Grade: - 11

Chapter: 5 Taxation and Regulations

TAXATION AND REGULATIONS

1 Why is it important to study about taxation and its regulations while/before
investing in mutual funds?
An • Taxation in case of Mutual Funds must be understood, primarily, from Capital
s Gains, Securities Transaction Tax (SIT) and Dividend's point of view.
• Tax rules differ for equity and debt schemes and also for Individuals, NM's,
OCBs and corporates.
• Investors also get benefit under section 80C of the Income Tax Act if they invest
in a special type of equity scheme, namely, Equity Linked Savings Scheme.
• Investors in all other schemes have to pay capital gains tax, either short term or
long term.
• In case a scheme invests 100% in foreign equities, then such a scheme is not
considered to be an equity scheme from taxation angle and the investor has to
pay tax even on the long-term capital gains made from such a scheme.

2 How is equity scheme taxed?

An • As per SEBI Regulations, any scheme which has minimum 65% of its average weekly
s net assets invested in Indian equities, is an equity scheme.
• If the mutual fund units of an equity scheme are sold / redeemed / repurchased after
12 months, the profit is exempt.
• However, if units are sold before 12 months it results in short term capital gain. The
investor has to pay 15% as short-term capital gains tax.
• While exiting the scheme, the investor will have to bear a Securities Transaction Tax
(STT) @ 0.001% of the value of selling price.

3 What is Indexation benefit in taxation?

An Indexation is a procedure by which the investor can get benefit from the fact that
s inflation has eroded his returns.

4 What is Dividend Distribution Tax?

An  The dividend declared by mutual funds in respect of the various schemes is exempt
s from tax in the hands of investors.
 In case of debt mutual funds, the AMCs are required to pay Dividend Distribution
Tax (DDT) from the distributable income.
 This ensures ease in tax collection. However, in case of equity funds no DDT is
payable.

5 What are the rates for dividend distribution tax?

An • For individuals and HUF — 25% (plus surcharge and other cess as applicable)
s • For others— 30% (plus surcharge and other cess as applicable)
• On dividend distributed to a non-resident or to a foreign company by an
Infrastructure Debt Fund —5% (plus surcharge and other cess as applicable)

6 Why is Fixed Maturity Plan Popular?

An • A Fixed Maturity Plan is a close ended debt fund for a specified period.
s • The maturity of the papers invested in is matched with the duration of the plan.

7 What are the guidelines for Investments by Schemes?

An Regulations ensure that schemes do not invest beyond a certain percent of their NAVs
s in a single security. Some of the guidelines regarding these are given below:
• No scheme can invest more than 10% of its NAV in rated debt instruments of a single
issuer wherein the limit is reduced to 10% of NAV which may be extended to 12% of
NAV with the prior approval of the Board of Trustees and the Board of Asset
Management Company.'
• No scheme can invest more than 10% of its NAV in unrated paper of a single issuer
and total investment by any scheme in unrated papers cannot exceed 25% of the NAV.
• No mutual fund scheme shall invest more than 30% in money market instruments of
an issuer: Provided that such limit shall not be applicable for investments in
Government securities, treasury bills and collateralized borrowing and lending
obligations.
• No fund, under all its schemes can hold more than 10% of company's paid up capital
carrying voting rights.
• No scheme can invest more than 10% of its NAV in equity shares or equity related
instruments of any company of a single company. Provided that, the limit of 10% shall
not be applicable for investments in case of index fund or sector or industry specific
scheme.
• If a scheme invests in another scheme of the same or different AMC, no fees will be
charged. Aggregate inter scheme investment cannot exceed 5% of net asset value of the
mutual fund.
• No scheme can invest in unlisted securities of its sponsor or its group entities.
• Schemes can invest in unlisted securities issued by entities other than the sponsor or
sponsor's group. Open ended schemes can invest maximum of 5% of net assets in such
securities whereas close ended schemes can invest up to 10% of net assets in such
securities.
• Schemes cannot invest in listed entities belonging to the sponsor group beyond 25%
of its net assets.
• Total exposure of debt schemes d mutual funds in a particular sector (excluding
investments in Bank CDs, CBLO, G-Secs, T Bills, short term deposits of scheduled
commercial banks and MA rated securities issued by Public Financial Institutions and
Public Sector Banks) shall not exceed 25% of the net assets of the scheme. An additional
exposure to financial services sectors not exceeding 5% of the net assets of the scheme
shall be allowed only by way of increase in exposure to Housing Finance Companies
(HFCs) for HFCs rated AA and above and registered with National Housing Bank
(NHB).

