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Mutual funds – Most tax efficient

Aug 1, 2000

For a long time, mutual funds have been perceived as an investment avenue for investors in the higher tax bracket, with nothing in it for investors in the lower bracket. However, that perception is changing gradually. Generally mutual funds take a backseat to investment avenues like bank deposits and company fixed deposits, which are considered more ‘safe’. Safety apart, mutual funds are deemed as the preferred investment option for investors in the higher tax bracket, with nothing in it for investors in the lower bracket.

Most investors have relegated mutual funds to the background purely on the tax angle. Investors have failed to understand the tax efficiency of mutual fund products vis-ŕ-vis other investment options. In an interview to personalfn.com, Milind Barve (Managing Director, HDFC MF) addressed this point – ‘Distribution (of mutual fund products) through the bank network in semi-urban areas will be critical. Until now, mutual funds were perceived as largely urbanite products for people in the higher tax bracket. With the branch network, accessibility of mutual fund products to semi-urban areas will increase and will encourage investors to put money in mutual funds, irrespective of the tax advantage.’

‘Basically, there is a rationale for investing in mutual funds even without the tax benefit. A mutual fund (income fund) is able to invest in many securities that are not available as investment options to the individual investor. Examples of these are Government Securities, Preference Shares, Treasury Bills etc. These investment alternatives enable mutual funds to earn returns that are in excess of those available to retail investors. Add to it the fact that returns are tax-free in the hands of the investors, the funds are professionally managed and the investment is far more liquid. Moreover, investors get a chance to see their portfolios and know where their money is going. Due to these reasons, mutual funds are not only attractive to investors in the higher tax bracket, but are also viable investment avenues for all investors irrespective of the tax considerations.’

Sandesh Kirkire, (VP Fixed Income, Kotak Mahindra MF) explained the tax advantage of mutual fund products vis-ŕ-vis bank deposits – ‘An investor in mutual a fund earns income either through dividends or capital appreciation. Both these revenue streams are far superior to interest income (on a deposit) and are also more tax-efficient. For a corporate, the income from a pure interest stream is taxed at 38.5%, while the dividend from an income scheme is taxed only at 22% (20% and 10% surcharge). So there are tax arbitrage opportunities there. Investors with a 12-month horizon should look at entering the growth option of income funds and they can avoid even the 22% tax on dividends.

So mutual funds offer investors a tax edge, far superior to that offered by any other ‘safe’ investment avenue. Investors (regardless of the tax bracket) who had ignored it for long, may want to look at it as a more rewarding investment option.


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