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Balanced Funds' Future

I have heard that balanced funds will now have to pay dividend distribution tax and the investor will also have to pay both short- term & long-term capital gains tax. What does this mean for the investor?
-Ben

I have heard that balanced funds will now have to pay dividend distribution tax and the investor will also have to pay both short- term & long-term capital gains tax. What does this mean for the investor? Should we remain invested in such hybrid funds or switch to equity funds?
-Ben
As per Budget 2006, in order to be termed as an equity-oriented fund any mutual fund scheme must have invested more than 65 per cent of its net assets in stocks of domestic companies on an average basis. Till now, this minimum limit was 50 per cent.

The implication is that equity-oriented mutual funds qualify for beneficial tax treatment, as you rightly mentioned, in regard to dividend distribution tax and capital gains tax. Further, if this budget proposal is accepted, then it has the potential to take away the status of 'equity-oriented fund' from some of the hybrid funds, and hence the beneficial tax treatment as well.

How this move will impact an investor is explained here. Suppose your hybrid fund ceases to be an equity-oriented fund, then whatever dividend it declares, it will have to pay a dividend distribution tax of 12.5 per cent (plus surcharge and cess), which will indirectly be borne by the investors only.

Secondly, short-term capital gains will be added to your income and taxed as per the slab system, rather than the current flat rate of 10 per cent. Lastly, the long-term capital gains (which are at present exempt from tax) will be subject to tax at the rate of either 10 per cent without indexation or 20 per cent with indexation.

Whatever be the case, it will not be advisable to switch to equity funds. See, the tax implications are obviously important and this clause does carry the potential to take away the beneficial tax treatment from some of the funds, but you should not fiddle with your asset allocation because of this.

An investor introduces debt component to his portfolio if he finds that given his circumstances, an all-equity portfolio will be too risky for him. This is where the hybrid funds assume a crucial role and from this point of view the latest amendment will not diminish the importance of this category of funds for the investors.

Moreover, do not forget that this beneficial tax treatment is quite a recent development, and till about one-and-a-half years back, even the equity funds were subject to similar tax laws as the debt funds.



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