Ever since the Union Budget was presented, there have been widespread discussions on the efficiency of the growth option of Mutual Funds (MFs) over the dividend choice, from a taxation perspective. As investment avenues, we have seen discussions on the comparison of Portfolio Management Services (PMS) with Mutual Funds. We will discuss one aspect that has not been covered so far – a comparison of PMS and MFs based on taxation in the post-Budget scenario.
Taxing dividends
From April 1, 2020, companies paying dividends on equity stocks will not be required to pay any dividend distribution tax (DDT). However, the tax liability is passed on to you, i.e., the investor. The amount of tax you pay depends on your slab. Theoretically, if you are in a lower tax slab, you pay a lower tax on the dividend. The DDT payable by a company till March 31, 2020 is approximately 20 per cent and if your marginal tax slab is lower than 20 per cent, you would be better off. However, this is more theoretical than practical.
The reason is, with the minimum amount of investment in PMS being Rs 50 lakh, it may be assumed that the investor is in the highest tax slab of 30 per cent (plus surcharge and cess), which corresponds to an annual income of more than Rs 10 lakh in the existing tax slab. That is, it is likely that from April 1, 2020 the investor is a little worse off from a tax perspective as his/her tax slab is higher than 20 per cent. PMS is a pass-through vehicle from a tax perspective, i.e., the investor is investing in the underlying equity shares through the PMS, and not investing in the PMS per se.
Now coming to MFs, there are two investment options, dividend and growth. The tax efficiency in the growth option can be availed of simply by shifting choices from dividend to growth. In PMS, there is no “dividend” or “growth” option; it is your investment in equity stocks routed through the PMS. The tax efficiency that is there in the growth option of MFs makes it a better investment avenue from this perspective. In a MF growth option, for a holding period of more than one year, capital gains are taxable at 10 per cent (plus surcharge and cess). You would say, this is same as buying stocks directly or through PMS and holding for one year. The difference is, a MF receives dividend from the underlying stocks but does not pay out anything in the growth option. The entire amount gets taxed at 10 per cent (plus surcharge and cess).
Comparing tax efficiency
There are two other aspects of taxation. One, in MFs, the NAV is net of expenses, whereas in PMS, there is one value against which charges are deductible. Taxes being payable from purchase NAV to redemption NAV, in MFs, the accretion is a little lower and you pay marginally lower taxes. In PMS, there is no concept of post-expenses NAV, hence you pay tax on the gains from initial portfolio value to the redemption value.
Let’s take a simple illustration. You invest Rs 50 lakh in a MF Scheme, which has an expense ratio of 2 per cent. At the end of one year, the fund earns 10 per cent from the market. The NAV of the fund after one year, post expenses, will be Rs 53,95,000 approximately, taking an average portfolio value for charging expenses. In the PMS, even if the expense ratio is same, portfolio value will be Rs 55 lakh, from which expenses will be payable. The relevance is, in a MF, you pay tax on the gains from Rs 50 lakh to Rs 53.95 lakh. In PMS, tax is payable on the gains from Rs 50 lakh to Rs 55 lakh.
Two, in PMS, if you are at the borderline of Rs 50 lakh or Rs 2 crore or Rs 5 crore, you get pushed to the higher surcharge bracket. In a MF growth option, there is efficiency here as well. Though in MF growth option, for a holding period of more than one year, the taxation rate is 10 per cent (plus surcharge and cess), on a lower base rate (10 per cent against 30 per cent), your surcharge is lower.
(The writer is founder, wiseinvestor.in)
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