Mutual fund

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Manan Shah (Querist)
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19 November 2011 Whether section 111a is attracted to Non Equity Oriented Mutual Fund? if not than kindly guide me in which section the same is covered??

CA. RENZ .V. RAJAN

CA. RENZ .V. RAJAN (Expert)
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19 November 2011 It’s important to note that under section 111A of the Income Tax Act, 1961, there is mention of only one type of mutual fund. i.e. “Equity Oriented Fund”.
It implies that from Income Tax angle mutual fund schemes can be categorized into-
(a) Equity oriented fund (Scheme)
(b) Non Equity oriented fund (Scheme)
“Equity Oriented Fund” is defined in explanation (b) OF CHAPTER XII-E, of Income Tax Act,1961.
“Equity Oriented Fund” is defined to mean:
Such funds where the investible funds are invested by way of equity shares in domestic companies to the extent of more then 65% of the total proceeds of such fund; and
Which has been setup under a scheme of mutual fund specified under section 10 (23D).
The percentage of equity shares holdings of such fund is required to be computed with reference to the annual average of the monthly averages of opening and closing figures.
TAX IMPLICATION ON INVESTORS
Investor can earn by investing in Mutual Funds in the one or more of the following ways :
Dividend
Short Term Capital Gains
Long Term Capital Gains
DIVIDEND INCOME:-
Any dividend received by investors of all kinds of schemes, is tax free in the hands of investors in accordance with provisions of Section 10(35)(a).
However, AMC deducts DDT in case of Non Equity oriented Schemes [S115R(2)]
TABLE OF DDT RATES
Income distributed to Effective tax rate (%) (Money Market Mutual Fund or a Liquid Fund) Effective tax rate (%)
(others)i.e, Debt Fund, Fund of Funds etc.Individuals and Hindu Undivided Families (‘HUFs’)28.325
(tax rate of 25% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)14.1625
(tax rate of 12.5% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)Persons other than individuals and HUFs28.325
(tax rate of 25% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)22.66
(tax rate of 20% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)
CAPITAL GAINS
If holdings period ? 12 months, then Short Term Capital Asset, Otherwise Long Term Capital Asset (Section 2(42A) in respect of all MF schemes.
Taxationof Short Term Capital Gain From MF Units

