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Equity Dose for Tax Relief

Seven hybrid funds have altered their asset allocations to fit Budget definition and continue enjoying tax concessions

Seven hybrid funds - three from Prudential ICICI Mutual Fund stable and two each from HDFC Mutual Fund and LIC Mutual Fund - have altered their asset allocation pattern. The move has come as a response to the change in the definition of an equity-oriented fund in the Budget 2006. Prior to that, an equity-oriented fund meant a fund which invested more than 50 per cent of its assets in equity shares of domestic companies. But the Budget hiked this 50 per cent limit to 65 per cent.

Asset allocation matters in regard to tax treatment. Equity-oriented funds get beneficial tax treatment for dividend distribution and capital gains. And to be eligible for the beneficial tax treatment, the balanced funds have started to alter their asset allocations so that they can invest a higher proportion of their assets in equities.

All three of the Prudential ICICI Funds - Pru ICICI Blended Plan- Plan A, Pru ICICI Balanced Fund and Pru ICICI Child Care Plan- Gift Plan, as well as two schemes of LIC Mutual Fund - LICMF Balanced and LICMF ULIS, have widened their band of equity allocation to 65-80 per cent. The schemes of HDFC Mutual Fund - HDFC Prudence and HDFC Children's Gift Fund- Investment Plan, have increased the equity allocation from 40-60 per cent to 40-75 per cent.

Stated Equity Allocation
Fund  Rating  Existing (%)  Revised (%)
HDFC Children’s Gift- Investment Plan «« 40-60 40-75
HDFC Prudence ««««« 40-60 40-75
LICMF Balanced Not Rated Up to 60 65-80
LICMF ULIS Not Rated Up to 60 65-80
Pru ICICI Balanced Fund «« 51-60 65-80
Pru ICICI Blended Plan A Not Rated 51-75 65-80
Pru ICICI Child Care- Gift Plan ««««« 51-60 65-80

As a result of the change, investors of Pru ICICI Blended Plan-A should expect a significant change in the complexion of their fund. Till now, the fund barely invested more than 52 per cent of its assets in equities. But as per the revised allocations, it will now invest at least 65 per cent in equities. On the other end are both the LICMF funds, which already have a high equity exposure. While the LICMF ULIS has 78 per cent of its assets in equities, LICMF Balance has allocated almost 70 per cent of its portfolio to stocks.

The remaining of these funds may adjust the allocations slightly. Pru ICICI Balanced invests about 68 per cent of its assets in equities while Pru ICICI Child Care-Gift Plan has been increasing its equity exposure in the recent months to just over 68 per cent by the end of April 2006. The two HDFC funds will also have to increase their equity allocations a bit from the present levels if they have to avail the tax sops. HDFC Prudence just touches the 65 per cent mark, while the other one usually remains below 60 per cent.

If you are not aware of the tax implications, then here is the explanation. 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.

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. Finally, 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.