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Dividend stripping is the mantra for AMCs

While dividend stripping has been a perfectly legal tool to dodge the taxman, it is likely to be plugged this budget. Thus, as fund houses are rushing with dividend declarations, it is make hay while the sun shines for AMCs and big-ticket investors.

For asset management companies this February, "dividend stripping is in the air" as equity funds line up payouts to earn a quick buck for the AMC. Only last week, JM Mutual Fund "paid" a 45% dividend in the growth option of its balanced fund though the scheme also manages a dividend option! Since the NAV of the dividend option is only around Rs 11, the AMC could not have declared an income of Rs 4.5 per unit and pulled the NAV below par. The fund with meagre assets is believed to have received "hot" inflows of Rs 1500 crore plus on Friday, which moved out on Sunday.

In January, a prominent industry player had declared a 25% dividend, each in two of its equity schemes within short span and attracted sizeable inflows for dividend stripping though there was no official announcement from the fund house. "Dividend stripping is meant only for big ticket investors and hence, fund houses are now avoiding public announcement of payouts since they do not want small ticket investments,'' says the Delhi-head of a private mutual fund.

Let us see how dividend stripping works. Consider an open-end equity fund, which declares a payout of 30%. With its Friday NAV of Rs 15, an investor puts Rs one crore in the fund, generated from the sale of an asset. With an entry load of 2%, the investor is alloted 6.53 lakh units at an entry price of Rs 15.3. However, the AMC normally retains only around 15 to 20% of the load amount while the rest goes back to the investor as an incentive. Assuming that the investor redeems on Monday and the NAV moves only to the extent of the dividend distribution (Rs 12), it will result in a notional capital loss since the investor has earned a tax-free dividend of Rs 19.60 lakh at Rs 3 per unit. Assuming an exit load of 2%, the investor will exit at Rs 11.76 with the AMC again sharing a part of the exit load with the investor.

In the final analysis, the investor gets back Rs 99.29 lakh from the AMC by way of tax-free payout, incentive and amount on redemption while the mutual fund earns Rs 71,000 on the whole transaction. The final amount with the investor will be lower if he routes investments through a distributor.

Assuming that the investor is a corporate, he would have otherwise paid a tax of 38.5% on the profit of Rs one crore and lost Rs 38.5 lakh to the exchequer. Add to it, since the investor has booked a notional capital loss of Rs 23.14 lakh (he gets back only Rs 76.86 lakh on redemption), he can adjust the same against future gains.

Here, the AMC has earned Rs 71,000 on an investment of Rs one crore. With dividend strippers putting money in excess of Rs 1,000 crore, a fund house normally earns Rs 7-8 crore in the process. Add to it, the AMC normally does not have to sell extensively for the payout since a small dose of profit booking can ensure payout for existing investors. And contrary to popular perception, dividend stripping only hurts the government since investors avoid paying tax to the exchequer. Existing and long-term investors are not impacted with the money staying for just a day.

While dividend stripping has been a perfectly legal tool to dodge the taxman, it is likely to be plugged in this budget. Hence, fund houses are now rushing with dividend declarations. For now, its make hay while the sun shines for AMCs and big-ticket investors.