Sebi says MF schemes with bonus option ‘not legitimate’
MUMBAI: The capital market regulator has plugged the loophole that allowed savvy mutual fund investors to lower tax by bonus stripping.
The Securities and Exchange Board of India (Sebi) has spelt out that it’s not in favour of fund houses launching new schemes with bonus option in their arbitrage funds. The regulator has told some of the asset managers that it will not give the goahead to these schemes if they are filed for approval, three senior officials of asset management companies told ET.
After the recent success of JM Mutual Funds’ annual bonus option in its Arbitrage Advantage Fund, many other mutual funds were planning to introduce the bonus option. But Sebi has told these fund houses that such innocuous schemes are not legitimate. “The objective of launching a new mutual fund scheme should be for investment purpose and not for tax planning. For that, there are different options such as equity-linked saving scheme,” said a person familiar with the development.
“No one can say in advance that they will get bonus… there may be a loss also… it depends on the performance of the fund. People are misusing this for tax avoidance purpose. Most of them are big investors and not retail investors,” the person said.
The bonus option involves an investor selling the original units for a loss and holding on to the bonus units which are sold later to realise long-term capital gains.
For instance, in a 1:1 bonus issue, the investor who holds 100 units receives another 100 units. Under the tax laws, the cost of the bonus units is considered as zero. Since the net assets of the scheme remain the same and only the number of unit increases, the net asset value (NAV) drops proportionately.
Investors then sell the original units at the reduced price and set off losses against capital gains in other assets. The accumulated bonus units are treated as tax free after a year since arbitrage funds are treated like equity funds for tax treatment. In addition, Sebi rules say bonus units are not subject to exit load.
“Sebi has informally told us not to go ahead with bonus stripping schemes as this is against the spirit of tax law,” said a chief executive officer of a leading mutual fund.
In August, J M Mutual Fund introduced an annual bonus option in its JM Arbitrage Advantage Fund which collected Rs 5,800 crore in less than a week. Later, JM Mutual Fund declared bonus of 40 units for every 100 units held. The record date for the declaration of bonus was November 27.
Typically, high net worth investors invest in a bonus plan to set off the newly created capital loss against capital gain in other assets.
“It’s a perfectly legitimate activity under the Indian tax law, though some claim that it’s against the spirit of the tax code,” said Dhirendra Kumar, CEO, Value Research.
Till a few years ago, wealthy investors used ‘dividend stripping’ to save tax. Here, investors would buy units based on advance information on dividend and then, sell the units after receiving the dividend. Since the ex-dividend NAV would be lower, they would book a capital loss with the intention of setting it off against some other capital gain.
In 2004, the government plugged this loophole. It tweaked the rule to discourage setting off any capital loss from the transaction against other capital gains from other assets.
Such accounting (for the purpose of tax saving) was disallowed up to the value of the dividend income exempted if an investor buys units within 3 months prior to the record date for dividend and sells those units within 9 months after the record date.