In case of individual/ HUFs being residents , where the Total Income, excluding Short Term Capital Gains, is below the maximum amount not chargeable to tax, then the difference between the current maximum amount not chargeable to tax, and total income excluding Short Term Capital Gains, shall be adjusted from capital gains. Therefore, only balance STCG will be liable to income tax at the rate of 15%.
In respect of short term capital gains arising to non resident individual unit holders, the Mutual Fund is required to deduct tax at source @15% +SC+EC, in case of Equity Funds and @ 33.99% (30% +SC+EC) in case of non equity schemes.
No tax needs to be withheld from capital gains arising to a FII (section 196D)
In respect of STCG arising to Foreign Companies (Other than FIIs and Overseas Financial Organisation but including OCBs), the fund is required to deduct tax at source @42.23% (40%+SC+EC)
LONG TERM CAPITAL GAINS
LTCG From Equity Schemes
Equity Oriented Scheme – NIL [S.10(38)]
However, companies are required to include such long term capital gains in computing the Book Profit and MAT liability under S.115JB
LTCG from Non Equity Oriented Schemes
i) Without Indexation -10%
ii) With Indexation – 20%
Further in case of Individuals/HUF, being residents, where the Total Income excluding LTCG is below the maximum amount not chargeable to tax, then the difference between the maximum amount not chargeable to tax and Total Income excluding LTCG, shall be adjusted from LTCG. Therefore, only the balance LTCG will be liable to be taxed @10% or 20% .
As per the provisions of Section 115AB of the Act, LTCG on transfer of units arising to specified overseas financial organizations, being companies, on transfer of units purchased by them in foreign currency shall be liable to tax @10.5575% (i.e. 10% +2.5%SC+EC). No indexation benefit is available to S.115AB entities.
If section 115AB entity is other than company, tax shall be chargeable at the effective tax rate of 11.33% (10%+SC10%+EC).
LTCG arising to FII (being company) shall be taxed @10.5575% (10%Tax +2.5%SC+3%EC)
LTCG arising to FII (non company)-11.33%
TDS PROVISIONS ON LONG TERM CAPITAL GAINS
Ø TDS rate is 22.66% (20% +10%SC+EC), in case of Non Resident Individual Unit holders.
ØIn case of FIIs and OCBs , TDS is mandatory.
DIVIDEND STRIPPING [S. 94(7)]
As per the provisions of section 94(7) of the Act, loss arising on transfer of units, which are acquired within a period of three months prior to the record date (date fixed by the fund for the purpose of entitlement of the unit holders to receive the income from units) and sold within a period of nine months after the record date, shall not be allowed to the extent of income distributed by the fund in respect of such units.
BONUS STRIPPING [S. 94(8)]
As per the provisions of S.94(8) of the Act, where any units (“original units”) are acquired within a period of three months prior to the record date (date fixed by the fund for the purpose of entitlement of the unitholder to receive bonus units) and any bonus units are allotted (free of cost) based on the holding of the original units, the loss, if any, on sale of the original units within a period of nine months after the record date, shall be ignored in the computation of the unitholders taxable income. Such loss will however be deemed to be the cost of acquisition of the bonus units.
TAX TREATMENT OF CAPITAL GAINS FROM SYSTEMATIC INVESTMENT PLANS (SIP)
Nature of capital gains arising to unitholder who has invested by way of SIP will depend upon the period of holding of units. There may be two situations-
i) Where SIP is closed and some / all units are redeemed ;
ii) Where SIP is not closed but some / all existing units are redeemed.
At the time of redemption it is impossible to understand as to which units are being redeemed. In this condition, for computing the capital gain chargeable to tax, the cost of acquisition and period of holding of units shall be determined on the basis of FIFO method.
TAX TREATMENT OF CAPITAL GAINS FROM SYSTEMATIC TRANSFER PLANS (STP)
STP denotes transfer of a certain amount on a certain date (i.e. weekly, monthly or quarterly) from one scheme of a MF to another scheme of the same MF. Generally transfer is from debt scheme to equity scheme of the same fund house, though it could be vice versa or from one equity scheme to another or one debt scheme to another. The complexity arises, when it is transfer from equity scheme to debt scheme or vice versa. Let’s understand the same through an example.
i) Initial investment in Debt Scheme Rs. 1,00,000/- (NAV Rs10)
ii) Mode of STP from Debt scheme to Equity Scheme Rs. 2,000/-P.M.
iii) NAV of debt scheme on the date of transfer to equity Scheme Rs. 10.30
iv) NAV of equity scheme on the date of transfer to equity scheme Rs. 25.00
v) NAV of equity scheme on the date of redemption Rs. 30.00

Thetaxability of Capital Gains from STP would depend upon :-
i) Holding period in debt fund;
ii) Holding period in equity fund;
iii) Difference between NAV of debt fund, between the date of investment and date of transfer to equity fund; and
iv) Difference between NAV of equity fund between the date of transfer from debt fund and redemption from equity fund
SHORT – TERM CAPITAL ASSET if,
T2 – T1 ? 12 months, STCG = 10.30 – 10.00=Rs0.30 per unit
T3 – T2 ? 12 months, STCG = 30.00 – 25.00=Rs5.00 per unit
LONG – TERM CAPITAL ASSET if,
*T2 – T1 > 12 months, LTCG = 10.30 – 10.00
T3 – T2 > 12 months, LTCG = 30.00 – 25.00
*Indexation benefits may be availed.
# FIFO method has to be applied.
SYSTEMATIC WITHDRAWAL PLANS (SWP)
SWP operates in two ways :-
i) A specified amount is given back to the investors at regular intervals by redeeming required no. of units. ; or
ii) The capital appreciation amount is given back to the investors by redeeming required no. of units.
In both the conditions the investor is paid back by redeeming a certain no. of units. The redemption may result into STCG/LTCG depending upon the holding period.
#FIFO method has to be applied.
IMPORTANT
i) Arbitrage funds are treated as equity fund.
ii) Fund of Funds (FOF) is treated as Non-Equity Fund.
iii) ETF will be treated as equity or non equity fund depending upon the underlying. If the underlying security is domestic equity it will be equity fund, otherwise non equity.

STT PROVISIONS

The Rates of STT are as under:-
i) Delivery based sale of equity fund on Stock Exchange 0.125% of value
ii) Delivery based purchase of equity fund on Stock Exchange 0.125% of value
iii) Non-delivery based trading of equity fund on Stock Exchange 0.025%
iv) Sale of units of equity fund back to Mutual Fund 0.25%