Capital gains on equity mutual funds

Tax queries 1413 views 2 replies

Rammohan

255 Points Joined April 2012

Would changing the option for receiving the dividend from an equity mutual fund investment, say from dividend payment to growth option within the same scheme of the mutual fund, mean that this is considered to be a 'transfer' for the purpose of income-tax? When a person makes such a change in the option within the same scheme of the mutual fund, he pays STT twice - once for exiting the registered option of dividend payment and again for registering the new option of growth. He also receives a different no. of units in the new option chosen within the same scheme of the mutual fund, based on the NAVs of the units for these two options on the date of the transaction.

My questions are:

1. Is this change of option within the same scheme considered to be a 'transfer' and whether the unitholder has to calculate the capital gain and report it in his income-tax return for the year in which the option change took place? (Sec. 2(47) of the I-T Act includes 'exchange' as one of the categories in the definition of ;transfer'.)

2. If the unitholder ultimately sells the units through the stock exchange or by repurchase/redemption by the mutual fund, from which date would his holding period be calculated for purposes of capital gains: whether from the original date of investment or from the date of change of the option from dividend payment to growth?

Thanks for the help.

Replies (2)

Arun Alvares

CA Final Student

52 Points Joined November 2010

1. The change of option does not amount to transfer as it does not fall within the ambit of section 2(47).

2. The original date of acquistion of the units would be considered as the relevant date for the purpose of capital gains

Arun Alvares

CA Final Student

52 Points Joined November 2010

Taxing withdrawals

Switching from one option to another, even if it is within the same scheme, is deemed like withdrawing money from one scheme and putting into another. Though such a switch can easily be done, when you withdraw from, say, a dividend plan and switch to a growth plan, you are deemed to have withdrawn from a scheme. This withdrawal attracts long-term capital gains or short-term capital gains, depending on the tenor that you had stayed invested in the first option.

The reason for this is that both the dividend and growth plans have different net asset value (NAV). Typically, a dividend plan’s NAV is lower than that of the growth plan because the dividend plan would have declared dividends regularly; dividend declarations come out of the scheme’s pocket and thus the NAV drops. A switch between a dividend and growth option—even if done within the same scheme—is deemed a financial transaction. Hence, it will attract capital gains tax.

Dividend reinvestment to dividend payout and vice-versa

However, you can seamlessly switch between dividend reinvestment and dividend payout options. The reason being, “payout” and “reinvestment” are sub-options within the dividend option. So when you are moving within the dividend option—treat this as an umbrella option—you are not really moving out of the option; you are just choosing what to do with your dividend; whether you want it in your hands or you want to reinvest it in the scheme. Remember: when you opt for a dividend reinvestment and later wish to switch to the growth option, each dividend that was reinvested earlier is treated like a fresh purchase. So when you switch to the growth option, those reinvested dividends will attract capital gains tax.