Taxes on MF investments

How do fund houses charge the various taxes like dividend distribution tax, capital gains tax and securities transaction tax that a mutual fund is subject to? Are these deducted from the returns the fund generates?

- R Mahesh

Let's look at the taxes you have mentioned individually.

Dividend Distribution Tax: As the name suggests, this is levied as and when the fund declares a dividend. However, only debt-oriented funds have to pay it; the equity ones are exempt. The quantum of tax is 14.163 per cent of the amount of dividend (12.5 per cent tax+10 per cent surcharge+3 per cent cess). This tax is deducted by the fund house at the time it makes the dividend payment. Often, the funds declare a gross dividend and a net dividend. Gross dividend is the amount deducted from the fund corpus, while net dividend is what an investor gets net of tax. The ex-dividend NAV of the fund is declared after factoring in the dividend distribution tax.

Capital Gains Tax: This is not charged by the fund house. It is paid by the investor directly to the tax authorities while filing the income tax return. More, any capital gains arising from equity-oriented funds are exempt from tax if the holding period exceeds a year.

Securities Transaction Tax: Equity-oriented mutual funds are subject to securities transaction tax (STT) at the rate of 0.25 per cent at the time of selling the fund units. This charge is deducted when you redeem your investments.

Often we read that a fund manages to implement a top-down or bottom-up approach of investing. Please explain these.

-Sanjay

In the top-down approach, the fund manager determines the sectors and industries he expects will do well in the future. Once these are identified, he picks out investible companies within that sector or industry. This approach involves the analysis of macro-economic factors.

The bottom-up approach focuses more on company. The implicit assumption here is that companies can perform well even if the sector/industry they operate in are not. This approach can have more challenges, since there is a huge universe to pick the stocks from, unlike the top-down approach where the universe gets narrowed to companies operating in select industries. However, it also presents the opportunity to discover some value bargains which otherwise could have been missed in a top-down approach as a result of omission of that industry.

I have read that many Nifty companies declare dividends. However, though I have invested in a Nifty index fund, I haven't got any dividends yet. Who gets these dividends?

- Charles

Most of the Nifty and Sensex stocks do declare dividends, but the dividend declared by the index as a whole is not much.

The dividend declared by stocks that the fund holds go back into the fund. This is reflected in the NAV. But because the quantum of dividends is very low, the dividend declaration does not result in a significant appreciation. As to when you will get the dividend, it depends on the fund you have invested in and the option chosen. Many index funds do not have a dividend option. This means any gains you wish to take will have to be got by redeeming the units. And the dividend declared by the inherent companies will appear as an increase in NAV. If you are invested in the dividend option of an index fund, wait for the scheme to declare dividends.