8 What is the name of Industry Association for the Mutual Fund Industry?
An Association of Mutual Funds in India (AMFI) is the industry association for the mutual
s fund industry in India which was incorporated in the year 1995.

9 What are the Objectives of AMFI?

An The principal objectives of AMFI are to:
s • Promote the interests of the mutual funds and unit holders and interact with
regulators-SEBI/RBI/Govt./Regulators.
• To set and maintain ethical, commercial and professional standards in the
industry and to recommend and promote best business practices and code of
conduct to be followed by members and others engaged in the activities of mutual
fund and asset management.
• To increase public awareness and understanding of the concept and working of
mutual funds in the country, to undertake investor awareness programmes and to
 disseminate information on the mutual fund industry.
• To develop a cadre of well-trained distributors and to implement a programme of
training and certification for all intermediaries and others engaged in the industry.

10 What is Product Labelling in Mutual Funds?

An The product labelling in mutual funds shall be based on the level of risk which shall be
s as under:
• Low: Principal at low risk
• Low to Moderate: Principal at low to moderate risk
• Moderate: Principal at moderate risk
• Moderately High: Principal at moderately high risk
• High: Principal at high risk
• Very High: Principal at very high risk
There shall be pictorial depiction of risk named 'Riskometer' which shall appropriately
depict the level of risk in any scheme.

11 What are the advantages of Mutual Funds?

An  Mutual funds offer diversification or access to a wider variety of investments
s than an individual investor could afford to buy.
 There are economies of scale in investing with a group.
 Monthly contributions help the investor's assets grow.
 Funds are more liquid because they tend to be less volatile.
 The investor gets professional investment management services.

12 What is Systematic Investment Plan (SIP)

An • A systematic investment plan involves investing a consistent sum of money
s regularly, and usually into the same security.
• A SIP generally pulls automatic withdrawals from the funding account and may
require extended commitments from the investor.
• SIPs operate on the principle of dollar-cost averaging.
• Most brokerages and mutual fund companies offer SIPs.

13 What is Systematic Transfer Plan (STP)?

An • In SIP investor's money moves out of his savings account into the scheme of his
s choice.
• Let's say an investor has decided to invest Rs 5,000 every month, such that Rs. 1,000
gets invested on the 5th, 10th, 15th, 20th and 25th of the month.
• This means that the Rs.5000, which will get invested in stages till 25th will remain
in the savings account of the investor for 25 days and earn interest @ 4-6%,
depending on the bank.
• If the investor moves this amount of Rs.5000 at the beginning of the month to a
Liquid Fund and transfers Rs.1000 on the given dates to the scheme of his choice,
then not only will he get the benefit of SIP, but he will earn slightly higher interest
as well in the Liquid Funds as compared to a bank FD.
• As the money is being invested in a Liquid Fund, the risk level associated is also
minimal.
• Add to this the fact that liquid funds do not have any exit loads.
• This is known as STP.

14 What is Systematic Withdrawal Plan (SWP)?

An • SWP stands for Systematic Withdrawal Plan.
s • Here the investor invests a lump sum amount and withdraws some money
regularly over a period of time.
 • This results in a steady income for the investor while at the same time his
principal also gets drawn down gradually.
• Say for example an investor aged 60 years receives Rs.20 lakh at retirement.
• If he wants to use this money over a 20-year period, he can withdraw Rs.
20,00,000/ 20 = Rs.1,00,000 per annum.
• This translates into Rs. 8,333 per month.
• (The investor will also get return on his investment of Rs.20 lakh, depending on
where the money has been invested by the mutual fund).

15 What is Growth Option?

An • Growth option is for those investors who are looking for capital appreciation.
s • Say an investor aged 25 invests Rs.1 lakh in an equity scheme.
• He would not be requiring a regular income from his investment as his salary
can be used for meeting his monthly expenses.
• He would instead want his money to grow and this can happen only if he
remains invested for a long period of time.
• Such an investor should go for Growth option.

16 What is Dividend Pay-out Option?

An A dividend refers to payments that a company makes out to its shareholders as a
s reward for investing in the company’s equity. The amount that is returned by the
company to its shareholders as opposed to the amount that is kept for reinvestment is
given by its dividend payout.

17 What is Dividend Reinvestment Option?

An A dividend Reinvestment plan is an option opted by the investor to reinvest the amount
s of cash dividend payable by the company to that investor. The reinvestment is into the
new shares of the underlying securities on the date of the dividend payment.