July 2, 2020

Stamp duty to cut returns on liquid funds; should you switch to short-term FDs?

stamp duty graphic 020720090056


Stamp duty is a tax collected by state governments. It will be applicable whenever you purchase fresh MF units, be it via lumpsum or the SIP route. It will not be applicable on redeeming MF units. Hence, it is a tax on the buyer, not the seller

If your SIP is due in the next few days, you must know that the entire SIP amount will not get invested in the mutual fund. From July 1 onwards, purchasing and transferring mutual fund units have started attracting the stamp duty of 0.005 per cent and 0.015 per cent, respectively.

Stamp duty is a tax collected by state governments. It will be applicable whenever you purchase fresh MF units, be it via lumpsum or the SIP route. It will not be applicable on redeeming MF units. Hence, it is a tax on the buyer, not the seller.

What about systemic transfer plan (STP) or switching to a new MF scheme in one go? Stamp duty will be levied in both the cases, since you are purchasing fresh units in a new scheme after selling the existing ones. Same holds true in the case of dividend reinvestment plans, in which dividend reinvested in buying fresh units will attract stamp duty.

In case of transfer of units on stock exchanges, for example, buying units through a stock-broker will attract 0.15 per cent stamp duty. Off-market transfer of units, that is, transfer of units from one demat account to another will attract the same rate.

“Effectively it will act as an entry load as allocation of units will be at net amount post deduction of stamp duty,” explains JM Financial in a research note.

For example, if the investment amount is Rs 1 lakh, after paying stamp duty of 0.5 per cent or Rs 5, Rs 99,995 will go into the chosen MF scheme.

The government in 2019 amended the Indian Stamp Act, 1899 to create a mechanism to enable states to collect stamp duty on all securities market instruments, including mutual fund units. Initially it was supposed to be effective from January 2020, but got postponed to April, and then July.

Longer the investment horizon, lesser the negative impact

If you are a long-term investor, you need not be worry about this new tax. It’ll have negligible impact on your returns. However, if you invest in liquid funds, you need to factor in the impact of stamp duty in your return expectations.

“Stamp duty is being charged as a one-time charge of 0.005 per cent, which will be an absolute percentage, however, the simple annualised impact of the same on returns will keep reducing with higher period of holdings,” says B&K Securities in a research note.

In an illustration in its research report, B&K shows that the impact of stamp duty on net returns reduces from 1.83 per cent in a single day to 0.26 per cent in seven days, 0.12 per cent in 15 Days and further to 0.06 per cent as the investment period crosses 30 days. For example, if pre-stamp duty return on a liquid fund is 3.50 per cent, the net return – factoring in the stamp duty – will amount to 3.24 per cent for seven days, 3.38 per cent for 15 days and 3.44 per cent for 30 days.

“Imposition of stamp duty will impact in case of churning the portfolio. It will encourage the investors to stay invested for a longer duration and not churn portfolio for higher yields,” says JM Financial report.

Returns on liquid funds still better than FDs

Since there is no stamp duty on fixed deposits (FDs), should you prefer short-term FDs over liquid funds due to this additional tax on latter? Not necessarily. Liquid funds have performed better than short-term FDs of the same duration in terms of returns till now (see table). Although liquid funds are one of the safest options in debt mutual fund, there is no guarantee that past performance will continue in the future also. Based on market conditions there always remains a chance of fluctuation in returns. So, if you are looking at predictable returns, FD could still be a more suitable option.

stamp duty graphic 020720090056

Also Read: Globally funds are moving back to riskier assets: Swati Kulkarni of UTI MF

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