the income of mutual fund is not taxable. The practice

world over is similar but full immunity is granted to the fund, only if a

specified amount is invested in equity shares to ensure that major income

is a post tax income. Further as per section 115A of the Income tax

Act,1961, it is added that the deductions under sections 80CCC to 80U are

not available against the income received in respect of units purchased in

foreign currency, of a mutual fund specified in section 10(23D) or of the

U.T.I. and tax is to be paid @20%

(1) Public sector banks means the state bank of India constituted under the statebank of India Act 1955, a subsidiary bank defined in the SBI (Subsidiary Bank) Act

1959, a corresponding acquisition and transfer of undertaking act 1970 or u/s 3 of the

banking companies acquisition and transfer of undertaking Act, 1980.(2) The expression public financial institution shall have the same meaning

assigned to it in section 2(1) (a), of the Companies Act, 1956.Some of the PublicFinancial Institutions are ICICI Ltd, IDBI, IFCI, LIC, and UTI.(3) The expression Securities and Exchange Board of India shall have the same

meaning assigned to it in section 2 (1) (a) of the Securities and Exchange Board of

India Act 1992.

TAX BENEFITS TO INVESTORS


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The income received by the investor of mutual funds is taxable in

their hands unless these are capital redemption. One of the reason for

mutual funds scheme being quoted at discount to NAV was the differential

in tax treatment to equity shares and mutual funds units, which made

investment in mutual funds less attractive than the equity. Before budget of

1994-95, units to claim benefits of capital gains u/s 48 were to be held for

more than 36 months but this budget removed this anomaly and put the

mutual funds units at par with equity shares. As a result an investor,

holding shares in a company directly or through mutual funds will now be

eligible to the benefits of capital gains tax at consessional rate. Investors

are likely to come flocking to Mutual funds to claim capital gains tax.

Similar concessions are available to Foreign Financial Institutions (FFIs)

for their investment in mutual funds i.e. low capital gains tax if units are

held for more than 12 months instead of more than 36 months.

Tax on income distributed by a Mutual Fund

According to section 115R, 115S, and 115Tof the Income Tax Act,

1961, the Mutual Fund shall pay tax @ 12.5% plus surcharge, if any on the

income distributed to its unitholders for the assessment year 2003-04 (for

A.Y.2004-05 @ 2.5%).However tax shall not be chargeable for any income

distributed to a unit holder of open ended equity oriented fund for a period

of one year commencing from 1.4.2003. It is hereby worth mentioning that

the mutual fund shall be liable to pay the amount of tax to the credit of the

central government within fourteen days from the date of distribution or

payment of income, whichever is earlier, to the unitholders, failing which

the mutual fund is liable to pay a simple interest of 1.25% every month for

the amount of tax it fails to pay. Further, MFs are not allowed any

deduction in respect of such income that has been charged to tax.


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Mutual funds have to furnish information to the prescribed income

tax authority on or before 15th September each year in a prescribed form

giving details as under

1. The amount of income distributed to the unitholders during the

previous year

2. The tax paid thereon

3. Such other relevant details as may be prescribed.

Payment on account of Repurchase of units by Mutual Funds or Unit

Trust of India (194F)

The person responsible for paying to any person any amount on

account of repurchase of units or termination of the scheme (referred to

in section 80CCB (2) of Income Tax Act as equity linked saving scheme

shall, at the time of payment thereof, deduct income tax thereon at the

rate of 20% plus surcharge @ 2 % of such tax. The rate of surcharge has

been raised to 5% for the financial year 2002-03.

These payments include:

Payment against investment made in units of any mutual funds

specified u/s 10(23D) of the Income Tax Act, 1961.

Payment against investment in units of UTI.

However, the aforesaid investments should have been made on or

before 31-03-1992 in accordance with ELSS as notified by the central

govt. obligation to deduct tax at source arises only with reference to

amount (investment) as referred to in section 80 CCB (1) of the Income

Tax Act, 1961 and not with reference to the capital appreciation

comprised in the payment.

Where any amount invested in respect of which deduction u/s 80

CCB is allowed is later returned to the assessee in whole or in part either

by way of repurchase of units or on termination of the plan in any


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previous year, the income so returned shall be treated as the income of

the assessee for that previous year and brought to tax. The difference

between repurchase price of the units and amount invested therein shall

be deemed as capital gains and charged to tax.

According to section 194F, person responsible for paying any person

any amount referred to in section 80CCC(2) shall, at the time of payment

thereof, deduct income tax thereon @20% plus surcharge. It means tax

shall be deducted on the principal amount at the time of repurchase of the

units and not on the whole amount paid at the time of repurchase of units.

