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Budget may pull the plug on bonus-stripping in MFs

Window for buying bonus, dividend units prior to record date to be widened

Ashley Coutinho  |  Mumbai 

Budget 2015-16 might sound the death knell for bonus or dividend stripping in mutual fund (MF) schemes. Such schemes are popular among rich investors, as these generate high returns by exploiting an anomaly in taxation.

Bonus stripping is the purchase of units three months before the record date and selling the original units at a loss or lower value after the bonus is paid. This loss can be used to offset capital gains from other assets. The bonus units are held and sold after another nine months. The process is similar for dividend stripping, except investors do not have to hold any units after the dividend is declared..

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  • 3-month window for buying bonus/dividend units prior to record date may be extended to 9 months
  • Fund houses intimate investors about expected dividend or bonus payouts, which is against spirit of regulation
  • Arbitrage funds came into limelight last year after one scheme collected over Rs 5,000 crore
  • Sebi wants MF pension plans to be eligible for tax benefits under section 80CCD
  • Industry wants dedicated tax slab of Rs 50,000 for ELSS within overall 80C limit of Rs 1.5 lakh

The coming Budget might extend this three-month window to nine months, to dissuade investors from buying schemes with the intention of taking advantage of bonus or dividend stripping.

While the current practice isn’t illegal, fund houses have been intimating investors about expected dividend or bonus payouts, against the spirit of regulation.

Sector observers believe the Budget might go as far as to reclassify arbitrage funds as debt funds to prevent investors from taking advantage of bonus stripping. Arbitrage funds, categorised as equity funds, typically take advantage of the price differential between the cash and derivatives segments. The category had come into focus last year, when a single arbitrage scheme collected about Rs 5,000 crore in assets.

Sector players said the reclassification would hit future inflows into these schemes. “The assets of arbitrage funds might halve if the category definition is changed. However, reclassifying these funds alone might not be able to fully tackle the menace of bonus and dividend stripping,” said an official.

As of now, this category has assets of about Rs 11,000 crore.

The sector has voiced various demands. It has sought scheme mergers no longer be viewed as redemption and fresh purchase of units. As of now, investors in a scheme merged with another might have to incur short-term capital gains if the holding period before the merger is less than a year for equity schemes and less than three years for debt schemes.

The Securities and Exchange Board of India has proposed all pension plans be eligible for tax benefits under section 80CCD. As of now, only those investing in the National Pension System can claim income tax deductions under section 80CCD. The sector has three retirement or pension plans that are eligible for deduction under section 80C, though more such funds might be launched in the coming months.

The sector has also sought a dedicated tax slab of Rs 50,000 for equity-linked savings schemes, within the overall 80C limit of Rs 1.5 lakh. It has also demanded the unfavourable tax treatment for fund of funds (FoF) be done away with. Currently, even FoFs with more than 65 per cent exposure to equities are considered debt funds.

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First Published: Thu, February 19 2015. 22:50 IST