It is further revived that u/s 196A, tax shall be deducted at source for any

income paid to a non resident not being a company, or to a foreign

company in respect of units of UTI and Mutual Funds at the rate of 20%.

The provisions relating to tax deduction at source under section 194F and

196A are effected from 1st June 2002.

Further, the tax benefits of section 88 of the Income Tax Act, 1961 is

available to investor as, individual and HUFs are entitled to rebate from

the amount of income tax on his total income which is chargeable for any

assessment year if sums are paid or deposited by assessee out of his

income chargeable to tax in respect of subscription not exceeding

Rs.10,000/- in units of any mutual fund notified under clause (23D) of

section 10 of the Income Tax Act,1961, or of Unit Trust of India and also

on the contribution to any pension fund set up by any mutual fund or Unit

Trust of India.

For assessment year 2003-04 ; Under clause v and va of section

80L individuals and HUFs are eligible to a deduction from dividend

income upto a maximum limit of Rs.12,000/-. The above clauses are

omitted w.e.f. A.Y. 2004-05.

TDS from income distribution


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Income distribution from mutual fund is not free from TDS

provisions. A mutual fund has to deduct TDS where the income

distribution exceeds Rs. 2,500 in a financial year. According to section

194 F. of Income Tax Act, 1961, for the financial year 2003-04, tax is to

be deducted at source in the case of a person other than a company when

the person is resident in India at the rate of 20% for payment on Account

of repurchase of units by mutual funds or unit trust of India (section 80

CCC).

CONCLUSION AND SUGGESTIONS

Mutual funds have received a boost, with dividends being made tax

free in the hands of investors, which on one hand would reduce

regulatory compliance and on the other, it would lead to a reduction in

tax implications for those in higher tax brackets, the cause being 12.5%

distribution tax payable by mutual funds is lower than the 30%, an

investor in highest tax bracket has to pay. Further equity funds and UTI -I

schemes have been exempt from paying the distribution tax which will

prove to be an incentive for investors taking the mutual funds route to

participate in the equity market.

Contrary to the international practice of segregating mutual fund

income into short term capital gains, current incomes and long term

capital gains, Indian funds do not split their incomes on this pattern.

Thus, irrespective of nature of income of mutual funds, income in hands

of investors are treated as dividends, it is known that tax rate for long

term capital gains is lower than tax on dividends (which varies as per the

tax slab of the investors). Some funds operating pure equity growth

schemes have been declaring annual dividends, which should be

distributed as capital appreciation, consequently put investors


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(presuming, they have exhausted dividend exemption limit u/s 80L) to

great disadvantage.

Thus it is desirable on part of SEBI to insist on mutual funds to

segregate their earnings into current income and capital gains instead of

the present practice of considering all types of income being the same.

Secondly, the amount distributed as dividend should also be splitted up

into current incomes and capital gains giving opportunities to investors to

avail all tax concessions.

Further, it is also advisable that there should be exemption from tax

on dividends as to avoid double taxation, steps should be taken to make

mutual fund an ideal investment vehicle as mutual funds promote growth,

along with capital appreciation which in turn helps in the development of

the economy.

REFERENCES:

Association of Mutual Funds in India yearbook-2000

Association of Mutual Funds in India Update Jan-Mar 2001 issue


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Mayya, H.R-2000 Few Thoughts on functioning of Mutual Funds,

Chartered Secretary 30(12) 1515

Shashikant, Dr. Uma- Invest India courses on Mutual Funds

Bansal, Lalit. K- Mutual Funds Management and Working 2000

Srivastava, R.M.-Essentials of Business Finance 2000

Machiraju,H.R.-Indian Financial System 2002

Bhole,L.M.-Financial Institutions & MarketsStructure, Growth and

Innovations 1999

Bhalla, V.K.- Management of Financial Services 2002

Thomas, Susan (Ed). Fund management in India 1999

Trivoli, George W. Personal Portfolio Management2000

REFERENCE MAGAZINES AND NEWSPAPERS:

Outlook money

Businessworld

Investment Monitor

The Economic Times

REFERENCE WEBSITES:

www.myiris.com

www.amfiindia.com

www.mutualfundsindia.com

www.indiainfoline.com

www.ici.org

and several other investment related websites of Mutual Funds and Asset

Management Companies (AMCs).
http://www.myiris.com/http://www.amfiindia.com/http://www.mutualfundsindia.com/http://www.indiainfoline.com/http://www.ici.org/http://www.myiris.com/http://www.amfiindia.com/http://www.mutualfundsindia.com/http://www.indiainfoline.com/http://www.ici.org/


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mutual funds and their taxation

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